Incentives Count

Dear Friends,

It seems to me that, in every human endeavor, incentives count, but no place more than in the field of economics. Government sets the incentives both obviously and not so obviously. Society and culture also create incentives and disincentives. Incentives are far more important than animal spirits or demand to an economy’s well being. The set of incentives that government creates by it’s actions, laws, regulation, taxation and rhetoric, can devastate an economy, or create the environment for rapid economic expansion. If a person wants to understand why a given economy is faltering or succeeding they need only look at the incentives that government has in place. Your family’s economic well being are subject to this natural law.

The most obvious is the societal attitude to wealth creation. In a society that holds wealth to be a bad thing, there will be few wealthy people, and they will almost certainly be the people who run the government. Under this type of incentives the government will usually be some form of autocracy or plutocracy. Monarchy and aristocracy are most often cited but tyranny and oligarchy are never far away under this set of societal attitudes. The Dark Age in Europe is an example of this societal attitude to wealth creation, with the Renaissance being the watershed moment, that changed the mind set of the people… to embracing wealth creation.

Every parent knows that you punish that which you want less of and reward that which you want more of. Only an idiot would knowingly reward acting out, stealing, lying or any of the other bad behaviors we civilize out of our children. We know this as parents, but amazingly some of us seem to forget this, when it comes to the economy. When government takes the position of a bad parent the economy suffers and the people suffer.

Taxation is most often thought of when talking about the incentives that effect an economy. Taxing something creates negative incentives to that action. Look at the great lengths, companies and individuals go to, to avoid taxes. They invest their money foolishly to get some tax write off. Look at GE in the last few years. They have paid no income tax because they play ball with the government. They buy the electric cars that don’t work, they invest in “green” technologies that cost more, to produce less, etc… This will eventually put GE at a disadvantage to their competitors in the future but today it makes them seem more profitable. Taxing income is an obvious form of discouragement to wealth creation.

When government places more and more regulation on an industry it creates bars to new companies entering that industry. Older more established firms have a regulatory step up, in that they have grown their business around the existing regulation, and can better cope with new regulation as a result. New firms have to research the laws and regulations and have less interaction with the regulators of that industry. Regulatory capture also creates a bar to entry for new firms, because older firms have built a rapport with their regulators, who may not like seeing there “friends” being out competed, so they may look more closely at the actions and business model of a new entry into the market. This is highly pernicious due to it’s undermining the very nature of a competitive marketplace and smothers new ideas. The very definition of Schumpeter’s law.

No matter how much demand there is for a product or service, regulation, taxation, attitudinal incentives and cultural moors have the ability, alone or as a group, to destroy any industry. Incentives can make an economy vibrant or stagnant. When government punishes wealth creation, no matter how, wealth creation slows and can be brought to a complete stop. When this happens we see economic stagnation and depressions. If you think about it a moment, the level of economic activity, as measured by the creation of firms, and how close to perfect competition there is in a country’s economy, is a metric of the incentives to wealth creation and vibrancy, of markets in that country. When we apply this measure to the American economy, since Obama took the Presidency, we see that the incentives his administration have set up… are uniformly negative to wealth creation. We can clearly see that the rhetoric of class warfare is a form of attitudinal negative incentive to wealth creation as well. Under this set of incentives we can expect a continuing lowering of the material standard of living in the USA, and since America is still the engine of the World’s economy, the material standard of living of the people of the World will also suffer.

Even if this concept is completely lost on the Obama administration it is obvious to the American citizenry. Perhaps that is why the Tea Party is ascendant today. They understand incentives…

Sincerely,

John Pepin