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

[danieldwilliam.livejournal.com]

How would one demonstrate that it was producing meaningful results?

[widgetfox.livejournal.com]

I just don't think one could, for a hypothesis of this nature. I'm trying to find a good analogy in the world of physics and haven't, so far. Basically I don't think it's mathematically possible for it to be true.

I'll keep thinking about this and looking for some better ways to explain what I'm trying to say.