Incentives

Most people don’t understand economics at all.  They might take a class or two but then they don’t really internalize anything.  Could be it’s the professor’s fault for not drumming home the real meaning of economics. Politicians talk about “fair”.  Fairness is subjective.  If you engage with economics correctly, it’s about positive economics and incentives.  Robert Reich would be an example of someone that peddles false economics virtually all of the time.

We see the word “fair” a lot in our debate today.  As soon as you hear that word, you should immediately question everything that comes after it and the assumptions made to get there.

This piece by John Cochrane is excellent and illustrates the divide.

Cochrane has been on a roll lately.  Read his blog religiously and you will learn.  You can sense his disgust in the way he writes.  I have never met him in person but went to a panel post-crisis in 2009 that he sat on.  He eviscerated the bank bailout policy.  The head of the Chicago Fed was there as was Nobel Prize economist Lars Hansen.  It was an enlightening debate.

Here are some excerpts from his blog post.

Actual economics is most delightful because it offers answers outside of the usual morality play.  Focus on incentives, not who gets what out of the tax code.  Point out the missing budget constraint. Notice that the behavior you deplore is a rational response to a misguided incentive, not a sign of evil.

Usually, “actual economics” finds little of value in either political party’s propaganda. Echoing that propaganda is a sure sign of empty analysis, so avoid it.

Here is the data on the tax plan:

Economics professor Greg Mankiw correctly states that “In any event, when you see distribution tables for this tax bill, remember that these numbers are not facts, they are judgments.”  Those numbers are arbitrary picked by people to set a policy.  It’s their judgement, not a divine fact sent down from the heavens.

Economics plays a gigantic role in how a company structures incentives.  Should you pay for employees to come up with innovative ideas?  Or not?  How should you incentivize behavior you want on a job?  How should you empower employees?  How should you set up feedback loops?  How do you figure out where Marginal Cost equals Marginal Revenue?  This is why it is absolutely critical to use positive economics versus what’s fair.

Economics isn’t there to make us feel good about ourselves or confirm what we think.  Most of the time it’s very uncomfortable and counter-intuitive.  That’s what can make it magical.