No. 363 · Fixing problems · Systems
Perverse Incentives
A badly designed reward can pay people to produce the opposite of what you wanted.
In the Almanac
“Hanoi’s rat tails”, 1902 · “PPI mis-selling”, 1990s–2019
Both stories in full, three ways to use it and where it misleads.
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Questions
What is Perverse Incentives?
A perverse incentive rewards people for something that undermines the real goal. Hanoi paid for rat tails, so people bred rats. UK banks, the regulator found, mis-sold payment protection insurance with large commissions, then paid tens of billions.
How do you use Perverse Incentives?
To use it, ask of every target how someone could hit it while missing the point. Pair counts with checks on the real outcome, reward quality over quantity, and review your rules often so loopholes close early.
When does Perverse Incentives matter?
Perverse Incentives is one of the 40 mental models for fixing problems, the situations where you ask: Why does this keep going wrong, and how do I fix it for good? Within that, it belongs to “Rewards and rules”, alongside Cap and Trade, Coase Theorem and Goodhart’s Law.
What is an example of Perverse Incentives?
Two stories show it at work: Hanoi’s rat tails (1902) and PPI mis-selling (1990s–2019). Both are told in full in The Mental Models Daily Almanac, which has two stories for each of its 365 models.
Which mental models are related to Perverse Incentives?
Moral Hazard, Proxy and Cobra Effect. Perverse Incentives itself comes from systems.