Free Naked Economics by Charles Wheelan Page B

was straightforward: Fewer cars on the road would lead to less air pollution.
    So what really happened? As would be expected, many people did not like the inconvenience of having their driving days limited. They reacted in a way that analysts might have predicted but did not. Families who could afford a second car bought one, or simply kept their old car when buying a new one, so that they would always have one car that could be driven on any given day. This proved to be worse for emissions than no policy at all, since the proportion of old cars on the road went up, and old cars are dirtier than new cars. The net effect of the policy change was to put more polluting cars on the road, not fewer. Subsequent studies found that overall gas consumption had increased and air quality did not improve at all. The policy was later dropped in favor of a mandatory emissions test. 7
    Good policy uses incentives to some positive end. London has dealt with its traffic congestion problems by applying the logic of the market: It raised the cost of driving during the hours of peak demand. Beginning in 2003, the city of London began charging a £5 ($8) congestion fee for all drivers entering an eight-square-mile section of the central city between 7:00 a.m. and 6:30 p.m. 8 In 2005, the congestion charge was raised to £8 ($13), and in 2007, the size of the zone for which the fee must be paid was expanded. Drivers are responsible for paying the charge by phone, Internet, or in selected retail shops. Video cameras were installed in some 700 locations to scan license plates and match the data against records of motorists who have paid the charge. Motorists caught driving in central London without paying the fee are fined £80 ($130).
    The plan was designed to take advantage of one of the most basic features of markets: Raising prices reduces demand. Raising the cost of driving discourages some drivers and improves the flow of traffic. Experts also predicted an increase in the use of public transit, both because it is a cheap alternative to driving, but also because buses would be able to move more quickly through central London. (Faster trips lower the opportunity cost of taking public transit.) Within a month, the results were striking. Traffic fell 20 percent (settling after several years at 15 percent lower). Average speed in the congestion zone doubled; bus delays were cut in half; and the number of bus passengers climbed 14 percent. The only unpleasant surprise was that the program had such a significant deterrent effect on car traffic that revenues from the fee were lower than expected. 9 Retailers have also complained that the fee discourages shoppers from visiting central London.
    Good policy uses incentives to channel behavior toward some desired outcome. Bad policy either ignores incentives, or fails to anticipate how rational individuals might change their behavior to avoid being penalized.
     
     
    The wonder of the private sector, of course, is that incentives magically align themselves in a way that makes everyone better off. Right? Well, not exactly. From top to bottom, corporate America is a cesspool of competing and misaligned incentives. Have you ever seen some variation of the sign near the cash register at a fast-food restaurant that says, “Your meal is free if you don’t get a receipt. Please see a manager”? Does Burger King have a passionate interest in providing a receipt so that your family bookkeeping will be complete? Of course not. Burger King does not want its employees stealing. And the only way employees can steal without getting caught is by performing transactions without recording them on the cash register—selling you a burger and fries without issuing a receipt and then pocketing the cash. This is what economists call a principal-agent problem. The principal (Burger King) employs an agent (the cashier) who has an incentive to do a lot of things that are not necessarily in the best interest of the firm.