A parable about incentives backfiring…

Pick up a basic economics textbook and it most likely will start with incentives. All that seems to matter in economics is incentives. If you get the incentiving right, people are likely to respond in the desired way. Any behavior away from the norm defined by economists is blamed on incentives.

However, life is hardly that simple. People react differently even if incentives are supposedly right. This is where behavioral economics also comes in. This post by Samuel Bowles (HT: INET Blog) also points to a story with people responding negatively to certain actions:

Having noticed a suspicious bunching of sick call-ins on Mondays and Fridays, the Boston fire commissioner ended the fire department’s policy of unlimited paid sick days on December 1, 2001. In its stead, he imposed a limit of fifteen sick days per year; firemen exceeding that limit would have their pay docked. Here is how the firemen responded: the number calling in sick on Christmas and New Year’s Day increased tenfold over the previous year.

The fire commissioner retaliated by canceling the firemen’s holiday bonus checks. The firemen were unimpressed: during the next year, they claimed 13,431 sick days, up from 6,432 a year earlier.2 Many firemen, apparently insulted by the new system, abused it or abandoned their previous ethic of serving the public even when injured or not feeling well.

I admit to having some sympathy for the commissioner. I once offered my teenage kids a price list for household chores as a way of topping up their modest weekly allowance. In response, they simply stopped doing the housework that they had once more or less happily done without incentives.

The commissioner’s difficulties and my failed experiment in home economics are far from exceptional.  In subsequent blogs I will discuss well-designed experiments – some by psychologists, but surprisingly, most by economists – showing that imposing explicit economic incentives and constraints to induce people to act in socially responsible ways is sometimes ineffective or even, as Boston’s fire commissioner discovered, counterproductive. In short, incentives that appeal to our economic interests may “crowd out” intrinsic motivation and moral values.

Hmmm. This is so true.

He thinks heavier fines might have worked though they would have killed the spirit of working:

But is crowding out a problem? My hunch is that a larger penalty would have worked. The firemen’s massive sick call-ins on Christmas and New Year’s Day do not mean they had lost interest in money. Had the fire commissioner imposed a heavier penalty, the firemen would surely have shaped up, even if their anger and distrust would, as a result, have eclipsed their sense of duty. Economic interest would have substituted for pride in serving the public.

But even extreme constraints and incentives may have limits. Heavy fines or more draconian punishments might have deterred phony call-ins, but would they have motivated the subtler and immeasurable aspects of a fireman’s professionalism and bravery? Even if extreme penalties could do the job, a liberal society might find them repugnant.

So crowding out is a problem:  even if a bigger incentive would have “worked” for reducing absences, it may well not have worked in motivating precisely what we rely on firemen to do.  Instead of letting penalties substitute for the firemen’s sense of duty, the commissioner might have looked for policies that would affirm and enhance their civic pride.         

Whether you think the firemen’s response to the commissioner’s incentives is a problem puts you on one or the other side of some venerable and unresolved questions in the philosophy of governance. These are, roughly, whether a society organized as if its citizens were entirely self interested could possibly work, and if so, would it be a good idea to govern according to one.

Superbly said.

In a way this is one of the most fundamental questions facing policymakers and society at large. With principles of economics becoming central to all policy making, the idea of rationality and self-interested individuals also dominates much of thinking. There is a lot of talk about getting incentives right and that is what matters. Despite getting umpteen contrarian evidence, there is little learning of the fact that people are not really self interested individuals atleast not as much as economics thinks them to be.

There has to be far more humility to all this and be aware of unintended consequences. People are just that predictably irrational..

One Response to “A parable about incentives backfiring…”

  1. Ellie Kesselman Says:

    No, people are NOT irrational! You missed the entire point of the quoted article. Monetary incentives are powerful, but there are unintended consequences from behavioral economics that cannot be anticipated or even counteracted. Even if the fire chief had made it prohibitively expensive for the firemen to miss time from work, there would be a negative outcome because morale and thus effectiveness would diminish. For a job such as firefighting, that is a disastrous outcome! If the work place were a restaurant or a shoe store, it would be of minimal consequence. It can be easily argued that firefighters are a necessary public good, with the cost of failure being too high to tolerate for any properly functioning community.

    The article also mentions the importance of determinants of behavior such as morality and intrinsic motivation. It is impossible to incentivize or quantify the power of morality and motivation.

    Ultimately, the libertarians are correct. It is impossible to regulate or incentivize behavior if the subjects are unwilling. There must be cohesion and shared values in order for public policy to be effective. Behavioral economics and incentivizing are not necessary when there is understanding and agreement about goals for a society. Evidence of such is abundant, e.g. 90% marginal tax rates were imposed in the USA throughout the 1950s without objection. There were no elaborate tax credits, deductions or accounting innovations necessary, because at that time, both individuals and corporations were willing to pay in order to achieve shared goals for the nation.

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