Nancy Folbre: Incentive Perversity - NYTimes.com Nancy Folbre is an economics professor at the University of Massachusetts, Amherst. It's all about incentives. The richer the reward, the more willing you are to work hard and take risks, and the faster the economy will grow. By this logic - elaborated by Mitt Romney's former business partner Edward Conard in a recent New York Times profile - income inequality benefits us all. Sloth and fear are singled out as economic sins that could condemn us to stagnation. Only the desire for more, more, more than anybody else can elicit the bold energy that economic growth requires. Only greed can redeem us. Effort is never misdirected. Risk is never carried to excess. You should thank the Higher Power for rewarding talents at the top. Before doing so, consider the empirical evidence that faith in this particular set of incentives is seriously misplaced. The most recent global financial crisis showed that increasing the reward for risk can create temptations to conceal its dangers or offload it onto others. Managerial efforts to increase short-term profits sometimes come at the expense of long-term profits and environmental sustainability. Big winnings in a competitive game can be spent on efforts to change the rules of that game: lobbying expenditures often offer a higher payoff than investments in new technology. Research in behavioral economics offers a variety of reasons that economic incentives can backfire, including perverse effects on moral commitments. High-stakes competition in educational testing contributes to increased cheating among both students and teachers. High-stakes competition in many sports contributes to use of performance-enhancing substances. Recent investigative reporting on the horse racing industry showed that higher purses were leading many owners to push unfit horses onto the track, increasing the likelihood of dangerous injuries to riders as well as their mounts. Differences in rewards can certainly offer incentive high performance. But if they become too extreme, negative effects kick in. Consider first the impact of reward on effort. As the economist Robert Frank emphasizes in his new book, "The Darwin Economy," most people care less about their absolute income than how they compare with others. Winner-take-all dynamics can lead to an arms race in which the size of top prizes gets larger and larger, and we pay more and more to elicit the same amount of effort. For instance, the ratio of executive pay to that of average workers in the United States has grown by almost a factor of 10 since 1980. Analysis of pay-setting practices suggests that corporate boards try to pay their own chief executives more than those at comparable companies, creating a ratchet effect that has more to do with relative status than actual effort. Shareholders at Citigroup recently voted against an executive pay package they considered overly generous. Second, consider the effect of effort on performance. Additional effort tends to have a positive effect but with diminishing returns. When people are already trying as hard as they can, extravagant rewards either go to waste or, worse, encourage cheating. Finally, consider the effect of performance on success. In a competitive game, people are not likely to put forth much effort unless they perceive some likelihood of winning. Yet unequal rewards often accumulate over lifetimes and are perpetuated within family dynasties, creating barriers to competition. Recent research suggests that the United States, with comparatively high levels of income inequality, is also characterized by lower levels of income mobility than many other affluent countries. Good incentives are always a good idea. But it's not as easy to design them as it might seem, because they should discourage a host of economic sins - not just sloth and fear, but also cruelty and greed.