Oskari Juurikkala of The Acton Institute has an interesting column on whether increased regulation in financial markets increases or decreases the virtuous behavior of market participants. I’ve reposted a good chunk of it here:
In his book Not Just for the Money, economist Bruno Frey sheds some light on the question. Invoking research in motivational psychology, he argues that external compensation or punishment does not always produce the desired results. Human persons are more complex actors than traditional homo economicus models suggest.
Frey writes: ”Intrinsic motivation is of great importance for all economic activities. It is inconceivable that people are motivated solely or even mainly by external incentives.” There is more: according to Frey, the use of monetary incentives and threats of punishment crowds out intrinsic motivation under identifiable and relevant conditions.
For example, giving monetary compensation to a child for doing household chores is likely to result in decreasing contributions made without compensation. Or if, at the end of having dinner at a friend’s place, you insist on paying for the dinner, you may destroy your friendship. Similarly, given that some university professors work harder than others, imposing strict working hour regulations will probably provoke those better workers to reduce their effort and dedication.
Frey talks about the hidden cost of reward or regulation. When an external intervention is perceived as controlling and not respecting the rightful autonomy and reasonableness of the person, extrinsic motivation tends to crowd out intrinsic motivation. When people feel that they are being forced to act in a certain way, their behavior becomes more extrinsically guided.
Incentives are not always harmful, of course. External interventions may enhance intrinsic motivation when they are perceived as supportive. When the father gives a present to his daughter who has been helpful in the house, he may reinforce her willingness to help, as the gift is a token of affection and gratitude rather than a payment conditional on specific performance.
When you go to a restaurant and leave a generous tip, the diner-waiter relationship is strengthened. Hard-working professors will work even harder if their dedication and effort is rewarded with, say, being elected to form an official delegation to an important conference in an attractive city.
According to Aristotle, a good ruler is much like an educator. A skilful educator does not focus on external conduct alone, but seeks to instill a sense of the good so as to encourage virtue chosen freely. Putting too much weight on external incentives – sticks and carrots – has hidden dangers that often reveal themselves later. Vice is the common fruit of the manipulator and the tyrant.
Is lighter regulation the solution to present and future economic crises? It depends. Let it first be noted that some over-the-counter financial derivatives are practically unregulated at the moment, so there is nowhere to cut regulation. It might be more appropriate to cover such clear gaps in existing rules in a principled manner so as not to lead people to the temptation of recklessness.
But a few clear and fast rules are often better than numerous rules that are hard to understand – especially if they are poorly enforced. The latter is arguably the state of the art in financial markets regulation.
When designing rules for a game, one must take into account the moral character of the players. But there needs to be adequate variation: general laws designed for crooks will not produce any saints.
Soft measures are sometimes more productive in the long term. Strict regulations imposed by law tend to damage the intrinsic motivation of better managers; in contrast, their motivation can be enhanced by explicitly acknowledging the value of those who maintain sound policies. The support principle could be applied in numerous ways in economic and regulatory policy.
In his book Not Just for the Money, economist Bruno Frey sheds some light on the question. Invoking research in motivational psychology, he argues that external compensation or punishment does not always produce the desired results. Human persons are more complex actors than traditional homo economicus models suggest.
Frey writes: ”Intrinsic motivation is of great importance for all economic activities. It is inconceivable that people are motivated solely or even mainly by external incentives.” There is more: according to Frey, the use of monetary incentives and threats of punishment crowds out intrinsic motivation under identifiable and relevant conditions.
For example, giving monetary compensation to a child for doing household chores is likely to result in decreasing contributions made without compensation. Or if, at the end of having dinner at a friend’s place, you insist on paying for the dinner, you may destroy your friendship. Similarly, given that some university professors work harder than others, imposing strict working hour regulations will probably provoke those better workers to reduce their effort and dedication.
Frey talks about the hidden cost of reward or regulation. When an external intervention is perceived as controlling and not respecting the rightful autonomy and reasonableness of the person, extrinsic motivation tends to crowd out intrinsic motivation. When people feel that they are being forced to act in a certain way, their behavior becomes more extrinsically guided.
Incentives are not always harmful, of course. External interventions may enhance intrinsic motivation when they are perceived as supportive. When the father gives a present to his daughter who has been helpful in the house, he may reinforce her willingness to help, as the gift is a token of affection and gratitude rather than a payment conditional on specific performance.
When you go to a restaurant and leave a generous tip, the diner-waiter relationship is strengthened. Hard-working professors will work even harder if their dedication and effort is rewarded with, say, being elected to form an official delegation to an important conference in an attractive city.
According to Aristotle, a good ruler is much like an educator. A skilful educator does not focus on external conduct alone, but seeks to instill a sense of the good so as to encourage virtue chosen freely. Putting too much weight on external incentives – sticks and carrots – has hidden dangers that often reveal themselves later. Vice is the common fruit of the manipulator and the tyrant.
Is lighter regulation the solution to present and future economic crises? It depends. Let it first be noted that some over-the-counter financial derivatives are practically unregulated at the moment, so there is nowhere to cut regulation. It might be more appropriate to cover such clear gaps in existing rules in a principled manner so as not to lead people to the temptation of recklessness.
But a few clear and fast rules are often better than numerous rules that are hard to understand – especially if they are poorly enforced. The latter is arguably the state of the art in financial markets regulation.
When designing rules for a game, one must take into account the moral character of the players. But there needs to be adequate variation: general laws designed for crooks will not produce any saints.
Soft measures are sometimes more productive in the long term. Strict regulations imposed by law tend to damage the intrinsic motivation of better managers; in contrast, their motivation can be enhanced by explicitly acknowledging the value of those who maintain sound policies. The support principle could be applied in numerous ways in economic and regulatory policy.
This sounds reasonable to me, but I also realize that my bias towards laissez faire economics may cause me to enjoy hearing what I want to hear. But trying to put that aside, a reason it does sound reasonable is when I compare it to a Christian faith. Christians talk of legalism and how setting rules or checklists to try and live a Christ-like life is most often (or always) defeating, since the spirit of the law is obviously not resonating, it is simply the letter of the law that is being followed and no transforming of the heart is taking place. I believe it is when we get to the core of our own reasoning for making a moral decision that we will be more consistent and more likely to make that moral decision again and again.
Obviously there is the matter of the Holy Spirit and its role in our lives that cannot be applied to a financial managers decision-making. But equally obvious is the fact that people who do not believe in the Holy Spirit or God or what have you, can and do make morally responsible decisions all day long. And if that is true, then perhaps as Juurikkala proposes it would encourage even better decisions when less regulation is enacted.
Is this is an appropriate comparison?
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