On Incentives and The Love of Large Machines

[danieldwilliam]

Today’s foray into the Ten Pillars of Economic Wisdom is my response to the second of Henderson’s Pillars, Incentives Matter, Incentives  Affect Behaviour.

I used to work for a power company. We owned a Combined Cycle Gas Turbine plant. It was an engineering marvel and a thing of great beauty. It operated at thousands of degrees of heat. The ceramic tiles that covered the inside of the gas turbine were the same as those on the  Space Shuttle. The blades of the turbine were cast and machined as pure crystals of alloyed steel to tolerances of mind exploding fineness.

It cost about $100m to build and each of the hundreds of turbine blades was upwards of $10k.  Having it not running might cost us £1m a day in lost revenue.

The guys who built and maintained the kit were highly skilled, very dedicated, almost obsessive in their work. They would work for days on end trying to fix a damaged component.  If you ever want to see a love poem made flesh and blood go and watch some engineers fix a gas turbine. Some of them earned more than our CEO per hour, too. Rather, if the machine started working again on time, every time, they earned more than our CEO.

Every so often during a maintenance cycle we’d discover that someone had tried to sabotage the turbine.  Typically, they would leave an oily rag in the one of the vents where the gas entered the combustion chamber. I’ve seen what happens when a small piece of debris gets loose inside one of these machines. It’s heart breaking. Heart breaking and expensive.

So why would a maintenance crew so devoted and so well paid sabotage their own work?  Incentives. Incentives matter.

Not everyone working on the site was directly employed by our firm or by the primary contractor.  There were guys there to do scaffolding, guys there doing bits of non-critical welding, to be stand-by rescue ambulance technicians, guys there to clean the cabins where the maintenance crew ate and slept, car park attendants.  All of these guys were paid by the day.  They were paid to help fix the machine, but they weren’t paid if the machine was fixed.  The single best thing they could to increase their take home pay was break the machine again.

Putting it another way. Some of the guys were on the inside. If our team did well, they did well personally.  Some of the guys were on the outside.  If we did badly, they did well.

We had two choices.  We could become obsessive about security. We could get guys who were on the inside to police the guys who were on the outside. But they are expensive guys to have as policemen.  Policing people creates a climate of suspicion and disunity and, if you’re the kind of person who is going to be making and fixing power stations you don’t want to work with people who you don’t trust and who don’t trust you. That’s a disincentive to come and work for us, and we want only the best and most dedicated people.

So, our other choice?  Turn the outside guys into insiders.  We offered our secondary contractors on-time completion bonuses.  We made it clear that some of that bonus should go directly into the pockets of the folk working on the plant.  We explained that if our secondary contractors did a good job we would hire them again to work on this power station and we’d hire them to work on our other power stations. We created a common health and safety culture (using a series of public incentives ) and made sure that we were personally looking after the well-being of every person on site.

It took years. It was hard work. It was difficult negotiating the fine details of on-the-job contract performance with people you had come to consider over many years as insiders. But we were incentivised.  If it worked we didn’t have to worry about our billion dollar fleet of power stations being sabotaged. We were incentivised. If it worked we all got five or six figure bonuses. If it worked, we all got to go to the pub and congratulate ourselves on a job well done. 

So we shaped ourselves to be the kind of people, the kind of organisation that could and would build long-term relationships with our peripheral contractors. It cost us millions, but when our power station really, really broke it saved the whole company. Saved my job.

So, incentives matter. Incentives affected my behaviour.

What lessons does the student or amateur economic anthropologist draw from the second pillar of economic wisdom.

If you don’t understand why people are behaving in a strange way have a close look at the pay-offs. Be alert to the way incentives are working. How they actually play out. Who gets money (or other goodies) put into their pocket for doing what, exactly. What they are actually incentivising. Look at not just the cash but the pride and respect. Look at not just the hard incentives but how the incentives affect risks and contingencies.

We could have offered all the cabin cleaners 10% more money. All this would have done was increase their incentive to break things by 10%. We might have ended up with a group of more honest contractors, or we might have ended up with a group of contractors more cunningly able to break things undetected.

People might have bounded rationality but they do know what side of the bread the butter’s on and a lot of economic knowledge is tacit. The individual actor doesn’t need to know why a particular incentive drives their behaviour, they just need to know that’s how we do things round here.

Incentives matter. Watch the Money. Who benefits? And for What. If you don't understand behaviour, try looking at how the incentives work

Comments

[widgetfox.livejournal.com]

We're back into the meta on the value of models.

Does everyone work for something slightly different, in which case there is nothing useful to be said?

Does everyone work for something different but there are some patterns that can be seen and usefully discussed - either a series of distinct viewpoints that can be modelled differently, or a series of underpinning themes, or a set of axes along which people vary?

I would be inclined to agree with Michael. I think that what he's talking about is a social phenomenon rather than a matter of individual motivation. Most people are required to work by the set-up of the system. Most people don't have a great deal of choice about what work they do. Most people, therefore, show up for work primarily because it enables them to lead a sustainable life. There will be high degrees of variance along the axes of individual tolerance for difficult work and individual willingness to opt out of the system and individual ability and motivation to find compatible work. There may also be periods where work is tremendously rewarding for reasons that have nothing to do with money - for example, the ability to serve customers or form strong collaborative relationships with colleagues or engage with interesting problems. This does not necessarily affect the fact that the primary reason for doing the job is still to earn money. I don't think that's a meaningless statement in the way that I think I'm reading from the above comment that you do?

[danieldwilliam.livejournal.com]

I didn’t say meaningless. I said shortened.

The genius of money is that it makes this sort of exchange both much more efficient and much more democratic.

Using money I don’t have to find someone who has (but doesn’t want) exactly the bundle of goods and services I desire and who wants (but lacks) exactly those things that I have but don’t want.

I don’t have to work through a centralised intermediary in order to get access to the gains from specialisation or trade. I have individual freedom and some protection from stong form and weak form corruption.

It’s also more private. I don’t have to explain to the community what I’d like. I can take my bundle of ten pound notes and go and find someone who wants to do business with me without involving the king or the high priest.

It means that it can be irrelvant to me what the bundles of goods and services my counter-parties are. We can do a spot transaction.

The fact that two people have different desires for different bundles of goods and services and that these can condensened into money and then unbundled is what makes economics (the process, not the science) happen.

(Saying that, you would have economics in a fuedal manor economy which operated without money using barter and fair-does but I’d argue that it still had ur-money in the sense that people carried round status and the ability to parlay this status into stuff coming out of the commonwealth. Money is something that allowed people to carry status outside of their own communities.)

[widgetfox.livejournal.com]

I don't disagree with any of this, but I don't get how it's relevant to the point in hand.

[danieldwilliam.livejournal.com]

Because we don’t need to unpack the bundles of goods and services that individuals value in order to study how they create, transfer and exchange value.

[widgetfox.livejournal.com]

My previous comment still holds. I think we may be having slightly different conversations.

[danieldwilliam.livejournal.com]

Not for the first time and probably not for the last.

Say more about the meta of models please.

[widgetfox.livejournal.com]

I really don't have a lot more to say than "I think linear models are of limited use at best in the conversation about complex systems"!

[danieldwilliam.livejournal.com]

Likely - and I wonder how much people have to reduce the systems they are dealing with to non-complex ones so that they can apply linear models.

For the avoidance of doubt - that is people not economists.

[widgetfox.livejournal.com]

There are a couple of general points: (a) I don't think most people are very good at dealing with the world, and (b) I think most disciplines vary widely in the extent to which their applications are useful. (Put differently, I think very little advice is worth heeding without extreme caution.) But I can't think of another discipline where the weighting seems to me to be as one-sided as it does with economics.

[danieldwilliam.livejournal.com]

Which weighting to what?

[widgetfox.livejournal.com]

Weighting of not apparently useful to potentially useful.

[danieldwilliam.livejournal.com]

If we're talking about the violence inherent in the system that's a slightly different thing all together.

[widgetfox.livejournal.com]

I'm afraid I don't understand this comment, and therefore I don't know whether or not we're talking about it.

[danieldwilliam.livejournal.com]

It’s a quote from Monty Python and the Holy Grail (which parodies the sort of epigram that Marx would come up with).

I guess what it’s saying is that a system that isn’t founded on justice (and perhaps even those that are) has the threat of violence in it. Don’t break the law because the police will drag you off and deprive you of your liberty.

In this case we think Michael is suggesting that, on a societal level, people do the work they do, in the way they do because if they don’t access to goods and services will be withheld from them (and attempts to gain access to those goods and services through non-trade means will be treated as a crime and subject to violence.

So, your choices are work and exchange work for goods and services, or don’t work and be subject to the violence of starvation or the violence of incarceration or actual violence. The money or the gun.

[widgetfox.livejournal.com]

Okay, thanks. No, I don't think I'm talking about that.

[danieldwilliam.livejournal.com]

I think when you say this

Most people are required to work by the set-up of the system. Most people don't have a great deal of choice about what work they do. Most people, therefore, show up for work primarily because it enables them to lead a sustainable life.

You are saying the much the same thing as this

In this case we think Michael is suggesting that, on a societal level, people do the work they do, in the way they do because if they don’t access to goods and services will be withheld from them (and attempts to gain access to those goods and services through non-trade means will be treated as a crime and subject to violence.

What is it I'm not understanding here?

[widgetfox.livejournal.com]

It's an implication. It's just not what I'm talking about. (Put differently, it's not what I'm interested in for the purposes of this conversation, so if it's what you and f4f3 are talking about then I'll drop out at this point.)

[f4f3.livejournal.com]

No one is oppressing you.