Monetary incentives

I f your friend offers you 50p to borrow your phone charger, are you more or less likely to lend it to them than if they didn’t offer you anything? The answer is obvious. Isn’t it ? In fact, the unexpected outcome to this question can be seen on even a corporate scale.

When the American Association of Retired Persons asked a law firm if they would be willing to provide legal services at a discounted rate of $30 an hour, they refused. However, when the ARRP then asked if the lawyers would provide the service for free, they consented. Why, then, do we assume monetary incentives work in the first place?

We expect monetary incentives to be effective since they reduce the opportunity cost of undertaking a certain action. The opportunity cost for school children to, for example, read books may be in the form of the next best alternative; an activity such as playing video games. When students in Dallas were paid $2 per book they read, they were receiving $2 on top of whatever may have initially motivated them to read.

This initial motivation can be called “intrinsic” as it is driven by internal rewards such as intellectual curiosity. Such an incentive reduced the “cost” these children faced by giving up their free time and effort since they were being rewarded in a monetary form. The results were unsurprising and showed that students in this class performed 20% better on a comprehension test than those in a control group.

However, a possible explanation for why such monetary incentives may fail to work is that they diminish these “intrinsic” motivations. When a fine was imposed for parents arriving late to pick up their children from a daycare centre in Israel, its results were certainly unexpected: late pickups increased.

It is likely that this incentive “crowded out” or diminished the intrinsic responsibility associated with being a parent, in the same way that paying 50p to borrow a charger would demean the value of a friendship and won’t convince your friend to let you use it. Therefore, parents may have interpreted the fine as a fee for their tardiness, freeing them from the sense of guilt they previously felt and started arriving late even more frequently.

The fact that it was necessary to impose the fine would similarly have signalled to parents that arriving late was a social norm which may have made them liable to a status quo bias. Since parents understood that coming late was common, they were less inclined to deviate from the current state of affairs and arrive on time. As a result, the incidence of late arrivals soared after the imposition of this fine, leading to as many as 100% more parents arriving late (see Figure 1).

Incentives which offer a financial reward may also fail to achieve their intended outcome since they reduce “image motivation”. It can be assumed that humans desire to promote their own image; something which can be done through self-less actions such as donations to charity.

A study in 2009 monitored donations and varied whether the donation was able to be observed in public and whether the donation was incentivised with a monetary reward. In private, monetary incentives were effective in increasing the magnitude of donations. When the donations were public, incentives reduced donations by 155%. A likely explanation for why this occurred is that individuals did not want to be seen donating because of a financial incentive, thereby making the incentives “crowd out” or diminish their initial motivation.

While it is logical to suppose that monetary incentives should be effective, irrational biases which humans are liable to prevent them from being so. This should lead policy makers to consider whether the imposition of a sugar tax or a guaranteed minimum price are in fact the most efficient way of achieving a desired outcome.

So, don’t offer your friend 50p if you want them to lend you their charger but assume that they will be willing to help – otherwise, they wouldn’t be your friend!

Further reading:

I would recommend reading What Money Can’t Buy: The Moral Limits of Markets by Michael J.Sandel for a more detailed explanation of how markets crowd out non-market norms. You can read our review of it here.

I would also encourage reading the Harvard Business Review article on “Why Incentive Plans Cannot Work”. It explores why monetary incentives result in temporary compliance but are ultimately unsuccessful.