If an incentive is too excessive, it can throw the market off balance. Demand can outstrip supply if the incentive is so excessive it is desirable. When it is so powerful, it can throw off the equilibrium of the market. If the incentive rewards measure rather than quality or honesty, it can throw the market off balance by creating perverse incentives.
An economic incentive is offered to encourage people to make certain choices or behave in a certain way1. They spur motivation within businesses and employees and increase productivity immensely. But incentives align with self-interest and working for the good of ourselves, and can create problems in a market by leading people to greed and fraud. In today’s market, it is not uncommon to come across an incentive for a certain product or work that is extravagant and unlike other incentives. Incentives range from an overwhelming sense of satisfaction, an example of an intrinsic incentive, to large sums of money, an example of an extrinsic incentive. Regardless of if the incentive is physical or mental, certain incentives that exceed expectations can throw the market off balance.
An example of this excessive or ill-driven incentive in today’s economy is with the continuing Wells Fargo scandal in which thousands of employees were fired after incurring fines totaling $185 million dollars after opening new accounts for existing customers without authorization. “In many cases, customers took notice only when they received a letter in the mail congratulating them on opening a new account”2, the New York Times wrote, “and many of the questionable accounts were created by moving a small amount of money from the customer’s current account to open the new one.” Wells Fargo employees were notified by customers and closed the accounts, returning the money, but were still able to get credit for opening new accounts in meeting their sales goals. “When they are done properly, account openings drive profitability because they create deeper customer relationships that will generate revenue far into the future”3, businessinsider.com writes. Employees were evaluated and paid based on how many new accounts they opened, and when people are paid to do something assessable, they are driven to do more of it. This does not disprove the incentive system but is a reminder that paying for performance is difficult and needs to be carefully monitored. This scandal created a perverse incentive, an incentive with unintended and undesirable results, with the loss of customers and the tarnish to the company’s reputation.
When an incentive is excessive or based on the amount of work, it can drive employees to work for immoral reasons in the wrong ways and hurt the market as well as generate perverse incentives. “Programs, organizations, and systems work better when they get the incentives right”4, Charles Wheelan writes. It is in our best interest to understand human nature and what motivates us and plan accordingly. This is not always possible, but as more and more companies reward with incentives that lead to perverse incentives, we are able to learn from those and improve.
1 “Incentives: Good or Bad?” EconEdLink. Accessed June 17, 2017. http://www.econedlink.org/.
2 & 3 Barro, Josh. New York Times. “Wells Fargo’s Scandal is a Cautionary Tale about Incentive Pay.” Business Insider. September 09, 2016. Accessed June 17, 2017. http://www.businessinsider.com/wells-fargos-scandal-is-a-cautionary-tale-about-incentive-pay-2016-9.
4 Wheelan, Charles, Burton G. Malkiel (Foreword). “Naked Economics: Undressing the Dismal Science (Fully Revised and Updated) Paperback – April 19, 2010.” Naked Economics: Undressing the Dismal Science (Fully Revised and Updated): Charles Wheelan, Burton G. Malkiel: 8601400354155: Amazon.com: Books. Accessed June 17, 2017. https://www.amazon.com/Naked-Economics-Undressing-Science-Revised/dp/0393337642.