One of the things that I like most about economics is that it truly is the driving force behind all of humanity. When you think about economics you may not think of it in this way. You might imagine that it is strictly the study of currency or financial markets, but in reality the true fundamentals of economics are quite different. Economics is in fact largely a social science, and its focus lies at describing the cause for all actions that have ever been taken by humans. At the core of this social science is the study of incentives. Understanding the economic incentive requires awareness of only a few fundamental assumptions. First of all, every person has unlimited wants and needs, and is inherently self interested. Second of all, all resources are scarce, meaning that the limited amounts that exist are not sufficient to fulfill the unlimited wants of each person. And because of this, every action and choice has a cost, meaning that by choosing to do one thing, you give up something else that you could have done instead. An example of this is that by choosing to pay to go to college, you are giving up all of the other potential things you could have done with the time and money you have expended by choosing to go to school. And finally all people are generally rational, meaning that when making decisions, they would always seek to maximize personal gain while minimizing personal losses. And from this structure comes the incentive. An incentive simply refers to an adjustment of either the costs or benefits of a choice with the intent of encouraging a desired action, this can be done through either positive or negative means. If implemented correctly, an incentive will cause the benefit of a desired action to outweigh the costs, or the costs of an undesired action to outweigh the benefits. It is very important to understand that in every single aspect of society, whether it was intentional or not, incentives based on cost benefit analysis are responsible for every action of ever person. People often say that a corporation “should” be doing something or some other sort of normative phrase. In reality it is very clear why people and firms act in the way that they do, it all comes down to a cost benefit analysis and the incentives that surround each situation. It may certainly be true that incentives control each persons actions, but that in no way applies that it is a straightforward task to predict just how an incentive will influence decision making. It is important that we acknowledged how incentives that we create will not always yield the intuitive results that we may expect.

 

An instance in which incentives have backfired can be seen in British Colonial India. At the time the city of Delhi was seemingly infested with venomous cobras. The British governor saw this to be a problem, and sought to end the cobra scourge. In an attempt to incentivize the extermination of cobras, a cash reward was offered to anyone who turned in a dead cobra. The idea was of course that the incentive would increase the benefits of hunting and killing cobras, which would in turn reduce the cobra population and solve the problem. The incentive seemed logical, but backfired in the most counter productive way possible. While the benefits of hunting cobras were increased, the benefits of farming cobras increased on an even higher scale. Citizens began to farm the snakes, and turn in their bodies in exchange for the cash bounty. By the time the British government had caught on, there were excessively higher numbers of cobras within the city than there had been to start with, especially after the farmers released most of their remaining snakes after the bounty was dropped. This idea of an incentive with unintended consequences has since come to be known as “The Cobra Effect“.

The main takeaway of the aforementioned story is not that incentives don’t work. In fact, incentives were the very reason that the Indians farmed the cobras at all. Rather, it is to show that incentives are a powerful, but complex tool, and that there is often more than meets the eye in any given situation. A story such as the Cobra Effect is not an antiquated tale of misfortune, this same concept applies very directly to many areas of modern life and politics. Every year politicians promote policies that they promise will change something for the better. It is important to remember that a great deal of these policies deal heavily with incentives, and are therefore subject to very similar risks as the cobra bounty in colonial India. Though politicians may think they know exactly how they can influence a situation, it is quite likely that they are missing a key detail somewhere. One of my favorite F. A. Hayek quotes summarizes this entire concept beautifully, ” The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”.