Creating an incentivized structure

A key requirement of any policy should be to create an incentive structure for all the agents in the economic system that enables the agents to act in a manner that best allows the policy to meet its ultimate objective.

Let us understand this with a simple example. Assume a simple economy where the citizens own highly fuel in-efficient cars that run on precious petrol. The government will have multiple policy options to reduce the pollution level. Here are a few (of the many) options-
1.Regulate the production of fuel in-efficient cars (actually effectively banning them)
2.Highlight how in-efficient cars are harming the economy and hope that conscious citizens hear the government’s call to change cars
3.Announce that people owning fuel efficient cars will get a tax cut and penalize the owners of fuel in-efficient cars with a pollution tax

Let us evaluate these options-

1.Supply side action. It will just help in increasing the ratio of fuel efficient to fuel in-efficient cars. The citizens here have no incentive to convert to fuel efficient cars. Hence, this is obviously the most in-effective policy
2.Demand side action. The government assumes that the citizenry has a moral duty towards the society. The effectiveness is very unpredictable unless the assumption of the government is true
3.Another demand side action. In this case the government creates an incentive structure. The government understands that in order to flush out the in-efficient cars from the system, the citizens need to play an active role. In order to force/enable the citizens to change their cars there needs to be a system of incentives. The citizens should have an incentive to change cars

Today, a number of companies give bonuses to CEOs and other executives. Ever wondered why these bonuses even exist? Cleraly an example of an incentivized pay structure.

I strongly believe that these economic agents are the key to any policy success, hence the effectiveness of any policy depends on how strong/leak-proof the incentivized structure is