Sunday, February 15, 2009

Incentives Matter

Reading the book Freakonomics this past week inspired in me an interest in the theme of incentives. While researching this theme I came across a very cool blog called Incentives Matter. As I read some of the articles I felt like I'd discovered a kindred spirit. I wanted to contact this blog writer to get to know him better. To my astonishment, Pedro Albuquerque, the blog's creator, teaches at a university right here in my home town.

We made contact, suggested lunch, and followed through in a matter of days this past Tuesday. I learned that he was born and raised in Brazil, met his French wife in Switzerland, and speaks Portugese, Spanish, English and French. A really nice guy, and sharp as a tack.

What follows is an interview that emerged from this meeting.

Ten Minutes With Pedro Albuquerque

Ennyman: How did you become interested in economics as a career?
PA: My youth in Brazil was marked by the many economic problems that the country was experiencing during that period: frequent cycles of boom and bust, hyperinflation, black markets, chaotic public finances, debt moratorium, price controls, government's seizure of people's savings or properties, in other words, a whole plethora of events that would make a Lewis Carroll universe look like a very ordinary place.

I had always wondered about the causes of all that distress. It was only after I read two amazing books by Milton Friedman, Capitalism and Freedom and Free to Choose, and Adam Smith's The Wealth of Nations, that I realized how useful economics was as a tool to understand the world around me, and that I wanted to follow a career in economics.

Ennyman: Your blog is titled Incentives Matter. Once a person starts thinking about incentives they realize how it touches such a broad swath of disciplines. How did you personally get attracted to this theme?
PA: The idea that incentives matter permeates the entire science of economics and can be found for example in the books by Friedman and Smith that I cited before. Recently however economists have become much more aware of the relevance of incentives as a defining characteristic of economics as a science. Books like Freakonomics by Steve Levitt discuss the point very openly, and the Nobel Prize given in 2007 to University of Minnesota professor Hurwicz (unfortunately deceased last year) was a huge recognition of the explicit role of incentives in the field.

Economist Glen Whitman once said that if he had to summarize economics in two principles they would be (1) "incentives matter" and (2) "there's no such thing as a free lunch." He called these principles the "two things of economics." Trying to reduce a science to two principles is naturally an oversimplification, yet it's a very useful one, and I entirely agree with his two choices. Among these two principles, "incentives matter" seems to me to be the more uplifting, so that's why I chose it as the title of my blog.

Ennyman: From reading your blog, it's evident that you are following current events in Washington… What is your take on the new administration’s first days in office, as regards economics?
PA: The new administration encircled itself with some extremely competent economists, and that's a good thing. However, I think that history has shown us again and again that one thing is a government that has good economists, and another thing is a government that listens to those good economists.

The first weeks of the new administration frustrated my best expectations and left much to be desired on those grounds. The reality however is that it's too early to tell.

Ennyman: I'm often fond of saying, “When there is an autopsy without blame, then we will find out what killed the patient.” Due to the nature of power politics in D.C.,how will we ever find solutions when no one seems interested in an accurate diagnosis?
PA: This problem is addressed by a field of economics called public choice, and it cannot be easily solved, both analytically and in terms of policy design. The solution naturally passes through the improvement of the quality of our democratic institutions, so they become more immune to political background noise and more focused on policy substance. This is however easier said than done.

One of the most obvious solutions to this problem is to count more on markets and less on politics to solve social problems. Such a statement may not be fashionable right now, given the current political climate, however modern developments in public choice point in that direction. Besides that, there's much that can be done in terms of regulating political action.

For example, politicians love to talk about establishing limits to market forces; however the success of the American experiment is the direct result of an incredibly smart Constitution that instead of promoting limits to markets promoted above all limits to political power. We need more of the blessings that the American Constitution originally gave us, not less.

Ennyman: You stated the one of the biggest problems in politics is pride. Can you elaborate on this?
PA: Pride, up to a certain extent, is a positive human trait. It's however a trait that is not compatible with statesmanship, especially when it presents itself as vanity or lack of humility. The true statesman (or stateswoman) knows that he (or she) is a public server, and it should never be the other way around.

I've always admired the American people for having a very good understanding of this point. We should always remind ourselves of this important positive aspect of our political culture so we make sure that we never forget it.

Ennyman: Sometimes it is difficult to assess how serious issues really are because the media is so frequently beating the drum to support legislation for those in power. How serious is our current crisis?
PA: The crisis is serious, however it's vital that we keep in mind that the American economy is flexible and robust by design, and therefore it has the energy and the means to get out of this mess by itself. The government can help to accelerate the recovery by parsimoniously using all policy instruments available in the macroeconomic toolbox, and, above all, by respecting the two principles of economics cited before. Choosing to ignore the role of economic incentives and costs will not help the economy, on the contrary, will only extend and deepen the crisis.

Unfortunately the new administration, following on the steps of the previous one, has shown until now a disturbing lack of concern for matters of economic incentives and costs. Because of this, I'm seriously concerned that misguided actions by the government may end up extending and deepening the crisis, making it worse than what it should normally be. For example, the constant referencing by government authorities to the idea that economic disaster will ensue if they're not empowered with legislation and funds according to their terms has the real potential to worsen the crisis that they're supposedly trying to resolve.

Ennyman: You mentioned being impressed by President Reagan's impact on world affairs. What in particular do you find impressive about his influence?
PA: President Reagan statesmanship was central to the revival of the American economy and political influence in world affairs in the eighties. He accepted to make very costly political sacrifices in order to get the country out of the economic stagflation of the seventies. With hindsight we know that his bets paid off, however there was no way he could have known that when his government started.Not many politicians have the humility, the moral fiber and the sensibleness necessary to make the hard choices that he made. You have to able to take the heat to do it. Your pride will hurt really bad, and a vain person would never be able to withstand it. Reagan did it however with dignity and grace.

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