Institutions and Incentives

This article from the summer 2010 issue of City Journal (HT to Cafe Hayek)is a sobering reminder that much of what happens in any economic system can be explained as a logical reaction to incentives. What is particularly arresting is that the incentives were often created by government in an attempt to manage economic growth and decision-making.

If we remember that incentives are the result of institutions, the rules and beliefs that guide our decision-making, it is harder to discount the effect of the institutions that have been put in place over the last quarter to half-century.

That is not to say that the rules were put in place to move the nation toward a financial crisis of the type and at the time of the the one recently incurred. However, one can say that efforts to promote certain activities (whether home-buying or derivative-trading) by distorting or transferring risk, should be seen for what they may result in - the attempted disguising of risk and postponed imposition of market discipline.

I hope you take a few minutes to read the article, think about it and then consider sharing your thoughts.