The Role of Incentive; L. Reed

LawrenceW. Reed THE ROLE Of INCENTIVE THERE'S a great deal of talk these days about incentives. An incentive is something which incites one to ac tion. It is a spur, a motive, a provo cation, a goad, a stimulus. Econo mists have long understood that the incentive to act is the prospect of the action yielding benefits to the actor. Because of that fact, particular in centives and incentive structures explain a very great deal of the eco nomic world which swirls around us. People respond to incentives and to their opposite, disincentives. An individual will feel compelled to re spond favorably to something which promises great personal benefit at low cost or risk. The same individ ual will tend to turn away from those things which deliver little or no ben efit, especially if they do so only at high cost. He will positively shun those things which would set his Mr. Reed is Assistant Professor of Economics at Northwood Institute in Midland, Michigan. He is di rector of the college's summer Freedom Seminars.

Also he is co-editor of the recent college text, When WeAre Free. progress back, much as a hot stove is a disincentive to bare hands. Hu man choice is th'lrts influenced by eco nomic incentive$ and by changes in economic incentives. Let's take a look at "real world" happenings and see how this might ~xplain some things. Many people complain today about the poor schooli~g their children re ceive in public sdhools.Declining test scores and a bre~kdown of discipline in the classroo~, even as the costs of schooling rise, bear testimony to the failure of public education. Does this happen be~ause public school teachers and administrators do not wish to provide, a quality product? Not really. There is no reason to believe that public school teachers and adminis trators are any" less desirous than other people that quality education be imparted. They are, however, re sponding to a p~culiar set of incen tive structures. l:ask the reader, what would your performance be like if your business ~ould legally draft customers and compel them, under 266 THE FREEMAN May threat of penalty, to buy your prod uct? Suppose you could go a step fur ther and force even those who do not use your product in any way to pay for it - and to continue paying throughout their productive life times! Not exactly a prescription for creativity and productivity, would you say?

Why doesn't the Post Office de liver a better service? For the same reason! Where is the incentive to do better when you have a legal, sub sidizedmonopoly? Self-interest dic tates that humans pursue benefits along the paths of least resistance. Compulsory monopolies just do not light fires under too many people. One would be hard put to find any individual who would contribute his own money to encourage others to stop smoking and to promote the growing of tobacco at the same time. No one would regard such a contra diction as being in his self-interest. Yet Congress votes to do both. Why? Because no one spends someone else's money as carefully as he spends his own. I have every incentive to spend your money on my projects if I can get your money by taxing you. Why do industries and labor unions contribute heavily to political cam paigns? It isn't always to promote better government for everybody.

Such groups have an incentive to contribute if the expected returns (favors, protections, subsidies, im munities, and the like) exceed the value of their contributions. If gov ernment could not or would not pay off, the contributions would slow to a trickle. The charge is frequently heard that British and Swedish workers have become lazy. They don't work as hard as they used to. Studies indicate, however, tha t when these sarrie workers migrate to America, they work harder! The reason for the dif ference is that the incentives for work in America, in. spite of high taxes, are greater than in Britain or Swe den, where taxes are even higher. If one encourages something, one gets more of it and if one discourages something, one gets less. of it. That. applies to work as much as it does to any other activity. Nowhere is this more poignant than in the Soviet Union. There, 97 per cent· of farmland is cultivated "collectively." The output of the col lective farms belongs to' the State.

The other 3 per cent of farmland is in the form of private plots, whose owners are allowed to sell their produce in a relatively free market. The productivity per acre on the pri vate plots, which account for as much as a third of all agricultural output in the' country, is estimated to be 35 to 40 times higher than that on the collectively-farmed land. Workers on the collective farms are .not geneti cally or mentally inferior to those who have private plots. In fact, in many instances, they are the same 1982 THE ROLE OF INCENTIVE 267 people! The different incentive structures of collective and private farming explain the situation fully. What about pollution? Why would anyone dump his junk into Lake Erie? Doesn't he know that it doesn't belong there? Well, consider the in centives and disincentives a polluter may face. Dumping junk into the lake undetected may be much less costly than alternative methods of dis posal. And since no one "owns" Lake Erie, it may be some time before anyone takes notice and complains.

Cattlemen of the old West were accused of overgrazing on public lands. They would allow their ani mals to strip the land bare, leaving it vulnerable to erosion, and then move on. This was land they tempo rarily leased from the government or acquired free by government grant. With no incentive to main tain the capital value of the land, their actions were perfectly ratio nal. The same men seldom exhibited such callous behavior toward prop erty they bought and paid for and therefore owned outright. Incentives explain so many of life's events: why higher prices call forth greater supply and why lower prices do not; why racism is tempered in a free market wherein profit-seeking businessmen search for the best la bor at the lowest cost; why drug "pushers" appear when drugs· are made illegal and then must sell at high prices; why students work harder in a class where excellence is rewarded and failure is penalized; why capitalist ieconomies do better than socialist economies; why some people quit working and go on wel fare; and so fot1h and so on.

Finally, thOE~e who seek to im prove economiq life in America to day would do well to learn the im portance of in~entive. In order to stimulate imp~ovement, the disin centives for individual improvement must be abolished. In The Wall Street Journal, David M. Smick recently wrote: Growth involves ideas and thus is un predictable. All we can provide is buoy ancy-that senseiof economic boundless ness where a pers<!)ncan, with energy and initiative, take a new idea as far and as high as he or shei wants. If we can keep that initiative fro;m being stifled, as it is today by an inefficient tax and regula tory system, people may once again fol low their dream~. Allow entrepreneurs and potential en~repreneurs across-the board worthwhile! returns on their effort and they will staJ1t;taking risks. Our en tire economy will :gain in production and jobs, and the nation will regain the en ergy and opportlilnity and spirit upon which its greatne$s depends. * Incentive-nothing less than the interest one has!in his own improve ment-will mold the future just as surely as it shaped the past. @ *David M. Smick, i'What Reaganomics is All About," The Wall St'reet Journal, July 8, 1981, p.20.