Montreal, January 15, 2010 • No 274


Gennady Stolyarov II is a science fiction novelist and philosophical essayist, and is Editor-in-Chief of The Rational Argumentator. He lives in Carson City, Nevada.




Incentives Matter... On the Margin


by Gennady Stolyarov II


          One of the favorite expressions of economists is "Incentives matter." There is much truth to this idea, but it is instructive to examine how it works a bit more closely.


          An incentive is a set of conditions that favors one course of action and/or disfavors its opposite. A positive incentive increases the reward or decreases the cost associated with a decision, while a negative incentive increases the cost or decreases the reward associated with it. An incentive can be a condition of the natural environment, a conscious human choice, or an emergent outcome—a characteristic of what Friedrich Hayek called a "spontaneous order."

          But it is not the case that all human beings are moved by the same incentives to a particular course of action or inaction. For instance, an increase in the cost of gasoline might lead some people to drive less—but a wealthy car enthusiast might just take the hit and pay the higher price; for him, a negative incentive was not a sufficient deterrent to his behavior of choice. On the other hand, ample information and culture available virtually for free on the Internet might motivate more people to become computer-literate, but for certain individuals with a strong visceral fear of electronic technology, this might not be enough; the positive incentive has failed to overcome the psychological barriers within them.

          We can best see how incentives matter by examining large-scale changes in behavior. Crime statistics in an area might fall, for instance, if people were allowed to carry concealed weapons in public, where a previous law might have prohibited this. But there would still be some individual acts of crime, just as there would still be some people who would never think of committing a crime, no matter how easy it would be to perpetrate one or to get away with it.

          If the government raised the minimum wage, the unemployment rate would increase over what it would have been otherwise, but it is not the case that all workers—or even all workers previously earning less than the minimum wage—would suffer or lose their jobs. Some low-income workers might even get a pay raise, but likely at the expense of others being laid off or never being hired in the first place. Yet some generous employers might choose to personally absorb the cost increase and refuse to lay off any workers—but this might mean fewer other investments in their businesses or a lower standard of living for these business owners.

          We can summarize this insight by stating that incentives matter on the margin. If a person's other characteristics—including ideas held, material position, and skills—strongly favor one course of action over another, then an incentive to the contrary is unlikely to change that person's behavior. On the other hand, if a person is barely inclined one way or another, then an incentive might result in a shift of behavior.

"The more a person can train himself to persevere in the face of significant externally imposed costs, the more likely that person is to succeed despite such obstacles. Such successes are the building blocks upon which all human civilization has been built."

          Once made explicit, all of this might appear self-evident to someone who paid attention in a basic economics course. Why is it important, and why does it bear emphasizing? There are several reasons.

          Recognizing the marginal importance of incentives prevents individuals from looking for panaceas or overnight revolutions, of which our world yields extremely few, if any. On the other hand, it also inculcates one against despair. Any sufficiently strong incentive will result in a desirable or undesirable statistical shift, but it is unlikely to completely solve a problem. On the other hand, it is also unlikely to completely doom the state of affairs, either. Human beings are remarkably resilient and intricately complex.

          Crimes, disasters, bad laws, and health defects will destroy some and keep down others—but human innovation and creativity will not completely die; it will flourish somewhere, in some way or another, where the negative incentives are not strong enough to thwart the civilizing desires of the best among us. But it is also important to recognize that human existence is a continual struggle against both natural perils and the follies and even the evils committed by our fellow men. We will need more than one incentive to be favorably arranged if we are to keep these enemies of civilization at bay.

          The marginal functioning of incentives is also a cause for hope. If a destructive policy were to completely cripple some facet of human life, then there might not be a way to resist it effectively. But because some individuals are sufficiently strong internally so as not to be diverted from their course by the policy, they can amass the will and the resources to resist it. Moreover, people can condition themselves to respond more or less strongly to certain incentives. The more a person can train himself to persevere in the face of significant externally imposed costs, the more likely that person is to succeed despite such obstacles. Such successes are the building blocks upon which all human civilization has been built.

          It is instructive to remember that there has never been an even tolerably calm and safe environment for innovators to flourish; at every time and place in history, some force—deliberate or not, more severe or less so, but never particularly mild—stood in the way of the thinkers and creators to whom we owe our progress. Where the carriers of civilization overcame these forces, they created a more favorable environment for us. We must, likewise, strive against the challenges of our time. By overcoming existing negative incentives, we can create positive ones for the future, through the examples we set and the work we bring forth.