Perverse incentive

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A perverse incentive is an incentive that has an unintended and undesirable result that is contrary to the intentions of its designers. The cobra effect is the most direct kind of perverse incentive, typically because the incentive unintentionally rewards people for making the issue worse.[1][2] The term is used to illustrate how incorrect stimulation in economics and politics can cause unintended consequences,[2] and is an example of the proverb "the road to hell is paved with good intentions".

Examples of perverse incentives[edit]

The original cobra effect[edit]

The term cobra effect was coined by economist Horst Siebert based on an anecdote of an occurrence in India during British rule.[2][3][4] The British government, concerned about the number of venomous cobras in Delhi, offered a bounty for every dead cobra. Initially, this was a successful strategy; large numbers of snakes were killed for the reward. Eventually, however, enterprising people began to breed cobras for the income. When the government became aware of this, the reward program was scrapped. When cobra breeders set their now-worthless snakes free, the wild cobra population further increased.[5]

Further historic examples[edit]

  • An incident similar to the one in India occurred in Hanoi, Vietnam (then known as French Indochina), under French colonial rule. In 1902, the colonial government created a bounty program that paid a reward for each rat killed.[3] To collect the bounty, people would need to provide the severed tail of a rat. Colonial officials, however, began noticing rats in Hanoi with no tails. The Vietnamese rat catchers would capture rats, sever their tails, and then release them back into the sewers so that they could procreate and produce more rats, thereby increasing the rat catchers' revenue.[6]
  • In building the first transcontinental railroad in the 1860s, the United States Congress agreed to pay the builders per mile of track laid. As a result, Thomas C. Durant of Union Pacific Railroad lengthened a section of the route forming a bow shape unnecessarily adding miles of track.[7]
  • At one point in the former Soviet Union, two unintended outcomes arose from incentives to produce sheet glass: first, when glass manufacturers were rewarded according to the tons of glass produced, they began to produce extremely thick glass (so thick that one could hardly see through it); and second, when the rules were changed to reward according to the square meters of glass produced, manufacturers produced extremely thin glass (thus, extremely fragile).[8]
  • The Duplessis Orphans — Between 1945 and 1960, the federal Canadian government paid orphanages 70 cents per day, per orphan, and paid psychiatric hospitals $2.25 per day, per patient. Allegedly, up to 20,000 orphaned children were falsely certified as mentally ill so that the province of Quebec could receive the larger payment of $2.25 per day, per patient.[9][10][11]
  • The 20th-century paleontologist G. H. R. von Koenigswald used to pay Javanese locals for each fragment of hominin skull that they produced. He later discovered that the people had been breaking up whole skulls into smaller pieces to maximise their payments.[12]
  • Bangkok police used tartan armbands as a badge of shame for minor infractions. However, the badges were treated as collectibles by those offending officers forced to wear them. Since 2007, in order to avoid the perverse incentive, the police department has been using armbands with the cute Hello Kitty cartoon character.[13]
  • Renewable Heat Incentive scandal — Introduced by the devolved government in Northern Ireland with the objective to reduce energy usage and promote switching to green sources, the Renewable Heat Incentive (RHI) unintentionally enabled business owners to make profits guaranteed for 20 years by simply using more and more renewable energy to heat their premises.[14]
  • In 1997, Texas passed the Texas House Bill 588 to ensure geographic diversity. The law would replace the state's previous affirmative action program, stating that the top 10% of every high school in the state would be guaranteed admission to the state's universities (such as the University of Texas at Austin or Texas A&M University). This, however, led to some students transferring from high-achieving high schools to low-achieving high schools to gain admission to TAMU or UT Austin.[15]
  • In American class action lawsuits, the 11th Circuit Court of Appeals found incentive awards are impermissible and promote litigation by providing a prize to be won in the form of a bounty. Incentive awards are a relatively modest payment made to class representatives as part of a class settlement, and are larger than the settlement for other members of the class.[16][17]
  • In late 2004, Fannie Mae was subject to an investigation regarding its accounting practices. It was discovered that, by providing company executives with bonuses for reporting higher earnings, executives at Fannie Mae and other large corporations were encouraged to artificially inflate earnings statements and make decisions targeting short-term gains at the expense of long-term profitability.[18]
  • 2008 housing crisis — Intending for poorer people to own homes, housing policies and regulations of the U.S. government in the early 2000s eventually saw government-sponsored enterprises being mandated to own 19.2 million of the 27 million outstanding subprime mortgages that were given. The result was a housing bust, which led to low house prices, which in turn led to instabilities within financial institution, causing a greater proportion of poor people to lose their homes.[citation needed]
  • Experiencing an issue with feral pigs, the U.S. Army post of Fort Benning in Georgia offered hunters a $40-bounty for every pigtail turned in. Unpredictably, however, people began to buy pigtails from butchers and slaughterhouses at wholesale prices then resold the tails to the Army at the higher bounty price.[4][better source needed]
  • Wells Fargo account fraud scandal — Intending to increase the number of accounts sold, Wells Fargo in 2016 introduced and impressed overly-ambitious sales goals to be met by their employees. As result, facing the threat of losing their careers if such quotas were not met, some employees began to open large numbers of unauthorized accounts.[4][better source needed]
  • In 2005 the UN Intergovernmental Panel on Climate Change began an incentive scheme to cut down on greenhouse gases. Companies disposing of polluting gases were rewarded with carbon credits, which could eventually get converted into cash. The program set prices according to how serious the damage the pollutant could do to the environment was, and attributed one of the highest bounties for destroying HFC-23, a byproduct of a common coolant, HCFC-22. As a result, companies began to produce more of this coolant in order to destroy more of the byproduct waste gas, and collect millions of dollars in credits.[19] This increased production also caused the price of the refrigerant to decrease significantly, motivating refrigeration companies to continue using it, despite the adverse environmental effects.[20][21] In 2013, credits for the destruction of HFC-23 were suspended in the European Union.[22]
  • Hacktoberfest is an October-long celebration to promote contributions to the free and open-source software communities. In 2020, participants were encouraged to submit four or more pull requests to any public free or open-source (FOS) repository, with a free "Hacktoberfest 2020" T-shirt for the first 75,000 participants to do so.[23] The free T-shirts caused thousands of frivolous pull requests on FOS projects.[24] A large volume of pull requests made by users amounted to counterproductive changes to code, including: changing project names from "My Project" to "My Awesome Project"; changing bullet points to dashes; and in some cases, even breaking working code.[25] The massive influx of spurious requests overwhelmed FOS maintainers who had to approve requests or report as spam, Hacktoberfest has been widely criticized by developers for harming good-faith FOS communities as effectively "a corporate-sponsored distributed denial of service attack against the open source maintainer community."[26]

Current examples[edit]

  • The US's Endangered Species Act of 1973 imposes development restrictions on landowners who find endangered species on their property.[27] While this policy is well-intentioned and has some positive effects for wildlife, it also encourages preemptive habitat destruction (draining swamps or cutting down trees that might host valuable species) by landowners who fear losing the use of their land because of the presence of an endangered species.[28] In some cases, endangered species may even be deliberately killed to avoid discovery.[27]
  • Funding fire departments by the number of fire calls that are made is intended to reward fire departments that do the most work. However, it may discourage them from fire-prevention activities, leading to an increase in actual fires.[29]
  • Paying medical professionals and reimbursing insured patients for treatment but not prevention encourages medical conditions to be ignored until treatment is required.[30] Moreover, paying only for treatment effectively discourages prevention (which would reduce the demand for future treatments and would also improve quality of life for the patient). Payment for treatment also generates a perverse incentive for unnecessary treatments that could be harmful—for example, in the form of side effects of drugs and surgery. These side effects themselves can then trigger a demand for further treatments.
  • The "welfare trap" occurs when money earned through part-time or minimum-wage employment results in a reduction in state benefits that would have been greater than the amount earned, thereby creating a barrier to low-income workers re-entering the workforce.[31] Underlying factors include a full tax exemption for public assistance while employment income is taxed; a pattern of welfare paying more per dependent child (while employers are prohibited from discriminating in this manner, and their workers often must purchase daycare); or loss of welfare eligibility for the working poor ending other means-tested benefits (public medical, dental, or prescription drug plans; subsidised housing; legal aid), which are expensive to replace at full market rates. If the withdrawal of means-tested benefits that comes with entering low-paid work causes there to be no significant increase in total income or even a net loss, then this gives a powerful disincentive to take on such work.[32]
  • Real estate brokers have an inherent conflict of interest with the sellers they represent, because the usual commission structures of brokers motivate them to sell quickly rather than to sell at a higher price. However, a broker representing a buyer has a distinct disincentive to negotiate a lower price on behalf of their client, because they will simultaneously be negotiating their own commission lower.[33][34]
  • Under the American Medicare program, doctors are reimbursed at a higher rate if they administer more expensive medications to treat a condition. This creates an incentive for the physician to prescribe a more expensive drug when a less expensive one might do.[35]

In literature[edit]

In his autobiography, Mark Twain says that his wife, Olivia Langdon Clemens, had a similar experience:[36]

Once in Hartford the flies were so numerous for a time, and so troublesome, that Mrs. Clemens conceived the idea of paying George a bounty on all the flies he might kill. The children saw an opportunity here for the acquisition of sudden wealth. ... Any Government could have told her that the best way to increase wolves in America, rabbits in Australia, and snakes in India, is to pay a bounty on their scalps. Then every patriot goes to raising them.

See also[edit]

References[edit]

  1. ^ Brickman, Leslie H. (1 November 2002). Preparing the 21st Century Church. p. 326. ISBN 978-1-59160-167-8.
  2. ^ a b c Siebert, Horst (2001). Der Kobra-Effekt. Wie man Irrwege der Wirtschaftspolitik vermeidet (in German). Munich: Deutsche Verlags-Anstalt. ISBN 3-421-05562-9.
  3. ^ a b Dubner, Stephen J. (11 October 2012). "The Cobra Effect: A New Freakonomics Radio Podcast". Freakonomics, LLC. Retrieved 24 February 2015. CS1 maint: discouraged parameter (link)
  4. ^ a b c "The Cobra Effect: Good Intentions, Perverse Outcomes". Psychology Today. Retrieved 29 March 2021.
  5. ^ Schwarz, Christian A. (1996). NCD Implementation Guide. Carol Stream Church Smart Resources. p. 126. Cited in Brickman, p. 326.
  6. ^ Vann, Michael G. (2003). "Of Rats, Rice, and Race: The Great Hanoi Rat Massacre, an Episode in French Colonial History". French Colonial History. 4: 191–203. doi:10.1353/fch.2003.0027.
  7. ^ Mark Zwonitzer, writer, PBS American Experience documentary "Transcontinental Railroad" (2006) "Program Transcript . Transcontinental Railroad . WGBH American Experience"
  8. ^ "Unintended Consequences/Perverse Incentives". American Enterprise Institute - AEI. 7 June 2012. Retrieved 29 March 2021.
  9. ^ Protesters in straitjackets demand inquiry of Duplessis Orphans era
  10. ^ Allegations of child abuse
  11. ^ Orphans sue Catholic orders over mistreatment
  12. ^ III, Carl C. Swisher; Curtis, Garniss H.; Lewin, Roger (November 2001). Java Man: How Two Geologists Changed Our Understanding of Human Evolution. University of Chicago Press. ISBN 9780226787343.
  13. ^ Myndans, Seth (25 August 2007). "Cute Kitty Is Pink Badge of Shame in Bangkok". The New York Times. Retrieved 6 November 2007. It is the pink armband of shame for wayward police officers, as cute as it can be, with a Hello Kitty face and a pair of linked hearts.
  14. ^ "RHI scandal: RHI 'cash for ash' scandal to cost NI taxpayers £490m". BBC News. 23 December 2016.
  15. ^ Cullen, Julie Berry; Long, Mark C.; Reback, Randall (2011). "Jockeying for Position: Strategic High School Choice Under Texas' Top Ten Percent Plan". NBER Working Paper 16663.
  16. ^ Troutman, Eric J. (18 September 2020). "Eleventh Circuit Court of Appeals Holds that Incentive Payments Commonly Awarded to Class Representatives are Impermissible in a Classwide Settlement". TCPA World. Retrieved 19 September 2020.
  17. ^ Johnson v. NPAS Solutions (11th Cir. September 17, 2020).
  18. ^ Bebchuk, L., & Fried, J. M. (2005) "Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage" Journal of Corporation Law, 30 (4): 807–822.
  19. ^ "The Cobra effect in Freakonomics".
  20. ^ Rosenthal, Elisabeth; Lehren, Andrew W. (8 August 2012). "Incentive to Slow Climate Change Drives Output of Harmful Gases". The New York Times. ISSN 0362-4331. Retrieved 2 July 2015.
  21. ^ Gupta, Anika. "Carbon credit scam slur on Indian firms". Hindustan Times. Retrieved 2 July 2015.
  22. ^ "Commission adopts ban on the use of industrial gas credits". Climate Action - European Commission. European Commission. 23 November 2016. Retrieved 3 November 2019. CS1 maint: discouraged parameter (link)
  23. ^ "Hacktoberfest 2020". Laravel News. 25 September 2020. Retrieved 31 January 2021.
  24. ^ Portfolio, Hwee's. "#Shitoberfest: How free T-shirts ruined #Hacktoberfest2020". ongchinhwee.me. Retrieved 31 January 2021.
  25. ^ "How One Guy Ruined #Hacktoberfest2020 #Drama". joel.net - JavaScript, ReactJS, and Node. Retrieved 31 January 2021.
  26. ^ "DigitalOcean's Hacktoberfest is Hurting Open Source". blog.domenic.me. Retrieved 31 January 2021.
  27. ^ a b Langpap, Christian, and JunJie Wu. 2017. "Thresholds, Perverse Incentives, and Preemptive Conservation of Endangered Species" Journal of the Association of Environmental and Resource Economists 4(S1):S227–59. doi:10.1086/692070.
  28. ^ Stephen Dubner and Steven Levitt, Unintended Consequences, New York Times Magazine, 20 January 2008
  29. ^ Department for Communities and Local Government (2002). "Fire" Archived 2004-08-01 at the Wayback Machine. In Consultation on the Local Government Finance Formula Grant Distribution. Retrieved November 10, 2006.
  30. ^ James C. Robinson, Reinvention of Health Insurance in the Consumer Era (2004). In JAMA, April 21, 2004; 291: 1880–1886. Retrieved 2008-01-12
  31. ^ "Gassing up the welfare trap machine", 6 January 1997, Atlantic Institute for Market Studies
  32. ^ Baetjer, Howard (24 August 2016). "The Welfare Cliff and Why Many Low-Income Workers Will Never Overcome Poverty". Learn Liberty.
  33. ^ Daniel Gross (20 February 2005). "Why a Real Estate Agent May Skip the Extra Mile". The New York Times. Archived from the original on 29 May 2015.
  34. ^ B. Douglas Bernheim; Jonathan Meer (13 January 2012). "Do Real Estate Brokers Add Value When Listing Services Are Unbundled?". The National Bureau of Economic Research. Retrieved 3 September 2016.
  35. ^ Sanger-katz, Margot (10 March 2016). "Medicare Tries an Experiment to Fight Perverse Incentives". The New York Times. ISSN 0362-4331. Retrieved 30 July 2016.
  36. ^ Mark Twain (2010), Michael J. Kiskis (ed.), Mark Twain's Own Autobiography: The Chapters from the North American Review, University of Wisconsin Press, pp. 151–2, ISBN 9780299234737

Further reading[edit]