The Curious Subject of Incentives

Started reading Levitt & Dubner: Freakonomics - a great book that despite its cheesy cover has a capacity to pull together facts and figures to reveal many of the truths hidden under such phenomena like why high-school teachers cheat, why prostitutes earn more than architects, why drug dealers still live with their mothers, why your name matters more than you think and why knowing what to measure, and how to measure it, is the key to understanding modern life. If you ever read Malcolm Gladwell's The Tipping Point, which explains how little things make a big difference this will certainly be up your street. A little edgier and snappier than Gladwell's book, Freakonomics pulls together all sorts of curious facts to reveal astonishing logic to often complicated social phenomena.

Take incentives for instance. Economics is, at root, the study of incentives: how people get what they want, or need especially when other people want or need the same thing. Ironically, the founder of classical economics, Adam Smith, was first and foremost a philosopher. Smith was entranced by the sweeping changes brought about by modern capitalism sweeping the nation at the time of the publication of his book, 'The Theory of Moral Sentiments' in 1759 and particularly the way icapitalism was influencing how a person thought and behaved in a particular situation. Smith's true subject was the friction between individual desire and societal norms and how economic incentives influence how we behave in a particular situation.

We all learn to respond to incentives, negative and positive, from the outset of life. An incentive is simply a means of urging people to do more of a good thing and less of a bad thing. But most incentives don't come about organically. Someone - an economist or a politician or a parent - has to invent them. There are three basic flavours of incentive: economic, social and moral. Sometimes social incentives work better than economic ones and in other cases it is a combination of all three. A good example is the naming and shaming of prostitutes - that works better than simply a $500 fine as nobody wants to be singled out by their friends, parents or neighbours as pimps or prostitutes.

In other cases incentives, although intended to work to deter undesirable behaviour, actually end up encouraging it. Take the recent World Cup match between the Netherlands and Portugal. Here are two countries pretty well balanced in terms of skill and ability and potentially the ideal ingredients to make the beautiful game truly come alive. What happens? Due to the card(trigger)-happy referee this match collected a total of 16 yellow cards and 4 red ones - an all time record, because rather than deter players from fouls, they quickly realised that if they could frame the opponents by diving and falling, they stood to benefit. The frequent ditching out of cards broke up the game, removed difficult opponents from the pitch, opened up the possibility of a penalty shot or were a small price for injuring the opponents, preventing them from playing properly. The opposing team quickly realised the same and thus the competition was more about who they could take out than the goals they could score. A sad day in football history.

Another subject frequently on the agenda these days is the environment. All of us are aware of the effects of global warming and the primary cause of it: fossil fuels. Plenty of moral incentives to change our ways, yet we do nothing. The sales of 4x4s and gaz-guzzlers are continuing their march of triumph, regardless of the environmental damage they cause. We know what's wrong, yet we can't help ourselves. The economic incentives to change our ways are simply too lame to make us do anything and socially it is still aspirational to have a big car, so the reasons to change aren't really that big - personally we are not willing to trade the convenience of a big car with the greater good of saving the environment - if everyone else is doing it why can't I?

In some cases the incentives don't even have to be grounded in reality: an illusion is enough. The promise of glamorous lives associated with sporting heroes, movie stars and drug dealers to name but a few make people form a queue right around the block just to have a chance, forgetting how intense the competition is and the fact that only a fraction of all the willing will ever make it. That is not what we get told. Drug lords apparently revel in money, cars and women, yet we are not told of the countless footsoldiers they rely on, with a 1 in 4 chance of getting killed (which is higher than sitting on death row in Texas), peddling the drugs for less than the minimum wage per hour with no prospects of ever making it large. Nor all the countless hopefuls moving to Hollywood to try to become moviestars, ending up waiting tables and never making a decent living. The 'Cinderella' stories are more attractive than the stories of struggling through college, working one's way up the ladder and maybe making a decent living at the end of the day - the perceived economic incentives are so strong, yet bear little or no relation to the actual ones and due to culture, media and communication they have entrenched themselves in our imagination and are enough for us to keep deluding ourselves even in the face of harsh reality telling us the opposite.

Interesting book, definitely recommend for all those of you who want to uncover the reality beneath the myths we are sold.