Tyler Cowen's Idea #2: Incentives Matter

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- [Tyler] Now let's say you could
only teach two words to everyone.

What would the two words be?

My candidate would be
"incentives matter."

If there could only be one lesson
from an economics class,

a single takeaway --

I can't boil it down to one word.

Even in German there's not one word
for "incentives matter."

I hope they coin one.

[audience laughter]

But to train or teach students
throughout life, in all areas,

to keep on seeing whether
our economic knowledge in those areas

is certain or uncertain --
incentives are playing a role.

So just very simple examples.

In a number of cities,
there are proposals

to ban tipping
of waiters and waitresses.

There have since then
been studies that show

that if tipping is banned,
the quality of service goes down.

Of course this is,
to us, common sense.

It has more or less
been verified empirically.

If the waiter or waitress
does not get more

by bringing you your plate
when you need it

because you leave a larger tip,

they're not going to be
as keen to do it.

It doesn't mean that
all people care about is money.

It does mean that incentives matter.

You look at these
Silicon Valley companies.

That's my trip after this.
I'm going out there.

Like Google and Facebook --
they've all gone public now,

the famous ones.

It was really striking.

Right after they go public,

there is a spike in the divorce rate
for their employees.

[audience chuckles]

Now why is that?

Is it that being
in a publically run company

is more stressful?

Or somehow causes people
to spend more time away from home?

I don't know.

But there's a pretty simple
economic reason --

that once it's
a publicly traded company

people can sell
their shares of stock, right?

And if there's a divorce settlement,

the partner who has more money
can pay off the other,

and they can reach an arrangement,

whereas if you're holding
relatively illiquid shares,

or you're not allowed
to sell them so rapidly,

and you have to reach
a divorce settlement,

it's much harder to do.

Maybe you have to borrow to do it.

People are reluctant to do that,

so they don't get divorced
until the company goes public.

You would think,
"My goodness! That's cruel

or cold-hearted, or calculating,
or Machiavellian!"

Morally, you may approve
or not approve,

but the point still remains --
incentives matter.

In the United States right now,

one big problem
we have with incentives

is that when people
at lower income groups

climb the income ladder
they lose a lot of their benefits.

That is like
an implicit tax rate on them.

So, in some estimates --

again, it depends
on your circumstance --

but if you go from being poor
to being, say, middle class,

your marginal tax rate might be,
say, 50 to 70% in some cases.

It's probably at least 40%.

So if you ask who are
the people in this country

who face the highest tax rates?

It's not generally the rich people.

It's not even
Warren Buffett's secretary.

Very often, when you understand
incentives properly,

it is the poor people.

When I was in Montreal,
one thing that struck me

is there's
relatively little gentrification.

Rents are quite low,
by most American standards,

for a city that large.

And when you walk around
it was striking to me

how many restaurants
are closed for lunch.

So think of Montreal.

The city still has a feel
a bit like in the '70s.

It's not poor,
but it hasn't grown very rapidly.

It doesn't have a tech sector.

Investment has been afraid
to go there,

because of all the talk
of secession.

So it has a retro feel.

Rents are much lower.

So you have a restaurant,

you don't necessarily
have to open it for lunch

to stay in business.

And if you open it for lunch
you work your staff more hours,

you bump up
against labor regulations.

Again, incentives matter,
incentives matter,

incentives matter.

It's true in the non-profit sector.

It is true in government.

It is true in every country
of the world.

Of course incentives mattering
does not have to be a good thing.

It does help us get
many good things done, right?

We have property rights.

Property rights help people
who create value

to internalize value.

That's another incentive.

So I don't really
teach property rights

as a separate category.

To me they're an example
of incentives.

They're part of the carrot.

They're how you get
to eat the carrot.

There's one story I read recently --
it's kind of scary, actually.

There was a fellow,

and he bought
an old tooth of John Lennon.

Yes, John Lennon the Beatle.

He bought the tooth at auction.

And now he's putting ads
all around the internet saying,

"Do you think you might be
an unrecognized descendant

of John Lennon?

I have his DNA.

Contact me.

We will test you,
and we can bring a lawsuit."

In my opinion --
It's now a personal opinion.

I'm not speaking as an economist --

but that's a negative incentive.

So a lot of the troubles
we have in the world

also spring from incentives.

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