Incentives

The Basic Idea

If you’ve ever had a salesperson pressure you into buying something, you know all about incentives. Often, salespeople make additional money based on how much they can sell – an incentivization tactic known as “working on commission.” Put simply, an incentive is something that motivates people – in the cases of sales, to sell as much as possible.

Incentives can be remunerative, like a commission, such that they motivate people to do something in order to get some sort of reward. They can also be moral, like doing volunteer work, which brings along a boost in self-esteem and possible praise from others. Coercive incentives occur when we are motivated to do something because the consequences of not doing it could be severe, such as respecting authority for fear of being fired or getting in trouble.1

Incentives and motivation are fundamentally intertwined, such that the incentive theory of motivation suggests that incentives give rise to motivation.2 This theory also suggests that different people are motivated by different incentives. An incentive will only boost motivation if what is being offered as an incentive is of value to the individual.3

Economics, when you strip away the guff and mathematical sophistry, is largely about incentives.

– John Cassidy in How Markets Fail: The Logic of Economic Calamities

Key Terms

Extrinsic motivation

Extrinsic motivation occurs when we are motivated to take part in an activity in order to obtain an external reward, such as financial compensation. External rewards can be useful for encouraging an individual to put more effort into something they are not particularly interested in.4 If your parents ever gave you rewards when you did well in school, for example, they tried to use extrinsic motivation to increase your work ethic.

Intrinsic motivation

Intrinsic motivation refers to a motivation that comes from within. While extrinsic motivation pushes us to accomplish something in order to gain a reward, intrinsic motivation drives us to accomplish something because we find the act itself rewarding.5 Using intrinsic motivation is often more sustainable, as it does not risk a decrease in motivation when a reward is inevitably taken away. In terms of school, this may look like having your child think about their future goals and then finding ways to show them how doing well in school can help them reach those goals.

History

Incentives are of particular importance within the field of economics. In economics, it is assumed that people will respond to incentives to bolster their economic standing.6 As such, incentives have played a large role in the economies of different countries for hundreds of years. When the field of economics was established, incentives went from being solely an applied concept, to an object of study as well.

Adam Smith, a political economist and moral philosopher who is known for his foundational contributions to the field of economics, discussed the importance of incentives in higher education in his magnum opus, The Wealth of Nations. At universities, academics often take on professorships in order to further their own research. Some may have an interest in teaching, while others may not. Smith suggested that the English university system, which guaranteed professors large salaries, did not sufficiently incentivize professors to be good teachers. Instead, he endorsed the Scottish system, in which university professors were guaranteed a small salary. In addition to this, they were paid based on the number of students enrolled in their course – which may be an indirect means of measuring their adeptness as a teacher. Furthermore, at some schools, such as the University of Glasgow, students paid their professors an honorarium, a voluntary payment with the sum to be decided at their own discretion. Smith argued that this approach incentivized Scottish professors to be good teachers. His arguments were largely ignored, and the issue of unmotivated university professors continues to be problematic.7 A few years following the publication of Wealth of Nations, David Ricardo, a British political economist who was heavily influenced by Smith, illustrated the role incentives play in the negotiation of rent between farmers and their landlords.

More recently, academics studying motivational psychology have conducted research into the power of incentives. This line of study picked up in the late-twentieth century and continues to this day. One aspect of motivation that psychologists are interested in is the implications of behavioral interventions, in which participants are offered an incentive for completing a certain desirable behavior or for refraining from engaging in a certain undesirable behavior. If these interventions are empirically supported, they have the potential to be applied in a variety of areas, including health and education.

Consequences

By boosting people’s motivation, incentives have the capacity to change people’s behavior, generally for the better. Take, for instance, the example of commission. This incentive motivates employees to make sales. It is mutually beneficial for the employee and the employer, as the salesperson will make a greater income and the company will bring in a greater profit. In theory, incentives could be used to encourage a variety of adaptive behaviors, ranging from increased academic performance to living a healthy lifestyle. The idea is that the small investment made to incentivize certain behaviors will lead to increased returns down the line, whether it is the incentive of commission resulting in increased sales, or the incentive for smoking cessation to reduce medical costs.

Controversies

In recent years, interventions to incentivize certain desirable behaviors have become increasingly popular. This is particularly common with financial incentives: for instance, offering a monetary reward to help people quit smoking or encourage them to give blood. However, not everyone is in favor of such interventions. While incentives are usually thought of as a tool for boosting motivation, some research suggests that they can sometimes have the opposite effect.8

Financial incentives are external rewards, and the literature shows that, while external incentives may be beneficial in the short term, they may actually undermine our intrinsic motivation. Psychologists have found that while extrinsic motivation may lead to behavior change in the short term, it will not have a lasting effect after the intervention ends. Intrinsic motivation, on the other hand, can successfully enable long term change.9 This suggests that external rewards, such as money, may not be effective in all contexts, specifically ones that require long term behavior change, such as quitting smoking.

Researchers have suggested that economists should exert care when using incentives. They stress the importance of the design of the incentive, what the reward is, and whether the incentive interacts with the individual’s intrinsic motivation.10 These are all important considerations, in order to avoid inadvertently reducing the individual’s intrinsic motivation.

Case Study

Ricardo’s theory of wages and profit

One application of incentives in economics can be found in David Ricardo’s theory of wages and profit. Ricardo, who was a political economist in late-eighteenth and early-nineteenth century England, is listed alongside Adam Smith as one of the key players in developing the field of economics.

Ricardo presented his theory of wages and profit with the goal of describing the means by which farmers and landlords negotiate rent. In order to pay their rent to their landlords, farmers allotted a portion of their produce to the landlords and kept the rest for themselves. Ricardo concluded that the most reasonable allotment would be for farmers to keep the amount of produce that could be procured from the worst plot of land being farmed and the surplus would be used to pay their rent.11

His reasoning was as follows: If the rent were so high that the farmer was left with less produce than could be obtained from the worst plot of land, it would not be worthwhile to continue renting from this landlord. Instead, the farmer would be better off renting land so bad that it was not being cultivated. The farmer could offer the landlord of this uncultivated land a very small amount of rent and, since it was not being rented up until that point, the landlord would still benefit from it. Alternatively, the farmer could request that the rent be lowered, which may lead the landlord to evict them and find another farmer to rent their land.12

Both scenarios illustrate the ways in which both farmers and landlords may be incentivized to improve their situation. The landlord may attempt to find someone new to whom they can rent land, who is willing to pay their high rent, while the farmer may try to find a new landlord from whom they can rent at a lower rate. Both are trying to boost their economic standing. The result of Ricardo’s theory was that all farmers in England made a similar income, which was approximately the amount that could be produced on the worst plot of land.

Incentives in health

Psychologists are interested in determining if incentives can be used to get people to stop engaging in unhealthy behaviors, like smoking, or to encourage them to engage in healthy behaviors, like exercise.

In order to assess the power of incentives, one study staged an intervention to help smokers kick the habit. All participants in the study attended five classes, with half the participants receiving $20 for each class they attended. The short term results of this intervention were promising: individuals who received the financial incentive were more likely to attend all the classes and give up smoking following the program. However, at a six month follow up, there was no significant difference in the number of people who quit smoking between those who received the incentive and those who did not.13 This suggests that financial incentives may not be as effective in the long term. That being said, there are instances when quitting smoking even just in the short term can be beneficial. For example, these types of interventions may be useful for individuals who are attempting to give up smoking while pregnant.14

When behaviors are intrinsically motivated, things can look different. In the realm of healthy behaviors, such as exercising regularly, one interesting finding revolves around the importance of habit formation. In a study conducted in 2009, participating university students were taught about the potential health benefits of exercise, then were split into three groups. The first was given no incentives to go to the gym, while participants in the second and third groups were promised $25 if they went to the gym at least once in the next week. In the next stage of the study, students in one of the two incentive groups were told that if they went to the gym at least eight times in the next four weeks, they would be granted an additional $100. The researchers recorded how frequently the students went to the gym before, during, and after the intervention. The key outcome of this study was that only students who were offered the $100 incentive were more likely to go to the gym during the course of the intervention and after the intervention had ended.

However, combining incentives with social networks can play a role, too. A similar study demonstrated that participants in the incentive condition were more likely to go to the gym frequently if they had more friends in the incentive condition than in the control condition, and less likely to attend the gym frequently if they had more friends who were not being incentivized. As you can see, incentives can help people develop healthy habits over time – such as the four-week period over which participants were incentivized to go to the gym. Once this habit has been formed, people may stick to it without the external incentive to do so, if it aligns with their goals or values (intrinsic motivation). Furthermore, social connections seem to enhance this effect, although more research is needed in this area.15

Related TDL Content

The Science of Reward

The prospect of obtaining a reward can motivate us to take on a certain task or push ourselves to do better. When we hear the term “reward”, the first word that comes to mind is often “money.” While money can be an effective incentive, we should not discount the power of intrinsic, performance-related incentives. Even more importantly, we should not ignore the effect external rewards can have on our internal motivation.

To Nudge or Adjudge? That’s the Enviro-Policy Question

Governments are implementing policies such as carbon-taxes to encourage more eco-friendly behavior. This article suggests that carbon-taxes might not be the most effective incentive for behavior change, and proposes the alternate approach of nudges.

To Be Right or Liked? Evaluating Political Decision-Making

Politics are a point of contention for many. Although people generally claim to value the truth, the way in which many of us attend to and interpret political information is biased. This is in part because we are more motivated to be consistent in our beliefs and to be accepted by others than we are to be right. Interesting findings show that monetary incentives have the potential to motivate people to be more accurate in their interpretations of political information.

Sources

  1. Dalkir, Kimiz (2011). Knowledge Management in Theory and Practice(Second ed.). The MIT Press. ISBN9780262015080.
  2. Motivation Theory: Everything You Need to Know. Indeed.https://www.indeed.com/career-advice/career-development/incentive-theory-of-motivation
  3. See 2
  4. Cherry, K. (2020). Differences of Extrinsic and Intrinsic Motivation. Very Well Mind. https://www.verywellmind.com/differences-between-extrinsic-and-intrinsic-motivation-2795384
  5. See 4
  6. Rollert, J.P. (2013). What Adam Smith Can Teach Us About Incentives in Higher Education. Boston Review. http://bostonreview.net/blog/rollert-adam-smith-education-incentives
  7. See 6
  8. Gneezy, U., Meier, S., and Rei-Beil, P. (2011). When and Why Incentives (Don’t) Work to Modify Behavior. Journal of Economic Perspectives, 25(4), 191-210.
  9. Promberger, M., and Marteau, T.M. (2013). When do financial incentives reduce intrinsic motivation? Comparing behaviors studied in psychological and economic literatures.Health Psychology, 32(9), 950-957. http://dx.doi.org.proxy3.library.mcgill.ca/10.1037/a0032727
  10. See 8
  11. Understanding Incentives in Economics: 5 Common Types of Economic Incentives. Masterclass. https://www.masterclass.com/articles/understanding-incentives-in-economics#5-common-types-of-economic-incentives
  12. See 9
  13. See 8
  14. See 8
  15. See 8

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