#2. Incentives Matter

What Every Debater Should Know... Why economics? If you could only know 10 things... 1. TANSTAAFL 2. Incentives matter 3. "Hazlitt's lesson 4. Ownership promotes responsibility and coorperation 5. Trade creates wealth 6. Profits direct businesses to create wealth 7. Competition increases efficiency and innovation 8. Taxation and regulation discourage production and destroy wealth 9. Political decision-making favors plunder over production 10. Central planning wastes resources and retards economic progress Conclusion Off-Site Link to:   NCPA Debate Central Home Page

# 2. Incentives Matter A common assumption underlying many policy proposals is that human behavior is somehow fixed, regardless of the new circumstances the policy would put in place. Economists, on the other hand, emphasize that human behavior by and large is the result of choices among alternatives. Any change in the alternatives available or the relative attractiveness of those alternatives will have an effect on peoples' choices. Incentives do matter. Experience bears out the importance of incentives for altering behavior. When Congress raised the tax on luxury goods like yachts, private jets, and fur coats they were shocked to learn that the higher tax reduced the revenue generated rather than increasing it. Faced with a higher effective price on these goods, consumers of luxury goods sought out substitutes (leasing their jet instead of buying, refurbishing the old yacht, wearing more cashmere and less fur). In the end the demand for these goods was so much lower that the taxes collected didn't even cover the cost of the additional paperwork. This is an illustration of the "Law of Demand" in operation: the price of a good and the quantity demanded are inversely related. When Congress strictly designated strong encryption technology as "munitions" that could not be freely exported out of the country, their intent was to prevent American technology from falling into the hands of terrorists or other criminals that might use it to hide communications about their activities from law enforcement officials. They gave little thought to the ways this changed incentives for producers of domestic computer software. Encryption technology today is included in almost any software that involves internet transactions or communication. While some companies could afford to make two versions of their software -one with strong encryption for the American market and another with weaker encryption for the export market- others could not do so profitably. By raising the cost of marketing new internet applications, Congress imposed disincentives against entering this market and gave the economic advantage to foreign software makers. Today, it is widely recognized that foreign software manufacturers have closed the gap in the market for encryption software and ended any superiority that American products once enjoyed.3 Harder to see are the American software products that were never produced because of reduced market incentives. 3 See www.cato.org/pubs/briefs/bp-042es.html for an analysis