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Incentives matter! This simple two-word sentence is the heart of Economics 101. Ask any economist, and she will tell you, “Yes, incentives do matter!” It also seems so simple and obvious when you stop and think about it. Sadly, as we start to think of more complex issues and problems, the importance of this little phrase seems to get lost in the shuffle.

Take for example the issue of bureaucracy. Most bureaucracies are seen as terribly inefficient. The average person may even rant about how terrible the DMV or post office is (no matter how much it tries to appear like a normal business). Most people may understand that the problem has to do with incentives, but they will still probably think there is no choice but for the State to perform such functions. They likely believe that making a few changes or putting in the right bureaucrats can fix things.

Today’s document, Henry Hazlitt’s New York Times review of Ludwig von Mises’s Bureaucracy, shows why we come to view bureaucracies as inefficient. They simply lack the knowledge and incentive to perform efficiently no matter how benevolent the bureaucrats may be. As Hazlitt states, “For the main thesis of Professor von Mises is that bureaucracy is merely a symptom of the real disease with which we have to deal. That disease is excessive State domination and control.”

The issue, as Mises puts it, is whether society should be organized on the basis of private ownership or government control of the means of production. Should goods and services be provided by market or State bureaucracies. It’s one or the other; there is no compromise. With each you get a different set of incentives as well as a different ability to collect and use the information necessary to make efficient decisions.

In a totally free market a private firm (or department within) is guided by the profit motive. It has discretion to expand and experiment as it sees fit. If it fails it will know and if it succeeds it will be rewarded. Bureaucracies, on the other hand, are not guided by the profit motive. The quality of their work cannot be judged in monetary terms. They can have little-to-no discretion since their work must be centralized and operate under the detailed controls of their superiors. Market value cannot be attached to their “product.” In other words, they cannot engage in economic calculation.

The irony is that the decentralized market may seem chaotic and out of control, but in reality it produces efficient outcomes. Resources get channeled to where consumers most want them, to the betterment of everyone. On the other hand, the seeming control of centralized State power is actually a mess of inefficiency that is simply unable to achieve the stated ends.

Incentives do matter, and correcting those incentives starts with picking the right institutions for our society to operate under. Once we understand this, we will choose the free market.

Download Hazlitt’s Review of Mises’s Bureaucracy here.