Monday, February 18, 2013

Incentives: Defining and classifying incentives

My economics professors are typically surprised that I call myself a communist, especially since I tend to do very well in their classes learning capitalist economics. They really shouldn't be that surprised; Marx and Lenin make the case that the problems of capitalism are inherent to the theoretical structure of capitalism itself, and nothing in three years of undergraduate education — and by the end of this semester, I will have completed all the courses in basic capitalist theory — have led me even to suspect Marx and Lenin might be wrong, at least about the nature of capitalism.

Yesterday, my professor discovered, to his astonishment, that I really was a communist. He's cool with that (all of my professors, even the Libertarians and Republicans, have been cool with my communism), but he wanted me to think about one concept: incentives. He didn't make any argument explicitly, but I think the underlying argument is that capitalism has a complex and powerful set of institutional and systemic incentives, and these incentives have been the primary social cause of the massive industrialization and overall increase in the material standard of living that capitalism has achieved over the last 200-300 years. If we do away with those systemic incentives, we risk backsliding into the inertia, complacency, and inefficiency of the pre-capitalist era. Is that what I really want?

Marx and Lenin have, I think, adequately covered the problems with capitalism's systemic incentives. Briefly, by rewarding the accumulation of money and capital, capitalism requires ad hoc incentives (mostly government stimulus) to increase consumer spending when the economy has accumulated excess capital relative to aggregate demand. Ad hoc incentives can happen, but they are weaker, temporary, and don't have the self-reinforcing character of systemic incentives. The welfare state is an attempt to create systemic incentives (mostly fiat money, social transfers, and continuous government deficits) but the capitalist class will never give up its implacable opposition to the welfare state. They have been making gains against the welfare state for forty years, until it lies in tatters today. But that's not the issue: as bad as capitalism might be, communism could be worse.

But how do incentives actually work?

An incentive is a social institution that encourages some or all citizens to do what they would not do without the incentive (or discourages some or all to not do what they would otherwise do).

As I see it, there are five kinds of incentives. (Keep in mind that I am more-or-less arbitrarily defining labels, and I find discussions about whether or not I use the "correct" labels or "correct" definitions to be tedious. If you want to criticize arbitrary definitions, it's interesting only if you critique them at a more sophisticated level.)

First, there are psychological incentives, which individuals use to reconcile conflicts within their own minds. For example, some people generally have an internal psychological conflict between their desire to lose weight and their desire to eat. Some find it helpful to create psychological incentives, such as the social solidarity offered by organizations such as Weight Watchers, to reconcile these conflicting psychological desires. Although we can and do use many psychological incentives in a political sense, such as raising excise taxes on tobacco to reduce smoking, I don't see these kinds of incentives as being of primary interest in talking about large scale political-economic institutions such as capitalism and communism.

Second, there are natural incentives. We do not need social incentives to encourage people to do what they usually want to do. We do not, for example, need to incentivize people to eat food or come in out of the rain. People will do these things on their own. These incentives seem trivial precisely because we don't need them, but they have some meta-ethical significance, which I'll discuss later.

Third, there are coercive incentives. If, for some reason, a dominant minority wanted to get the majority to do something the majority had no natural desire to do. We would have to have some sort of social incentive if, for example, we wanted people to cut off their left pinky fingers. These incentives also seem trivial, because why would we want to encourage people to do what they just don't want to do? But these definitions also have meta-ethical significance.

Fourth, there are negotiated incentives. If I want something from you, I have to offer you something you want more than you want what I want. For example, if I want you to give me a bicycle, I have to give you a case of beer, which you want more than you want the bicycle. Since trade can make both parties better off, and since people by definition naturally want to be better off, people will naturally want to trade; there's a natural incentive at the abstract level to offer negotiated incentives at the concrete level. Since there's an abstract natural incentive to trade, we don't need to do much at the institutional level to support the idea of trading.

Fifth and finally, there are game-theoretic incentives. When there is a natural incentive to do something, but doing it works only if (most) everyone does it, then we need to create game-theoretic incentives so that people can trust others to do it. The concept of the promise is the most obvious game-theoretic incentive. When we can use promises as negotiated incentives, we can achieve a lot of long-term benefits that are extremely difficult, and perhaps impossible, without promises. However, promises work only if (most) everyone keeps her promises, and there are short-term natural incentives to break promises. If I promise to give you a case of beer tomorrow in exchange for a bicycle today, we get a benefit — i.e. it is more efficient for me to use the bicycle today than for you to use it — that we couldn't get without the use of promises. However, once I have the bicycle, I have a short-term natural incentive to renege on the promise of beer tomorrow. If even a few people don't keep their promises, the whole edifice of using promises collapses, and we lose the benefits of using promises.

So when we create game-theoretic incentives to keep our promises (such as the possibility that men with guns will come to my door, take possession of the promised case of beer, and give it to my neighbor who gave me the bicycle) we are not saying we need to be forced to keep our promises. We know rationally that keeping our promises has rational benefit. Instead, we are saying by adopting game-theoretic incentives that we are committed to keeping our promises, that we are eliminating the possibility of free-riding on the system; in other words, we use game-theoretic incentives to establish trust. And we require political-economic institutions to establish precisely these kinds of game-theoretic incentives.


  1. I think the biggest incentive is competition. If a company does not grow and 'innovate', it is devoured by its competitors. If an individual does not plan and advance his career, he can find himself unemployed and unemployable because his skills are out of date. Competition we are told will lower prices as companies compete and increase our standard of living because companies and individuals who innovate are rewarded and those who remain stagnant are removed.

    Competition then was once a means to an end. It was an engine to drive progress forward, to create incentives aimed at improving the human condition by increasing our mastery over nature.

    But very quickly competition became an end in itself. It seems to me that we have lost all control over our economic affairs. We cheer growth for the sake of growth; we work ever increasing number of hours in jobs that simply do not need to be done (eg the majority of financial services jobs); the boundaries between work and leisure are increasingly blurred with new technology; scientific research is enslaved to profit driven corporations and on and on. Even our leaders now dress like office managers and adapt business language to inspire us. It has become common to refer to humans as 'resources' and treat nature as a huge warehouse to be used at will. It's impossible to conclude that our economic system serves the human race. Yes we get to watch the Kardashians on wide screen plasma TVs behind increasingly common walled and gated communities. Whoop de do. The price is merely the majority of your life spent trading your labor for another persons benefit.

    We have created so many damn incentives that we are not sure what we are incentivizing any more. Incentives, once a means, have now become an end in itself.

    1. You're jumping ahead. :-) I share the intuitions you describe here, but I want to put them in a slightly more rigorous framework.

      Strictly speaking, I would classify competition as a behavior in response to incentives. Competition shares, however, the moral or means-end inversion that we apply to many incentives.

    2. My idea of a rigorous framework involves the rigorous hammering of round peg into a square hole because I happen to have a round peg when someone else produces a square hole.


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