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Of Rats and Cobras: The Power of (Perverse) Incentives

Hanoi, Vietnam (formerly called French Indochina), circa 1900.  French colonists began occupying the city and brought with them a fancy sewer system.  Little did they know that the beneath a ritzy, glamorous town is a major breeding ground of rats. Eager to get rid of the infestation and spread of disease, the French colonists devised a bounty system, paying people one cent for every rat killed.  Within two months, over 20,000 rats were eliminated.  In spite of the staggering effort, the rat problem continued and the problem even grew! Soon, “tail-less” rats were running amuck the city.  Apparently, all the bounty hunters needed to show for every rat killed was just its tail. So the rats were just set free to continue to breed and the more enterprising hunters became farmers, that is, rat farmers.

The same thing happened in India with the British colonists when it came to a major infestation problem with cobras.  In fact, the phenomenon has earned a textbook moniker called, The Cobra Effect—the unintended negative effects when an incentive is introduced.  In economics, these are also called perverse incentives.

Let’s back up a minute and talk about incentives first.  Incentives are basically things that encourage someone to do something.  Still vague? Let’s say your room is a filthy mess and to encourage you to clean, your parents gives you 5 bucks.  Or, they can also ground you from video games until you clean your room.  Either way, you have an “incentive” to clean because you can either get something out of it or miss out on some fun.

In economics, incentives are monumentally important because it makes people respond to them and thus make people act the way you want them.  In other words, it gets things done.  But what if there are unintended and unforeseen consequences that arose from those incentives?  Remember, our rat and cobra example earlier?  The goal was rid the city of these unwanted pests by remunerating people, but doing so encouraged the behavior even further.  

And we don’t have to go that far back to see examples of perverse incentives.  Stock options and bonus schemes used as incentives can encourage top level management to inflate earnings or engage in less than ideal business dealings. Perverse incentives are pretty much everywhere: healthcare policies, environmental programs, farming subsidies, and many more. 

So how do we help mitigate these unintended consequences? I think realizing that money is a powerful motivator is a good place to start.  And recognizing that, with great power, comes great responsibility.  Its power to make change happen needs to viewed with a long-term (longer than long even) view of its possible consequences.  Money also doesn’t have to be the only way to incentivize people, but an incentive should be enticing and/or compelling enough to make policies work and effect change.  In certain business environments, employees earn rewards, extra days off, recognition, even small gifts for a job well done.  Maybe one of these days, you’ll get a single mint for your commit-mint, invest-mint, and involve-mint. What a “cool” idea!

The Gist…

  • Incentives are important in economics because it makes people so something we want them to do.

  • Incentives sometimes can have unintended consequences-perverse incentives

  • For policy making, incentives need to be examined in light of the possible scenarios and behavior 

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