Incentives matter

Lecture handout: Incentives matter*
Case: Incentive Design, December 2020
Activity: Soviet Planning, June 2022

Textbook Reading: Chapter 1 (Intro and Section 1.1; pp. 5-16)

The aim of this session is to fully understand the power of incentives, which are what economists define as the relationship between the benefits (the value we expect to gain) and the costs (the value we expect to give up) of a decision.

In this lecture we saw how conventional wisdom believes that seatbelts make you safer. But economic wisdom asks how they affect the benefits and costs of being in an accident. The lecture content on seatbelts comes from a great book called “Risk“, by UCL’s John Adams. An interesting argument against mandatory car seats for children is that by making it harder to fit three or more children into a car, it reduces fertility rates and this outweighs the safety benefits (i.e. we lose more children through a lower birth rate than are saved through better protection in an accident). See “On Car Seats as Contraception“. (Although if you do want 3 young children you can do what my sister did and buy a Ford S Max). 

Regarding bicycle helmets, here is the New York Times article claiming that “Bicycle Helmets Put You At Risk”. In terms of academic studies, there is some interesting evidence. Schmidt et al (2019) find that wearing helmets reduces the cognitive control of riders, and reduces risk sensitivity. Hoye et al (2020) found that the cyclists under their observation in Denmark who wore helmets did not demonstrate signs of riskier behaviour than those who didn’t, but acknowledged that this may be because their risk compensation is inhibited by the fact that people who wear helmets are more likely to be safety conscious than those who don’t. Indeed given that helmet wearers are systematically more likely to be risk averse, evidence of no difference in actual risk taking may be considered evidence for risk compensation! Finally, the issue is serious and I have no intention of contradicting the claim that if you happen to be in an accident, it is good to have been wearing a helmet. Indeed Olivier and Creighton (2017) looked at 40 studies to conclude that for people who are involved in an accident, helmet use reduced the likelihood of serious and fatal head injuries. I am grateful to an ESCP GMP student for sending me these studies.

In this article, Tom Chivers provides a really good overview of how changing incentives can be more effective than trying to change people’s desires, and therefore technological fixes can be just as important social policy tools as attempting to fix the “root causes”.

Here is short quiz on the effect of taxation.

The economic reforms conducted in China that prompted their integration into the global economy is a perfect example of the power of incentives. For an overview of what happened, see:

The lecture also looked at how coordination might take place without centralised control. This clip of San Francisco in 1906 demonstrates a spontaneous order:

And here’s a video on the concept of “shared space”, and what happens when traffic lights are removed:

This is a great photo essay about “continuous sidewalks” and here’s a video about their usage in the Netherlands:

Learning Objectives: Understand and apply the “Economic Way of Thinking”.

Spotlight on sustainability: A discussion of cycling safety