Economics provides us with a really big insight into how the world works. People respond to changes in incentives. A great deal of public policy is based on this principle. You want fewer people to drive into Central London? Introduce a congestion charge and make it more expensive. It works.
In practice, of course, estimating exactly how much any given change in a particular incentive alters behaviour can be a difficult problem. Indeed, changing incentives can sometimes have unforeseen consequences, which may appear perverse.
A couple of months ago, a school in Milton Keynes proposed to fine parents £60 if their child was late more than 10 times in a term. We do not know yet how this has worked out. But a similar scheme in a day care centre in Israel seemed to backfire. After the fine had been introduced, there was a rise, not a fall, in the number of parents delivering their children late. People now knew the price – the fine – for being late. They could then make judgements as to the value of the effort required to arrive on time compared to the cost of being late. Previously, they had only incurred the displeasure of the teacher. A recent book by the Harvard political philosopher Michael Sandel cites this as an example of the intrinsic limits to the use of markets. Social norms, not incentives, matter. His book has metropolitan liberals both here and in America gurgling with pleasure.
But the problem essentially arose not because of the limitations of markets, but because there were too few markets. Without a market, the disapproval could not be priced transparently. Parents just had to guess what this was worth, and they clearly placed on average a higher price on it than the level of the fine set by the school. The school was also at fault for not increasing the fine by trial and error steps until it started to do its intended job.
More challenging is the study carried out by the Frameworks Institute in America on public attitudes towards global warming. The document, ‘How to Talk About Global Warming’, reported that substantial numbers of people, when faced with how they respond to more extreme weather, choose to buy an SUV to help them cope, rather than to support increases in fuel-efficiency standards.
The instinctive response of a regulator to this finding would be to say that these individuals only had access to incomplete information. With more and better information, they would then respond to incentives so that they made the ‘correct’ choice. But more information does not necessarily help. Al Gore’s 2006 film about global warming, ‘An Inconvenient Truth’, received enormous publicity. But the number of Americans telling Gallup that the media was exaggerating global warming has grown from 34 per cent then to 42 percent today.
A popular policy for avoiding a financial crisis is to restrict bankers’ bonuses, giving them different incentives. It may work. But understanding exactly how incentives operate in practice does not always have a pat solution.
As published in City AM on Wednesday 16th April