[Market Economy Guide] The Pros and Cons of Incentive Systems

They Offered Bounties to Reduce Cobras in India,

but the Payouts Went to Cobra Breeding and the Number of Cobras Rose Even More

This happened when Britain ruled India in the past. At the time, the British colonial administration in India sought a way to eliminate the swarms of cobras. After much deliberation, it decided to introduce an incentive policy that paid a bounty according to the number of cobras people brought in. At first, the policy seemed highly effective. Indians rushed to catch cobras in order to collect the bounty. As people competed to bring in more cobras, the British colonial administration grew confident that it would soon eradicate them.

What Happened in India

But something strange happened. Even after a long time, the number of cobras did not decline. On the contrary, even more cobras than before were being brought in.

After 1 year, then 2 years, with no sign that the cobra population was shrinking, the British colonial administration in India launched an investigation into the cause. The result was astonishing. In order to keep receiving bounty payments, Indians had built cages in their homes and were breeding cobras. And because they kept increasing the number of cobras they raised to collect even more bounty money, there was no way the number of cobras could fall.

They Were Raising Cobras to Collect the Bounty

Once the British colonial administration learned this, it abandoned the cobra eradication policy and announced that it would no longer pay rewards to people who brought in cobras. Then the problem became even more serious. With no longer any reason to breed cobras, people began throwing them outside. In the end, India’s cobra population increased to dozens of times what it had been before the policy was implemented. In trying to eliminate cobras efficiently, the policy ended up making them proliferate everywhere.

In the end, the British colonial administration’s incentive policy was a clear failure. But doesn’t that seem a little strange? Incentives are a powerful force in moving people to act. In that sense, the cobra policy carried out by the British colonial administration was clearly an incentive policy designed to motivate Indians. Even so, why did the incentive produce the exact opposite result?

An incentive is a sweet reward. Once people begin to enjoy an incentive, they naturally want to continue enjoying it. So they work harder and harder for it, seeking to produce the best possible outcome.

But in the case of the British colonial administration’s cobra eradication policy, things were different. Indians knew that the moment cobras disappeared completely, the incentive they had been enjoying would disappear as well. So they began looking for a way to keep the incentive going, and that way turned out to be breeding cobras.

The Effects of Incentives Are Not the Same

As the British colonial administration’s cobra eradication policy shows, indiscriminate and hasty incentives often produce adverse effects. Countless examples make it clear that incentives do stimulate human behavior and can help generate the best outcomes. But introducing incentives rashly, without considering whether their effects will be large or small, positive or negative, or sustainable over time, is likely to produce results worse than not introducing them at all.

As the capitalist system developed and evolved, incentives developed along with it. That is because incentives help unleash human passion. But as we have seen, incentives must be applied carefully. One cannot guarantee that applying the same incentive will produce the same effect.

Incentives work exceptionally well for people such as athletes or chief executive officers (CEOs). That is because, depending on their own efforts and choices, performance can vary greatly, and gains and losses differ clearly according to results.

The use of incentive systems should also vary depending on differences in incentive effects. Incentive policies that are applied inappropriately do little to improve productivity. Worse, they can backfire and bring about not greater productivity, but lower productivity.

■ Please remember

Incentives must be applied carefully. One cannot guarantee that applying the same incentive will produce the same effect.

Sung-no Choi, President of the Center for Free Enterprise (CFE)

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Original title: [시장경제 길라잡이] 인센티브제도의 명암

Author: Sung-no Choi

Date: 2019-06-24

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=13&idx=20285