When Economic Incentives Backfire

Organizations and societies rely on fines and rewards to harness people’s self-interest in the service of the common good. The threat of a ticket keeps drivers in line, and the promise of a bonus inspires high performance. But incentives can also backfire, diminishing the very behavior they’re meant to encourage. A generation ago, Richard Titmuss claimed that paying people to donate blood reduced the supply. Economists were skeptical, citing a lack of empirical evidence. But since then, new data and models have prompted a sea change in how economists think about incentives—showing, among other things, that Titmuss was right often enough that businesses should take note. Experimental economists have found that offering to pay women for donating blood decreases the number willing to donate by almost half, and that letting them contribute the payment to charity reverses the effect. Consider another example: When six day-care centers in Haifa, Israel, began fining parents for late pickups, the number of tardy parents doubled. The fine seems to have reduced their ethical obligation to avoid inconveniencing the teachers and led them to think of lateness as simply a commodity they could purchase. Dozens of recent experiments show that rewarding self-interest with economic incentives can backfire when they undermine what Adam Smith called “the moral sentiments.” The psychology here has eluded blackboard economists, but it will be no surprise to people in business: When we take a job or buy a car, we are not only trying to get stuff—we are also trying to be a certain kind of person. People desire to be esteemed by others and to be seen as ethical and dignified. And they don’t want to be taken for suckers. Rewarding blood donations may backfire because it suggests that the donor is less interested in being altruistic than in making a buck. Incentives also run into trouble when they signal that the employer mistrusts the employee or is greedy. Close supervision of workers coupled with pay for performance is textbook economics—and a prescription for sullen employees. Perhaps most important, incentives affect what our actions signal, whether we’re being self-interested or civic-minded, manipulated or trusted, and they can imply—sometimes wrongly—what motivates us. Fines or public rebukes that appeal to our moral sentiments by signaling social disapproval (think of littering) can be highly effective. But incentives go wrong when they offend or diminish our ethical sensibilities. This does not mean it’s impossible to appeal to self-interested and ethical motivations at the same time—just that efforts to do so often fail. Ideally, policies support socially valued ends not only by harnessing self-interest but also by encouraging public-spiritedness. The small tax on plastic grocery bags enacted in Ireland in 2002 that resulted in their virtual elimination appears to have had such an effect. It punished offenders monetarily while conveying a moral message. Carrying a plastic bag joined wearing a fur coat in the gallery of antisocial anachronisms. Understanding why Irish shoppers responded positively to the fine, unlike Haifa parents, is the next challenge. How to reliably design synergistic incentives will be a hot topic for behavioral economists in the coming years. Meanwhile, organizational and social policy makers would do well to examine their incentive systems to see whether they’re unwittingly encouraging the opposite of the behavior they desire.

When Economic Incentives Backfire

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