Perverse Incentives!

There is a proverbial story about snakes in Delhi. During British days, apparently there was a time when Delhi was infested with snakes. The authorities were challenged to find a solution to the snake menace. People respond to incentives and one might not take recourse to economics for the same and instead follow common sense. So the authorities announced a reward for all those who kill snakes. The condition was the dead snake has to be produced as proof for claiming reward. The story goes when the reward was stopped, Delhi was infested with far more snakes than it began with. In other words the problem had multiplied. Without doubt, one needs to look why the policy failed. Does this story remind us that economics is not infallible and incentive mechanism does not work?

Let us probe it in some depth. As Adam Smith first pointed out, at least in documented modern times, people function in their self interest. The self interest as an aggregate is what culminates into enlightened collective interest. More recently economists talk about the role of incentive mechanism in flourishing collective interest. According to one commentator, whole of economics can be summed up in the phrase ‘People respond to incentives’. The rest apparently is mere commentary.

As with any other principles, this is contingent on human behaviour. Implied is the mechanism works under certain conditions.  Economic actors are without doubt utility maximizing rational individuals functioning in self-interest and therefore positively or negatively respond to the incentives on offer. Yet, as with any story, it projects just a part picture.

People are rewarded for killing snakes. The ostensible purpose is people attracted by the reward will kill snakes, thus help in minimizing the menace. For any individual, who is responding to the same, non-satiation implies he/she will desire greater and greater rewards. The total reward increases with the increase in number of snakes killed and presented as proof. Average reward might remain same for any number of snakes killed but marginal reward is positive for each snake killed. A rational individual settles on a point where marginal reward becomes zero.

Unsurprisingly, rational thinking at the margin, implies killing more snakes. In other words, to kill more snakes, you need to rear snakes once the existing stock is exhausted. Moreover, rearing snakes for kills is relatively than hunting for the same in the wild or in bushes where they infest. A rational outcome implied a rise in ‘snake farming’ to kill and this is what exactly happened.

The collective interest lay in reducing snakes, individual self-interest lay in rearing snakes for kill thus gaining more rewards. A conflict of motivations between what society desires and what an individual desires ensues. Thus aggregate of individual choices thus exercised act and result in outcomes contrary to what is desired by the society. The externalities generated thus diminish societal utility. Incentives thus offered that conflict between societal desired outcomes and individual self-interest generate a perverse nature that yields negative utility to the society as a whole. Benefits are borne by individuals, costs diffused across society cause a skewed cost benefit analysis arising out of perverse incentives

What might have been the solution? A possible solution lay in keeping a fixed time period for claiming of the reward.  Let us say, the authorities had said, all snakes killed and presented as proof in the next couple of weeks (let us say) would get rewards. This would have meant the people focus would shift to finding snakes and killing rather the focus on rearing which would be time consuming. Open ended incentive would give all the time for the people to practice snake farming, produce more snakes and when offer is withdrawn, they have no utility with the snakes thus reared. The only logical outcome would be to release the snakes in the open. As they solution would be worse than the problem.