Recreating the incentive structure

2 02 2011

Money is indeed a powerful stimulus. (Funny as it may be, most economists are fully capable of saying “stimulus” without even the slightest thought of sex. I find this amazing). But getting back to the monetary issue. There is all too often an unhealthy tendency to think one of two oversimplified things about the market:
1. money can structure a market in such a perfect way through competition and trade, that no regulation is necessary
2. state regulation needs to interfere proactively in markets to mitigate the detrimental effects of money concentration

Both of them are too simple to capture reality, and therefore fail miserably to serve as a first step in a fruitful journey of the mind. Money is, in fact, a perfectly neutral incentive. Undoubtedly frighteningly efficient, but still neutral. And the economic agents who use money are neutral as well. They are usually guided by a set of atavistic instincts – to survive, to dominate, to mate, to control territory, etc. The beauty of money lies in the fact that it helps achieve those natural urges more easily. (Morality came much later after instinct, and is therefore a much weaker stimulus).

The above argument actually explains why we have extremely rich people like conman Bernard Madoff, alongside with philanthropists like Bill Gates (even though he is the Dark Lord of operating systems). Simply, people use money in different ways. So what?

That is hardly a brilliant insight. However, the next logical step is all too often neglected – the neutrality of money and people provides us with invaluable tools to recreate the incentive structures in communities, organizations and societies. There is nothing inherently good or bad in either people or money, so creating the right context will channel behaviour into a mutually beneficial way. Weber’s protestant ethic is a good case in point: Weber argued that it was because of a culture promoting thrift and hard work that protestant countries experienced increased economic growth. Only later, in the forties and fifties of the twentieth century it was formalized that higher savings (channelled into investment) are one of the crucial determinants of growth. And mind you, the only thing that was done here was to change the context – neither money, nor people changed – it was only their perception. Results were spectacular.

A next interesting example – I have always deeply admired the Romans (with all the wars and orgies, and all that) but have to admit that their contribution to science is rather miniscule. You can easily trace that back to the Roman numerals – a set of number uniquely unsuitable for complex calculation. Despite their astounding achievements in architecture, the arts, and war machines, they could never truly capitalize on their vast knowledge. Why? Because of the simple numbers. Imagine changing the context – using Arabic numerals. That happened in Venice. The simple adoption of one set of numbers propelled one people on the road to trade and innovation. Same people, same money.

Only the context changed. Which is exactly what we should be thinking about right now – how to structure the context in such a way that monetary incentives can lead the people, as they are, into socially optimal equilibria? I think economics might have something to say about this. All incentives must be directed in such a way that the focus falls on, figuratively speaking, the customer. Any employee, or community member, or citizen should be rewarded as his efforts bring utility to somebody else – i.e. his work is useful not (only) for himself, but for the wider society in general. Think of a successful firm – Dell only made it that big because it provided a superb customer experience. It cared not for itself but for somebody else, and was likewise rewarded with high profits.

Such attitude, I think, needs to permeate also non-market activities – for example citizens get rewarded for doing community work. The voluntary spirit should not be a stigma or a boring duty but rather a legitimate activity which gets rewarded by society. Obviously, this is much easier said than done. I can at this moment think of at least 15 legitimate reasons for which this idea will fail. On the other hand, I also begin thinking of ways to overcome the obstacles. Funnily, most of them boil down to one single word: context. Reinvent money to channel positive energy in constructive projects.

There might be some objections, especially regarding issues of choice. Don’t we take away people’s choice to do what they want through this manipulation of environment?? And the answer is a resounding no. Nobody should take away any individual liberty – people should think and decide as they want. And act accordingly. The change of context is not mind control. On the contrary – it’s empowering people to develop. Think of you getting a nice vacation at the Bahamas. However you can hardly swim in the ocean, because it is full of sharks. Probably you won’t swim, or if you are on the aggressive side, will take a harpoon and turn into a cruel murderer of endangered species. The change of context here would be to remove the sharks. The choice to swim or not is still vested with the individual.

Therefore, the change of context does not infringe on the rights of people who do not want to swim. It only enables people who do, to do so. It is through such a restructuring of contexts through monetary incentives that I think we can improve our communities, organizations, societies and indeed groups of societies (EU, cough, cough). Such an idea is hardly an ultimate solution. It is much more of an interesting way to go. I am personally intrigued where it will lead us.

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