Understanding incentives and letting your workers leave early
(Introduction to Economics, Lesson 17)
If you want to make a business, a charity, a public body or an entire country more successful, this generally involves getting people — be they workers or customers or suppliers or families — to change their behaviour in some way. If you run a business, you want workers to work more efficiently. If you run a country, you might want people to live healthier lifestyles or buy more locally-produced goods.
If you want people to change the decisions they make, it helps to understand how they make decisions and the things that influence their decisions. As I often say; Economics is a branch of Psychology.
Of course, there are many things — biology, genes, upbringing etc. — that can affect the decisions that people make. In many situations, however, it’s not really possible to do anything about these things. We can’t usually change a person’s genes or go back and change history to change the way a person was brought up.
One of the key things an economist does, therefore, in order to understand how to change people’s behaviour, is to look at the more immediate incentives people face when they make their decisions. If we want to make a better society and a better world, then we may wish to influence people and help them make better decisions. This is where incentives come in. Through understanding the incentives people face, we can see how we might be able to alter those incentives in order to persuade people to act differently — in ways we might consider to be more beneficial for the people themselves, for their employers, for our society in general and for the planet we live on.
There are, essentially, two kinds of incentives. Sometimes we use the carrot. Sometimes we use the stick. As a simple example, we may want people to do more to look after the environment. We may use the carrot — finding ways to reward those who act responsibly towards the environment. Farmers, for example, are sometimes paid subsidies to reward them for leaving hedgerows in place and thus providing a habitat for wildlife. And we may use the stick — punishing decisions which damage the environment — such as making people with gas-guzzling cars pay extra tax. This might discourage people from buying inefficient cars in the future.
This idea of using incentives might seem all fairly straightforward, but it’s amazing how often problems arise because people have failed to consider the incentives that are in operation.
As an example, most employees are paid an hourly wage — a set amount of money for each hour that they work. Is it any wonder then, that many of these people don’t make very good use of their time at work? If they work hard throughout an eight hour day, work efficiently and do a really good job, they still get paid exactly the same amount as if they had been really lazy during those eight hours and done the absolute minimum they thought they could get away with.
An hourly wage system may encourage workers to work long hours — because the more hours they work, the more they get paid — but it doesn’t, in itself, encourage them to work hard or diligently or efficiently.
An hourly wage can even encourage workers to be lazy, because, if they are lazy and work inefficiently, you may have to pay them overtime in order to get essential work finished. In a way, they are being incentivised to work slowly.
Perhaps, if you let your staff go home early if they’ve completed their work for the day, you might find they start to work more efficiently. You might then be able to gradually increase the work they’re asked to do. So long as they’ve got that chance to go home early, they’ve got an incentive to work efficiently.
Unfortunately, many firms are plagued by accountancy-types who would be appalled by the idea of people going home early, yet still being paid. They would consider it a waste of money. They would probably have no idea why stopping this practice might drastically reduce efficiency rather than improve it. That’s why these decisions should be left, not in the hand of accountants, but in the hands of people who actually understand Economics.
As another example of incentives at work, suppose you run a government department and you ask your staff to find ways that they can work more efficiently. How often do these efficiency drives actually result in greater efficiencies? Hardly ever — but is that surprising? Your staff have got no reason to cooperate with your efficiency drive. If they find ways to work more efficiently, some of them might not be needed anymore and they’ll be out of a job. Perhaps, if you told staff that any future pay rises would have to be funded by cutting staff levels, they’d have an incentive to help you find efficiency improvements.
Often, when businesses want to incentivise their staff to work harder or to work more efficiently, they offer managers bonus payments when certain targets are met. The trouble here is that managers often find ways to fiddle the statistics and reach their statistical targets without actually having to do a better job.
For example, managers in hospitals have sometimes been offered bonuses if they could reduce waiting times for patients to have an operation. This was supposed to encourage the managers to find efficiency improvements. Naturally, what a lot of managers did, however, was to cheat. They simply made patients wait longer to see a specialist, since they had to see a specialist before they could actually go on the waiting list for an operation in the first place. The statistical targets were reached and the bonuses were paid, but patients were waiting longer than ever to get their operations.
Often, successfully incentivising people to do a good job is not a crude matter of money — of wages, targets and bonuses. Often, people are much more effectively incentivised simply by their employer trusting them, giving them more freedom and generally just treating them in a decent, respectful way — by treating them as human beings rather than as mere economic units in a production system. Then they might be incentivised to do a good job simply for the job satisfaction they might get from doing things well.