Can financial incentives help heavy drinkers stay sober?

Rational (and quasi-rational) decision-makers respond to incentives. If the costs of doing something go up, they tend to do less of it. If the costs go down, they tend to do more. And the reverse is true of benefits. Changing the costs and/or benefits of an activity therefore should be expected to change behaviour.

Does that logic extend as far as behaviours involving addiction and self-control problems? Consider alcohol consumption. Can heavy drinkers be incentivised to remain sober, at least temporarily, by increasing the costs of drinking, or increasing the benefits of not drinking? That is essentially the question addressed in this 2019 article by Frank Schilbach (MIT), published in the prestigious journal American Economic Review (open access).

Schilbach conducted a field experiment over three weeks with 229 cycle-rickshaw drivers in Chennai, India. In the experiment, the drivers were randomly split into three groups. The first group received a financial incentive to remain sober (the 'Incentive group'). The second group were paid an unconditional payment of similar magnitude (the 'Control group'). The third group got to choose between the sobriety incentives and the unconditional payment (the 'Choice group'). To receive their payment, the study participants had to report to the study office and submit to a breathalyser test. Schilbach was really interested in the effect of alcohol consumption on savings behaviour, so each research participant was offered the opportunity to save money at the study office each day. He was also interested in the effects on labour market participation and earnings, which were determined using surveys of the research participants.

The results reveal a number of important things about rational behaviour among heavy drinkers. First, the group that was given the choice between sobriety incentives and an unconditional payment demonstrated a strong demand for sobriety:

One-third to one-half of study participants chose sobriety incentives over unconditional payments, even when this choice entailed a potential or certain reduction in study payments...

One-third of the participants in the 'choice group' were willing to give up as much as 30 percent of their study earnings in order to be given the sobriety incentives. Schilbach isn't able to definitively determine why there was such high demand for sobriety, but he does note that:

First, study participants had significant experience with alcohol consumption and the potentially resulting self-control problems. The average study participant had been drinking alcohol for over a decade and many of them had been drinking (almost) daily...

Second, individuals perceived the costs associated with their drinking as significant. Many individuals expressed a strong desire to reduce their drinking in surveys and informal conversations. These men had spent substantial income shares on daily alcohol consumption for many years before participating in the study. Compared to these expenses, the forgone study payments due to the commitment choices may have appeared relatively small to individuals, especially if they implied a positive (perceived) chance of reducing subsequent alcohol consumption in the longer run.

So, the research participants may have perceived the experimental setting, and the money on offer, as a way to commit themselves to sobriety, at least for the period of the study. Did the incentives work, though? Schilbach finds that they did:

In the pre-incentive period, about one-half of the individuals in each of the three groups visited the study office sober. This fraction gradually declined in the Control Group to about 35 percent by the end of the study... In contrast, with the start of the incentivized period, sobriety in the Incentive and Choice Groups increased by about 10 to 15 percentage points. Subsequent sobriety at the study office also declined in these two groups, but the difference to the Control Group remained roughly constant.

Regression models confirm that the Incentive and Choice groups were approximately 13 percentage points more likely to visit the study office sober than the Control group, and the average breath alcohol content (BAC) was 2 to 3 percent lower for the Incentive and Choice groups than for the Control group (conditional on visiting the study office). Schilbach notes that the effect was largest on daytime drinking and not overall alcohol consumption, suggesting that many study participants simply shifted their drinking to later in the day (after visiting the study office).

Did sobriety affect labour market outcomes? Schilbach finds small and statistically insignificant effects on labour supply, hours worked, and earnings. As for savings, Schilbach found that the intervention increased savings, with the Incentive and Choice groups saving about 50 percent more than the Control group over the study period. Schilbach interprets this as showing that:

...increasing sobriety reduced self-control problems in savings decisions. An alternative interpretation could be that alcohol is a key temptation good for this population such that reducing alcohol consumption mitigates the need for commitment savings. However, given that the intervention only moderately reduced overall alcohol consumption and expenditures, this channel is unlikely.

My takeaway from this paper is that many heavy drinkers recognised their own self-control problems and were willing to give up some income for a commitment device that would help them remain sober. The commitment device increased the costs of drinking (or, equivalently, increased the benefits of not drinking). So, the drinkers who chose the sobriety incentives were acting rationally in response to a change in incentives. The research participants who shifted their drinking to later in the day were also acting quite rationally. By shifting their drinking to later in the day, they could receive the benefits of the sobriety incentive, while continuing to drink (albeit later in the day). In other words, the incentive changed behaviour, just not necessarily in the way it was intended to.

So, if you wanted to roll out a broader intervention based on changing incentives for heavy drinking, it might be better to measure sobriety at multiple times of the day. However, in this context even the later drinking may have reduced some of the potential alcohol-related harm, since there may have been fewer drunk-driving cycle-rickshaw drivers on the streets of Chennai (although, to be fair, the study doesn't actually show that there was less drink-driving).

It would be interesting to know how much of these study results are context-dependent, and whether a similar intervention would work elsewhere. If you tried to incentivise heavy drinkers in a high-income country to reduce their consumption, would they respond in a similar way? That question will have to wait for future research.

Could prosecuting STI transmission increase infections?

In my ECONS102 class this week, we covered unintended consequences - where an incentive is created that works against what was originally intended. One of my favourite examples is the familiar (but possibly apocryphal) story about cobras in Delhi, as I noted in this 2015 post:

The government was concerned about the number of snakes running wild (er... slithering wild) in the streets of Delhi. So, they struck on a plan to rid the city of snakes. By paying a bounty for every cobra killed, the ordinary people would kill the cobras and the rampant snakes would be less of a problem. And so it proved. Except, some enterprising locals realised that it was pretty dangerous to catch and kill wild cobras, and a lot safer and more profitable to simply breed their own cobras and kill their more docile ones to claim the bounty. Naturally, the government eventually became aware of this practice, and stopped paying the bounty. The local cobra breeders, now without a reason to keep their cobras, released them. Which made the problem of wild cobras even worse.

Just because the consequences of a policy are unintended, that doesn't necessarily mean that they are unforeseen. Sometimes, we can anticipate what will go wrong with a particular policy. And it's not just policies that can go wrong. Any change in costs or benefits that alters people’s incentives can produce unintended consequences. As an example, consider this recent article in The Conversation by Bridget Haire and David Carter (both University of New South Wales):

In an Australian first, a Canberra man has been convicted for giving genital herpes to a sexual partner...

This recent case represents a significant expansion of criminal law into sexual health. It sets an unhelpful legal precedent, and undermines successful public health messages.

Decades of research have concluded that prosecuting disease transmission doesn’t reduce infection and may make things worse...

But criminalising transmission can create perverse incentives not to seek medical care and treatment. If a person genuinely doesn’t know their status, it can be more difficult to prove “reckless” transmission.

The intuitive case for punishment is especially strong in this case: the man knew his status, denied having an STI when directly asked, and repeatedly had unprotected sex with his partner. However, the punishment itself will change incentives for other people.

Ideally, we want people to know their STI status. For curable STIs, diagnosis enables treatment. For example, for infections such as herpes, it allows people to use medication and other precautions that reduce the risk of further transmission.

At one level, it makes sense to punish people who knowingly infect others with an STI. That creates a strong disincentive to transmit STIs to other people. However, criminalising STI transmission also reduces the incentive to get tested, because a person not knowing that they are infected might be able to use their lack of knowledge of their infection status as a defence in a criminal case. So, we might expect that fewer people would get tested for STIs. So, on the one hand there are disincentives to transmit STIs, but on the other hand there are disincentives to find out whether you are infected with an STI, which leads to move STI transmission. If the latter effect is larger, then overall there could be higher prevalence of STIs and greater incidence of new infections.

And so, rather than reducing STI infections, criminalising those who transmit STIs may have the unintended consequence of increasing STI infections overall.

Tuition fees, incentives, and 'ghost students'

When the New Zealand government introduced 'first-year fees free' in 2018, the universities expected a big uptick in student numbers. It didn't happen (as I discussed in this 2023 post). As the figure below (source) shows, the mild downward trend in domestic student numbers (equivalent full-time students, or EFTS) continued for at least a couple of years past 2018:

My colleagues were worried that we would see an increase in the number of students who enrol, and then do nothing at all (what we call 'ghost students'). My impression was that this didn't happen, but until now I never looked intentionally at the numbers. However, the figure below shows the proportion of each of my A Trimester ECON100 classes (up to 2017) or ECONS101 classes (for 2018 onwards) that were ghost students (I didn't teach the class in 2022, which is why there is no observation for that year). Here, I define a 'ghost student' as any student who didn't attempt any of the tests or exams (although they may have attended some classes during the trimester). In each trimester, the class had between 250-350 enrolments in total. [*]

As the figure shows, there was a big jump in 'ghost students' in 2021, but that is attributable to the COVID pandemic and the weirdness of that whole time period, rather than anything to do with fees-free. In most years, somewhere between three and five percent of students are 'ghosts'. In 2025, the government shifted from first-year fees free to final-year fees free. There's no evidence that change affected the proportion of 'ghost students' either. Or it's too early to tell - the proportion in 2025 was lower than either of the previous two years.

Why might we expect the changes in fees to affect the number of 'ghost students'? It comes down to incentives. As my ECONS101 students will hear next week, when the cost of something decreases, we tend to do more of it. First-year fees free decreased the cost of being a 'ghost student', so ceteris paribus (holding all else constant), we would expect to see more 'ghost students'. Final-year fees free (with first-year fees reintroduced) increased the cost of being a 'ghost student', so ceteris paribus, we would expect to see fewer 'ghost students'. The fact that didn't happen is interesting, and we'll come back to that a bit later.

To see why the New Zealand effect might be negligible, it helps to compare with a setting where student status comes with larger immediate benefits. To do that, I want to discuss this recent article by Johannes Berens (RH Köln), Leandro Henao, and Kerstin Schneider (both University of Wuppertal), published in the journal Labour Economics (ungated earlier version here). They look at the impact of the removal of tuition fees in North Rhine-Westphalia in Germany in 2011. Tuition fees were a very modest EUR500 per year (for every year of study), and Berens et al. essentially compare students who were more or less affected by the policy (depending on how many years they didn't have to pay fees for), looking at a range of academic outcomes including exam registrations and withdrawals, credit points earned, grades, and dropout probabilities, as well as the number of 'ghost students'.

Their data come from a single university, with over 11,000 students who first enrolled between 2008 and 2011. The students in the 2008 cohort would have graduated before the fees were removed, while those in the 2011 cohort would not have faced any fees at all. The other cohorts would have had fees in their later year/s, but not earlier year/s. Applying a difference-in-differences approach, Berens et al. find that:

...abolishing tuition fees significantly affected student behavior and academic outcomes. Active students reduced their academic performance by 1.7 credit points per semester (12 % relative to baseline), despite maintaining similar exam registration patterns... Additionally, the reform increased the prevalence of ghost students by 10 percentage points...

So, removing fees in this context substantially increased the proportion of 'ghost students' by 10 percentage points, from a baseline that was already over 10 percent (Berens et al. present the data by study semester, and the 'ghost student' proportion varies between 10 percent and 20-25 percent, depending on year and study semester).

What explains the high impact of removing fees in Germany? Berens et al. highlight the role of incentives, and in particular the generous nature of public assistance available to students. Specifically:

...student status confers substantial benefits, generally independent of academic performance... These benefits include subsidized health insurance (until age 25), state-wide public transport access (worth EUR 2900 annually), and parental child allowance (EUR 2450 annually). About 16 % of students also receive need-based grants averaging EUR 6800 annually...

So, being classified as a student can be quite lucrative in Germany, even if the student is a 'ghost'. That might also explain the lack of effect of first-year fees free in New Zealand. While the fees are higher in New Zealand than in Germany, being a student in New Zealand is hardly a pathway to great riches (at least, not during the time spent as a student - see this post, and the links at the end of it). The student allowance is not very generous, and while there are some other perks to being a student, cheap movie tickets and public transport are not exactly worth a lot of money. So, it shouldn't be much surprise that the impact in Germany was much larger than for a similar policy change in New Zealand.

Another reason that the impact was not apparent in New Zealand could be that many students do not pay their tuition fees immediately. Instead, many (perhaps most) students' tuition fees are paid by student loans. 'Student Greg' is probably quite content to say that the student loan is 'Graduated Greg's' problem, and not worry about it today. So, from the perspective of 'Student Greg', first-year fees free doesn't really impact the decision to become a student or not. It doesn't change the costs of being a student for 'Student Greg', because they don't consider paying back the student loan as part of the costs of studying today. [**] And that might explain why there was no incentive effect of first-year fees free in New Zealand (also, fees-free papers are not free if students fail them, as I noted in this 2023 post).

The incentives in Germany and New Zealand, when the tuition fees were changes, resulted in quite different impacts. In Germany, where the benefits of being a student were higher, lower costs of being a 'ghost student' induced many people to enrol, whereas in New Zealand, where the benefits of being a student are lower, and the costs of tuition are typically deferred to the future, lower costs of being a 'ghost student' appear to have made no difference.

The nature of incentives, and the costs and benefits around the decision, definitely matter. The policy takeaway from this is that tinkering with fees alone may induce more (or less) 'ghost students', so the other immediate benefits and costs associated with student status also need to be considered. 

*****

[*] The data are for only one paper, but ECON100 and ECONS101 have been, for the most part, compulsory papers for business students. In a couple of years, some students could avoid the paper by taking all of the other first-year business papers. However, unless 'ghost student' status was more likely for students who did not take first-year economics, these results should be broadly representative.

[**] Essentially, 'Student Greg' is heavily discounting the future. In my ECONS102 class, we say that 'Student Greg' exhibits present bias, and is therefore only quasi-rational, not purely rational. Of course, not all students will have acted like 'Student Greg', but if enough of them did, that would explain the lack of incentive effects of the changes in first-year fees.

The Guardian Cap mandate in the NFL and the 'Peltzman effect'

Yes, this is another NFL post (after yesterday's post). And before we get to the post: Yes, I will be cheering for the Atlanta Falcons tomorrow, since a Falcons win is the only way for my Panthers to make the playoffs, after they lost to the Buccaneers today. With that out of the way, onto business: player safety in the NFL.

Concussions have become big news in contact sports over the last decade or so. Long-time fans will be sure to have noticed that more players are being substituted out of games, or missing games entirely, due to concussions, than was the case in the past. The concern about concussions is due to their implication in Chronic Traumatic Encephalopathy (CTE), which is linked to behavioural problems, mood swings, and cognitive issues, which all look very similar to dementia.

The NFL has been the target of a lot of attention, and has taken action. One change that was implemented was to introduce 'unaffiliated neurotrauma consultants' to make in-game decisions about whether players should be kept out of a game after an on-field concussion (although that change has not been without controversy). Another change was the introduction of the Guardian Cap, which is a soft shell that attaches over an existing helmet and is supposed to reduce the force of impacts to the head. Do Guardian Caps work though? Guardian, the makers of the cap, is itself cautious on that point:

Researchers have not reached an agreement on how the results of impact absorption tests relate to concussions. No conclusions about a reduction of risk or severity of concussive injury should be drawn from impact absorption tests. Guardian has always stood by the fact that Guardian Caps reduce the impact of hits and that its use should be one piece of the puzzle to an overall safety strategy.

That shouldn't dissuade researchers from looking into the impact on concussions, and it hasn't. This new article by Kerianne Lawson Rubenstein (Syracuse University) and Todd Nesbit (Ball State University), published in the Southern Economic Journal (open access), looks into whether the introduction of the Guardian Caps was associated with a reduction in concussions in the NFL.

Before you conclude that it is self-evident that a padded helmet that reduces head impacts must reduce concussions, we need to discuss the 'Peltzman effect'. In a famous paper in the 1970s, Sam Peltzman (University of Chicago) showed that mandatory safety devices on cars, such as seat belts, do not reduce traffic deaths, and actually increase the number of non-fatal car accidents. This 'Peltzman effect' is otherwise known as 'offsetting behaviour', where a policy makes an activity less risky, but results in more of the now-less-risky behaviour. One example of this in sports was that when new driver safety devices were installed in race cars in NASCAR, drivers responded by driving more recklessly, increasing the number of crashes.

Rubenstein and Nesbit test for a Peltzman effect of the Guardian Caps. They hypothesise that:

...wearing the Guardian Caps incentivizes riskier tackling due to the perceived safety from wearing the Cap. Players may not accurately calculate the risk of a helmet-to-helmet hit if they place a lot of faith in the Cap's ability to absorb the shock. And if the players only wear the Caps in practice and not during games, they may actually end up hitting harder and protecting themselves less when falling to the ground in games without the Caps because of their practiced behavior.

In other words, even if the Guardian Caps work as intended and make each impact less dangerous, players may respond by taking more risks, leading to more hits, harder hits, or less care in avoiding hits. This would be the unintended consequence of using the Guardian Caps.

The NFL mandated the use of the Guardian Cap in contact practice sessions through to the second preseason game in 2022, for all linemen, linebackers, and tight ends. This was extended to all contact practice through the entire season in 2023, as well as including running backs and fullbacks. In 2024, this was extended again, by including wide receivers and defensive backs, and by allowing (but not mandating) players to wear the Guardian Cap during games (although, from my viewing, very few players play while wearing a Guardian Cap).

Rubenstein and Nesbit use data from the 2021/22 to 2023/24 NFL seasons, and a difference-in-differences research design. This basically involves calculating: (1) the difference in concussion prevalence between players in positions with the mandate and players in positions without the mandate before it was introduced; and (2) the same difference after the mandate was introduced; and then testing whether the difference in those two differences is statistically significant. Rubenstein and Nesbit rely on data from weekly injury reports, and their unit of observation is the injured player. Essentially this analysis answers the question whether, for a given injured player, were they more likely to be injured by a concussion when the Guardian Cap was mandated for their position than when it was not?

In their main analysis, Rubenstein and Nesbit find:

... a consistently positive and significant relationship between players that were mandated to wear Guardian Caps after the mandate took place and concussions. This suggests that relative to before the mandate, concussions after the mandate were more likely for players in the position groups affected by the mandate when looking at the total number of injuries across the NFL.

The size of the effect is small but nevertheless meaningful - a given injured player is about 2.6 percentage points more likely to have been injured by a concussion with the Guardian Cap mandate in place, than without it. However, there is a problem here. The question they are answering isn't the question we really want to answer. An injury report might be more likely to be a concussion if there are more concussions, or if there are fewer injuries of other types. In other words, the share of injuries that are concussions can go up either because concussions are more common, or because other injuries are less common, even if concussions themselves haven't changed much. Rubenstein and Nesbit partially allay this concern by showing that there are no effects on either knee injuries or ankle injuries. However, despite being statistically insignificant, the point estimate on knee injuries is negative and of the same magnitude as the positive effect on concussion injuries. So, the effect they observe with their main analysis could be driven by there being fewer knee injuries, and not more concussions.

Fortunately, Rubenstein and Nesbit then go on to look at the count of concussions in each game, comparing players in positions mandated to wear the Guardian Cap and players in positions who were not mandated. In this analysis, they find that:

The coefficient on our variable of interest is consistently positive and statistically significant, suggesting that the prevalence of concussions among players that were mandated to wear the Guardian Caps increased compared to other players after the mandate went into effect. The magnitude of our coefficients suggests about 0.07 more concussions per game for the treated group of positions on a team relative to the untreated group of positions on the team. This may seem small, but considering the observation is per team and per week, our estimates suggest there were about 36 more concussions per NFL season across all linemen, linebackers, tight ends, full backs, and running backs required to wear Guardian Caps than in the season before the mandate.

So, it does appear from the analyses that there was an unintended consequence of mandating the Guardian Caps. The number of reported concussion injuries increased. But not so fast! Remember that the mandate was introduced during a period of increasing scrutiny of head injuries in the NFL. The introduction of the Guardian Caps was not the only change during this period. The NFL changed its concussion protocols during the 2022 season (see also this note by the NFL Players Association). So, an increase in concussions noted on injury reports might be because of a genuine increase in concussion injuries, or it might be because of an increase in the reporting of concussions. Because the concussion protocols changed during the same period, it’s hard to know what concussion reports would have looked like in the absence of the Guardian Cap mandate. Overall, that means that it's very hard to separate a true increase in concussions from increased reporting.

So, we can't conclude from this research that there was a Peltzman effect of mandating the Guardian Caps. It remains a possibility, but we would need better research in order to identify any such effect.

[HT: Marginal Revolution]

Read more:

• Safer cars and offsetting behaviour: NASCAR edition

Grade inflation at New Zealand universities, and what can be done about it

Grade inflation at New Zealand universities has been in the news recently. This is a delayed reaction to this report from the New Zealand Initiative released back in August, authored by James Kierstead. He collected data on grade distributions from all eight New Zealand universities (via Official Information Act requests), and looks at how those distributions have changed over time. The results are a clear demonstration of grade inflation, and most clearly demonstrated in Figure 2.1 from the report:

Over the period from the mid-2000s to 2024, the proportion of New Zealand university students receiving a grade in the A range has increased at every New Zealand university, and by more than ten percentage points overall. Kierstead notes that:

Overall, the median proportion of A-grades grew by 13 percentage points, from 22% to 35%... The largest increases occurred at Lincoln, where the proportion of As grew by 24 percentage points between 2010 and 2024 (from 15% to 39%), more than doubling, and Massey, where they grew by 17 percentage points (from 19% to 36%) from 2006 to 2023.

A similar pattern of increases, although not as striking, is seen for pass rates, which in 2024 were above 90 percent at every university except Auckland. The results are also apparent across different disciplines, as shown in Figure 2.4 from the report:

Of course, this sort of grade inflation is common across other countries as well, and Kierstead provides a comparison that shows that New Zealand grade inflation is not dissimilar from grade inflation in the US, UK, Australia, and Canada.

Kierstead then turns his attention to why there has been grade inflation. He first dismisses some possible explanations such as better incoming students (NCEA results have not improved, although even if they had that might be due to grade inflation as well), more female students (the proportion of female students has been flat over the past ten years, while grades have continued to increase), better funding (bwahahahaha - in fact, funding per student has declined in real terms since 2019, while grades have continued to increase), and student-staff ratios (which have declined over time, but the student-academic ratio, which is the one that should matter most, has barely changed).

So, what has caused grade inflation? Kierstead describes it as a collective action problem, akin to the tragedy of the commons first described by Garret Hardin in 1968:

It is our contention that grade inflation is the product of a dynamic that is not dissimilar to the tragedy of the commons. Just like Hardin’s villagers, academics pursue a good (in this case high student numbers) in a rational way (in this case by awarding more high grades). And just as with Hardin’s villagers, negative consequences ensue, with a common resource (sound grading) being depleted, to the cost of every individual academic as well as others...

In the grade inflation game, the good that academics want to maximize is student numbers. Individual academics, on the whole, want to have as many students in their courses as possible. This suggests that they are popular teachers and can help get them promoted (and hence gain more money and prestige). It can also help make sure the courses they want to teach stay on the menu.

I like this general framing of the problem, where 'sound grading' is a common resource - a good that is rival and non-excludable. However, I would change it slightly, by thinking about the common resource as being A grades generally, which are depleted when the credibility of those grades reduces. In my slightly different framing, awarding A grades is rival in the sense that one person awarding more A grades reduces the credibility of A grades awarded by others. Awarding A grades is non-excludable in the sense that if anyone can award A grades, everyone can award A grades (while it is possible to prevent academics from awarding A grades, universities would probably prefer not to do so because that would reduce student satisfaction). So, while the social incentive for all academics collectively is to reduce the award of A grades to keep the credibility of those grades high, the private incentive for each academic individually is to increase the proportion of A grades awarded, leading to fame and fortune (or, more likely, leading to fewer awkward conversations with their Head of School as to why their grade distribution is too low, as well as better student evaluations - see here and here, for example). Essentially then, the incentives are for academics to inflate grades. The universities have few incentives to act to reduce grade inflation, since higher grades increase student satisfaction and lead to greater enrolments.

However, there is a problem. As Kierstead notes, grade inflation is well-termed because its effects are similar to the inflation that economists are more familiar with:

If universities hand out more and more As in a way that isn’t justified by student performance, the value of an A will go down. The same job opportunities will ‘cost’ more As as As flood the market. Students who worked hard will see the value of their As decrease over time, just as workers in the economy see their savings decrease in value due to monetary inflation.

So, what to do? Kierstead offers a few solutions in the report, including moderation of grades, reporting grades differently on transcripts, calculating grades differently, making post-hoc adjustments to grade point averages, having national standardised exams by discipline, changing the way that universities are funded to reduce the incentive to inflate grades, changing the culture of academics, and giving out prizes for 'sound grading'. I'm not going to dig into those different solutions, because sometimes the simplest one is the best one. With that in mind, I pick this:

Perhaps the simplest addition that could be made to student transcripts alongside letter grades is the rank that students achieved out of the total number of students on the course. So a student’s transcript might read, for example, ‘Classics 106: Ancient Civilizations: A- (27th of 252).’...

Adding ranking information restores some of the signalling value of grades without needing to reverse grade inflation itself. To see why, consider an example. If an employer has the transcripts of two students, one of whom got an A- grade in econometrics and ranked 17th out of 22 students, while the other student got a B grade and ranked 3rd out of 29 students, it's pretty clear that the grade might not be capturing the full picture of the students' relative merit. Kierstead worries about this simple solution because:

A limitation of rank-ordering is that it might suggest that students who achieved only a lowly ranking had performed badly, whereas they might well have performed very well in an especially difficult course.

Possibly, but the key point is not how well students did in the course, but how well they did relative to the other students in the class, which is exactly what the ranking provides. The benefit of this approach is that providing a ranking alongside the grade would reduce the incentives for students to cherry pick easy papers that award high grades, because a high grade on its own would not necessarily lead to a good ranking within the class.

Of course, there are potential problems with the simple solution. One such problem is that comparisons across different cohorts of students might not be fair. Taking the example of the two students I gave earlier, perhaps the student who got an A- grade and ranked 17/22 completed the paper in a cohort that was particularly smart, while the student who got a B grade and ranked 3/29 completed the paper in a cohort that was less smart. In that case, the grade without the ranking might be a better measure.

Kierstead's more complex solutions don't really deal well with the problem of between-cohort comparisons, and suffer from being more complicated for non-specialists to understand. A simple ranking, or a percentile ranking, is relatively easy for HR managers to interpret. Having said that, the between-cohort comparisons issue might not be too much of a problem in any case. My experience though, is for classes of a sufficiently large size (30 or more), the grade distributions do not differ materially (and if they do, it is usually because of the teaching or the assessment, not the students).

I can see some incentive issues though. Would students start to choose papers that they suspect that many weak students complete? Good students might anticipate that this would lead to a higher grade and a better ranking, which will look better on their transcript. On the other hand, is that really any worse than what students are doing now, if they choose papers that give out easy grades?

There are also potential issues with stigmatising students who end up near the bottom of a large class (how dispiriting would it be to have your transcript say you got a grade of E, and ranked 317th out of 319 students?). Of course, that could be solved to some extent by only providing ranking information for students with passing grades. And consideration would also be needed for how to deal with very small classes (is a ranking of 4th out of 5 students meaningful?).

Grade inflation is clearly a problem. It's not just nostalgia to say that an A grade is not what it used to be. Grade inflation has real consequences for employers, because the signalling value of high grades is reduced (see here for more on signalling in education). This means that there are also real consequences for high-quality students, who find it more difficult to differentiate themselves from average students. Solving this problem shouldn't involve government intervention to change university funding formulas, or trying to change academic culture. It shouldn't involve complicated statistical manipulations of grades. It really could be as simple as reporting students' within-class ranking on their academic transcripts.

The question now is whether any university would take it on themselves to do so. The credibility of university grades depends on it.

[HT: Josh McNamara, earlier in the year]

Read more:

• Teaching evaluations and grade inflation
• Grade inflation is harming students' learning
• A few papers on grade inflation at universities
• Grade inflation and college completion in the U.S.
• More on teaching evaluations and grade inflation

More on taxing the super-rich, and exit taxes

In a weird coincidence following yesterday's post about the challenges of taxing the super-rich, the Financial Times published an article on the same topic overnight, making some of the same points:

Income taxes and social security contributions, along with sales taxes, tend to be the main revenue-raisers in developed countries. But they do not address the capital wealth of the super-rich, which is often concentrated in real estate, investments or equity in businesses.

Yet imposing higher capital taxes on a relatively small number of very wealthy individuals often prompts changes in their behaviour that limit or even reduce the amounts raised. Raising taxes on the moderately wealthy, a much larger and less mobile cohort, usually has consequences at the ballot box.

The history of wealth taxes provides a prime example. In the mid-1980s, about half of OECD countries imposed an annual net wealth tax on their richest inhabitants. Today, in Europe only Spain, Norway and Switzerland retain taxes on individuals’ overall net wealth — and they raise relatively small amounts.

“Given the rich are extremely mobile and less and less attached to the country that made their wealth, they can shift and they do,” says Pascal Saint-Amans, a former head of tax at the OECD. “I suspect if you were to ask most billionaires, ‘Where is your loyalty, with your country or with your money?’, most would say, ‘My loyalty is with my money.’”

Interestingly though, the article also presents a potential solution:

One option to address the issue of the rich simply moving their assets elsewhere is the exit tax. Australia, Canada, France, Germany and Japan are among the 14 OECD countries that tax unrealised capital gains for those who change their tax residence, while the US taxes individuals who relinquish their citizenship.

“Tax flight happens less than most people think, but it does happen,” says Arun Advani, director of CenTax, a UK based think-tank, and professor at the University of Warwick. But, he adds: “It’s a policy choice to let them emigrate tax free.”

An OECD working paper on capital taxation this year agreed that exit taxes could curb revenue leakage and discourage tax-induced migration, though it added that these objectives needed to be balanced against other policy aims “such as attracting and retaining talent and entrepreneurs”.

That OECD working paper is available here, and is well worth a read. Exit taxes do sound like a potential solution to the negative incentive effects of wealth taxes or higher taxes on capital income. However, the working paper does not offer a strong endorsement of the effect of exit taxes on curbing out-migration of wealthy taxpayers. Instead it notes that:

...no empirical research on the impact of exit taxes on inward migration and entrepreneurship is yet available.

That definitely suggests a relevant research gap for someone to fill. Since we already have evidence (from the paper I discussed yesterday) of the large incentives for out-migration created by wealth taxes, it would be good to be able to quantify how much that incentive could be offset using an appropriately designed exit tax.

Read more:

• Newsflash! The super-rich are mobile, and higher taxes incentivise them to move away

Newsflash! The super-rich are mobile, and higher taxes incentivise them to move away

The super-rich are super-mobile. So, if a country decides to increase taxes on the super-rich (for example, with a wealth tax), some (but not all) of the super-rich will simply move elsewhere. This should not be a surprise to anyone. And yet, simplistic proposals to tax the super-rich are a favourite policy for some political and advocacy groups.

So, in case there was any doubt about how the super-rich respond to tax incentives, this recent article by Enea Baselgia and Isabel Z. Martínez, published in the Economic Journal (open access), provides some useful empirical evidence. They look at the case of Switzerland which, in addition to being an attractive place for the super-rich to locate themselves, also has taxes at the local (canton) level. Baselgia and Martínez make use of a special tax regime for wealthy foreigners, which was removed by five cantons between 2010 and 2014. As they describe:

One important reason why Switzerland is so attractive for wealthy individuals from around the globe is a special tax privilege the small country offers to wealthy foreigners: the so-called expenditure-based taxation. Those eligible for this special tax regime pay taxes on their (and their spouse’s and dependants’) global living expenses, rather than on their true income and wealth. Living expenses are defined broadly and include all expenditures for food, clothing and housing, taxes and social security contributions (around 25,000 CHF per adult and year), alimony payments, remunerations paid to household employees (in cash and in kind), expenses for education and leisure (sports, travel, cultural events, hobbies), for health and wellness cures, and costs of keeping pets (riding horses, etc.), as well as maintenance and operating costs of cars, motorboats, yachts, aeroplanes, etc.

Then:

Expenditure-based taxation has become the subject of heavy criticism over the past decade, both from outside and within the country. In light of these discussions, several cantons proposed to abolish this practice, usually holding a popular vote... Zürich (2010), Schaffhausen (2012),Appenzell Ausserrhoden (2012), Basel Stadt (2014) and Basel-Landschaft (2014) adopted corresponding proposals and removed the option of expenditure-based taxation. Seven other cantons held a popular vote between 2011 and 2014 that did not find a majority...

Baselgia and Martínez use data from a rich list compiled by BILANZ (the equivalent of the Forbes rich list internationally, or the NBR rich list in New Zealand). They apply a difference-in-differences approach, looking at the difference in the number foreign-born super-rich between the time before and the time after the special tax privilege was withdrawn, between cantons that withdraw the privilege and those that did not. They also apply a different approach, based on a location choice model. Both models result in similar estimates, such that:

...removing this preferential tax treatment reduces the stock of super-rich foreigners by approximately 43% five years after the abolition.

There were no corresponding results for Swiss-born super-rich individuals, who were not affected by the tax change (because they weren't eligible for the special tax privilege). That is an important aspect of the results, because if the Swiss-born also responded to the tax change, it should make us wonder if something else changed at the same time.

Baselgia and Martínez then conduct some back-of-the-envelope calculations, finding that:

...the elasticity of the stock of super-rich taxpayers in a canton with respect to the total net-of-tax rate on wealth lies in the range of 28.4–32.2.With respect to a revenue-equivalent tax on capital income (rather than on wealth), our estimates would imply an elasticity of the stock of super-rich taxpayers of 1.4–1.5.

What that first elasticity means is that a one percent increase in wealth tax rate decreases the number of super-rich taxpayers in a canton by between 28.4 and 32.2 percent. So, as we might expect, tax increases are a big disincentive to the super-rich. And the way that the results are expressed probably understates the magnitude of the effect. Notice that the elasticity is expressed as a one percent increase in wealth tax, not a one percentage point increase. That difference is important. Increasing a wealth tax from two percent to three percent is a one percentage point increase in the tax rate, but it is a 50 percent increase in the tax rate. The elasticity tells us the impact of the latter, which is massive. Now, of course the effect is not likely to be linear, but nevertheless that elasticity is enormous.

The implied elasticity on capital income is also large - a one percent (not one percentage point) increase in tax on capital income decreases the number of super-rich taxpayers in a canton by between 1.4 and 1.5 percent. The effect is not as large, but taxes on capital income are much less consequential for super-rich taxpayers than are taxes on wealth.

Incentives matter, and proponents of wealth taxes and other taxes on the super-rich must not be allowed to ignore the incentive effects. Is it better to tax a larger number of super-wealthy foreigners a little bit, or to tax a much smaller number of super-rich foreigners (or no super-rich foreigners at all) by much more? This research doesn't tackle that question, but that is what needs to be considered.

The moral hazard of bailing out scam victims

Earlier this year, bowing to pressure from media and advocacy groups, banks acted to help out victims of financial scams. As the New Zealand Herald reported in April:

Banks will be required to reimburse fraud victims up to $500,000 and introduce new rules to crack down on scammers in a suite of measures unveiled today.

The changes include new technology to identify risky or unusual transactions based on a customer’s banking history and the ability to freeze payments and suspect accounts.

The moves are in response to Government demands to improve customer protections or be regulated in the face of Kiwi victims losing hundreds of millions of dollars to scammers each year...

The New Zealand Banking Association says it is rolling out a package of new protections in line with international best practice, which will be in place by November.

However, by itself the reimbursement of fraud victims creates a problem that might actually result in there being more victims of fraud overall. That is because of what economists call moral hazard. Moral hazard arises when one of the parties to an agreement has an incentive, after the agreement is made, to act differently than they would have acted without the agreement. Importantly, the agreement doesn't have to be a formal contract. It can be an implicit understanding or expectation.

In this case, there is an implicit agreement between banks and their clients, that makes it clear that the bank will reimburse the client when the client is impacted by a financial scam. Without that implicit agreement, bank clients have a strong financial incentive to avoid being scammed. If they are scammed, they lose a lot of money. However, now that banks will bail them out, bank clients have less incentive to act carefully and avoid financial scams. Scammers may be more successful as a result, leading to more scam victims.

This is not to say that bank clients will be flagrantly imprudent with their money, only that at the margin, clients will act a little less cautiously. The moral hazard problem here is that the risky actions of the bank clients end up costing the banks money, in the case when the bank client is scammed and the bank needs to reimburse them. If banks couldn't do anything about the risk, they would be less inclined to take on depositors. If the risk turned out to be extreme, the market for bank deposits could fail entirely.

Fortunately, banks can respond to this increased moral hazard in various ways. The first way is through increased monitoring of their clients. Notice in the quote from the article above that banks will employ "new technology to identify risky or unusual transactions based on a customer’s banking history". By monitoring clients' transactions, banks can hopefully head off any scam activity. Banks could also use incentives to reward their clients for not being scammed. Perhaps they could pay slightly higher interest rates to those that pass occasional bank-delivered 'scam checks' (where the bank employs someone to test whether the client will fall for a scam). None of the banks are proposing this yet, but it is a solution that is open to them.

Overall, this change is likely to be positive for bank clients. However, with these new scam protections in place, people will be less careful. Banks will need to remain very vigilant, or the number of scam victims will increase.

Tim Harford on unintended consequences

In the Financial Times last month, Tim Harford (who is always an interesting read) had a good piece on unintended consequences (paywalled, but available ungated on his website). It covers a number of examples of unintended consequences, including the (possibly apocryphal) 'cobra effect':

It describes an attempt by the British Raj to rid Delhi of its cobras by paying a bounty for each cobra skin, thus encouraging a thriving cobra-farming industry.

However, Harford devotes more attention to a more recent example that is definitely not an urban myth, where:

...the Straits Times and Climate Home News recently reported on a striking scheme in Melaka, Malaysia, where locals were selling cooking oil that would eventually be used to supply European producers of aviation fuel. The underlying idea of turning a waste product, used cooking oil, into something that can be blended into aviation fuel seems as appealing as getting the cobras out of Delhi. Cooking oil starts tasting bad after being used for frying three to five times, but as an input to aviation fuel, used oil is perfectly good.

At this point two intriguing forces intersect: European governments are demanding that airlines use more biofuels from sustainable sources — used cooking oil being one — while the Malaysian government subsidises cooking oil. This means that in Malaysia buying fresh oil is cheap and selling used oil is lucrative. If you run a food stall or restaurant in Malaysia, you can buy subsidised fresh oil, fry food a few times, then sell the waste oil at a profit. It’s a nice side-hustle.

The trouble is, writes financial journalist Matt Levine, “If you don’t run a restaurant, you can buy fresh cooking oil for $0.60, not use it to fry food any times, and then say, ‘Oh, yeah we totally used this oil,’ and sell it to a refiner for $1.” That seems a simpler and more scalable way to proceed. It certainly cuts out the precarious, time-consuming hassle of actually running a restaurant. It is hard to know how much fresh oil is being resold this way, but fraudsters have both the motive and the opportunity. Climate Home news notes that Malaysia collects an astonishing volume of “used” cooking oil: more per person than anywhere else, and two and a half times as much as second-placed Singapore.

You can real the original stories on this on the Straits Times and Climate Home News. Incentives matter, and it is incentives that can create unintended consequences. When a policy like this goes wrong, it is often a failure to consider the incentives.

However, just because the consequences are unintended, that doesn't mean that they need be unanticipated. Policies should be subjected to a careful consideration of the incentive effects that they create, and importantly, how entrepreneurial folks might try to game the policy. Software developers have a practice of 'red teaming' new software (like generative AI tools) to test whether they can be hacked or used for no good. Perhaps governments need to start red teaming policy?

The negative incentives in driver licence testing

My son has had a motorbike and his motorbike learner's licence for the last six months or so. Last week, he attempted the practical driving (riding?) test to move to a restricted motorbike licence. The test cost him $175, paid to the testing agency. The good part was that at least he could do the test riding his own motorbike, which he is familiar with. He was looking forward to the additional freedom that the restricted licence allows.

My son failed the test. Apparently, part of the practical driving test involves being able to maintain stable control of the motorbike while travelling at 100km/h. The person administering the test asked my son to ride along a straight road uphill. My son's 225155cc motorbike can only just maintain 100km/h on a straight flat road. It was never going to be able to do so on an incline, and it didn't. That's why he failed his test (although he also admits he didn't indicate when turning around at the end of a cul-de-sac).

So, now my son will have to attempt the test a second time. Unlike testing to get a car licence, the fee you pay does not include multiple attempts. My son will have to pay again for his next test. And because he may legitimately worry that his motorbike won't get to 100km/h in that part of the test again, he will need to use a bike on loan from the testing agency. The cost for that is $225.

What does this have to do with economics, you ask? I question the incentives here. The agency doing the testing benefits each time a driver fails the test, because the driver will need to sit an additional test at additional cost. That additional test means additional revenue for the testing agency. The agency therefore has an incentive to fail as many drivers as possible, to increase their revenue (and profits). I'm not saying that's what happened for sure in this case, but it's consistent with the incentives that the system creates.

And there are any number of ways that a testing agent can fail a driver. When I was young, I had two friends who both failed their restricted car licence test, because the testing agent leant over, honked the horn and waved to someone walking by. Because this was dangerous and the driver didn't prevent the testing agent from doing it, my friends both failed their test. At the time, we all just thought that it was messed up and that the testing agent was a bit of an ass. But again, it is consistent with the incentives that the system creates.

How could this problem be resolved? To some extent, it is now resolved for car licences. Unlike when I was young, the application fee for a car licence includes two tests (see here). If a driver fails their first test, they can sit a second test for free. With that system, there is little incentive for the testing agent to fail the driver, because having the driver come back for a second test costs the testing agency but provides no additional revenue. The incentive problem is alleviated. What I don't understand is why the system is different for motorbike and heavy vehicle licences, where drivers have to pay for every test.

Incentives matter. People will take advantage of a system that provides them with an avenue for additional gain, and the driver licensing system seems to do that for testing agencies. My son will no doubt pass his next licence test, but at significant extra (and possibly unnecessary, depending on how serious not indicating at the end of a cul-de-sac is viewed) cost. He won't be alone in this experience. Motorbike riders would be significantly better off if the system was changed.

Unintended consequences of visas for victims of serious crime

Following yesterday's post, and still on the topic of incentives, consider this example reported by CWB Chicago back in May:

Federal prosecutors on Friday announced charges against five people in connection with a Chicago-based scheme that staged armed robberies so the purported victims could apply for U.S. immigration visas reserved for legitimate crime victims...

Officials believe hundreds of people, including some who traveled from out of town, posed as customers in dozens of businesses across Chicago and elsewhere, all hoping to win favorable immigration status by becoming “victims” of pre-arranged “armed robberies.”...

Federal prosecutors said on Friday that each. purported “victim” paid “thousands of dollars” for the privilege of being robbed at gunpoint. Ringleaders then instructed the “victims” to be at a certain location at a specific time to be “robbed.”...

After the robberies, the “victims” went to their local police departments to secure documentation that they were the victims of a crime that qualified them to apply for a “U-visa.” That’s an immigration status reserved for “victims of certain crimes who have suffered mental or physical abuse and are helpful to law enforcement or government officials in an investigation or prosecution,” federal officials explained Friday. Some relatives of U-visa recipients also qualify for special status. In time, U-visa recipients may qualify for permanent residency.

Obviously, the policy to grant a visa to victims of serious crime was implemented in order to help those victims (as well as crime investigators, since the victims would remain available to provide witness statements and testify if a case goes to trial). The problem is that it changes the costs and benefits of being a victim of crime for those who are not already US citizens, and created unintended consequences.

Being a victim of a serious crime comes with obvious costs, but nothing much in the way of benefits. However, being able to claim a U-visa adds some benefits to being a victim of serious crime (for non-US citizens). That by itself is probably not enough to make someone want to be the victim of a serious crime. But what if they could be a 'victim of a serious crime', without being victimised by the crime? They would gain the benefit of the U-visa, without the psychological costs of being a victim.

Now, if the benefit of the U-visa is sufficiently valuable (and given the number of illegal border crossings into the US each year, it seems like living in the US is pretty attractive), a non-US citizen might even be willing to pay for the 'privilege' of being a 'victim of a serious crime'. And there you have it - an unintended consequence of the U-visa.

[HT: Marginal Revolution]

Incentives turn against term-time holidays for families

Both my ECONS101 and ECONS102 classes covered incentives this week (among other things). So, I was interested to see this article in the New Zealand Herald last week:

Families with school-aged children are choosing not to take their children out of school to travel, Flight Centre data has shown, as the Government cracks down on truancy.

Flight Centre New Zealand general manager Heidi Walker said it appeared the messages from the Ministry of Education were getting through to parents.

New data had shown travel bookings during the winter holidays were up 10% from last year, while travel during the school term had dropped 30%.

It comes after the Government announced in April it would start cracking down on truancy by introducing a “traffic light system” of punishments for students and their parents, including fines for parents and police referrals.

Incentives are rewards or punishments that influence the benefits and costs of the alternatives that a decision-maker can choose. In this case, parents can choose to go on holiday during the winter school holidays, or during term time. Going on holiday during term time means parents must take their children out of school.

Because of the Government's recent rule changes, parents now face the risk of punishment if they take their children out of school to go on holiday. The cost of term-time holidays has therefore gone up, because the 'full cost' of the holiday includes not just the price of the holiday, but also the risk of punishment for children missing school. When the cost of something increases, we tend to do less of it. The increase in the cost of term-time holidays leads families to take fewer term-time holidays (which have decreased by 30 percent, according to the article).

However, the policy change also affects holidays during the winter school holiday period, even though the full cost of those holidays has not changed. To see why, consider the relative price (or relative cost) of travel during school holidays compared with travel during term time. Since the cost of travel during term time has gone up, and the cost of travel during school holidays has remained the same, the relative price of travel during school holidays has decreased (travel during school holidays is now relatively cheaper than travel during term time, compared with before the policy change). When the relative price of something decreases, we tend to do more of it. The decrease in the relative price of travel during winter school holidays leads families to do more winter school holiday travel (which has increased by 10 percent, according to the article).

Incentives matter. They affect our decisions, by changing the costs and/or benefits of the alternatives available for us to choose.

Singapore Airlines' incentives for connecting passengers on late flights

I'm writing this post from a hotel in Singapore, during an unscheduled day-long stopover during my return to New Zealand from Belfast. It has been a bit of an experience, but interestingly it highlights a number of things related to incentives, which I'll be covering in both my ECONS101 and ECONS102 classes in their first week coming up.

Today (technically, it was actually yesterday, due to the time zone changes) started in an eventful way. We travelled from Belfast to London Heathrow yesterday and stayed overnight in the Hilton Garden Inn, which overlooks one of the runways and Terminal 2. When we woke up and looked out the window, we could see a massive crowd of people outside, with police and ambulance vehicles lined up at the entrance to Terminal 2. It turns out that Terminal 2 had been evacuated after someone had left a 'suspicious package' at check-in.

Fortunately for us, the evacuation was all over in about 90 minutes, and before we had to check in for our return flights, via Singapore to Auckland. However, the reopening of Terminal 2 was the start of absolute chaos (which you can see in the articles linked above). The check-in and security system at London Heathrow is usually running at full capacity at the best of times. Now factor in a 90-minute backlog of passengers trying to get through in time for their flights.

My wife and I arrived in plenty of time and, thanks to the fast track (and arriving early) we made it to our flight on time. However, others were not so lucky. Singapore Airlines kept the flight at the gate for an hour and twenty minutes, waiting for the last 40 passengers to clear security and get to the gate. Our plane then missed its take-off slot, and the Heathrow air traffic control tower then kept us parked at the gate for a further half hour waiting for a new slot to open up.

Finally, we were underway, but nearly two hours late. That doesn't sound too bad, but my wife and I (and a not insignificant number of other passengers) were supposed to be connecting with an Air New Zealand flight from Singapore to Auckland, which was due to leave one hour and twenty minutes after the originally scheduled landing time of our Heathrow to Singapore flight. I thought the pilots might try to make up some time during the flight (which I have experienced on other delayed flights in the past), but these pilots did nothing. We arrived in Singapore, and our flight to Auckland had already left. So, Singapore Airlines rebooked us on a later flight, and put us up in a hotel for the day. And we were not alone. There were dozens of affected connecting flights, and dozens of passengers that were rebooked and sent to hotels.

So that's my story. What does this have to do with incentives? As I will note in lectures for ECONS101 and ECONS102 this week, incentives for decision-makers to change their behaviour arise when the costs and/or benefits change. In this case, there are a number of changes in costs that affected Singapore Airlines' decisions.

Think about my story from Singapore Airlines' point of view. There were several choices they had to make. First, when they realised that a number of passengers were running very late for the Heathrow to Singapore flight, they had (at least) two alternatives to choose from. They could have the original flight leave on time (or close to it) and re-book the 40 late passengers on alternative flights. Or, they could wait for those late passengers. Clearly, re-booking passengers is expensive and time-consuming, and especially so for long-haul flights with connections that might also be missed. So, Singapore Airlines chose the least costly option, which was to delay the departure of the Heathrow to Singapore flight.

Second, once the Heathrow to Singapore flight was in the air, they could choose to amble along at regular speed, or try to make up time. Both of these options were going to be costly to Singapore Airlines. Making up time would use more fuel, and jet fuel is expensive (according to this website, it costs approximately £205,000 or NZ$430,000 to fill an Airbus A380 full of fuel). However, ambling along at regular speed entails costs in terms of re-booking passengers, as well as taxi and hotel costs for passengers re-booked on much later flights. I don't know the real costs involved here of course, but clearly Singapore Airlines believed that it was less costly to re-book passengers and face those costs, rather than paying for additional jet fuel. [*]

Finally, there are some long-term incentives for passengers here, and Singapore Airlines' decisions could be counterproductive to their long-term interests. Airlines want passengers to arrive at the airport early, check in and clear security. This gives them some certainty over the number of passengers flying, and baggage weight, which need to be known for calculating the fuel load required for the flight. However, Singapore Airlines' decisions today were to the benefit of passengers who arrived at the airport later, and imposed additional costs on passengers who arrived early (like my wife and I). The expected costs and benefits of future airline travel have changed. Perhaps we shouldn't bother to be so early to the airport in future, if airlines are simply going to hold the plane for us if we are running late? In the meantime, we'll enjoy Singapore Airlines' hospitality during this unexpected stopover, and I'll be thankful that I will still arrive in time for teaching on Monday.

*****

[*] Of course, there may be another possibility here, which is that the A380 didn't have enough fuel to operate fast enough to make an appreciable difference to the flight time. I'd be surprised by this though, as planes are required to carry additional fuel beyond what is necessary for the journey.

The consequences of free drivers licence test resits

The New Zealand Herald reported this morning:

On October 1, at the Labour Government’s directive, NZ Transport Agency Waka Kotahi (NZTA) changed driver licence fees to an all-in-one fee for each stage of testing and the fees to resit a driver test, or to cancel or reschedule, were removed.

The intention was to help ease costs for people going through the driver licensing system. The Transport Minister at the time, Michael Wood, said the changes would save drivers on average $86 each and cumulatively save $5.5 million every year altogether.

But delays to practical test bookings have followed since the change. Average wait times for the week ending April 14 were 44 days for a full licence test throughout the country and 55 days for a restricted test.

The longest delays for a full test were 52 days in the Bay of Plenty, and 68 days in Wellington for a restricted test.

The issue is affecting all regions in New Zealand. As an example, at 10am on April 3 there were only 15 available spots nationwide for a full licence test and only 10 for a restricted licence test.

It should be no surprise that when you lower the price of something, without that price change being driven by a decrease in costs or a decrease in demand, you end up with a shortage. This can be seen in the diagram below. At the original market price for a driver licence test of P0, the quantity of driver licence tests is Q0. That quantity (Q0) is both the quantity of tests demanded, and the quantity of tests supplied (the number of tests available for drivers to take). We can say that the market clears, because quantity demanded is equal to quantity supplied (the market is in equilibrium).

With the market price below equilibrium, at P1, [*] the quantity of driver licence tests demanded is QD, while the quantity of driver licence tests supplied is QS. Since QD is greater than QS, there is excess demand (a shortage). That is what we are seeing, with long waits for driver licence tests.

There are other problems as well. From the same New Zealand Herald article:

[VTNZ’s national technical manager for vehicle testing, Craig] Basher said a large factor of the delays has been the amount of people not showing up to tests, with 2000 no-shows for booked practical tests in the last month.

He has also received feedback that more drivers are turning up unprepared and with unfit cars, making simple mistakes and trying to rebook straight away without further practice.

When a learner driver has to pay for another driving test when they miss an appointment, that creates an incentive to show up, and to show up prepared and with a good quality vehicle. When the learner driver doesn't have to pay, the incentive to show up is much less. In other words, the opportunity cost of missing a driving test is lower when learner drivers don't have to pay for the next appointment. When the opportunity cost of something decreases, people tend to do more of it. In this case, that means more missed driving test appointments.

None of this is surprising to an economist. And the solution is obvious:

[Minister of Transport, Simeon] Brown said he is talking with NZTA and the Ministry of Transport to deal with the issue, which he said could include reintroducing resitting fees.

Some may argue that increasing the number of test slots, and increasing the number of driving instructors, would decrease the shortage. However, that ignores that part of the problem is the number of missed appointments. Both the shortage and the excessive number of missed appointments could be alleviated if the price of repeat driving tests was allowed to increase. Learner drivers would have to pay a little more to get their licence, but they wouldn't have to wait as long, and would have a stronger incentive to show up for their driving test well-prepared.

*****

[*] Notice that the price doesn't fall all the way to zero, because the first drivers test is not free, only the resits. So, the average price of a drivers licence test is not zero.

When you offer free rubbish disposal, you'll get more rubbish

The Rotorua Daily Post reported today:

Kāinga Ora has been forced to pick up the clean-up tab after “mountains of rubbish” were dumped on Rotorua’s Wrigley Rd following what was supposed to be a friendly day to bring the street’s community together.

More than 40 tyres, whiteware, lawnmowers, old mattresses, drawers, old bikes, bags of household rubbish and dirty nappies were dumped on Fordlands’ Wrigley Rd, mainly over the weekend, after people who don’t live on the street “abused” a clean-up day organised by Kāinga Ora that offered free skip bins...

One resident, who didn’t want her name published for fear of repercussions, told the Rotorua Daily Post it was initially an awesome day as residents were pitching in to help each other carry heavy items, including old fridges and mattresses...

She said word then quickly spread, including on social media, that Wrigley Rd was the place to go to dump rubbish free of charge.

She said on Friday she was concerned when more people arrived in cars with trailers and started to dump rubbish.

None of this should be particularly surprising. When the cost of doing something (in this case, rubbish disposal) reduces, people will tend to more of that thing. When the cost is lowered to zero, people may do a lot more of that thing. When the residents of Wrigley Road were offered free rubbish disposal, we shouldn't be surprised that the Wrigley Road residents disposed of lots of extra rubbish.

However, this came with an unintended consequence. Because there was no way of easily policing who was disposing of rubbish, other enterprising individuals took the opportunity to dispose of their rubbish in Wrigley Road as well. As I note in my ECONS102 class, this might have come as a shock to the Kāinga Ora staff, because they didn't think through the incentives that free rubbish disposal creates. That's because it's easy to envision how people who think like you do will react to an incentive plan, but not everyone thinks like you do. In fact, people are often far smarter at taking advantage of incentives than we give them credit for.

So, it should not surprise us at all that offering free rubbish disposal resulted in a lot of rubbish being dumped.

Woolworths learns the hard way that incentives change behaviour

In their book Think Like a Freak (which I reviewed here), Steven Levitt and Stephen Dubner give an explanation of how incentives lead to unintended consequences:

• No individual or government will ever be as smart as all the people out there scheming to take advantage of an incentive plan;
• It’s easy to envision how people who think like you do will react to an incentive plan, but not everyone thinks like you do; and
• We assume that people will always behave the same way they do today. But incentives by their very nature change people’s behaviour, sometimes in unexpected ways.

Woolworths learned this the hard way this week, as explained in this New Zealand Herald article:

A loophole in the new Woolworths Everyday Rewards loyalty programme has seen some shoppers create burner accounts and claim hundreds of dollars in points to spend in-store.

A generous 1000 points for downloading the app and registering an account has seen people create multiple accounts to claim the reward.

The points were then shared back to the main account. A $15 voucher to spend in-store or online was given for every 2000 points.

One man who worked with computers had heard through friends about the loophole and was surprised it was so easy.

“I heard about people making multiple burner accounts and stocking them each with $150-plus in rewards, then driving around buying up the sports supplements,” he said.

He said Woolworths had since shut the loophole by disabling the ability to share points between cards.

How did this happen? Woolworths is clearly not as smart as all the people who try to take advantage of the new rewards scheme. It's easy for Woolworths to anticipate how their own marketing team (or whoever devised the rewards scheme) will react to the scheme, but not everyone thinks that way. And, if they based the scheme on people's past behaviour on the OneCard loyalty scheme, making a change to the scheme (by giving away 1000 free points) will change their behaviour. This was a classic case of unintended consequences, and an expensive lesson about human behaviour for Woolworths.

[HT: The incomparable Gemma Piercy-Cameron]

Electric vehicles, relative prices, and changing consumer behaviour

My ECONS101 class doesn't start for a couple of weeks, but I figures I would post this now. In yesterday's New Zealand Herald, there were two stories related to changes in electric vehicle policies, and the resulting changes in consumer behaviour.

First, this article talks about the removal of the electric vehicle subsidy scheme (which I discussed earlier here and here and here):

EV sales drove off a cliff in January, as expected, with a carrot gone and stick about to hit.

At the same time, light commercial sales jumped 53 per cent with the abolition of the “ute tax” and “ICE” passenger vehicle sales surged.

With the clean car discount gone, petrol and diesel vehicles - less than half the market during most months of 2023 - accounted for 96 per cent of new vehicle registrations in January 2024, according to Motor Industry Association (MIA) figures.

There were just 244 new registrations of new battery electric light vehicles during the month compared to 3469 during December - when sales spiked in the final month of the CCD - and 448 in January 2022.

Consider the change in relative prices here. When one good (Good A) gets more expensive relative to some other good (Good B), consumers will tend to buy less of Good A and more of Good B. There is no surprise here. Removing the 'clean car discount' subsidy from electric vehicles makes them more expensive to buy, relative to petrol and diesel vehicles. Consumers respond by buying more petrol and diesel vehicles, and fewer electric vehicles.

The figures here probably overstate the impact of removing the subsidy. Some consumers who were thinking about buying an electric vehicle this year probably pushed their purchase decision forward to the end of last year instead (and there is some evidence for that).

Removing the clean car discount wasn't the only recent policy change that will affect electric vehicle owners though. As this second New Zealand Herald article reported:

Kevin Parker’s Outlander plug-in hybrid vehicle is getting on in age, and its electric battery is down to around 15km of driving range even when fully charged.

Since Parker lives in a rural Marlborough, he said, the battery “only gets him to the end of the road” - meaning, for most of every journey, he uses petrol.

Under changes to road user charges, this means he faces paying both petrol taxes (on his fuel) and road user charges (for driving an EV) for most of every journey - a change he said made his vehicle “not economically viable”.

Like some other plug-in hybrid owners, he wants to remove the electric plug, to avoid the Government’s new road user charges.

As I note in my ECONS101 class, rational decision-makers tend to try to capture benefits, and avoid costs. This is a clear case of avoiding costs. Since plug-in hybrid vehicles will now attract additional costs, it makes sense for some drivers to remove the plug from their vehicle. That will especially be the case where the benefits of having the plug are low. If you only get 15 kilometres of travel from the battery, the costs in additional road user charges are going to far outweigh the benefits of having the battery.

None of these changes in behaviour should be unexpected though. When the costs and/or benefits associated with decisions change, some decision-makers will change their behaviour.

Read more:

• You can pay a subsidy with a tax, but it won't eliminate the deadweight loss
• Who will really gain from the electric vehicle subsidy?
• Network externalities and electric vehicle subsidies

Effective marginal tax rates, and work incentives for older people

Tax rates matter for work incentives. When tax rates are high, there is less incentive for people to work. They may pass up additional work and choose leisure time instead. However, it isn't just taxes that matter. It is the loss of other entitlements as well. All of these are bound up in what is called the effective marginal tax rate (EMTR), which is the amount of the next dollar of income a taxpayer earns that would be lost to taxation, decreases in rebates or subsidies, and decreases in government transfers (such as benefits, allowances, pensions, etc.) or other entitlements.

Because they relate not just to tax rates, but to the loss of other entitlements, EMTRs can get very high (sometimes over 100 percent), and present a strong disincentive for work. This article in The Conversation this week, by Peter Martin (Australian National University) presents one example for Australia:

Pensioners who do go over the $227 per week limit lose half of every extra dollar they earn in a cut to their pension.

Plus tax, this means they lose a total of 69% of what they earn over the limit where their tax rate is 19%, and 82.5% on the portion of earnings taxed at 32.5%.

And this is after the boost designed to “incentivise pensioners into the workforce”.

So, the EMTR for older people in Australia could be as high as 82.5 percent. And the consequence of this, in comparison with New Zealand (where there is no reduction in national superannuation for older people who work):

In Australia, 15.1% of the population aged 65 and older are in some kind of paid work, up from 14.7% a year earlier.

In contrast, in New Zealand the proportion has just hit 26%. That’s right: more than one-quarter of New Zealanders aged 65 and older are employed.

That's a substantial difference, that is almost certainly explained in part by the difference in EMTRs between New Zealand and Australia. Now, sometimes government may have a good reason for high EMTRs and the work disincentives they create. For example, tertiary students in New Zealand who receive a student allowance face an EMTRs of 100 percent beyond the first $258.08 of additional work earnings. That ensures that students don't spend so much time working that they can't concentrate on their studies. However, it's hard to make a similar argument for older people. Would the Australian government want a high EMTR on older people who that they don't spend so much time working that they can't concentrate on their retirement?

Most governments want older people to work more, not less, in order to mitigate labour force shortages (e.g. see the Older Workers Employment Action Plan for New Zealand). Australia seems to be getting this wrong. As Martin concludes:

...New Zealand is certainly making it easier for retirees to work legitimately, rather than stay at home or accept cash in hand.