By Shubhangi Kumar
“It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities but of their advantages.”
Over two centuries since Adam Smith wrote this, man has understood only too well the meaning of these advantages – incentives. We try to offer the most lucrative incentives, so that we are able to clinch the deal. Unfortunately, there are times when the target audience won’t hesitate to change tack and exploit the incentive. The rational (or irrational, depending on your take of economic theory) beings that we are, we seek to maximize our well-being. History provides numerous examples of times when policymakers have failed to solve a problem, because the solution in fact ends up worsening it: something that we know today as the cobra effect.
Its etymology dates back to the British colonial rule in India, when the government, worried about the large number of cobras, placed a bounty on dead cobras. This worked for a while, but it wasn’t long before the natives started breeding cobras in order to make more money. Realising the loophole, the government revoked the scheme, only to find that people released the now-worthless cobras into the wild. The scheme had backfired colossally.
If you thought it was only the British, let me introduce you to the Frenchmen in Hanoi in the early 1900s and the Americans in Fort Benning in 2007. To control the tremendous populations of rats in Hanoi and wild pigs in Fort Benning, the authorities offered rewards for every animal killed, if you provided its tail in return. As spy novels go, these assassins weren’t to be dissuaded from double-crossing their employers. Hanoi soon began boasting not just of rats, but tail-less rats, while the pig population in Fort Benning shot up. The natives had a greater incentive to simply trap the animals, cut off their tails and release them, so that the animal population was sustained, leading to a steady stream of income. The pigs were lured using nutritious food, and once they had eaten their fill and had their tails chopped off, they reproduced with greater flourish.
Two particularly relevant examples from recent times are those of e-commerce firms and congestion-reduction schemes. E-commerce firms equate unrealised revenue with lost revenue, i.e., an item that was added to the cart but not purchased is considered to be a loss. To incentivize customers to buy such products, firms started offering heavy discounts for products that had been in the cart for sixty days or more. Quick to realise what the firms were up to, consumers started adding products to the cart and waiting for two months to avail the discount. As a result, firms had to switch to more optimal, conditional cart discount schemes.
New Delhi was not the first place to try the odd-even car scheme to reduce congestion and pollution. Colombian and Mexican authorities implemented it, but only to their dismay. Families bought two cars – sometimes four, in the case of households with two working members – to be able to drive around every day. The additional cars were often old, less fuel-efficient and more polluting models, aggravating the very problem the scheme was trying to solve.
It is common sense that people respond to incentives. Thus, the quest before us now is not to figure out how to make people act, but how to give them the best possible incentive, one that will not lead to unintended consequences.
econ after hours 