Incentives usually always do what they’re supposed to do. They also usually do a lot of other unpredictable things.
Take securities trading, as described in this Businessweek article “Where has all the trading gone?”
The article describes how volumes are way down at traditional exchanges like the NYSE and Nasdaq and are way up at “dark pools” – exchanges that trade “exotic” securities (which don’t need to be that exotic) in a less regulated and observed environment.
That regulated trade is down and unregulated trade is up: it is exactly what the incentives incentivize.
Some quotes that paint the picture:
“Most dark pools were set up in the mid-2000s, taking advantage of regulatory changes that encouraged more electronic trading.”
“Public exchanges are subject to more regulatory requirements than dark pools are. For one thing, they must file extensive data on trading activity to the Securities and Exchange Commission. Exchanges also must treat all customers equally. Since dark pools are run by brokerages, they can discriminate, granting access only to certain firms and charging them different prices.”
And note that the NYSE CEO wants to “fix” this problem through more regulation. His exchange can’t compete so he wants the government to help him. Crony capitalism at its worst; and not only that, but it will make the problem worse. Is the so called war on drugs working? Well, neither will the war on stock trading. The incentives won’t allow it.
Incentives get distorted and weird things result in Evolve, Part 2: Incentives. Is truth stranger than fiction? Read the book and find out.