There’s a fallacy that exists in both the world of business and the world of politics. It goes something like this: “If you want people to do ______, you need to incentivize them in that direction.” This line of thinking is based on the belief that human beings are self-serving creatures and that whenever his interests are in conflict with someone else’s, the average person will always choose in favour of himself. This is a very common belief.
But, hey, don’t let that stop you from basing all kinds of public policy around it. Last week, I showed you a talk by Barry Schwartz discussing the problems that come from an over reliance on rules and procedures in place of critical thinking. If you watched the talk all the way through, you already know that there is a second tool used to motivate ethical behaviour: incentives. The financial collapse of 2008 was largely caused by bankers offering loans to customers who could not afford to pay them back. Naturally, this created a bubble that was guaranteed to pop – and the bankers knew this – but they went on about their business anyway. The incentive of short-term profit far outweighed any sense of social responsibility. Whenever people start talking about reform, someone inevitably mentions the need to create new incentives that will make it more lucrative for these Wall Street wolves to play by the rules. The only problem is incentives don’t work.
Incentives are very good at inducing people to act in their own best interest – we all remember the way AIG, Merril Lynch and the others insisted that huge bonuses were the only way to attract talent – but when you want to influence people toward socially conscious behaviour, incentives almost always fail. It turns out there’s a lot of research on this subject. The very act of offering the incentive causes people to prioritize self-interest over civic duty.
In his talk, Scwartz told the following story. “Back in 1994, Switzerland was trying to decide where to site its nuclear waste dumps. There was going to be a national referendum, and some psychologists went around and poled citizens who were very well informed. They asked people, ‘Would you be willing to have a nuclear waste dump in your community?’ Astonishingly, fifty percent of the citizens said ‘yes.’ They knew it was dangerous; they knew it would reduce their property values, but it had to go somewhere, and they had responsibilities as citizens.
“The psychologists asked other people a slightly different question. They said, ‘If we paid you six weeks salary every year, would you be willing to have a nuclear waste dump in your community?’ Instead of fifty percent of people saying yes, twenty-five percent said yes.
“The introduction of incentive makes it so that instead of asking, ‘what is my responsibility?’ all we ask is ‘what serves my interest?’”
The research that Schwartz is referring to was conducted by economists Bruno Frey and Felix Oberholzer-Gee, the latter of whom went on to become a professor at the Harvard School of Business. You can find a full accounting of their findings here.
In particular, I’d like to share this little nugget: “The econometric analysis (table 1, cols. 3 and 4) also confirms that compensation crowds out public spirit. The support for nuclear energy and the acceptance of the current siting procedure, both indications of the willingness to contribute to the public good, ceased to muster support once financial incentives had been introduced.” (It’s on page 1307)
And it gets better.
Incentives have the ability to distort our perceptions, particularly when it comes to concepts like risk. In research conducted by World Bank economists Martin Kanz and Leora Klapper, a group of 209 loan officers were asked to evaluate actual loan applications that had been submitted to lenders in India. Some were offered low incentives for loans that performed well and minor punishments for loans that performed badly. Others were offered high incentives and major punishments. Finally, a third group was offered a commission for every loan issued regardless of performance.
The high-stakes lenders tended to be more cautious and performed best over all. (No surprise there). But the group who received a commission regardless of loan performance had a tendency to grossly overestimate the performance of each loan they made. To quote Klapper and Kanz, “It wasn’t simply that receiving an origination bonus increased the likelihood that an officer would approve an application for a loan; it was that the bonus made him or her truly believe that the application was more worthy.”
This is the problem with a moral framework that relies entirely on incentives as a motivational tool; it biases people toward self-interest. Then we wonder so many people in so many industries make so many idiotic and downright immoral decisions. You can’t appeal to self-interest to solve the problem of selfish behaviour.
It’s time for a change.
The philosophy of “look out for number one” has brought us nothing but economic ruin and environmental catastrophe. Unrestrained self-interest stands in the way of progress; it does not further it.
Hey, looking for some great fiction? Check out Symbiosis, the book reviewers have called the illegitimate love child of Star Trek and Buffy.
Now available on Kindle
It’s had some great reviews!