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Sunday, August 5, 2007day link 

 Perverse incentives
Wikipedia: Perverse Incentive:
A perverse incentive is a term for an incentive that has an unintended and undesirable effect, that is against the interest of the incentive makers. Perverse incentives by definition produce negative unintended consequences. It is a term probably first coined by Edgar Allan Poe in his short story: The Imp Of The Perverse
Some examples:
- Some social welfare programs only give money to people with no job. Some argue that this discourages people from working because they would lose welfare benefits if they became employed. According to these critics, this leads to a net increase in poverty. This effect is called the 'Welfare trap.'

- Paying the executives of corporations proportionately to the size of their corporation is intended to encourage them to grow their companies by growing the bottom line (and not their earnings per share). However, it may cause them to pursue mergers to grow their companies, to the detriment of their shareholders' interest.

- Funding fire departments by the number of fire calls made is intended to reward the fire departments that do the most work. However, it may discourage them from fire-prevention activities, which reduce the number of fires.

- In Hanoi, under French colonial rule, a program paying people a bounty for each rat pelt handed in was intended to exterminate rats. Instead it led to the farming of rats.

- In computer security, users are encouraged to use passwords that are difficult for an attacker to guess. However, assigned passwords that are too complicated may be hard to remember, leading users to write them down rather than memorizing them. If this password is kept in an insecure location such as near the user's computer, it is easier for an attacker with physical access to locate this strong password than to try to manually crack a weak password.

- Setting the same minimum punishment for crimes of different severity may increase the incidence of the most serious crimes. For example, the practice of executing thieves may lead to an increase in murders, since the thief has an incentive to kill any witnesses to avoid being convicted - he will not be any the worse off if caught.

- Banning the sale of various recreational drugs may make drug dealers more likely to sell to minors. When it is illegal to sell to minors but legal to sell to adults, drug dealers have an incentive to refuse to sell to children. When all sales are equally punished, selling to minors may be safer for the dealer.

- 19th century palaeontologists traveling to China used to pay peasants for each fragment of dinosaur bone that they produced. They later discovered that peasants would dig up the bones and then smash into multiple pieces to maximise their payments.

- Digital Rights Management schemes are often used to discourage illegal piracy by preventing copying of content, which also has the effect of reducing its utility to paying customers who want to play their purchased material on multiple machines, or make backups. Since pirated content usually does not contain DRM, user who do not want DRM restrictions on their content have a perverse incentive to pirate it. For example, if the publisher attempts to increase revenues by preventing ripping with DRM, it may be easier to pirate the ripped content than buy a disc with DRM, therefore effectively reducing the publisher's revenues.
It should be a required study for any kind of policy maker to understand this phenomenon really well. A great many laws and government programs accomplish approximately the opposite of what they set out to do. Punishing victim-less crimes as much as real crime will increase violent crime. Making recreational drugs illegal will place more harmful drugs into people's hands. Outlawing prositituion places many more women in very precarious situations. Confiscating pictures of child pornography will motivate people to harm new children to produce more. Speed radars make people pay more attention to looking for speed traps than to driving well. Traffic lights sometimes makes traffic flow less well. Large fines for late payments make it less likely for poor people to be able to pay their bills. Etc., etc.
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