This book examines the ways in which incentives designed around the premise that people are solely motivated by self interest can often be counter-productive; either by crowding out desirable behaviour or by prompting people to behave in ways that are the direct opposite of what was intended. The author provides a useful taxonomy of why this is so, but what I found especially interesting is the history of how the idea that good institutions and a free market based economy could “harness self interest to the public good” has come to dominate so much of current economic and public policy.
Many parts of this story are familiar but it was interesting to see how Bowles charted the development of the idea over many centuries and individual contributors. People will no doubt be familiar with Adam Smith’s “Invisible Hand” but Bowles also introduces other thinkers who contributed to this conceptual framework, Machiavelli and David Hume in particular. The foundation of the framework is neatly captured in this quote from Hume’s Essays: Moral, Political and Literary (1742) in which he recommended the following maxim
“In contriving any system of government … every man ought to be supposed to be a knave and to have no other end … than private interest. By this interest we must govern him, and, by means of it, make him notwithstanding his insatiable avarice and ambition, cooperate to public good” .
Bowles makes clear that this did not mean that people are in fact solely motivated by self-interest (i.e “knaves”), simply that civic virtue (i.e. creating good people) by itself was not a robust platform for achieving good outcomes. The pursuit of self interest, in contrast, came to be seen as a benign activity that could be harnessed for a higher purpose. The idea of embracing self-interest is of course anathema to many people benefit on moral grounds but its intellectual appeal is I think obvious. Australian readers at this point might be reminded of Jack Lang’s maxim “In the race of life, always back self-interest; at least you know it’s trying“. Gordon Gekko’s embrace of the principle that “Greed is good” is the modern expression of this intellectual tradition.
Harnessing self-interest for the common good
Political philosophers had for centuries focused on the question of how to promote civic virtue. Attention now turned to finding laws and other public policies that would allow people to pursue their personal objectives, while also inducing them to take account of the effects of their actions on others. The conceptual foundations laid down by David Hume and Adam Smith were progressively built on, with competition and well defined property rights coming to be seen as important parts of the solution.
“Good institutions displaced good citizens as the sine qua non of good government. In the economy, prices would do the work of morals”
“Markets thus achieved a kind of moral extraterritoriality … and so avarice, repackaged as self-interest, was tamed, transformed from a moral failing to just another kind of motive”
Free market determined prices were at the heart of the system that allowed the Invisible Hand to work its magic but economists recognised that competition alone was not sufficient for market prices to capture everything that mattered. For the market to arrive at the right (or most complete) price, it was also necessary that economic interactions be governed by “complete contracts” (i.e. contracts that specify the right and duties of the buyer and seller in all future states of the world).
This is obviously an unrealistic assumption. Apart from the difficulty of imagining all future states of the world, not everything of value can be priced. But all was not lost. Bowles introduces Alfred Marshall and Arthur Pigou who identified, in principle, how a system of taxes and subsidies could be devised that compensated economic actors for benefits their actions conferred on others and made them liable for costs they imposed on others.
The problem with incentives
Incentives can work but not, according to Bowles, if they simplistically assume that the target of the incentive cares only about his or her material gain. To be effective, incentives must account for the fact that people are much more complex, social and moral than is strictly rational from an economic perspective. Bowles devotes a lot of the book to the problem with incentives (both positive and negative, including taxes, fines, subsidies, bonuses etc) which he categorises under three headings:
- “Bad News“; incentives send a signal and the tendency is for people to read things into incentives which may not have been intended but prompt them to respond negatively (e.g. does this incentive signal that the other party believes I am not trustworthy or lazy)
- “Moral Disengagement”; the incentive may create a context in which the subject can distance themselves from the moral consequences of how they respond
- “Control Aversion“; an incentive that compromises a subject’s sense of autonomy or pride in the task may reduce their intrinsic motivation to perform the task well
“A Liberal Civic Culture”.
“If incentives sometimes crowd out ethical reasoning, the desire to help others, and intrinsic motivations, and if leading thinkers celebrate markets as a morality-free zone, it seems just a short step to Karl Marx’s broadside condemnation of capitalist culture”
Having noted the ways that incentives can have adverse impacts on behaviour, Bowles notes that civic minded values continue to be an important feature of market based economies and examines why this might be. One answer is that trading in markets encourages people to trust strangers and that the mutual benefits of trading over time teach people that trust is a valuable commodity. This theory goes back to Adam Smith and came to be labelled “doux commerce” but Bowles does not buy it.
While admitting his alternative answer is speculative, Bowles argues that Liberal states have developed institutions (property rights, rule of law, etc) that protect citizens from worst-case outcomes such as personal injury, loss of property, and other calamities. The consequences of mistakenly trusting a defector much less dire. As a result, the rule of law lowers the bar for how much you would have to know about your partner before trusting him or her, thereby promoting the spread of trusting expectations and hence of trusting behavior in a population.
Markets remain part of this story but not the whole explanation. In the example above, the occasion for a trusting relationship between buyer and seller would not have arisen without the possibility of mutual gain through exchange. In addition, the emergence of the rule of law appears to have been associated with a parallel shift from trust in kin and other particular individuals to generalized trust. Markets may have also assisted the “civilizing process” in other ways. The spread of markets often contributed to the emergence of national states bound by the rule of law, which Bowles argues favoured the evolution of generalized trust.
So I think Bowles is saying that the institutional structures that have evolved to facilitate trading with strangers and mitigate the risk are the real foundations of the generalised trust that he observes in market based economies
Bowles concludes with the following recommendations for navigating the problems with incentives that he has laid out:
- where crowding out occurs and then decide if the best response is to increase the incentive or try something different
- that attempts to perfect the conditions for markets to work well in the absence of social preferences cannot succeed entirely and may crowd out social preferences
- Incorporate the following design principles
- Protect civic-minded citizens from exploitation or risk moral disengagement
- If a policy has a public purpose that would be endorsed by citizens then make sure that moral message is clear
- Avoid incentives designed to control or take unfair advantage of the target
- Incentives implemented by peers (especially if linked to some social purpose) may avoid negative reactions (i.e. we are OK with playing by team rules but don’t like being dictated to)
- Provide opportunities for people to express their pro sociality, both in their own actions and in peer punishment (We are social animals and shame is a powerful tool)