Price is an Signal wrapped up in an Incentive
Another few stories on the same theme… taken from the blog- https://fs.blog/2016/05/incentives-gone-wrong/
The British ruling India were concerned by the number of cobras- venomous snakes in Delhi- their capital city. To reduce the cobra population in Delhi they instituted a reward for every dead snake brought to officials. The Indian citizens dutifully complied and began breeding venomous snakes to kill and bring to the British. By the time this was all said and done, the snake problem was worse than when it began.
Much more perverse, from the Congolese massacre in the late 19th and early 20th century under Belgian rule — the period Joseph Conrad wrote about in Heart of Darkness.
As King Leopold II of Belgium forced the Congolese to produce rubber, he sent in his Force Publique to whip the natives into shape through genocidal murder. Fearful that his soldiers would waste bullets hunting animals, Leopold ordered that the soldiers bring back the severed hands of dead Congolese as proof that they were enforcing the rubber decree. As the quotas were impossible to meet, shortfalls were common. And with the incentives placed on Belgian soldiers, many decided they could get human hands more easily than meeting rubber quotas, while still conserving their ammo for hunting.
An interesting result ensued, as described by Bertrand Russell in his book Freedom and Organisation, 1814-1914. “Each village was ordered by the authorities to collect and bring in a certain amount of rubber – as much as the men could collect and bring in by neglecting all work for their own maintenance. If they failed to bring the required amount, their women were taken away and kept as hostages in compounds or in the harems of government employees. If this method failed, native troops, many of them cannibals, were sent into the village to spread terror, if necessary by killing some of the men; but in order to prevent a waste of cartridges, they were ordered to bring one right hand for every cartridge used. If they missed, or used cartridges on big game, they cut off the hands of living people to make up the necessary number.”
As Peter Forbath describes in his book The River Congo, the soldiers were paid explicitly on the number of hands they collected. So hands gained in demand. “The baskets of severed hands, set down at the feet of the European post commanders, became the symbol of the Congo Free State. … The collection of hands became an end in itself. Force Publique soldiers brought them to the stations in place of rubber; they even went out to harvest them instead of rubber… They became a sort of currency. They came to be used to make up for shortfalls in rubber quotas, to replace… the people who were demanded for the forced labour gangs; and the Force Publique soldiers were paid their bonuses on the basis of how many hands they collected.”
Looking to bolster an economy of rubber, Leopold II got an economy of severed hands. Leopold himself never even visited his colony, although he did cause at least 10 million deaths.
Joseph Heath describes another case of incentives gone wrong in his book Economics Without Illusions, citing the book Out of Poverty: And Into Something More Comfortable by John Stackhouse.
Stackhouse spent time in Ghana in the 1990s, and noticed that the “socially conscious” retailer The Body Shop was an enormous purchaser of shea nuts, which were produced in great quantities by Ghanians. The Body Shop used shea butter, produced from the nuts, to produce a variety of skin products, and as a part of its socially conscious mission, and its role in the Trade, Not Aid campaign, decided they were willing to pay above-market prices to Ghanian farmers, to the tune of an extra 50% on top of the going rate. And on top of that premium price, The Body Shop also decided to throw in a bonus payment for every kilogram of shea butter purchased, to be used for local development projects at the farmers’ discretion.
Thinking that the Body Shop’s early shea nut orders were a harbinger of a profitable boom, farmers began to rapidly up their production of shea butter. Stackhouse describes the result in his book:
A shea-nut rush was on, and neither the British chain nor the aid agencies were in a position to absorb the glut. In the first season, the northern villages, which normally produced two tonnes of shea butter a year, churned out twenty tonnes, nearly four times what the Body Shop wanted….Making matters worse, the Body Shop, after discovering it had overestimated the international market for shea products, quickly scaled back its orders for the next season. In Northern Ghana, it wasn’t long before shea butter prices plunged.
Unfortunately, in its desire to do good in a poor part of the world, the Body Shop created a situation which was worse than when they began: Massive resources went into shea butter production only to find that it was not needed, and the overproduction of nuts ended up being mostly worthless.
These cases above, and many more, lead us to the conclusion that people follow incentives the way ants follow sugar. It’s imperative that we think very literally about the incentive systems we create. Remember that incentives are not only financial. Frequently it’s something else: prestige, freedom, time, titles, sex, power, admiration…all of these and many other things are powerful incentives. But if we’re not careful, we do the equivalent of creating an economy for severed hands.
Sometimes when we solve one problem, we end up unintentionally creating another one that’s worse. First-order thinkers look for things that are simple, easy, and defendable. They fail to realize that they are dealing with complex systems, or if they do realize it, they mistake cause-and-effect relationships. They are incapable of thinking in terms of second and subsequent steps. And, more fundamentally, they are generally unaware of the need to think in terms of second steps. Second-order thinking helps identify the second and subsequent order consequences of a decision before they happen. Knowing these problems before they occur allows us to take steps now to avoid problems later.In his exceptional book, The Most Important Thing, Howard Marks explains the concept well. Second-order thinkers take into account a lot of what we put into our decision journals. Things like 1) what are the key variables and how do they interact?, 2) where is the leverage?, and 3) if I take this action, what happens next?
“You must have the confidence to override people with more credentials than you whose cognition is impaired by incentive-caused bias or some similar psychological force that is obviously present. But there are also cases where you have to recognize that you have no wisdom to add— and that your best course is to trust some expert.”
— Charlie Munger
Three stories taken from a blog- https://fs.blog/2016/05/incentives-gone-wrong/