How virtually everything can backfire
Real world examples that make you laugh (and feel sad at the same time)
One day a guy sitting in traffic had had enough. He looked at the cars, and drivers around him and realized something: everyone was driving alone in their god-forsaken car. If only they would carpool together… obviously, they are all going in the same direction, so why is it so hard for them to share their rides…? With the mission in his head to reduce traffic, he set out and created a company.
That company is now called Uber.
Yes, the ridesharing app and now a $60B company. But Wait! If Uber is worth so much money, how can it have backfired or even be a failure? Well, it has been a financial success (at least so far), but what about the original mission?
Uber made it possible to take rides for even shorter trips. People demanded more and more of those rides, which in turn led to Uber drivers making more money, which led to more people becoming Uber drivers, and thus, to more cars on the road. The traffic in cities with Uber became significantly worse than in similar cities without it.
Hearing this story makes me want to tear my hair out, every time… I guess you just can't fight market forces1…
Similarly, we could talk about how Airbnb set out to help optimize the expensive and unused resources of apartment space, but what happened there… is probably a little bit on the nose after our Uber example just now.2
However, there is another great lesson, or at least a nice visualization, of a concept in economics that we can derive by looking at Airbnb: Negative Externalities. Just by looking at this weird name, you know immediately that only economists would come up with something like that.
What are negative externalities?
Airbnb uses apartment spaces more efficiently by renting them out to other people when the main renter is not in need of it or has an extra room to spare. So far so good... However, this led to an increase in “hotel rooms” in attractive cities, which led to increased travel activity in those cities, which in turn not only filled up that extra space rather quickly but also led to a lot more air travel and CO2 being released into the atmosphere. Definitely not one of the goals that Airbnb set out to achieve, and a textbook example of negative externalities.3
You can never know in advance what your idea, or policy’s, side effects will be.
Did I just say policies? Oh yes, let’s talk about government failures. Because who doesn’t like to complain about their incompetent government - right?
Well, sometimes what looks like incompetence, started out with honest and good intentions, at least that is the case in our next example, from Japan.
In the 90s, the Japanese were using old and energy-wasting refrigerators. So the government set out to “incentivize4” its people to buy modern and energy-efficient fridges. Too bad they didn’t have an economist on their team (if they had, he wasn’t a very good one), Because, what happened next could be predicted by knowing the basics about markets: the incentive, or the subsidies, the government created, made it possible for people to afford way bigger fridges than they could afford before… now, let’s see if you can guess what happened next.
Of course, they bought bigger fridges, and in some cases, people even bought two, which led to a constant increase in energy usage by refrigerators in Japan. The precise opposite of what the government set out to do.
The three examples above, covered companies and governmental institutions. But those are not the only places these kinds of things occur (in fact, there are probably examples from all walks of life). This next example takes place in a completely different area from the other two: Kindergartens.
Like the founder of Uber, one day, the headmaster of this kindergarten had enough. Some parents were constantly late for the pick-up time of their children, which in turn led to many problems with the staff, who demanded to be paid for the overtime, of course. So the headmaster did the only rational thing that came to his mind. Penalties; Extra charges were installed as kind of penalties, to incentivize parents to pick up their children on time. This way, theoretically, even if they wouldn’t change their behavior, at least the overtime costs could be covered… Sounds like a reasonable idea? honestly, I couldn’t see anything wrong here that could potentially backfire.
With this penalty system in place, the average delay of pick-ups had to come down significantly right? That’s the basic economic principle. The price for the service went up (dramatically- from zero to something), so the demand has to come down.
Well, theoretically yes, just that this is exactly the opposite of what happened. Delays went up - by a lot! But how can that be? the economic forces had been on our side this time… well…
Yes, they were, in a world with rational beings, who make decisions based on facts and not emotions. See, the problem is that, before the penalties, the parents were late from time to time, and when they were, they had a really bad conscience, knowing that being late led to unpaid overtime for the teachers.
Now, however, they regarded the delay more as a business transaction (and well… to be fair, they were paying for it) - so no need for feeling guilty. Guilt and shame, however, are one of the strongest drivers for behaviors, and in this case, they worked far better than financial penalties, as the headmaster discovered right after he implemented the changes.
Don’t underestimate guilt and shame as incentives in an economy or society.
All these stories and examples, make me question my good intentions... I try to consume less, and if I do I try to buy quality things that last for a long time. However, these things tend to be produced in more developed countries than their cheap alternatives. So sometimes I think- maybe my money would be better in the hands of people in developing countries instead...
Another thing I wonder is what happens with the extra money spent on something of higher quality- does it actually go down the value chain? Because, if it ends up in the hands of people who, in turn, spend it on cheap products, that hurt the environment, wouldn’t it be better if I just kept it in my hands, or in my bank account? Also, what is my bank even doing with my money?
However, to end on a happier note; I try to do the good and right things, and if from time to time they backfire then at least with these examples in mind I know that I am not alone. Don’t beat yourself up if your action didn’t yield the desired outcome. You are not alone, because, as you saw, it happens to billion-dollar companies and sophisticated government experts.
Have a great day
GNF
Market forces are the forces of supply and demand that drive the price and quantity of goods and services in a market.
With Airbnb apartment space was used more efficiently, however, market forces quickly came to play. Owners and renters alike figured out the potential income from unused space and this led to a sharper price increase than ever before. Which of course drove poor people further away from the city centers. The pressure in the housing market did not ease but actually increased, even though the space is being used more efficiently, no argument there.
A negative externality is a cost that is suffered by a third party as a consequence of an economic transaction. In a transaction, the producer and consumer are the first and second parties, and third parties include any individual, organization, property owner, or resource that is indirectly affected. Externalities are also referred to as spillover effects, and a negative externality is also referred to as an ‘external cost’.
Some externalities, like waste, arise from consumption while others, like carbon emissions from factories, arise from production.
“Fun” fact: The word "incentivize" is a relatively new word and is not yet recognized by all dictionaries. However, it is widely used in business and economic contexts, and it is generally accepted as a standard English word.