Markets for Managers
Markets for Managers
'The theory of economics does not furnish a body of settled conclusions immediately applicable in policy. It is a method rather than a doctrine, an apparatus of mind, a technique of thinking which helps its possessor to draw correct conclusions.'
- John Maynard Keynes 1
In early 1998, day care centres around Haifa, in Israel, had a problem. It was a problem common to many of us who have looked after children for a living: late parents. 2 After a long day being responsible for other people's children, by 4pm the teachers were ready to go home. And they weren't being paid for staying any longer. But invariably some parents would be late, and someone would have to stay behind and wait with the child. But one day some social scientists turned up (or rather, sent their research assistants) and made a suggestion: why not fine the parents for being late? It is a solution any economist would give.
Over the next few weeks things carried on as normal, as the researchers gathered data before making any changes. Then, they adopted a policy where any parent who was more than 10 minutes late would pay a $3 fine. But instead of reducing lateness, the number of late pickups more than doubled. The incentive backfired.
As an economist, I've heard this example a lot. It's often used to show economists that assuming people's behaviour can be manipulated with financial incentives is naïve and narrow minded. Indeed there is some truth to this. Just because originally there was no fine doesn't mean that there was no incentive to be on time. The social norm is to be on time, and late parents probably felt guilty. Once the arrangement moved from the social to a financial realm, parents realised they could 'buy' the right to be late. Indeed they weren't just buying the right to be late, but also the ability to not feel guilty about it. In fact, maybe the lesson of the day care experiment is not that economists overstate their subject matter, but that non-economists understate it. After all, the average monthly cost was about $380. A good economist would suggest that the fine was set at a price that was too low! If the goal was to reduce lateness, raise the fine. And even more importantly, discovering the point at which the fine has an effect will help the day care centre to know just how valuable the parents consider their time to be. This whole experiment might help them to discover which opening hours best suit their customers. Clearly the parents are willing to pay the teachers to stay later. Far from demonstrating the failure of markets, this example is like a cursory foray into their magic.
We tend to think that economics is the study of the economy, and indeed this is an important application. But economics isn't a subject matter; it's a way of thinking. The essence of the economic way of thinking is to understand how incentives and institutions affect people's behaviour. In terms of management, economics can give us important clues about why behaviour may be generating bad outcomes. Understanding concepts such as opportunity cost, price elasticity and price discrimination are tools that managers can use to improve a company's performance. But economics does more than this. It provides us with a way of thinking about human action. Economics is the study of society, and the tools with which we understand social behaviour are of direct relevance to management.
1.1 MANAGERIAL INDIVIDUALISM
In their excellent textbook Managerial Economics , Luke Froeb and Brian McCann offer the following guide to decision making: when you see an outcome that you deem to be undesirable, ask yourself three questions: 3
Who made the bad decision?
Did they have the information they needed?
Did they have the right incentives?