Perverse Incentives
What is Perverse Incentives?
Rules change incentives, incentives change behaviour, and behaviour then swallows what the rule was for. In management: handing out bonuses outside the system buys gratitude in the short run, but over time people work on pleasing the boss rather than on results, the principled ones leave, and the system stops meaning anything. Ruling by decree produces fast decisions at first, and then people stop saying what they think, bad news gets held back, and the company pays for judgement while using only hands — the better move is to separate the right to discuss from the right to decide.
Perverse Incentives: common mistakes and how to handle them
In policy: a price cap lowers the headline number, but developers invest less, supply shrinks while demand grows, shortages and hidden costs appear, uncapped stock rises, and expectations are pushed up over the long run. Generous benefits narrow the gap between working and not working, so some people able to work do less of it, the tax base shrinks, and the system gets harder to sustain. Strict dismissal rules protect the people already employed, so firms hire fewer permanent staff and shift to temporary contracts and outsourcing, which makes it harder for young people to get in. Extended parental leave paid for by the employer makes firms warier of hiring the people most likely to take it — who bears the cost of a benefit decides who reacts to it. In dealings between two sides: take more and give less and the other party gets careful, invests less, or walks, and you lose the next deal and your reputation with it; in a close relationship, asking without answering for long enough leaves the other person disappointed and putting in less. Second-order thinking doesn’t ask you to concede unconditionally — it asks you to leave both sides a reason to keep going.
What the Perverse Incentives questions test
deriving how the party bearing the cost will respond to a management measure or a policy; spotting a well-intentioned scheme whose incentives point the wrong way; judging which consequence is a second- or third-order effect; choosing an alternative design that avoids the backfire.