This is the 50th blog and therefore in order to celebrate this milestone, I asked my very good friend to write a blog. He is exceptionally brilliant and yet extremely humble. He is also very generous in gifting books and sharing ideas.  He has taught himself accounting and has made a killing in investing.  Oh- besides investing, he has a day job too! He wishes to remain anonymous and has no Twitter, Facebook or LinkedIn profiles.  

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Having learned from  Charlie Munger, I started collecting inanities on incentives and incentives caused bias. In every realm of human endeavor, we get to see the power of incentives. In fact, if an alien were to visit us today, he would be wondering why we do not spend more time thinking about the power of incentives? Am I overselling incentives? Not at all! Let us take a tour, across different disciplines and time.

Back in 1700s, England used to send prisoners to Australia by private ship. Only about 50% of the prisoners arrived alive. So, the English government changed the incentives to private ships that they would be paid based on the number of prisoners that would arrive alive. And guess what? Right from the first voyage, 99% of the prisoners reached Australia alive.

Say you are a British Colonial official in Delhi in 1850s. You are concerned with the number of venomous cobras in Delhi. Now, if you are not well-versed with the power of incentives, then you might announce a bounty on every dead cobra. Initially the strategy would be successful, but you fail to notice that
enterprising people will start breeding cobras for income. When you discover this, you scrap the reward program, leading to the cobra breeders setting the cobras free. The apparent solution for the problem made the situation even worse.

Well, you might say this problem has not happened since then. Not so fast! How about Hanoi in 1902? A mere 50 years later, in a different city, a similar solution to a similar problem. The French Colonial Government created a bounty program for every rat killed! Colonial officials, however, began noticing rats in Hanoi with no tails. The Vietnamese rat catchers would capture rats, sever their tails, and then release them back into the sewers so that they could procreate and produce more rats.

Ah, but this is old and dated stuff. Surely this was solved by the space-age? How about Georgia, US? In 2007, feral pigs were wreaking havoc on the area surrounding Fort Benning, including destroying equipment and crops. A program was started to pay $40 for each pig tail turned in and hunting restrictions were loosened. Again, it did not work.

Okay, now you say, incentives went bad here in dealing with ‘pests’. Incentives must have been put to good use in saving a few endangered species? The exact inverse? To save a few animals instead of getting rid of them? Unfortunately, no. The Endangered Species Act in the US imposes development restrictions on landowners who find endangered species on their property. This encouraged landowners to drain swamps and cut down trees that might host endangered species. Or worse, deliberately kill the species to avoid discovery!

You now say, I shall think carefully when dealing in man-animal domains. But other domains do not exhibit such inanities? Or do they?

Say you were an archaeologist, and you were looking at Dead Sea scrolls. The discovery of the Dead Sea Scrolls soon created a new market. However, the archaeologists who wanted the scrolls paid Bedouins,who had access to caves around the Dead Sea, by the piece. The natural outcome? The Bedouins would tear the scrolls in pieces to get a higher price, because at that time they were being paid by the piece. Not exactly an outcome you desire eh?

Or an archaeologist looking at Javanese hominin skulls. If you pay Javanese locals for each fragment of hominin skull that they produced, you will discover the people had been breaking up whole skulls into smaller pieces to maximize their payments.

You might wrongly conclude this is a third world problem. How about an archaeologist chancing lost nets off Normandy coast? Should you pay per piece? Well, you say, I neither deal with man-animal conflict nor ancient history, I am in the office of the first transcontinental railroad in the 1860s. The United States Congress, then agreed to pay the builders per mile of track laid. As a result, Union Pacific Railroad lengthened a section of the route forming a bow shape unnecessarily adding miles of track.

Not in the transport department but in Education? In modern day Texas? Concerned about geographic diversity? Texas House Bill 588 stated that the top 10% of every high school in Texas would be guaranteed admission to the state’s universities (such as the University of Texas at Austin or Texas A&M University). This was to ensure geographic diversity. This led to some students transferring from high- achieving high schools to low-achieving high schools to gain admission to TAMU or UT Austin.

Employed with a mining company? Perhaps, paying workers to clear sand off a dam? When KMDCL decided to pay Rs. 300 per worker per day to load sand into the lorries, was it so hard to guess that sand would not be lifted out of the dam at the expected pace?

Jumping into the modern tech industry, say you are a hot-shot program manager. If you prioritize deadlines over quality, buggy products will get shipped. If you prioritize quality over deadlines, you will never see products getting shipped. Guess, what did a semiconductor giant prioritize when they decided to race against time, in getting a chip out, before their competitor did. Hint: The chip did not power up in the lab!

You now conclude that you are better off with a non-profit org, than with a for-profit business. Surely, no incentives at play here? How about at Gates Foundation? Gates foundation donated mosquito nets to a village in Mozambique. The enterprising folks used it to catch fish instead.

Well, these anecdotes are a few years old. Did Covid lockdown throw up surprises? A 7-star hotel has three banquet/ wedding halls. But since government has imposed a limit of 50 per wedding, they tell their guests, please book the 3 halls under 3 different names and then you can invite 150 people. Unintended consequences and incentive caused bias.

Charlie Munger once said “I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. Never a year passes that I do not get some surprise that pushes my limit a little farther. Show me the incentive and I will show you the outcome. Never, ever, think about something else when you should be thinking about the power of incentives.”

I have come to accept this philosophy as one of the simplest, strongest heuristics through which to view nearly everything pertaining to human affairs.

Thanks once again for the honor of the guest post here and may we see many more milestones in the blog space here! (Vikas says: Thank you for a wonderful post. The honor is ours.)

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If you liked this blog, you may also like my other blogs on incentive caused biases here and here.

Featured photo by Brett Zeck on Unsplash