Incentives are to Economics what Forces are to Physics

On capitalism, cronyism, and communism, plus, a potential solution to the college cost crisis

The “almighty” dollar

When I arrived at college my freshman year, in what I came to see as a bout of naiveté, I immediately declared a double major in computer science and mathematics. The CS major stuck, but the math major certainly didn’t. Calc II wasn’t too tough, and I got a B+, but after working my ass off for a B in Calc III, I could see the writing on the wall and dropped math. I was content to be just a CS major, secure in my programming skills and armed with the promise of a lucrative job upon graduation. On deciding which gen-ed requirements I’d knock out my sophomore spring semester, though, I happened on Introduction to Microeconomics. My roommate at the time being an economics-adjacent major, and always having found economics somewhat interesting, I thought what the hell and signed up. This turned out to be probably the single best academic decision of my college career. I’ll never forget the first day of class, when the quite young professor walked in wearing ripped jeans and an open flannel with a band t-shirt underneath¹— I actually mistook him for another student until he walked up to the front board and started writing. And from there, it was off to the races. Supply, demand, economies of scale, profits, expenses, marginal costs/returns, opportunity costs, the monetary cycle, ceteris paribus² … suddenly, so many facets of human behavior and society at large began to fit together as the intuitive was made explicit. I’m forever grateful to this professor for awakening a love for economics that persists to this day. I didn’t major in economics, since I was already halfway through school, but I was able to fit in a minor. While psychology can tell us a lot about ourselves as human beings, I’ve come to think that economics is an underrated discipline when it comes to describing human behavior. It’s no coincidence that Mises’ magnum opus is called Human Action.

The flip side of formally studying economics, though, is that mainstream discussion on the subject is often oversimplified and sometimes straight-up wrong. It’s also often frustratingly rigid, in that a lot of talking heads have a set of talking points that they regurgitate on demand with no room for nuance. Thomas Sowell’s famous quote— “There are no solutions, there are only tradeoffs”— comes to mind here. But I digress.

Economics makes use of a wide variety of concepts including the ones I mentioned earlier, but in my opinion, the concept with the most explanatory power is that of incentives.

Incentive (noun) - something that incites or has a tendency to incite to determination or action - Merriam-Webster Dictionary

Put more simply, an incentive pushes you to think or act a certain way. Most people are incentivized not to be criminals since criminals often face jail time if caught. Some are incentivized to exercise by the promise of better health. Some are incentivized to hold luxury beliefs by the promise of social acceptance. You’ll note, though, that I didn’t say incentives force you to act a certain way. To return to criminality, prison is a significant deterrent for most people, but my favorite TV show, The Sopranos, provides a whole cast of characters for whom prison isn’t incentive enough. This brings me to the central metaphor and title of the piece— incentives are to economics what forces are to physics. I’m no physicist, so I’m sure it’s far from a perfect analogy, but consider gravity. If you jump, or throw an object, it inevitably falls back down to earth. But with enough countering force— say, with a rocket ship— you can escape earth’s gravitational pull. Incentives function in much the same way, except instead of gravity and movement we have incentives and actions.

Incentives provide a useful lens through which we can take a look at the competing economic philosophies of the 20th century. Capitalism versus communism— few words carry such baggage. Let’s start with capitalism. Central to capitalism is the idea of a free market, where people exchange goods or services on their own terms. The most primitive form of this idea would be a barter economy, in which goods and services are exchanged for other goods and services. Imagine a few farmers operating under these conditions. Perhaps neighbor A agrees to help neighbor B build a new barn in exchange for a cow from neighbor B. Neighbor B places more value on having a new barn and losing a cow, and neighbor A would rather give their labor to neighbor B and gain a cow. In this scenario, both participants are better off by mutual exchange. The barter-economy model suffices for a few farmers, but would likely run into issues at scale. Enter the concept of currency. Currency acts as a store of value, mediating the exchange of goods and services and offering a level of precision that isn’t present in a barter economy.

currency - (noun) something (such as coins, treasury notes, and banknotes) that is in circulation as a medium of exchange - Merriam-Webster dictionary

To return again to the farmers, instead of trading cows and labor, A could simply say, “I’ll help you put up the barn for $100.” Now imagine both farmers enlist the help of farmer C— but C’s getting on in years, so he values his labor a bit more, both due to his experience and the increased physical strain. He might say, “I’ll help for $150.” Now, instead of operating in terms of farm animals, we’re operating in precise, quantifiable dollars and cents. This situation scales much better than mere bartering. 

In the present-day US, though, capitalism has become quite the controversial topic. Depending on which flavor of cultural commentary you subscribe to, capitalism is God’s gift to mankind, where anyone can pull themselves up by their bootstraps with a bit of grit and hard work, or it’s everything that’s wrong with society, an oppressive force that’s probably racist and sexist too. As with most political issues, the answer is more nuanced than the extremes would have you believe. Let’s bring the discussion back around to incentives to provide a better, more nuanced understanding of the economics at play.

What kind of behaviors are incentivized under capitalism? The first, more altruistic type of behavior is to provide the most value to the most people, which in turn provides value to you. The other, more sinister type of behavior would be classified as rent seeking, an economics term that basically means economic cheating.

Rent-seeking is the act of growing one's existing wealth by manipulating the social or political environment without creating new wealth. - Wikipedia

If you were operating in such a system, and you were a competent actor thinking long-term, providing lots of value to lots of people is the clear winner here. Cheating might work in the short- or medium-term, but confidence games and fakery are not good long-term strategies. But you can’t get around human nature, so any economy will have some rent seeking. This is where one of the core responsibilities of a government comes in. Minimum necessary force is an idea that gets brought up after instances of police brutality; I’d propose an analogous idea of minimum necessary regulation here. Such an idea would involve banning outright harmful forms of rent seeking, and encouraging the provide-value-for-people path where it can. The devil’s always in the details, of course, but a society in which everyone is incentivized to provide the most value for the most people sounds like a healthy society to me.

I brought up the role of government in the last paragraph, and that brings us nicely to our next economic model, the one currently embraced by Washington, that of cronyism. Sometimes referred to as “crony capitalism,” I make a distinction between cronyism and capitalism. Why? You might’ve guessed it— different incentives. But what is cronyism?

Crony capitalism, sometimes called cronyism, is an economic system in which businesses thrive not as a result of free enterprise, but rather as a return on money amassed through collusion between a business class and the political class. - Wikipedia

So, as discussed, providing value for others at scale is most strongly incentivized under capitalism. Rent-seeking is either the second best option, or actively discouraged. But under cronyism, rent seeking is actively incentivized as well.

Let that sink in for a second.

Under cronyism, you can still get ahead providing value at scale. But like gravity pulling objects down toward earth, a robust system of lobbying, bribery, collusion, and God knows what else provide a path for anyone with the right connections or deep pockets to manipulate the system to their own ends, everyone else be damned. The right campaign donations or a strategically placed favor can be the difference between a regular quarter and record-breaking profits.

On an unrelated note, Pfizer pulled in around $81,300,000,000 in 2021, a lot of which was for a product that barely worked and is likely harmful in the long-term.

On another unrelated note, they say a picture says a thousand words, right?

In the middle, SBF and congresswoman Maxine Waters.

There’s a lot of interesting threads I could pull on here, so I’ll touch on two major ones, along with links to other writers who have given these topics more depth, and then we can venture on to incentives under communism.

The first is an interesting side effect of cronyism— it decouples success and competence. Under capitalism, businesses rise and fall based on their ability to deliver goods and/or services that consumers want at prices they’ll pay. Businesses can rise and fall in this manner under cronyism too, but like I mentioned earlier, cronyism can provide a myriad of opportunities for manipulation. Who knows how many businesses, or even entire industries, would collapse if the US government suddenly decided to let the chips fall where they naturally would? Such manipulation usually results in economic inefficiencies as well, making almost everyone (besides the manipulator) worse off economically.³

While the fact that cronyism decouples success and competence is mostly true, it excepts those who are competent at— and choose to— manipulate the system for their own benefits. While I could expand on the kind of people who thrive in this sort of environment and the consequences that follow, the talented and insightful writer Harrison Koehli authors an entire Substack dedicated to the topic with a focus on the political angle, Political Ponerology, which I highly recommend.

The other issue isn’t directly caused by cronyism per se, but nonetheless hampers the economy and generally makes life worse— bloated, institutional bureaucracy. Yeah, we all hate waiting in line at the DMV, but our cancerous form of bureaucracy in the US extends much deeper, infecting everything from the military to science. For a more thorough exposé on the topic, I recommend Grant Smith’s Late Stage Bureaucracy, and his Substacks in general.

Late Stage Bureaucracy

Excessive bureaucracy combined with cronyism is fertile ground for the political mess we call the federal government, aptly called “the swamp” by Trump and others.

And finally, we arrive at communism.

You’d think citizens starving to death by the tens of millions would be enough to shake anyone out of the illusion that anything resembling national communism can work in the first place, but here we are. We can ignore the fantasy of a communist utopia, and examine the incentives that exist in a practical example of a communist regime. Under such a system, market forces are much more limited. The main incentive to provide value is the state putting a gun to your head. And of course, these usually aren’t mutual exchanges like under capitalism, so you get little if anything in return. Although other incentives to provide value can arise out of personal relationships and altruism, these motivations generally don’t scale. So, under communism, rent seeking reigns supreme. That, or a political or military career. But these careers wouldn’t incentivize providing value to citizens, they incentivize loyalty to the state. Communism is truly a dead-end⁴ as an organizing principal of society.

So why does communism still have support? Well, From each according to his ability, to each according to his needs might sound nice if you don’t think about it too hard. But, of course, how is “ability” defined? How is “need” defined? The real answer to these questions would be they’re defined however best benefits the regime. I can’t help but be reminded of the scene early in The Wolf of Wall Street where Leonardo DiCaprio’s character gets hit with a dose of Wall Street reality by Matthew McConaughey’s character.

McConaughey: Fuck the clients… name of the game? Move the money from your client’s pocket into your pocket.

DiCaprio: Right, but if you can make the client some money at the same time, it’s advantageous to everyone, correct?

McConaughey: No.

… except replace clients with citizens and money with resources.

This is a thread I could pull on for a long time— exactly why, in a technical sense, communism can’t work. I actually wrote my final economics paper on this exact subject in college. But, really, that’s an expansive topic that would deserve its own post, plus, I think the perverse incentives that exist under a communist regime speak for themselves.

So, why does capitalism get such a bad rap? Criticisms of capitalism, as I see it, fall into three camps. The first are the marxist criticisms of the private-property-is-theft variety. Marxist theology, uh, I mean theory, invariably results in the sorts of societies I described a few paragraphs ago, so we’ll dismiss those for now. The second set of more robust criticisms tend to not actually be criticisms of capitalism, but of cronyism, or just plain bad governance. When politicians rail against “unfairness”… well, most of that’s just careerism and grandstanding, but the underlying sentiment often stems from a recognition that we’re not playing a fair game, we’re playing a game that’s been rigged in favor of a specific group of people. That’s a cronyism problem, not a capitalism one.

The final set of criticisms are most salient yet also the trickiest to nail down, I think. It’s often pointed out that the top 1% of wealth holders in the country control as much wealth as the bottom 25%, or whatever the number is, with the implicit add-on that this is capitalism’s fault. Well… not quite. If you stop and think about it, an arrangement in which a small group of people control most resources and most people have almost nothing is the arrangement that most large-scale societies have fallen into for most of human history. This seems to be just a fact of human societies, rather than a problem with capitalism. Consider the ways this general phenomenon manifests itself now: a very small fraction of musicians dominate the airwaves. At any given point, only about 2% of self-declared “actors” can make a living that way⁵, and a smaller fraction still are widely known. A small group of NBA players score most of the points. And, in the entrepreneurial realm, most will fail, and a small few will enjoy outsized success. Under capitalism, successful entrepreneurs occupy the upper rungs of society. Under communism, it’s the politicians. I’d say one group is more deserving of status and resources than the other.

Okay, so, inequality exists in society, for reasons of human nature rather than capitalism. This can be a problem, as a too-divided society will tear itself apart, but on the other hand, the idea that we can do away with wealth disparity completely is a dangerous fantasy. How do we reconcile this? The political left usually offers some sort of redistribution or welfare policy here, and the mainstream right is often silent on this issue altogether.

To me, the solution seems simple— invest in the middle class. This doesn’t necessarily mean financial investment, although it can, but more broadly it means policies that incentivize a robust, productive, financially secure middle class. It means a middle class that can relatively easily afford their groceries, afford to buy a home and start a family, and afford to put gas in their cars— which, incidentally, are all things that have been made increasingly harder under the Brandon administration.⁶ When it comes to members of the lower class, it means policy that helps with and incentivizes upward movement, rather than coddling and dependence on the state. As to the upper class— well, as long as they’re playing by the rules, and the average citizen can get ahead with hard work, who cares how much money they make?

I think a large part of what continues to drive the capitalism-communism debate stems from our unbelievably prosperous society, and its clash with human nature in some instances. A quote from my first Substack essay feels relevant here—

Many lefty individuals and politicians discuss social problems like they’re math problems. Solve for x, and drug overdoses, homelessness, school shootings, or whatever your favorite problem is will disappear. But human beings aren’t equations. The Bible says that “the poor will always be with us.” Dostoevsky warned that if there were ever a perfect, utopian society, it wouldn’t be long before its citizens began smashing and burning it down just so something interesting would happen. It seems fair to say that human beings will always have problems— it’s in our nature.

Some people look out at our level of material abundance, and think, If only we could engineer the perfect system of redistribution, or welfare, or communism, then we could achieve utopia. I find this line of reasoning to be understandable from a compassionate perspective, but ultimately arrogant. Far more common, I’d guess, is the case where resentment and envy play into a feeling of, Well, if only I were in charge… And, hey, communist rhetoric sounds nice if you don’t think too hard.

From this analysis, I think I’ve made a compelling case that capitalism with minimum necessary regulation is the winner. Perhaps I’m wrong, though, and if you still think this after reading the piece, I encourage you to leave a comment! Free debate is how we would arrive at the best policies anyway, and I’m very open to hearing competing perspectives.

Looking at economic issues through incentives provides a lens through which otherwise baffling economic phenomena can begin to make sense. Take, for instance, the ever-escalating costs of college in the US. Personally having graduated back in the spring of 2021, this is a particularly relevant topic to me as I stare down the barrel of ~$20,000 of student debt. Consider the incentives faced by the modern-day university.⁷ With tuition, room, and board as a college’s primary income, the college’s primary incentive is to attract students. Their secondary incentive is to keep students enrolled. This distinction was made crystal clear to me personally back in the fall of 2021. Even with corona hysteria in full swing, my school decided to try having most students come back to campus that semester. However, when the amount of cases rose to an unacceptably high level, the college transferred to remote-only schooling, abruptly kicking all the students off campus… with the exception of the freshman class. You see, the incentive of keeping students enrolled diminishes as each class goes through school. The college has no reason to care if a spring senior drops out, since they’ve already extracted all the tuition and fees they can, but if a fall freshman drops, this represents a loss of 7 more semester’s worth of income. From an economic perspective, the college’s decision made sense. But from a personal education perspective, I definitely received a sub-par education that semester, to say the least.⁸

Anyways, I discussed a hypothetical college’s incentives, but now consider the incentives facing students. From the student’s perspective, college functions as something of an investment, the thinking being that with a degree, they’ll have more earning power upon graduation. Whether this is still the case or not is subject to debate, but the point here is that students and colleges are faced with very different incentives— the institution is incentivized to make money up-front, where the student ostensibly uses their education to make more money later. But what if we could align the incentives, somehow? Before I present my solution, I have to add the disclaimer that I didn’t come up with this idea,⁹ but it stuck with me because it makes total economic sense. What if, instead of charging up-front tuition and fees to students, colleges and students entered into a contract that said that for a 4-year degree, for 10 years after graduation, the student agreed to pay 5% of their income back to the university? Of course, I expect that the numbers would be subject to adjustment, but this idea elegantly shifts the college’s incentives from attracting potential students to investing in current students, which is similar to the incentives that face the students themselves. Colleges that provide a practical, useful education would thrive, with a high return on investment, and, well, colleges that don’t, won’t. This would also change the calculus colleges face when attracting students. These days, colleges are beholden to ideological concerns when it comes to admission, but with their bottom line on the line, merit would once again reign supreme, as it should. Get woke, go broke!

Unfortunately, with cronyism running the show in Washington DC, I’m not all that hopeful that we’ll see hugely positive reforms in this case anytime soon. Brandon’s attempt to address the issue involved simply giving people money, and it looks like he won’t be able to do even that. Still, though, I’ve had this idea bouncing around in my head for awhile, and after reading Anarchonomicon’s essay on Cocytarchy, I really got to thinking about incentives and how they factor into lots of different kinds of decision making, from the federal government, to mega-prisons, to each individual person. At the end of the day, if we want to foster a healthy discussion of economics, we have to include discussions of the incentives at play. Otherwise, it’s not a serious discussion.

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I know this was a long one, so if you made it to the end, thank you for reading! I hope you found it interesting, and maybe you even learned a thing or two! If you feel so inclined, please like, share, subscribe, and comment. Coming up next, I’ve got another economics-focused piece brewing in the background on why ESGs are a bad idea. Also, with Succession in its fourth and final season, I might also write about my favorite currently running TV show. Hope to see you on Deimos station, or on my next rolling of the dice. Cheers!

1. At least, I think it was a band tee… he was definitely wearing ripped jeans and a flannel though.

2. A latin phrase, often used in economics, that roughly translates to “all else equal.”

3. The manipulator is worse off from a moral standpoint, but that’s outside the scope of the essay.

4. Morbid pun intended. (:

5. At least, that’s the number I see often on the internet.

6. Not saying the situation is 100% Brandon’s fault, although him and his administration certainly bear a decent amount of responsibility.

7. For simplicity’s sake, we’ll skip over endowments, although it’s certainly the case that colleges are incentivized to seek out donations as well.

8. And was pretty mad about the whole situation, too!

9. I have no idea where I heard it originally, but the fact that I remember the idea and not the source should tell you how highly I think of the idea.