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♪ [music] ♪

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

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What would the two words be?

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My candidate would be
"incentives matter."

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

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a single takeaway --

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I can't boil it down to one word.

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

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I hope they coin one.

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[audience laughter]

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

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to keep on seeing whether
our economic knowledge in those areas

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

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So just very simple examples.

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In a number of cities,
there are proposals

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to ban tipping
of waiters and waitresses.

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There have since then
been studies that show

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

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Of course this is,
to us, common sense.

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It has more or less
been verified empirically.

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If the waiter or waitress
does not get more

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by bringing you your plate
when you need it

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because you leave a larger tip,

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

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

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It does mean that incentives matter.

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You look at these
Silicon Valley companies.

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

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

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the famous ones.

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It was really striking.

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Right after they go public,

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

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[audience chuckles]

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Now why is that?

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Is it that being
in a publically run company

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is more stressful?

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

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I don't know.

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But there's a pretty simple
economic reason --

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that once it's
a publicly traded company

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people can sell
their shares of stock, right?

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And if there's a divorce settlement,

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

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and they can reach an arrangement,

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whereas if you're holding
relatively illiquid shares,

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

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and you have to reach
a divorce settlement,

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it's much harder to do.

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Maybe you have to borrow to do it.

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People are reluctant to do that,

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

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

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

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Morally, you may approve
or not approve,

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but the point still remains --
incentives matter.

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In the United States right now,

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one big problem
we have with incentives

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is that when people
at lower income groups

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

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That is like
an implicit tax rate on them.

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So, in some estimates --

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again, it depends
on your circumstance --

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

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

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It's probably at least 40%.

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So if you ask who are
the people in this country

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who face the highest tax rates?

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It's not generally the rich people.

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It's not even
Warren Buffett's secretary.

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Very often, when you understand
incentives properly,

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it is the poor people.

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When I was in Montreal,
one thing that struck me

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is there's
relatively little gentrification.

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Rents are quite low,
by most American standards,

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for a city that large.

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And when you walk around
it was striking to me

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how many restaurants
are closed for lunch.

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So think of Montreal.

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

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

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It doesn't have a tech sector.

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Investment has been afraid
to go there,

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because of all the talk
of secession.

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So it has a retro feel.

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Rents are much lower.

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So you have a restaurant,

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you don't necessarily
have to open it for lunch

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to stay in business.

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

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you bump up
against labor regulations.

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Again, incentives matter,
incentives matter,

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incentives matter.

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It's true in the non-profit sector.

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It is true in government.

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It is true in every country
of the world.

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

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

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We have property rights.

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Property rights help people
who create value

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to internalize value.

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That's another incentive.

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So I don't really
teach property rights

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as a separate category.

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To me they're an example
of incentives.

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They're part of the carrot.

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They're how you get
to eat the carrot.

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

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There was a fellow,

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and he bought
an old tooth of John Lennon.

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Yes, John Lennon the Beatle.

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He bought the tooth at auction.

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

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"Do you think you might be
an unrecognized descendant

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of John Lennon?

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I have his DNA.

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Contact me.

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

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

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I'm not speaking as an economist --

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but that's a negative incentive.

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So a lot of the troubles
we have in the world

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also spring from incentives.

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♪ [music] ♪

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- [Narrator] Click here
to watch the next episode

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of "Tyler Cowen's
9 Big Ideas of Economics."

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Or maybe you're not ready
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and instead want to learn more
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Then you should
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