The complex economics of self interest

In social systems, incentives can work in perverse ways.

Part of a continuing series about complexity science by the Santa Fe Institute and The Christian Science Monitor, generously supported by Arizona State University.

An email to me recalled the “exciting and stimulating times” that an old friend of mine had spent in the early 1950s as a staffer in the Executive Office of the President. “People worked long hours,” he told me, “and felt compensated by the sense of accomplishment, and . . . personal importance. Regularly a Friday afternoon meeting would go on until 8 or 9, when the chairman would suggest resuming Saturday morning. Nobody demurred. We all knew it was important, and we were important. . .” 

But then something changed. 

“What happened when the President issued an order that anyone who worked on Saturday was to receive overtime pay . . . ? Saturday meetings virtually disappeared.”

The emails were from Thomas Schelling, who half a century after he left the White House was awarded the Nobel Prize for convincing economists that their discipline should broaden its focus to include social interactions beyond markets. Things like segregated neighborhoods and business organizations and traffic jams and epidemics and information sharing on the internet.

The take-home message from Schelling’s story – that incentives sometimes backfire – is familiar to psychologists. In a 2008 study, kids less than two years old avidly helped an adult retrieve an out-of-reach object in the absence of rewards. But if they were rewarded with a toy for helping the adult, the helping rate fell off by 40 percent. (I review dozens of similar experiments done by economists in my recent book, The Moral Economy: Why Good Incentives Are No Substitute for Good Citizens.)

Emergent morality

That incentives sometimes backfire, as Schelling discovered, is definitely a problem if you are an economist (I am one). Incentives, according to the dismal science, are the foundation of a well ordered society. Adam Smith, considered by many to be the father of economics, said it well: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”  

And this, he explained in the Wealth of Nations (1776), is not altogether a bad thing: the butcher, the baker, and other economic actors  “intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”   

Smith’s idea still resonates. In the aftermath of the stock market crash of 1987, the New York Times headlined an editorial “Ban Greed? No: Harness It,” which continued: “Perhaps the most important idea here is the need to distinguish between motive and consequence. Derivative securities attract the greedy the way raw meat attracts piranhas. But so what? Private greed can lead to public good. The sensible goal for securities regulation is to channel selfish behavior, not thwart it.”

The radical idea here is that shabby motives can be harnessed for elevated purposes. Thus, how well a society or economy works does not depend on a summing up of the quality of its citizens. What really matters is how they interact. In the language of complexity theory, how well an economy works is an emergent property of the interactions of the people making it up: it is something about the whole that cannot be inferred from the parts, or at least not by adding up the parts, or by any other simple rule.  

Smith was among the first to use the idea (not the language) of emergent properties to understand the workings of the economy. (My Santa Fe Institute colleague, John Miller, in an earlier article in this series had more to say about this.) But Smith must have missed something important. Economic self interest may have put the beef, the beer, and the bread on the table, but it did not get Schelling and his colleagues to show up at the White House for Saturday meetings.. 

Where did the classical economists go wrong? Neither Smith nor the great 19th century economists who followed him made the mistake of thinking that people are in fact entirely selfish. Smith, in his other great book, The Theory of Moral Sentiments, held that “How selfish soever man may be supposed, there are evidently some principles in his nature that interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.” John Stuart Mill three quarters of a century after Smith termed the assumption of unmitigated self interest “an arbitrary definition of man.”

When more is less

What Smith (and most economists since) missed is the possibility that moral, generous, or other socially beneficial behavior would be affected – perhaps adversely – by incentive-based policies designed to harness self-interest. To most economists the unspoken first principle is that incentives and morals are what is called “additively separable.” This mouthful of a term is from mathematics; it means that the effects of the one did not depend on the level of the other. When two things are additively separable, they are neither synergistic – each contributing positively to the effect of the other, like a duet being better than the separate parts – nor the opposite.

You have already seen where separability can go wrong. Offering Schelling and the White House staffers overtime pay for Saturday meetings was not simply another reason to show up, additional to their sense that what they were doing was important. Their public spiritedness was not separable from their self-interested regard for their own pay. The policy addressed to the latter appears to have diminished the former. The whole in this case was less than the sum of the parts. 

This brings us back to complexity, a way of thinking in which the effects of things are rarely simply additive. Smith’s invisible hand argument had the whole, namely, the dinner on the table, being greater than the sum of its parts, namely, the self-interested motives of those providing the food who, Smith supposed, could not have cared less about the hungry family about to sit down. 

But it can also go the other way. What economics has missed is that adding an incentive – a fine or a bonus – may be subtracting something else, the individual’s sense of responsibility, or obligation, or intrinsic pleasure. 

The psychologists Felix Warneken and Michael Tomasello, authors of the study about how rewards crowded out infants’ intrinsic desire to help others, concluded: “Children have an initial inclination to help, but extrinsic rewards may diminish it. Socialization practices can thus build on these tendencies, working in concert rather than in conflict with children’s natural predisposition to act altruistically.”

This might be good advice for public policy too.

Samuel  Bowles, an economist, directs the Behavioral Sciences Program at the Santa Fe Institute,  recently published The Moral Economy: Why Good Incentives Are No Substitute for Good Citizens (Yale University Press) on which this essay is based, and is one of the authors of The Economy, a collaborative free online introduction to economics by the Curriculum Open Access Resources for Economics (CORE) Project. He also blogs at Psychology Today. He is featured in the Institute for New Economic Thinking's video on "The Death of Homo Economicus” and in this video on morals, markets and incentives that backfire.