Tuesday, October 21, 2008

Everything I Needed to Know about Economics I Learned in Daycare

Yesterday on Talk of the Nation Joseph Stiglitz, University Professor of Economics at Columbia University and winner of the 2001 Nobel prize in economics, discussed the U.S. economy. In particular he discussed misplaced incentives, like government distortion of the real estate market through tax rebates for relatively wealthy mortgage payers. Bob has raised concerns regarding this particular misplaced incentive in previous posts. Prof. Stiglitz went on to describe regulation in terms of behaviorism which reminded me of Terri's comment to my post Corporations as Voldemort.

Specifically, Terri, so insightfully stated,

I agree with the soulless definition, but I also think of it in terms of strict behaviorism that you may use on a child without the development yet for empathy and long term planning. It seems that positive or negative reinforcement would be the only way to regulate the system as it is. Right now, the government seems to be giving positive reinforcement for screwing up, though. Clearly the wrong thing to do to change any behavior.

Stiglitz echoed Terri's analogy when he said,
If you don't change incentives you're going to wind up having very similar behavior to what we've had in the past. Many of us expected the sort of bonfire we've been having. We had distorted incentives. Incentives that encouraged short sighted behavior and excessive risk taking. And we got what the incentives encouraged. We have now given the banks a lot more money to play with, $250,000,000. But if we don't change incentives, we don't change regulatory constraints, why should we expect their behavior to be any different.
Stiglitz emphasized the need for regulation at the individual level, in terms of accountability for financial managers, as well as at the level of corporate governance. As an example of individual incentives encouraging short sighted behavior and excessive risk taking he described how fund managers receive huge bonus pay for one year's success, but suffer no repercussions in the years when their funds lose all of those previous gains. He recommends, among other things, regulating the form of pay (i.e., not accounting fudging stock options) and the rate of pay of corporate executives.

How else could we apply the lessons of early child development to address the failings of corporations?

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