Incentives and Externalities: A Deep Dive into Behavioural Economics | All Else Equal
This episode of All Else Equal: Making Better Decisions delves into the profound influence of incentives on human behavior and the subsequent negative externalities that may arise.
Professors Jonathan Berk and Jules van Binsbergen explore a variety of scenarios, from complex legal contracts to traffic light inefficiencies, where incentives lead to unexpected and often detrimental outcomes.
The Inefficiency of Traffic Lights
Traffic lights operating on timers rather than dynamically adjusting to traffic flow create unnecessary delays.
With the advent of self-driving cars and smart technologies, traffic lights could potentially adjust to traffic flow in real time, reducing this negative externality.
The ‘Crying Wolf’ Scenario
Officials often overstate the severity of weather emergencies, leading to unnecessary preparation and potential complacency in the face of a real emergency.
This ‘crying wolf’ scenario can be attributed to their incentive to avoid blame in case a severe weather event does occur.
People who ignore incentives, ignore incentives at their own peril. Because I think that there’s one truism about human behavior, it’s that humans respond to incentives. – Jonathan Berk
The Issue of Drought Declarations
Officials may declare droughts even when the risk is low, due to the incentive to protect their job security.
However, constant drought declarations can lead to complacency and a lack of preparedness when a real drought occurs, creating a negative externality.
We introduce something called a delay tax. Any government organization has to pay the cost of the delay that they impose when they impose a delay. – Jonathan Berk
Information Overload in the Digital Age
With the ease of producing and distributing information in today’s digital age, there’s an information overload.
This highlights the need for an efficient mechanism to aggregate and filter this information.
Negativity in News Reporting
As traditional media outlets lose their aggregation function, news reporting has become increasingly negative.
This trend may be driven by these outlets’ incentive to grab attention in a crowded information landscape.
The Long-Term Effects of Incentives
Incentives can often lead to unintended negative consequences.
Incorporating externalities and long-term effects into decision-making could help mitigate these issues and lead to better outcomes.
The Importance of Group Achievements
Compensation structures should not only focus on individual performance but also consider the overall achievements of the group or corporation.
This approach could potentially mitigate some of the negative externalities within an organization.
Addressing Specific Externalities
Identifying key externalities and designing work contracts to address them specifically can lead to better outcomes for organizations.
Relying solely on overall performance for compensation may not be sufficient.