The Cobra Effect and the Pitfalls of Poor Incentives

What makes New York’s rat problem seem minor? A venomous cobra infestation. The British Raj controlled India from 1858 to 1947. According to a famous tale, they once faced a severe problem — the city of Delhi was overrun by venomous cobras. The British, always keen to solve a problem from the top down, came up with a grand solution. 

To reduce the growing cobra population, a bounty was offered. To receive their rewards, residents turned in cobra skins — walking away with some cash. This incentive worked like a charm. At first. 

The bounty program was so enticing that many ambitious Delhiites launched cobra breeding operations. They raised the snakes, killed them, and turned them in to collect their prize. But all good things must come to an end. Once the British rulers realized their solution was being exploited, they canceled the program. 

Clearly, the overlords didn’t think things all the way through. The enterprising breeders, who’d come to expect payment for their snakes, became outraged and unleashed their “excess inventory” on the city. Delhi’s cobra problem promptly went from bad to worse. 

I couldn’t confirm the historical accuracy of the story, but “The Cobra Effect” stuck, as coined by economist Horst Siebert. The term describes a perverse incentive— “an incentive that has an unintended and undesirable result that is contrary to the intentions of its designers.” 

The cobra effect occurs because we fail to examine our actions and policies and fully understand their secondary and tertiary consequences. When looking for solutions to problems, we create one and forget to ask, “and then what?” As a result, we’re pleased to install a solution without investigating its weaknesses. In other words, no loophole goes unexploited.

Here are a few modern examples of the cobra effect in action: 

Plate-Based Driving Restrictions

In the late 1980s and early 90s, many developing countries sought to combat worsening air pollution and traffic congestion. Several Latin American countries implemented plate-based driving restrictions. The idea goes like this: if your license plate ends in an even number, you’re permitted to drive on certain days of the week, and if it ends in an odd number, you can drive on the other days. Theoretically, this would cut the number of vehicles on the road in half, resulting in cleaner air and free-flowing traffic. 

To the dismay of policymakers, this solution didn’t work; it worsened matters. Many families bought more cars, some having as many as four, to ensure they could commute to work as needed without breaking the law. Since they had extra vehicles, they didn’t let them go to waste. More vehicles ended up on the road, and air pollution worsened. 

Bank Account Incentives

Businesses work hard to create a positive public image. Still, Wells Fargo has become the corporate poster child for the cobra effect due to the customer service model they implemented in the mid-2010s. The company brass believed their customers would enjoy using more of its services, and they could become a one-stop financial shop — the big box of banks. To make this vision a reality, the company created incentives for employees to open new accounts for existing clients. 

And open new accounts they did. The incentives were so effective that employees began opening accounts without the prior authorization of clients. The client satisfaction program ultimately failed as customers lost faith in the financial giant, tarnishing the brand’s image. 

Afghan Poppy Fields

Not to be outdone by their forbearers, the British were back at it in 2002 as they led the counter-narcotics effort in Afghanistan. “In spring 2002, the UK implemented a compensation-based eradication program. The program, Operation Drown, was designed to offer a one-time payment of $350 per jerib (1/5 of a hectare or almost 1/2 acre) to farmers whose crop was destroyed during the operation.” According to the Afghanistan papers, the policy “ignited a poppy-growing frenzy among Afghan farmers who sought to plant as many poppies as they could in order to collect payouts from the cash-for-poppies program. Some farmers harvested the sap before destroying the plants, getting paid twice for the same crop.” Lesson not learned.

In hindsight, most examples of the cobra effect look obvious, but at the moment, they’re widely supported and backed by “evidence” and sound theory. Policymakers are incentivized to make policy; thus, they sometimes hastily develop and implement policies counter to their objectives. Sound familiar? 

When we hear about incentives, we should think beyond the first order. For example, we should pause and examine the unintended consequences of government subsidizing corn production. Will subsidies lead to the over-consumption of high-fructose corn syrup and contribute to diminishing health? Will they incentivize farmers to feed corn to farm animals that don’t naturally digest grains, resulting in less nutritious meat? Will subsidies create a barrier to food imports, ultimately increasing prices? Will relations with trade partners deteriorate due to protectionist policies? Will supply gluts be created, leading to food waste? Will the environment be harmed due to mono-cropping and reduced diversity? Or could oversupply lead to prices that don’t allow for small farms to survive?

The idea isn’t to destroy the notion of a subsidy-based agricultural system; that would require a much deeper dive into the relationship between government and markets. The point is that policies with a noble goal might not achieve that goal. Worse, they could worsen the problem and create new ones.

How can we anticipate and avoid unanticipated negative outcomes?

Think Beyond the First Order

In a piece I wrote about thinking beyond the first order, I said, “second-order thinking is complex and requires significantly more effort. (Howard) Marks compared them by saying, “the difference in workload between first-level and second-level thinking is clearly massive, and the number of people capable of the latter is tiny compared to the number capable of the former.” Thus, second-order thinking is helpful when solving complex problems, and making impactful policy, business, or personal decisions with long-term consequences.” To think beyond the first order, it’s critical to examine many outcomes, continuously ask “what happens then,” and consider the long-term effects. 

Use Simple Incentives

The more complicated the incentive program, the more loopholes to be exploited. Keep it simple. Simplicity makes for easier efficacy tracking and allows for swift pivots if needed. 

Seek Multiple Perspectives

We’re full of cognitive biases. When developing incentive programs, seek the input of others who can identify potential loopholes and weaknesses. If the program can involve outsiders, include them. If it’s a work or government program, seek the input of multiple departments. Sometimes a fresh perspective can bring to light weaknesses that were hidden in plain sight to the initial organizers. 

The uniquely human ability to reason makes us problem solvers, but sometimes we’re too eager and far too shortsighted. Whether an exploding population of venomous snakes, a warming climate, excess student loan debt, or some business challenge, we’re primed and ready to “help.” Our hubris leads us to think we can control the uncontrollable, easily fix challenging problems, and conquer nature. And sometimes we can. But for each solution, the cobra effect is coiling, ready to strike. 

Armed with the lessons of the past, our unique ability to reason and collaborate, and higher-order thinking, we can reduce the impact of the cobra effect and take more thoughtful actions in progressing society.