Perverse incentive

A perverse incentive is an incentive that has an unintended and undesirable result that is contrary to the intentions of its designers. Perverse incentives are a type of negative unintended consequence. A classic example of a perverse incentive occurred when the British government offered a bounty for dead cobras with the intent of decreasing the wild cobra population. However, enterprising people began to breed cobras for the income. When the government became aware of this, the reward program was scrapped, causing the cobra breeders to set the now-worthless snakes free. As a result, the wild cobra population further increased. The term cobra effect was coined to describe a situation where an attempted solution to a problem actually makes the problem worse.[1][2]

Examples
  • In Hanoi, under French colonial rule, a program paying people a bounty for each rat tail handed in was intended to exterminate rats. Instead, it led to the farming of rats.[3]
  • The Duplessis Orphans: Between 1945 and 1960, the federal Canadian government paid 70 cents a day per orphan to orphanages, and psychiatric hospitals received $2.25 per day, per patient. Allegedly, up to 20,000 orphaned children were falsely certified as mentally ill so the government of the province of Quebec could get $2.25 per day, per patient.[4][5][6]
  • Funding fire departments by the number of fire calls made is intended to reward the fire departments that do the most work. However, it may discourage them from fire-prevention activities, which reduce the number of fires.[7]
  • 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 the people had been breaking up whole skulls into smaller pieces to maximise their payments.[8]
  • Paying medical professionals and reimbursing insured patients for treatment but not prevention encourages medical conditions to be ignored until treatment is required.[9] Also, 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.
  • Bangkok police used tartan armbands as a badge of shame for minor infractions, but they were treated as collectibles by offending officers forced to wear them. Since 2007, they have been using armbands with the cute Hello Kitty cartoon character to avoid the perverse incentive.[10]
  • The Endangered Species Act in the US imposes development restrictions on landowners who find endangered species on their property. 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.[11] In some cases, endangered species may even be deliberately killed to avoid discovery.
  • Providing company executives with bonuses for reporting higher earnings encouraged executives at Fannie Mae and other large corporations to inflate earnings statements artificially and make decisions targeting short-term gains at the expense of long-term profitability.[12]
  • 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.[13]
  • The "welfare trap" occurs when money earned through part-time or minimum-wage employment results in a reduction in state benefits which would have been greater than the amount earned. This creates a barrier to low-income workers re-entering the workforce.[14] 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.
  • Real estate brokers have an inherent conflict of interest with sellers they represent because their usual commission structures motivate them to sell quickly rather than 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.[15][16]
  • Awarding carbon credits for destroying the greenhouse gas HFC-23 encouraged increased manufacture of the refrigerant HCFC-22 (chlorodifluoromethane) whose production included HFC-23 as a by-product. This increased production caused the price of the refrigerant to decrease significantly, motivating refrigeration companies to continue using it, despite the adverse environmental effects.[17][18]
  • Under the US 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.[19]
  • The devolved government in Northern Ireland enabled business owners to make profits guaranteed for 20 years by simply using more and more renewable energy to heat their premises in their Renewable Heat Incentive scheme.[20] The declared objectives of the scheme were to reduce energy usage and promote switching to green sources.
  • The Wells Fargo account fraud scandal resulted from incentives intended to increase the number of accounts sold, but overly ambitious quotas combined with the threat of career ruin if quotas were not met caused some employees to open large numbers of accounts without customer permission.

See also

References
  1. Siebert, Horst (2001). Der Kobra-Effekt. Wie man Irrwege der Wirtschaftspolitik vermeidet (in German). Munich: Deutsche Verlags-Anstalt. ISBN 3-421-05562-9.
  2. Schwarz, Christian A. (1996). NCD Implementation Guide. Carol Stream Church Smart Resources. p. 126. Cited in Brickman, p. 326.
  3. Michael G. Vann, "Of Rats, Rice, and Race: The Great Hanoi Rat Massacre, an Episode in French Colonial History," French Colonial History Society, May, 2003
  4. Protesters in straitjackets demand inquiry of Duplessis Orphans era
  5. Allegations of child abuse
  6. Orphans sue Catholic orders over mistreatment
  7. 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.
  8. 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.
  9. James C. Robinson, Reinvention of Health Insurance in the Consumer Era (2004). In JAMA, April 21, 2004; 291: 1880–1886. Retrieved 2008-01-12
  10. Myndans, Seth (2007-08-25). "Cute Kitty Is Pink Badge of Shame in Bangkok". The New York Times. Retrieved 2007-11-06. 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.
  11. Stephen Dubner and Steven Levitt, Unintended Consequences, New York Times Magazine, 20 January 2008
  12. 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.
  13. Mark Zwonitzer, writer, PBS American Experience documentary "Transcontinental Railroad" (2006) "Program Transcript . Transcontinental Railroad . WGBH American Experience"
  14. "Gassing up the welfare trap machine", 6 January 1997, Atlantic Institute for Market Studies
  15. Daniel Gross (20 Feb 2005). "Why a Real Estate Agent May Skip the Extra Mile". The New York Times. Archived from the original on 29 May 2015.
  16. B. Douglas Bernheim; Jonathan Meer (13 Jan 2012). "Do Real Estate Brokers Add Value When Listing Services Are Unbundled?". The National Bureau of Economic Research. Retrieved 3 Sep 2016.
  17. Rosenthal, Elisabeth; Lehren, Andrew W. (2012-08-08). "Incentive to Slow Climate Change Drives Output of Harmful Gases". The New York Times. ISSN 0362-4331. Retrieved 2015-07-02.
  18. Gupta, Anika. "Carbon credit scam slur on Indian firms". Hindustan Times. Retrieved 2015-07-02.
  19. Sanger-katz, Margot (2016-03-10). "Medicare Tries an Experiment to Fight Perverse Incentives". The New York Times. ISSN 0362-4331. Retrieved 2016-07-30.
  20. "RHI scandal: RHI 'cash for ash' scandal to cost NI taxpayers £490m". BBC News. 23 December 2016.

Further reading
  • Sloan, John III; Kovandzic, Tomislav V.; Vieraitis, Lynee M. (2002). "Unintended Consequences of Politically Popular Sentencing Policy: The Homicide-Promoting Effects of 'Three Strikes' in U.S. Cities (1980–1999)". Criminology & Public Policy. 1 (3): 399–424. doi:10.1111/j.1745-9133.2002.tb00100.x.
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