Incentives and Consequences
June 1 1997 by JP Donlon
John Yochelson’s 10-year strategic overview and outlook on
Yochelson is president of the Washington-based Council on Competitiveness, a non-partisan, non-profit forum of CEOs and leaders from labor and academia that seeks to set a national agenda to strengthen
Nine out of 10 council members polled by the organization reckon the
This will not surprise those familiar with public choice theory. Last year, two reports from the Joint Economic Committee (JEC) demonstrated why government tends to diminish economic well-being. Politicians and civil servants respond to incentives-the problem is they face different incentives than most. In the private sector, competition ensures that businesses minimize costs. In an open market, offering additional benefits, such as higher quality goods, while maintaining or reducing costs, will boost profits. Others must then match such benefits or compensate to survive. As a result, there is a relentless search for additional benefits, which in turn spurs economic growth.
This incentive is completely absent in the public sector. Politicians do have incentives, such as job security, power, or prestige, but the structure is murky at best. And even those with the best of intentions naturally assume that the size of their bureaus, budget, and staff ensures their agency’s effectiveness.
Public-sector incentives also obscure information. In a socialist economy, for example, there is no way for a manufacturer to gauge the value of a service or to determine which mistakes are costly and which are trivial-without profits as an indicator.
To ensure that taxpayers’ resources are not wasted, public officials must develop rules and procedures that define appropriate behavior. However, rigid rules have a cost. They can stifle innovation and initiative. They drive up costs and force public servants to make poor economic decisions, such as the IRS spending $4 billion on a computer system it later admitted it could not use. Without prices to provide signals and profits to guide behavior, grave mistakes are avoided by setting more elaborate rules, which invariably impede creativity and flexibility, adding further to cost.
The different incentive structure of the public sector partly explains the expanding size of the government and its tendency to slow economic growth and reduce economic well-being. A sobering statistic not found in Yochelson’s report is the real government outlay per household in 1987 dollars. According to Steve Moore of the Institute for Policy Innovation and author of “Government:
An understanding of the effects of public-sector incentives clearly suggests that re-engineering government is critical to improving the health of the economy. The