A World Driven by Incentives

I have my bachelor’s degree in international economics, and the only three things that I really internalized from my collegiate education is:

(A) The good ol’ supply and demand graph,

(B) The law of diminishing marginal returns, and

(C) The fact that incentives drive everything.

The first two points aren’t going to be of much relevance to this discussion. That final point, however, is the thing that helped me realize something fundamental about human nature. We are all flawed (of course), but some of these flaws can be gamed so that they produce desirable outcomes for the rest of society.

Capitalism is a clear example of this dynamic at work. The thing that makes capitalism work is the recognition of our greatest feature (or bug), which is that we are all self-interested beings. We place ourselves at the pinnacle in the hierarchy of needs: our own health, wellness, and desires must be satisfied before we can shift our attention to that of others. Even if our discomforts are minor, we will give more attention to our personal discomforts than the absolute misery that other people may be feeling.

Adam Smith touched on this when he offered his “little finger” parable:

Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connection with that part of the world, would be affected upon receiving intelligence of this dreadful calamity.

He would, I imagine, first of all, express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment . . .

And when all this fine philosophy was over, when all these humane sentiments had been once fairly expressed, he would pursue his business or his pleasure, take his repose or his diversion, with the same ease and tranquillity, as if no such accident had happened.

The most frivolous disaster which could befall himself would occasion a more real disturbance. If he was to lose his little finger to-morrow, he would not sleep to-night; but, provided he never saw them, he will snore with the most profound security over the ruin of a hundred millions of his brethren, and the destruction of that immense multitude seems plainly an object less interesting to him, than this paltry misfortune of his own.

Smith’s observation that a man’s loss of his little finger would cause him far more suffering than the knowledge of the pain of millions points to the inherent nature of self-interest in human beings.

What capitalism does is recognize this bug in human nature, and flips it around so everyone can benefit as a result of having it. Since your own well-being will always be at the top of mind, it will be in your self-interest to produce goods that will benefit others’ self-interest, which facilitates trade between you and the other party. You get money you can use to buy things that will benefit you, while the other party receives a product that increases their well-being. This type of free-market trade is the cornerstone of capitalism, and it all starts with the recognition of one key characteristic of human nature:

We prioritize our personal needs over the needs of others.

It can be quite jarring to hear that, and many people throughout history have refused to accept this. On a systemic level, socialism was the rebuttal to this way of thought, as it tried to consolidate possible economic outcomes and spread them equally among its people.

But the reason it failed was that no system – regardless of how compelling it sounds – can override human nature. The core tenets of socialism emanate good intent, but when put into practice, it devolves into resentment and envy because self-interest and the desire for more always comes into play.

Winston Churchill once quipped, “Democracy is the worst form of government, except for all the others.” Perhaps the same could be same about capitalism as an economic system. This points to the recognition that capitalism employs an incentive system that turns our deepest flaws into drivers of economic and technological growth, which is scary, but it happens to work (for now). After all, self-interest is what created the iPhone, not worldly love. Greed is what powers the stock market, not philanthropy.

I’ve been thinking about how incentives coat our behaviors, and the ways this plays out in the moral realm. We tend to think of incentives as alignment mechanisms in an economic sense, but in reality, they are much more prescient when we delve into things from an ethical standpoint.

Let’s start with something we just mentioned: philanthropy.

There should be nothing more deserving of praise than philanthropy, but why is it that many people look on it with scorn? When news came out that Jeff Bezos donated $125 million to COVID-19 relief, he received far more backlash than praise. People derided him for donating such little of his vast wealth, and relegated it to nothing more than a publicity stunt for Amazon.

The reason philanthropy is tricky is that reputational incentives tend to be embedded into the mix. The moment someone announces that they are giving, it’s natural to question whether it’s coming from a sincere heart, or if it’s coming from a calculated mind. Because any good act is accompanied by a favorable bump to one’s reputation, this makes people wary of what the true intentions may have been.

This leads to a fundamental question that I’ve been thinking about:

Can good acts truly be good when they’re accompanied by a reward?

The thing about any good act is that if it’s broadcasted or recognized by another, a reward comes in the form of a compliment or a reputational bump. Even if I didn’t ask for that reward, my mere receipt of it already alters the color of that good act. The fact that my virtuous act was observed changes its nature.

And even if it wasn’t observed by any other being, how do we explain the fact that doing good actually feels good for ourselves as well? When I give to a cause greater than me, I can’t help but to feel that I did something that’s worth being happy about. Is that just another form of self-interest, or is it something that actually transcends the self? The line between the two can be thin, but it’s worth pondering.

For the most part, I think doing good and helping the less fortunate is a desire worth having, whether it comes from self-interest or not. Just like capitalism turns our greatest flaws into economic powerhouses, virtuous acts convert our desire to feel good into actually doing good for others. Sometimes the outcomes outweigh the intentions, but the best possible scenario is to be driven by nothing more than the desire to make the world a slightly better place.

In an era of virtue signaling and the ability to broadcast our good deeds, it’s important to be honest with ourselves about why we do the things we do. Sometimes it’s beneficial to show others what you are doing so you can inspire them to do the same. Other times it’s more suitable to keep your actions stored solely for your own memory, acting as a personal reminder of what’s worth doing when no one is looking.

Knowing which route to take is the first step to recognizing the incentives that drive our behaviors today.