The Role of Incentives

The last posting started a little mini-series on Wealth Creation with a piece on Supply and Demand. Today we continue with The Role of Incentives. This is something we all know and is so basic that it requires little elaboration: you get more of what you reward and less of what you punish.

Therefore, the wealth of a society is heavily influenced by the incentives and disincentives that it adopts. If it rewards idleness and destructive behavior
(think unemployment and illegitimacy), it’ll get more. If it punishes work (excessive taxation), innovation and risk-taking (regulation and litigation), it’ll get less.

This rule is the short explanation of why socialism doesn’t work. Socialism rewards indolence and failure. It punishes work, innovation and risk-taking.

Maybe you’ve seen the story about the college professor who, on the first day of class, asks his students how many favor socialism. A majority of hands go up. So he announces that he will use a socialist grading system for that class. Instead of giving each student the grade she earns, he will average the grades and everyone will get the same grade.

On the first test, each student performed as usual, some A’s, lots of C’s, a couple of F’s (assuming anyone actually gets an F anymore). After averaging the grades, everybody got a B. Now the people who studied hard earning an A figured, what the hell, why should I work so hard if I’m going to get the same grade as everyone else. You can see where this goes: on successive tests the average grade keeps dropping until, on the final exam, everyone gets an F.

In a recent nationwide poll only 53% of respondents said that capitalism is a better system than socialism. If there is a bright side, it is that only 20% favored socialism. Twenty-seven percent didn’t even have an opinion. (These are the people we need to reach, if indeed they interested and capable of forming an opinion.)

If those polls results concern you (and they should), consider that, according to economist Gary Schilling, 52.6% of Americans now receive “significant income” from the government in the form of paychecks, Social Security and various welfare programs. Surprised? You ain’t seen nothin’ yet!

So, next time you read about a new government program or legislation, ask yourself, How will this affect people’s behavior and what effect will that have on wealth creation.