Markets for Managers: A Managerial Economics Primer

CHAPTER 1 Incentives Matter

‘The theory of economics does not furnish a body of settled conclusions immediately applicable in policy. It is a method rather than a doctrine, an apparatus of mind, a technique of thinking which helps its possessor to draw correct conclusions.’

—John Maynard Keynes¹

In early 1998, day care centres around Haifa, in Israel, had a problem. It was a problem common to many of us who have looked after children for a living: late parents.² After a long day being responsible for other people's children, by 4pm the teachers were ready to go home. And they weren't being paid for staying any longer. But invariably some parents would be late, and someone would have to stay behind and wait with the child. But one day some social scientists turned up (or rather, sent their research assistants) and made a suggestion: why not fine the parents for being late? It is a solution any economist would give.

Over the next few weeks things carried on as normal, as the researchers gathered data before making any changes. Then, they adopted a policy where any parent who was more than 10 minutes late would pay a $3 fine. But instead of reducing lateness, the number of late pickups more than doubled. The incentive backfired.

As an economist, I've heard this example a lot. It's often used to show economists that assuming people's behaviour can be manipulated with financial incentives is naïve and narrow minded. Indeed there is some truth to this. Just because originally there ...