Freeman

IDEAS AND CONSEQUENCES

If Incentives Matter, We Might Be in Trouble

OCTOBER 03, 2012 by LAWRENCE W. REED

Known for his numerous literary and theological works, such as The Chronicles of Narnia and Mere Christianity, C. S. Lewis was also a keen observer of people and the consequences of their ideas—good or bad. He took note of the topsy-turvy world of postmodernist America with these cogent words: “In a sort of ghastly simplicity we remove the organ and demand the function. We make men without chests and expect of them virtue and enterprise. We laugh at honour and are shocked to find traitors in our midst. We castrate and bid the geldings be fruitful.”

So behavior is actually influenced by the incentives and the disincentives we confront? You bet it is. This is an iron law of the human condition. The failure to understand it or apply it consistently explains many of the dystopian malfunctions that surround us.

The most ardent advocates of draconian taxes and regulations on smoking argue that such penalties will deter the smoker. Strange, isn’t it, that many of those same people think they can soak the entrepreneur, the investor, the saver, the employer, and the inventor with little or no negative consequence.

The Obama administration says it wants to stimulate the economy but calls for higher taxes on those who take risks, create enterprises, hire people, and invent products. It says it wants to foster medical innovation, then it imposes a tax on medical devices. It vilifies the rich and successful while imploring us to work to become rich and successful. Examples abound.There’s a glitch in the cognitive wiring somewhere, and it’s often a bipartisan one.

An incentive is something that incites one to action. It is a spur, a motive, a provocation, a goad, a stimulus. Economists have long understood that the incentive to act is the prospect that the action will yield benefits to the actor. Because of that fact, particular incentives and incentive structures explain a very great deal of the economic world that swirls around us.

People respond to incentives and to their opposite, disincentives. An individual will feel compelled to respond favorably to something that promises great personal benefit at low cost or risk. The same individual will tend to turn away from those things that deliver little or no benefit, especially if they do so only at high cost. He will positively shun those things that would set his progress back, much as a hot stove is a disincentive to bare hands. Human choice is thus influenced by economic incentives and by changes in economic incentives. Let’s take a look at “real world” happenings to see how this might explain some things.

Incentives and the Real World

Many people complain today about the poor schooling their children receive in government classrooms. Stagnant test scores and a breakdown of discipline, even as the costs of schooling rise, bear testimony to the failure of government education. Why does it happen?

Teachers and administrators are responding to a peculiar set of incentives. What would your performance be like if your business could legally draft customers and compel them, under threat of penalty, to buy your product? Suppose you could go a step further and force even those who do not use your product in any way to pay for it—and to continue paying throughout their productive lifetimes! This is not a prescription for creativity and productivity.

Why does the post office provide a mediocre service at an ever higher price (and lose money doing it) even though it doesn’t have to pay taxes or returns to shareholders and gets legal protection against competition in first-class mail delivery? Compulsory monopolies just do not light fires under anybody.

Why do industries and labor unions contribute heavily to political campaigns? It isn’t always to promote better government for everybody. Such groups have an incentive to contribute if the expected returns (favors, protections, subsidies, immunities, and the like) exceed the value of their contributions. If government could not or would not pay off, the contributions would slow to a trickle.

Cattlemen of the old West were accused of overgrazing on public lands. They would allow their animals to strip the land bare, leaving it vulnerable to erosion, and then move on. This was frequently land they leased temporarily from the government with no guarantee they could renew the lease. With no incentive to maintain the capital value of the land, their actions were perfectly rational. The same men seldom exhibited such callous behavior toward property they personally owned and fenced.

Perhaps nowhere was the power of incentive and disincentive more evident than in the old Soviet Union. There, as much as 97 percent of farmland was cultivated “collectively” and the output belonged to the State. The remaining 3 percent was in private plots, whose owners were allowed to sell the produce in a relatively free market. The productivity per acre on the private plots, which accounted for as much as a third of all agricultural output in the country, was many times higher than that of the collectively farmed land. Workers on the collective farms were not physically or mentally inferior to those who owned private plots. In fact, in many instances, they were the same people! The different incentive structures of collective and private farming fully explained the remarkable disparity

Incentives and Supply

Incentives and disincentives also explain why higher prices call forth greater supply and why lower prices do not; why bad behavior never goes away if it’s subsidized; why students work harder in a class where excellence is rewarded and failure is penalized than in a class where everyone gets a C; why some people quit working and go on welfare; why politicians promise more spending as long as voters reelect them for it; why capitalist economies do better than socialist economies, and so on and so forth.

The future world we are creating will surely be shaped by the incentives and disincentives we are putting in place today. In that light we must hope that this warning from novelist and philosopher Ayn Rand does not also become our epitaph:

“When you see that trading is done, not by consent, but by compulsion; when you see that in order to produce, you need to obtain permission from men who produce nothing; when you see that money is flowing to those who deal, not in goods, but in favors; when you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them, but protect them against you; when you see corruption being rewarded and honesty becoming a self-sacrifice—you may know that your society is doomed.”

 

ASSOCIATED ISSUE

October 2012

ABOUT

LAWRENCE W. REED

Lawrence W. (“Larry”) Reed became president of FEE in 2008 after serving as chairman of its board of trustees in the 1990s and both writing and speaking for FEE since the late 1970s. Prior to becoming FEE’s president, he served for 20 years as president of the Mackinac Center for Public Policy in Midland, Michigan. He also taught economics full-time from 1977 to 1984 at Northwood University in Michigan and chaired its department of economics from 1982 to 1984.

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