Societies we live in are often stuck in suboptimal Nash equilibria (more context here).
Those equilibria often arise from misaligned incentives. In many cases, decision makers have no stake in the game and the result, unsurprisingly, sucks.
The solution is seemingly easy: Change the rules in such a way that the incentives are aligned. Shift decision making to those who will be affected by the decision.
While generally a good advice this is often not that straightforward.
Here's a story of one such attempt.
After the communist regime fell in 1989 basically everything in former Ostblock countries belonged to the state. Enterprises were inefficient and often required subsidies from the state. Switching to market system was supposed to solve the problem. And to do that the state-owned enterprises had to be transferred to private ownership.
The way to did that in Czechoslovakia (a system later adopted by Russia and other East European countries) was so called "voucher privatization". Technically, you, as a citizen, got vouchers that you could use to buy shares in state-owned enterprises. Having shares you would be incentivized to care about the company, vote in shareholders' meetings and so on. Or so did the theory go. Would could go possibly wrong?
Soon thousands of Czechs were signing over their voucher books to "Harvard Funds", who promised a 1000% rate of return on investment. Harvard Funds bought shares in a number of companies, stripped assets and transferred the money abroad to offshore tax havens like the Bahamas.
But even those who haven't fell for such obvious scams have often exhibited the proverbial Slavic pessimism and tried to cash out as soon as possible. Offers like "A microwave over for your vouchers!" were popular. A bird in the hand is worth two in the bush.
And given the massive asset-striping that went on during the next decade one can't say that the strategy was unwise. I haven't conducted a survey but among the people I know one managed to get some 5000 EUR selling his shares. Everyone else got either nothing or only a laughable amount.
Those who haven't cashed out immediately may haven't fared much better. They found themselves holding shares of companies located at random places in the country, companies they often knew nothing about, companies they had absolutely no attachment to. They were supposed to attend shareholders' meetings, try to keep the company afloat, prevent it from being asset-stripped. But hey, if the shareholders' meeting takes place 500 kilometers away and the value of your shares is dubious maybe it's wiser to stay at home and keep the money you would have to pay for the train ticket and the stay in a hotel. And then, even if you attended, what would you do? The shares were small and your vote was unlikely to change anything. You haven't known other shareholders to form a voting faction. And even if you had a chance to change the outcome then what would you vote for in the first place? If presented with two guys contending for the role of CEO how would you know which one was a scammer and which one was a honest person? And probably (Slavic pessimism kicks in again) they were both scammers and what you were seeing was a contest for the mandate to asset-strip the enterprise.
In the end, economy was owned by the nouveau riche class, also known as oligarchs, mostly petty criminals turned big criminals and clueless simpletons turned corrupt politicians.
One takeaway from the story may be that aligning incentives isn't enough. You also have to make sure that people are able to act on those incentives. You have to make sure that they are educated enough to handle the challenge. Forty years of real socialism haven't exactly made people into savvy investors. You have to make sure that information is propagated back to the decision makers. You have to build the trust in the rule of law to make people do long-term bets. You have to make people actually invest real money or effort in their shares so that sunk cost fallacy kicks in. And so on.
But better way to think about the whole thing is to internalize the fact that incentives are a tricky business. If you believe you know what incentives a policy will result in, you are wrong. In this particular case the policymakers made a prediction on a basis of the most simplistic economic worldview. It was, speaking metaphorically, homo economicus gone berserk. The model told them that people would care about their investment and thus they will care about the companies they've owned. In reality, it turned out that people cared about their investment and thus they cashed out immediately. The result was a decade of Mafia-run state. However, Czechoslovakia managed to escape the worst consequences by being accepted to the EU. Other countries have fared worse. Just look at the mess that is Ukraine.
Could we have done better? Am I being clever just because I have the advantage of the hindsight?
Well, if you want to know what a result of a policy is going to be, just do an experiment. What prevented us for running an experiment on 1% of the population, first come first served style? Once those 150000 people got their shares we could have waited a bit to see what went wrong. Then we could have tried to fix it.
Instead, we chose to rely on our economists' hubris and we failed.
December 23rd, 2017