Perverse incentive

Updated on Oct 31, 2023

Edit

Comment

A perverse incentive is an incentive that has an unintended and undesirable result which is contrary to the interests of the incentive makers. Perverse incentives are a type of negative unintended consequence or cobra effect.

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.

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 Catholic Church could get $2.25 per day, per patient.

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.

19th century palaeontologists traveling to China used to pay peasants for each fragment of dinosaur bone (dinosaur fossils) that they produced. They later discovered that the peasants dug up the bones and then smashed them into many pieces, greatly reducing their scientific value, to maximise their payments.

Paying medical professionals and reimbursing insured patients for treatment but not prevention encourages medical conditions to be ignored until treatment is required. 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 which 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.

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. In some cases, endangered species may even be deliberately killed to avoid discovery. Similarly, if the fine or other penalty for committing environmental damage is perceived as less burdensome than the cost of preventing the damage in the first place, an individual or company may not place safeguards in place and simply pay the penalty if the damage occurs.

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.

Before the Anatomy Act 1832, executed criminals were the only legal source of bodies for hospitals to use for surgeon training. Due to high demand from chronic shortage of legal cadavers, "resurrection men" resorted to illegal means to obtain bodies, such as digging up corpses from graveyards or even murder. In 1828, William Burke and William Hare murdered 16 people and sold the bodies. Thomas Williams and John Bishop, part of a group of body snatchers known as the London Burkers, committed murder for the purpose of selling the victim's body in 1831.

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.

The "welfare trap" occurs when money earned through part-time or minimum wage employment result in a reduction in state benefits which is greater than that amount. This creates a barrier to low-income workers re-entering the workforce. Underlying factors include 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, this gives a powerful disincentive to take such work.

Real estate brokers have an inherent conflict of interest with the sellers they represent because their commission motivates them to sell quickly more than it motivates them to sell at a higher price.

Eliminating social safety nets can discourage free market entrepreneurs by increasing the risk that business failure from a temporary setback will lead to financial ruin.

Awarding Carbon Credits for destroying the greenhouse gas HFC-23 incentivized increased manufacture of the coolant HCFC-22 (chlorodifluoromethane) whose production included HFC-23 as a by-product. This increased production caused the price of the coolant to decrease significantly, incentivizing refrigeration companies to continue using it, despite the adverse environmental effects.

Under the US Medicare program, doctors are reimbursed at a higher rate if they prescribe 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.

References

Perverse incentive Wikipedia

(Text) CC BY-SA