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Incentives - El American

Incentives Matter—Everywhere!

Adam Smith told us two and a half centuries ago: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

Theologian C. S. Lewis was a keen observer of people and the consequences of their ideas—good or bad. He took note of our topsy-turvy world 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 honor and are shocked to find traitors in our midst. We castrate and bid the geldings be fruitful.”

Lewis was observing that if we reward or subsidize something, we’ll get more of it; if we penalize, tax or otherwise discourage something, we’ll get less of it. Behavior is hugely influenced by the incentives and the disincentives we confront. This is an iron law of the human condition. It applies anywhere and everywhere, to all humans on all continents.

Advocates of 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, the worker and the inventor with little or no negative consequence.

The Biden administration says it wants to stimulate the economy but calls for higher taxes on those who take a risk, create an enterprise, hire people, invent a product. It will price the unskilled and the inexperienced out of the labor market by boosting the minimum wage at the same time it declares it wants to help poor people. In one breath, it says it favors energy independence and then in the next, it cancels the Keystone Pipeline and throws tens of thousands of people out of work.

People respond to incentives and to their opposite, disincentives, because we’re rational beings, not mindless blockheads. An individual will feel compelled to respond favorably to something which promises great personal benefit at low cost or risk. The same individual will shun those things which would set his progress back, much as a hot stove is a disincentive to bare hands. 

Incentives and disincentives 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” regardless of effort or performance; why some people quit working and go on welfare; why politicians promise more spending as long as voters re-elect them for it; why capitalist economies do better than socialist economies, and so on and so forth.

In his 1998 article, The Power of Incentives, economist Dwight Lee wrote that some people resist the notion of utilizing incentives to achieve positive results. These are the folks who think self-interest is unseemly, that other motivations such as altruism or charity are loftier. Here’s how Professor Lee once handled the matter in class:

I was pointing out that the elephant populations in Zimbabwe and South Africa were expanding because policies there allow people to profit from maintaining elephant herds. A student who had stressed his environmental sensitivity responded that he would rather not see the elephant saved if the only way to do so was by relying on people’s greed. In other words, he was willing to stand on principle as long as only the elephants suffered the consequences. His principle, one that I suspect was shared by others in the class, was that good things should be motivated by compassion and concern, not self-interest. I couldn’t resist telling him that I would be impressed with his moral stance if, when he required delicate surgery to save his life, he refused to go to a surgeon and let his mother perform the operation instead.

Don’t take Professor Lee’s word for it, or mine either. Here’s a simple thought experiment you can perform wherever you are: Look around you and take a physical inventory of what you see—things such as your computer, your table and chairs, your car, your food, etc., etc. Then create a ledger. On the left side, list all those things produced for non-self-interest reasons such as charity or compulsion. In the right column, list those things produced because the producers desired to improve their own welfare (the incentive) by improving yours with products and services you would buy.

The results should reaffirm what Adam Smith told us two and a half centuries ago: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

Incentives matter. They really, really do.

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