Economics: Harnessing the Power of Incentives

From today's WSJ, an excellent article by University of Rochester economist Steven Landsburg (author of "Armchair Economist: Economics and Everyday Life" and "More Sex is Safer Sex: The Unconventional Wisdom of Economics," and Slate.com columnist for "Everyday Economics"), here are some excerpts:

Modern humans first emerged about 100,000 years ago. For the next 99,800 years or so, nothing happened. Well, not quite nothing. There were wars, political intrigue, the invention of agriculture -- but none of that stuff had much effect on the quality of people's lives. Almost everyone lived on the modern equivalent of $400 to $600 a year, just above the subsistence level. (See graph above, click to enlarge.)

Then -- just a couple of hundred years ago, maybe 10 generations -- people started getting richer. And richer and richer still. Per capita income, at least in the West, began to grow at the unprecedented rate of about three quarters of a percent per year. A couple of decades later, the same thing was happening around the world. (See graph above.)

Then it got even better. By the 20th century, per capita real incomes, that is, incomes adjusted for inflation, were growing at 1.5% per year, on average, and for the past half century they've been growing at about 2.3%. If you're earning a modest middle-class income of $50,000 a year, and if you expect your children, 25 years from now, to occupy that same modest rung on the economic ladder, then with a 2.3% growth rate, they'll be earning the inflation-adjusted equivalent of $89,000 a year. Their children, another 25 years down the line, will earn $158,000 a year.

The underlying expectation -- that the present is supposed to be better than the past -- is a new phenomenon in history. No 18th-century politician would have asked "Are you better off than you were four years ago?" because it never would have occurred to anyone that they ought to be better off than they were four years ago.

Rising income is only part of the story. One hundred years ago the average American workweek was over 60 hours; today it's under 35. One hundred years ago 6% of manufacturing workers took vacations; today it's over 90%. One hundred years ago the average housekeeper spent 12 hours a day on laundry, cooking, cleaning and sewing; today it's about three hours.

As far as the quality of the goods we buy, try picking up an electronics catalogue from, oh, say, 2001 and ask yourself whether there's anything there you'd want to buy. That was the year my friend Ben spent $600 for a 1.3-megapixel digital camera that weighed a pound and a half. What about services, such as health care? Would you rather purchase today's health care at today's prices or the health care of, say, 1970 at 1970 prices? I don't know any informed person who would choose 1970, which means that despite all the hype about costs, health care now is a better bargain than it's ever been before.

The moral is that increases in measured income -- even the phenomenal increases of the past two centuries -- grossly understate the real improvements in our economic condition.

The source of this wealth -- the engine of prosperity -- is technological progress. And the engine of technological progress is ideas -- not just the ideas from engineering laboratories, but also ideas like new methods of crop rotation, or just-in-time inventory management.

Some good ideas even come from economists. Julian Simon came up with the idea of bribing airline passengers to give up their seats on overbooked flights -- and gone were the days when you relied on the luck of the draw to make it to your daughter's wedding. Economists first suggested creating property rights in African elephants, a policy that has given villagers an incentive to harvest at a sustainable rate and drive the poachers away. The result? Villagers have prospered and the elephant population has soared.

Engineers figure out how to harness the power of technology; economists figure out how to harness the power of incentives. Our prosperity relies on both.

See some previous CD posts on economic growth over time here, and here, and here.

About the importance of incentives, Landsburg wrote "Most of economics can be summarized in four words: "People respond to incentives." The rest is commentary."