Good Economics and Good Incentives: A Symbiotic Relationship

Let’s take a stroll down memory lane. Well, memory lane is about 50,000 years ago, but in the grand scheme of things, a relatively recent occurrence. There once lived a ‘man’ (in modern day Iraq), who for our convenience was known as Shanidar-1, and he led a life full of physical deformities and ailments. Yet Shanidar-1 lived well into his 40’s, an anomaly in those days given that you could be swallowed whole by a mammoth at any given instant. This raises a very pertinent question – How did Shanidar-1 survive for that long when he was clearly a liability for his fellow people, the Neanderthals?

Source: WSynder. DeviantArt.  

An approximation of what Shanidar-1 could have looked like (after examining his fossils).

Clearly, no form of social security existed in those times, so the onus of taking care of Shanidar-1 lay completely on his Neanderthal brethren. Given our existing knowledge of Neanderthals and Darwin’s ‘Survival of the Fittest,’ it makes no rational sense for the Neanderthals to have assumed responsibility and care for Shanidar-1. Yet something prompted them to do so. This is where the key idea of this article enters. The factors nudging the Neanderthals to care for Shanidar-1 was their humanity, i.e., the ‘good’ element that exists within us. It is the incentive element which is a much more tantalizing prospect to analyse in the care of Shanidar-1 and for economics at large.

Anthropologists and historians have come to the conclusion that Shanidar-1 may have been an important cultural figurehead in those days or could have been a part of an important tribe among the Neanderthals. Caring for those who occupy positions of power is a key step in assuming similar positions in the future. Thus, caring for Shanidar-1 could have served as a positive incentive for the community members. The above scenario points towards a very crucial behavioural construct which exists among us Homo Economicus, which is that our response to incentives predates our perceived notions of economic rationality or even that of the Invisible Hand.

In probabilistic terms, being good ultimately boils down to a multitude of factors, with individual preferences being a key factor among them. Societal mindset and psychological underpinnings are among the other factors. However, what distinguishes the individual preferences is that they differ for each one of us, making them an uncontrollable factor. Such a factor would have an unknown probability ‘p’, wherein ‘p’ refers to the likelihood of an individual being good, ceteris paribus

The interesting feature of ‘p’ is that even in the case of ceteris paribus, it becomes impossible to determine given the dynamic behaviour of a human being. Thus, no policy maker nor individual actor can influence the likelihood of ‘p’ and it remains completely unique to the behaviour of the individual. However, incentives can be used to nudge or mould an individual’s behaviour to subscribe to the desired course of action, which here would refer to social benefit.

Let’s take the example of a waiter at a restaurant or a food delivery agent. This individual does receive a fixed component in terms of their incomes, which would dictate that they have been paid as per their productivity in performing the job (ceteris paribus, obviously). However, the waiter/delivery boy still looks at satisfying our every need, and quite often determines the quality of our dining/eating experience. But what is in for the waiter or the delivery boy in this scenario, given that they have already achieved the contractual output level? 

The answer lies in the tip which we offer them. This incentive is what creates a good environment for the waiter, the diners, the restaurateur, and the overarching economy. The added incentive of the tip also creates a unique opportunity for the following to occur:

1. Increased utility for the diners, due to the waiter’s behaviour having a positive impact on our dining experience.

2. Upward social mobility for the waiter due to the increased tip they were to receive for their conduct.

3. Ultimately, on a much greater scale, we could project such an incentive as a catalyst for declining unemployment and poverty (due to the same tip/benefit working positively for many workers in the macroeconomy), and an increase in overall social welfare.

The tip as an  incentive aids the creation of a good environment for all agents involved. 

On a microeconomic scale, we can gauge the benefits. However, on a macroeconomic scale, would similar incentives have a duplicative effect? The answer is slightly complicated due to the fact that macroeconomics is a study of dynamic trends in an economy, and well, dynamic literally would necessitate immense volatility to arrive at the answer. We, however, could expand our time frame and view the process. For this, we must say goodbye to a notion proposed by Mr. Keynes of our death in the long run and view the situation as a study of Overlapping Generations (Check out the works of Oded Galor, Peter Diamond, and Paul Samuelson on this field – I refer only to its basic premise, and not the in-depth mathematics of the model).

Overlapping Generations looks at the economy with multiple generations of humans living in the same time frame. Basically, it discusses our reality and approaches any economic decision keeping in mind the impact it would have on the futures of both generations of humans. For the Overlapping Generations, we must assume that any investments we make in charity or for the purpose of incentives will not yield higher utilities for us instantly, nor would it necessarily result in profits of any form in the short run. Our expectation for any monetary returns must be delayed to potentially our next generation or even after that. However, any psychological benefit we receive in terms of feeling good about our deeds will be felt in the short run. With the above clear, the cycle of any charitable investment we make in the present, i.e., the incentive, can be realised over a time span of 2 generations or more, depending on the prevailing social conditions in the nation.

Source: Author’s interpretation (An interaction of the works of Samuelson and MacAskill)

Figure 1: The Life Cycle of Charitable Investments

In the chart above, what’s fascinating is the original investment ‘x’ which is made in time ‘t’ does provide a significantly large Return on Investment, however, its realisation occurs in time ‘t+1’, which here is across generations. Simply put, investing in the welfare of society today, be it on a microeconomic or macroeconomic scale, results in the benefits being realised by our progeny, which possibly makes us sceptical to such investments. It boils down ultimately to a single question– Can an investment in society be made appealing to an investor such that they are willing to delay their Return on Investment (RoI)? 

Therefore, for any investor who is looking to make an investment in societal welfare, they would consider the societal and economic frameworks both in the present time period as well as in the future. In doing so, they would be able to estimate how a future generation would be able to effectively make use of their investment in the present in maximising their returns as well as social welfare in the future. This could be formulated as follows-

RoI t+1 = f (Social Conditions (t,t+1), Economic Interactions (t,t+1))

The quantification of the above function could be the answer for policy makers today to work on building a more ideal society with lesser inequalities and social problems. If economic incentives were designed along the above framework, it could be possible for us in the future to remove the need for long-held assumptions of rationality and state intervention for poverty alleviation. The above mechanism and its working is in its basic premise a Social Investment Multiplier.

For Shanidar-1, having repute in society and being a part of that tribe of Neanderthals allowed him to survive well into his old-age. In the 21st century however, with our lifestyles having evolved exponentially more compared to Shanidar-1, our perception of repute and altruism too have changed. For us to absolutely and accurately  understand why we care for the elderly or the people around us is difficult at best. What isn’t that difficult to comprehend however is understanding what makes us human beings tick, and that dear reader is a good economic or ‘monetary’ incentive. A good incentive has the potential to frame our future for the generations to come, and is unquestionably the ideal way forward in optimising the interaction between overall benefit and individual utility maximisation.

– Abi Antony George (Guest Writer)

TYBA, St. Xavier’s College (Autonomous), Mumbai

Edited by: Sanika Sawant (Editor, Econ Declassified)

Further Reading

Oded Galor – Unified Growth Theory

Galor, O. (2011). Unified Growth Theory. PRINCETON; OXFORD: Princeton University Press. doi:10.2307/j.ctvcm4h7m

Peter Diamond – National Debt in a Neoclassical Growth Model 

Diamond, P. (1965). National Debt in a Neoclassical Growth Model. The American Economic Review, 55(5), 1126-1150. Retrieved March 21, 2021, from http://www.jstor.org/stable/1809231

References

Everding, G. (2021, February 09). Older Neandertal survived with a little help from his friends: The Source: Washington University in St. Louis. Retrieved February 17, 2021, from https://source.wustl.edu/2017/10/shanidar/ .

MacAskill, W. (2016). Doing good better: Effective altruism and a radical new way to make a difference. London: Guardian Books.

Samuelson, P. (1958). An Exact Consumption-Loan Model of Interest with or without the Social Contrivance of Money. Journal of Political Economy, 66(6), 467-482. Retrieved February 17, 2021, from http://www.jstor.org/stable/1826989 .

Photo Credit

Adam Smith Institute. Blog by Ben Southwood. (17 Dec, 2017).  https://www.adamsmith.org/blog/economics/people-respond-to-incentives

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