Cobra Effect.
During British rule, government got concerned about large number of deadly Cobra snakes in and around Delhi. So they decided to give a reward to every person who brought a dead cobra.
During British rule, government got concerned about large number of deadly Cobra snakes in and around Delhi. So they decided to give a reward to every person who brought a dead cobra.
As expected, large number of Cobras were killed for the reward. However, an unintended consequence was that lot of people started actively breeding Cobras for earning these rewards.
On seeing this, the government decided to scrap the reward system. But by then lot of breeders had come up. When the policy was scrapped, these breeders set their now-worthless snakes free.
This caused the population of cobras to significantly increase!
This caused the population of cobras to significantly increase!
This is an excellent example of "Perverse Incentive"
- where incentive is given with a certain intent but the results that come out are unintended and undesirable.
- where incentive is given with a certain intent but the results that come out are unintended and undesirable.
Financial system is also full of examples where incentive structures are intended to bring the best out of people but many a times lead to undesirable outcomes.
Raghuram Rajan famously highlighted "perverse compensation incentives" of Wall Street for 2008 crisis.
Raghuram Rajan famously highlighted "perverse compensation incentives" of Wall Street for 2008 crisis.
Even post 2008 crisis, we have seen such stories play out. In 2016, Well Fargo incentivized employees to open more bank accounts and gave very aggressive targets for the same. If goals were met, they would be handsomely rewarded but if not they could potentially loose their job.
It did increase the sales in short term as more bank accounts were opened.
However, later on this led employees to open millions of unauthorized and fake accounts!
However, later on this led employees to open millions of unauthorized and fake accounts!
Various insurance policies, credit cards etc. were also issued in the name of customers without their permissions.
Wells Fargo was fined heavily for the misalignment of incentives.
Wells Fargo was fined heavily for the misalignment of incentives.
This goes to show that while designing "incentive systems" its extremely important to understand the second order effects.
As Mark Twain once wrote :"Any government can tell 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."
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