Saturday, August 11, 2012

Incentives and Unintended Consequences

By: Greg

One of the most important and talked about matters in economics is the power of incentives, or, how a particular rule or policy changes the behavior of individuals or society as a whole. Though not a parent myself, I am sure that parents are constantly thinking about how particular parenting behaviors will create incentives for good or bad behavior. One example is how your child’s behavior might change if every time they have a temper tantrum they get what they want, as opposed to if they don’t get what they are screaming for. Incentives are everywhere and play an especially large role in deciding if a particular policy is good for society or bad.

In many cases creating legislation that seems like a great idea has really bad unintended consequences. Learning to anticipate those unintended consequences is, in my mind, extremely important. I have an example below and will surely return to this topic in future posts so I wanted to introduce what I mean by incentives and unintended consequences.

Forgiving Debt
In his book “The Elusive Quest for Growth,” William Easterly examines various efforts to help the world’s poorest countries grow out of extreme poverty. One of the efforts he explains is the “Jubilee 2000” campaign heavily supported by U2 rock start Bono as well as the Pope and the Dalai Lama. Jubilee 2000 called for meaningful debt reduction (totaling billions of dollars) for 20 poor countries. The intentions of this aid campaign were obviously very good. Many poor countries are heavily indebted and just paying the interest on their loans is extremely cumbersome. To aid these poor countries, wealthy individuals stepped in and helped them pay down their debts. This movement seems and feels right, but it had some negative consequences.

The astonishing result of this multi-billion dollar debt reduction program is that a large proportion of these countries who received aid were even more indebted shortly after receiving the money. The shocked Bono, Pope, and the Dalai Lama stated that this was a result of “irresponsible governments” which is definitely true. Easterly explained the following in his book:

The Jubilee 2000 debt campaigners treat debt as a natural disaster that just happened to strike poor countries. The truth may be less charitable. It may be that countries that borrowed heavily did so because they were willing to mortgage the welfare of future generations to finance this generation’s (mainly the government clientele’s) standard of living.

That’s one explanation. But let’s also take a look at the role incentives played. Jubilee 2000 wasn’t the first movement made to forgive poor countries’ debts. This practice has actually taken place since 1967, according to Easterly, including a huge amount of money donated in the 1987 G-7 All World Tour. Since many of these poor countries are used to having their debt erased, what is their logical conclusion? Rack up as much debt as possible! Despite the campaign’s best efforts and intentions, its real effect was poor.

Debt forgiveness is seen in other areas as well, and those policies ring up as “stupid” to me for the same reasons as Jubilee 2000. One example that is being pushed for right now is student debt forgiveness.  Don’t forget to think about the incentives.

1 comment:

  1. Yep. Makes perfect sense. Debt is a consequence of bad financial choices (not always, like in cases of catastrophe, but usually), and if we take the consequence away, the bad choices will continue. From a parenting standpoint, it works perfectly too. If a child doesn't do a large school project until the last minute, then stays up until midnight rushing to finish it but still can't, it's not a good idea for the parent to finish it up while the child sleeps.