Do we really respond to incentives?

Incentives are often the first port of call to influence people’s behaviour. How justified are we in relying on these instruments?

In The Armchair Economist, Steven Landsburg writes,

Most of economics can be summarized in four words: “People respond to incentives.” The rest is commentary.

I remember reading this for the first time many years ago, and being struck by the simultaneous profoundness and simplicity of the observation. Our society, from the microcosm of the household to the place of work, the country and indeed the world, is very much organized around this principle.

As children, we got punished when we were naughty, and got rewards when we were good. At work we get bonuses when we perform well, and we get written warnings when we don’t, or when we behave badly. We risk a fine when we drive too fast or when we drop litter in the park. And even countries can get financial support if they behave in a friendly way, and are exposed to military threats if they don’t.

Incentives are everywhere – shops advertise discounts to lure us in and try to keep us coming with loyalty cards, car manufacturers offer attractive finance deals, companies run employee of the month competitions. Signs announce the penalties for misbehaving. The use and effect of incentives, negative or positive, has become a heuristic that we almost blindly apply, and that we think universally applies.

Paid to stay at home

And yet, as Landsburg says, “*most* of economics…”. Sometimes life is just a bit more complicated. This occurred to me when I came across a recent paper by two economists, Stefan Pichler and Nicolas Ziebarth, in which they explore the pros and cons of sick pay schemes. When they examined the incidence of influenza in the USA and correlated it with the presence or absence of mandated sick pay systems (which differ from one region to the next), they found that there is a strong decrease in occurrence of the flu after the introduction of mandated paid sick leave. Their conclusion is that such public schemes can help prevent sick people coming to work and so spread diseases.

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Not cheap!

This is because a sickness pay scheme acts as an incentive for people to stay at home. Without paid sick leave, some people who are ill and contagious might come to work and infect others because they would otherwise lose out financially – the authors label this ‘contagious presenteeism’. This is technically a so-called moral hazard: the situation where someone (the sick person) takes a risk (of infecting many other people, in order to avoid losing income), the cost of which is borne by other people (colleagues and customers who contract the disease).  But there is another even more obvious moral hazard, as with all insurance schemes: there might be people who are not ill at all, who can now shirk off work without losing out (‘non-contagious absenteeism’), because the cost of their behaviour is carried by the employer or their insurers.

The balance between these behaviours is of course important at the macro level if you want to work out the net economic effect of introducing sick pay: does the reduction in contagious presenteeism, and the consequent economic cost of excess sickness outweigh the increase in the economic cost of the non-contagious absenteeism of the shirkers?

But it is also interesting to look at how employees act from a more specific behavioural perspective, and to examine how we need to nuance the idea that ‘people respond to incentives; the rest is commentary’.

(Not so) strange behaviour

A first observation is that some people do not need incentives to stay at home when they are sick. Even leaving out the cases where the illness is so severe that it would be impossible to turn up at work, there are people who deliberately decide to stay home when they are ill, despite the fact that it is financially damaging. Why might they make the trade-off between going into work and staying at home in this disadvantageous way?

One reason might be that they make a reasoned analysis. Being at work when feeling ill is not pleasant. Most people are prepared in principle to pay to avoid unpleasantness – for example, lots of us buy umbrellas to escape the unpleasantness of being soaked. So it is very well possible that a day’s wages is, for some, a reasonable price to pay for not having to suffer at work. This is a perfectly rational decision.

Provided the loss of income does not cause major hardship, the decision to stay at home might also determined by social norms: if this is what you saw grown-ups do when you were a child, or what you see colleagues do, then you are more likely to follow their example. You are, in a way, nudged by your history or your environment.

Or maybe people are guided by their strongly held beliefs and the desire to do the right thing. Going to work when ill and contagious is not the right thing, so even if it comes with a financial loss, you’ll act in accordance with your convictions. Personal morality conquers moral hazard.

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I’d rather be at home [credit Mojpe/Pixabay]


But for some people, the beliefs or the nudging effect from colleagues and parents might not be strong enough, or the price they’re willing to pay to avoid going to work sick is less than what they earn in a day. And those people are much more likely to respond as expected to the incentive of paid sick leave.

 

What about the other moral hazard – when there is paid sick leave? Why doesn’t everyone just pretend to be ill once in a while? Would that not be the rational trade-off to make – getting paid without having to work? Someone who defines rationality very narrowly around financial gains and losses may well consider non-shirkers as irrational. But in practice, when people do make deliberate trade-offs, they generally consider more than just the financial consequences.

Here too the social context is likely to hold considerable nudging power. If your work colleagues dodge work every so often, it would be tempting to join in. Likewise, if they never do, then social norms may well make you think twice – if only because of the risk of being found out acts as a negative incentive counterbalancing the positive incentive of a day’s pay without a day’s work.

And of course believing that it’s good to act honourably and morally instead of stealing from your employer or their insurers may well be enough to prevent you succumbing to the temptation.

The commentary matters

While it is true that people respond to incentives, not everyone responds to the same incentives in the same way in all circumstances. The ‘commentary’ in Landsburg’s quote can be quite important. Backseat drivers (a role with which I confess being quite familiar) sometimes ignore this bit, and can be lured into thinking the behaviour of this or that group of people can simply be changed with some obvious positive or negative incentive.

But also when we actually do seek to change people’s behaviour, maybe as a manager, as a teacher or even as a parent, it’s easy to uncritically call upon such incentives that appear self-evident. People have complex sets of preferences, however, and it is rarely the obvious incentives that work the best – the battlefield of behaviour change is rife with unexpected side effects. Uri Gneezy, Stephan Meier and Pedro Rey-Biel discuss several such unintended consequences. Alongside the classic Haifa day care centre where financial penalties for late pick-ups crowded out the social guilt, they look at incentives to improve academic achievement, to encourage prosocial behaviour (like giving blood or volunteering) and even to change lifestyle habits (bad ones, like smoking and good ones, like exercising). Self-evident they may all seem, but they are not.

The lesson is (as it is so often): it’s not that simple. The right incentives may produce the desired change in behaviour, but you need to do your homework and establish what precisely these ‘right’ incentives are. And that requires effort – which is of course a disincentive…

(Credit for featured image: Alan O’Rourke/Flickr)
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About koenfucius

Wisdom or koenfusion? Maybe the difference is not that big.
This entry was posted in Behavioural economics, Economics and tagged , . Bookmark the permalink.

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