The Ideology of Incentives

With the exception of his stint as head of the Multi-National Security Transition Command in Iraq in 2004, throughout his career the general sense has been that General David Petraeus has been performing well. And yet, nowhere along his path from West Point to heading up United States Central Command has he received a multi-million dollar bonus payment. No stock options. Not even a decent salary by Wall Street standards — Generals seem to max out at around $216 grand a year plus what is, admittedly, a pretty solid benefits package. According to prevailing economic wisdom, it should be completely impossible for the United States Army to field a high-quality officer corps or to motivate its personnel to perform at a high level. And yet something seems wrong with this theoretical picture.

That, I think, rather than the now-banal point that Wall Street bonuses create perverse incentives is the most provocative element of Nassim Nicholas Taleb’s latest:

Finally, I was involved in trading for 21 years and I can testify that traders consciously play the free option game. On the other hand, I worked (in my other job as risk adviser) with various military organisations and people watching over our safety. We trust military and homeland security people with our lives, yet they do not get a bonus. They get promotions, the honour of a job well done and the disincentive of shame if they fail. Roman soldiers signed a sacramentum accepting punishment in the event of failure.

Now I don’t particularly know where this leaves you. But I think it’s a provocative reality staring us in the face. And it’s important to observe that even though there are a lot of economics PhD programs in the United States and a lot of business schools in the United States, you wouldn’t exactly say that looking into ways to design incentive schemes that don’t involve windfall financial rewards for organizational leaders has been a huge research priority of these institutions. Not, I think, because anyone would strictly deny that alternative motivational schemes exist. Or really because anyone consciously says to themselves “my job is to produce work that’s pleasing to the sort of monied individuals who finance the existence of the sort of institutions that employ me.” But somehow things work out the way they do, and I don’t think it’s unrelated to the fact that part of the power of money is that it carriers with it the power to call flatterers into existence. If I recall correctly, this is how Marx used the term “ideology” — to describe the process by which a society inevitably managers to create a set of ideas that justify the existing hierarchy. And when the hierarchy’s power starts to crack, then so does the power of its ideas.

Brad DeLong is not, I know, a fan of Marx. But yesterday he was writing about the return of neo-Hooverite economics:

Back in 2000 my teacher Olivier Blanchard wrote an article: “What Do We Know About Macroeconomics that Fisher and Wicksell Did Not?” (PDF). But he wrote the wrong article. The Cato Institute and the Republican Party demonstrate that we economists have forgotten — or at least can no longer reach consensus on — things that Fisher and Wicksell knew very well indeed.

I think you need understand this process of “forgetting” at least in part in these kind of terms. The collapse of the Gilded Age ushered in an era in which we “knew” various things about the virtues of the mixed economy and the non-automatic nature of economic growth. The rise of the New Gilded Age caused those ideas to be “forgotten.” But note that Ed Prescott, who DeLong is complaining about, hasn’t actually forgotten the old ideas, he’s developed some rather ingenious, if somewhat laughable, new theoretical models that just reach the same conclusions as the liquidationists of old.


Near the end of his very interesting book, A Farewell to Alms, Gregory Clark also does a bit of work toward developing the idea that the role of “incentives” in economic growth is overstated. You can get a flavor here where he argues that neoclassical theory predicts that Malawi should be richer than Sweden which, obviously, it isn’t.