In the early 1900s, British colonizers tried to solve a disturbing problem in Delhi, India.
Venomous cobras were everywhere.
Their bites were often fatal, with over 20,000 deaths recorded across India each year.
To deal with this hazard, the British authorities announced that there would be a reward for every dead cobra they received.
The Indian locals raced out into the streets tracking down cobras, killing them and turning in their bodies.
The plan worked until it didn't.
It wasn't long until cobras were seen as a valuable item.
Locals began breeding cobras just to kill them to claim the reward for turning them in.
Cobra breeding became a profitable business.
The British government was confused because the amount of dead snakes kept rising.
After a few years, they caught on to what was going on and stopped offering the reward.
Suddenly, cobras were worth nothing, so breeders set them free.
Once again, the streets slithered and hissed.
It is even said that the problem was worse than before the government intervened in the first place.
This story coined the term cobra effect, which refers to a situation where good intentions lead to bad outcomes through misguided incentives.
They say the road to hell is paved with good intentions, but the engineer of that road was a bad incentive.
Lao Tzu, the legendary founder of Taoism, wrote The more rules and regulations, the poorer people become.
The sharper men's weapons, the more trouble in the land.
The more clever the scheme, the stranger the outcome.
End quote.
Everyone has good intentions, or at least everyone claims to have good intentions, but oftentimes the results are completely at odds with those intentions.
It's almost like the more we intervene, the worse things can get.
Intentions are easy to get right.
We say we want to fix a problem or help those in need or improve a system, but incentives are not so cut and dry.
A poorly thought out incentive can lead to a tremendous amount of energy to be spent moving in the wrong direction.
Another example to illustrate this point comes from Vietnam.
At the end of the 19th century, Hanoi was plagued by rats.
The French colonial government created a bounty program which paid citizens a small amount of money for each rat they killed.
Given the health risks, the colonial government didn't want piles of rat corpses to be handed over to officials.
So they opted to pay locals for every rat tail they handed over instead.
Can you foresee what happened next?
Rat tails became the center of a booming industry.
Vietnamese locals realized they didn't have to kill the rodents.
All they needed to do was catch a rat, cut off its tail, release it, and cash in.
This way the rats could even breed again, producing more valuable rat tails.
Needless to say, the bounty failed to achieve its desired outcome, worsening the rat plague rather than solving it.
The French government's plan failed for reasons similar to the cobra effect, but their approach also shines a light on a critical aspect of incentives how success is measured.
This brings us to Goodhart's Law, an adage named after British economist Charles Goodhart.
It states that when a measure becomes the target, it ceases to be a good measure.
In our example, the intention was to reduce the rat population by way of citizens killing them for money.
Rat tails were determined as the measure of the number of rats killed and determined how much money people could earn.
As a result, the measure became the people's goal and rat tails became an object of value overnight.
Citizens optimized to get more rewards rather than reducing the number of rats.
In hindsight, the consequences seem obvious again.
The reward was attached to a problem, so more problem equaled more reward.
Now let's look at a different example that shows us what happens when an incentive is not clearly defined.
In the Soviet Union in the early 20th century, nails were in high demand.
But the Soviet Union did not have a market economy.
All production was centrally planned.
In order to increase production, the government tried to incentivize nail factory workers.
First, the government offered to reward workers by quantity.
The more nails they produced, the more they earned.
This led workers to use their limited steel resources to make as many small nails as possible.
So the government shifted their incentive structure, now measuring the output by weight and rewarding workers accordingly.
Unfortunately, this also proved counterproductive, as the factory started making fewer but insanely large and heavy nails.
The factory workers adapted their behavior to increase their reward rather than act in the spirit of the incentive structure.
The incentive to meet quotas did not match the true goal to satisfy consumer needs.
When quotas are the target, quality always gets sacrificed, and what we end up with is flimsy, useless junk.
What all three of these examples tell us is that humans act in their own self-interest.
Incentive systems are often targeted across large populations to achieve a common good, but individuals will always prioritize themselves over the collective.
Yes, cobras are dangerous, but I need to eat and feed my family.
Yes, rats carry plagues, but I need a roof over my head.
A centralized government authority does not need to incentivize me to take care of my own home, because that's my home and the impact of not taking care of my home directly affects me.
It is in my own self-interest to take care of my home.
But how do you get people to care about large group efforts?
How do you encourage them to act in a manner that achieves a common good?
First, an incentive structure must be based around outcomes, not inputs.
If the input is rewarded, then the problem becomes a source of revenue.
So instead of paying per dead snake, the British colonists could have rewarded communities for measurable reductions in cobra sightings or bites over time.
This shifts the goal from producing snake carcasses to actually reducing the population.
Instead of paying per rat tail, the French colonists could have rewarded neighborhoods or households for measurable reductions in rat populations.
Fewer burrows, fewer sightings, plague cases declining.
This aligns the incentive with the actual goal.
Fewer rats, not just tails.
Instead of rewarding nails by the amount of weight, reward by the number of nails that pass a stress test or meet a clearly defined standard.
This would ensure that the nails actually serve their purpose.
Free market economies do this naturally.
Customers don't buy nails based on weight.
They buy nails that actually work.
Unfortunately, input-based incentive structures are everywhere in our society.
The pharmaceutical companies make money when they medicate sick people, so sickness has become lucrative.
A patient cured is a customer lost.
This is not to say that the entire healthcare industry is evil, but the incentives are perverted.
Anytime you have profit attached to a problem, a great deal of energy and intelligence will be directed towards keeping the problem going and growing.
This is what we call an industrial complex.
Look at all the major issues America faces.
Crime, war, drugs, illness, poverty, racism.
Each one of these has become its own industrial complex.
Prisons profit off arrests.
Drug companies profit off chronic illness and prescriptions.
Banks profit off people in debt.
Defense contractors profit off war.
DEI programs profit off injustice.
Homeless nonprofits benefit from more homelessness.
Maybe it's time to focus less on the intentions of these so-called do-gooders and focus more on the results they produce.
Carl Jung famously said if you cannot understand why someone did something, look at the consequences and infer the motivation.
One good way to stifle the emergence of an industrial complex is to introduce time limits on the people designated to solve the problem.
Time limits prevent problems from becoming endless wells of money to draw from.
Without deadlines, the very program designed to solve the problem eventually mutates into a parasite, one that is invested in keeping the problem going so it can keep feeding.
Perhaps the British would have been successful in reducing the cobra population if they only offered the reward for one year.
This way, there wouldn't be enough time or reason to set up cobra breeding factories.
Now, before this video makes you too cynical, I'd like to give you one example of an incentive structure that actually did some good.
In the mid-20th century, beverage companies moved from reusable glass bottles to cheap single-use containers.
Customers had no reason to return them, so people threw them out.
Litter piled up and cities were overwhelmed by waste.
States like Oregon in 1971 introduced the Bottle Bill, a deposit return system.
Instead of simply asking people to do the right thing, they created a small cash incentive.
Pay 5 or 10 cents extra when you buy a drink and get it back when you return the bottle or can.
Redemption rates soared in Oregon over 80.
Return rate litter decreased dramatically and recycling became financially self-sustaining.
The incentive flipped from it's easier to throw this away to I get money if I return this.
Another important thing to note is that good incentives give people skin in the game.
Workers are best motivated when they get to experience the fruits of their labor.
People tend to game the system when they don't have to suffer the consequences of their actions.
A good incentive must also be flexible.
It's like running an experiment.
If it's not working, it must be tweaked and updated.
The world is infinitely complex.
It's hard to know what will be the second and third order effects of our initial assumptions.
Even the best incentive structures eventually run into the limits of human nature.
That's where culture comes in the invisible force that guides behavior, even when no reward is on the table.
A good culture is one where people care about the long-term outcomes, where people feel valued, challenged and connected to a purpose greater than themselves.
This is why founders and CEOs act like cult leaders, constantly emphasizing culture every chance they get.
If you have a strong culture, incentives are barely necessary.
When you don't have a strong culture, you end up in a situation in which the individual's interests are disconnected from the group's and incentive structures have to account for an endless amount of loopholes.
If you find yourself in such a cynical position, what else is there to do except outgame your own reward system?
As Mark Twain put it, the best way to increase wolves in America, rabbits in Australia and snakes in India is to pay a bounty for their scalps.
Then, every patriot goes to raising them.
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