Thinking like an investor Series: Part 3 – Incentive and optimal choice

March 2, 2019

Hopefully over the course of the last few articles, Part 1 and Part 2, I have helped you better understand the mindset of an investor. So far, we have discussed about the 5 Checklist principles and the three core fundamentals.

In today’s article I am going to explore the issues of incentives and optimal choice by conducting a case study on the world’s commercial fisheries in order to understand this concept.

The reason we are conducting a case study of the world’s commercial fisheries is to analyse and dissect an industry which is on the verge of collapse, to sharpen our critical analysis. The first question is to ask why is the industry on the verge of collapse? Over fishing is a real dilemma the industry is facing with the depleting populations of fish and the rate of catch to feed the market demand has become unsustainable.

The real losers in this scenario are the commercial fishers, as they are prisoners to their reality. I am saying this because what makes sense for each of them to do individually, is taking them all closer the precipice of disaster collectively. Let’s say the fishers around the globe worldwide were to band together and collectively agree to catch less, they would benefit from the increase in demand for the goods.

However, this is highly unlikely as large agreements like that are almost impossible to negotiate and invariably break down. As an investor lets ask ourselves a question, its not like the fishers don’t understand their reality. So what incentive is driving their actions?

They are probably thinking “I’m best off taking as much as I can. If no one else restricts their fishing, I’m still best off taking all that I can.” As a result, the fish population continues to decrease and the fishing seasons get shorter. Commercial businesses and fishers are pushed to the extreme as they try to gain advantages over one another by buying bigger and faster boats and more expensive equipment; and they go out regardless of weather conditions, making fishing increasingly dangerous.

An investor will see that this is not sustainable as the last thing we want to see is a mutually self-destructive prophecy unfold. Iceland put into practise a very basic solution. They changed individual incentives, which in turn changed their behaviour, which lead to changes in social outcomes. The country redesigned and put incentives in place so that the behaviour of individual fishers would become more consistent with the preservation of fisheries, rather than their eventual destruction. Each fishery is assigned a total allowable catch for the year, and each boat is then assigned an individual tradable quota.

The reason I wanted to discuss this case study was because you and I as an investor have to understand the rules and right surrounding businesses and the incentives, they and their competitors face. It will help us understand, predict they influencing choices and behaviour that governs their actions.

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