What makes us do things? This is a simple question with a variety of complex answers. One of those answers is incentives. An incentive is something that motivates a person to do something. Consider these examples of incentives:
“I am hired to do paperwork for a company. Because I do this work, I am rewarded with a paycheck, health insurance, paid time off, valuable experience, and networking.”
“I play sports at my high school. I practice hard with my teammates and, if we perform at our best, we win. When we win, we are rewarded with a cheering crowd the adulation of our peers.”
“I work hard at my job because I know my hard work will be noticed by my superiors and they will reward me with a raise or promotion on down the line.”
In business, politics, and various other endeavors, incentives are used to drive human behavior towards a specific goal. Sometimes, unfortunately, the people setting the incentives mess them up and actually wind up incentivizing behavior that is contrary to what they intended. This is called a perverse incentive.
You can see perverse incentives at work in politics and economics:
The Welfare Trap: Due to taxation and lost welfare benefits, it is possible in many circumstances for individuals to see a reduction in their net income by either going to work, working more hours, or rising above the minimum wage. According to an Illinois economics study by Erik Randolph.
Transcontinental Railroad Payment Policy: When building the first transcontinental railroad in the late 1860s, the US Government paid the builders per mile of track laid. As a result, the contractors who won the bid artificially lengthened the course the railroad would follow by making the tracks run at a gentle arc rather than a straight line.
Lawyer Billing Methods: Lawyers bill by the hour, not any measurable productivity towards the closing of the client’s case. This is an oft-bemoaned method of determining what a client is charged, as many people rack up huge legal bills, while feeling they aren’t getting anything actually done towards meeting their needs. There have been examples given of legal offices (and their clients, in some cases) dragging out court cases in order to artificially inflate the legal fees involved. If the lawyer does an efficient job and closes the cases quickly, he or she actually makes less money!
Rat Farms: A policy in French Colonial Hanoi paid a bounty for dead rats (to attempt to exterminate them). However, the bounty created a demand for dead rat corpses. Wily locals started breeding rats in rat farms instead, as a way to gain income. In the long run, this caused an explosion in the rat population.
On the surface, the solutions to many of these concerns seem simple. However, it turns out that the most obvious-seeming policies actually often do not create the desired result. How do we avoid this? Critical thinking and creativity are important here. We need to be skeptical of obvious solutions to complicated problems, and try to imagine how people might respond to the proposed incentives. We have to outgrow the assumption that any problem can be confronted head-on with brute force.
Consider these two principles:
- Things are often more complicated than they appear. Zoom in and analyze the situation in all its minute details.
- Seemingly unrelated things are often connected in some way. Zoom out to see the bigger picture and try to imagine how a given policy might affect other areas.
Perverse incentives are dangerous and require our most critical and creative thinking to prevent them. If you can think of one, leave an example of perverse incentives in the comments below. Have you encountered perverse incentives in your job or your home? Have you seen them at play in politics? Let us know!