How incentives matter

How incentives matter
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First Published: Tue, Jan 05 2010. 08 15 PM IST
Updated: Tue, Jan 05 2010. 08 15 PM IST
Should rapists be given the death sentence? Think about it. The first reaction of most people would be that a rapist should be sent to his death. Violence against women is growing in India, and the tragic suicide of the young Ruchika Girhotra after she was molested makes any decent person’s blood boil. There are moral reasons to believe that those who attack women should be given the maximum penalty allowed in a nation’s laws.
But economists have a different way to think through the problem.
Consider this puzzle posed by David Friedman in his textbook on law and economics. “You live in a state where the most severe criminal punishment is life imprisonment. Someone proposes that since armed robbery is a very serious crime, armed robbers should get a life sentence. A constitutional lawyer asks whether that is consistent with the prohibition on cruel and unusual punishment. A legal philosopher asks whether it is just.
“An economist points out that if the punishments for armed robbery and for armed robbery plus murder are the same, the additional punishment for the murder is zero—and asks whether you really want to make it in the interest of robbers to murder their victims.”
Now replace “armed robbery” with “rape”. I asked a jurist whether this was a valid way of looking at things: that maximum penalties should be used sparingly or else they drive criminals to murder. This was his emailed reply: “Friedman has rightly pointed out an anomaly. There is hot debate about the desirability to prescribe death penalty for rape. Such a measure would tempt the rapist to murder the victim after the rape. Sentences for longer terms like 50 years are an option not provided in Indian law.”
The point is that death penalty for rape could create perverse incentives for rapists to murder their victims. Indians generally do not like to think about incentives since good intentions are believed to be the only things that matter in policy. The world is more complex.
Here’s a favourite anecdote about the importance of incentives. An economist was at a bar when a stranger asked him: “What are the two things about economics?” The economist did not understand till the stranger explained: “You know, the Two Things. For every subject, there are really only two things you really need to know. Everything else is the application of those two things, or just not important.”
“Oh,” said the economist. “Okay, here are the Two Things about economics. One: Incentives matter. Two: There’s no such thing as a free lunch.”
Almost all economics follows from these two simple propositions.
The issue of incentives came up once again at a recent lunch with one of India’s top internal security experts. He gave me two further examples. “I think the illicit liquor mafia keeps prohibition going in states such as Gujarat because it has a strong incentive to do so. Their business would collapse if liquor is freely available in the state.”
He believes that much the same logic applies to drugs. The international drug cartels have reason to prevent governments from making drugs legal. It is well known that revenues of the Mumbai underworld were badly hit after it became easier for citizens to buy in electronic goods and gold. The smuggling rackets collapsed, and the underworld moved into real estate and the film industry.
There are a host of other examples that can be used to illustrate how human behaviour changes when the incentives change. Free market economists have often pointed out that mandatory car seat belts create incentives for rash driving and, hence, lead to more car accidents. This is to Peltzman effect, named after regulatory economist Sam Peltzman who showed how one type of safety regulation often results in risky behaviour elsewhere.
An 11 November story in The Wall Street Journal reported on how new research showed that brain damage in retired American-rules football players is often not because of one major trauma but the thousands of small blows to the head over the length of a sporting career. The root of the problem lies in helmets that are used to protect the head.
“The first hard-shell helmets, which became popular in the 1940s, weren’t designed to prevent concussions but to prevent players in that rough-and-tumble era from suffering catastrophic injuries such as fractured skulls. But while these helmets reduced the chances of death on the field, they also created a sense of invulnerability that encouraged players to collide more forcefully and more often,” wrote Journal reporters Reed Albergotti and Shirley S. Wang.
Not all second-order effects can be predicted when a policy or regulation is changed. But it is always good to remember that a careful study of incentives is often a better way to assess policy than raw anger or fashionable moral posturing.
Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at cafeeconomics@livemint.com
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First Published: Tue, Jan 05 2010. 08 15 PM IST