Understanding Incentives Is Understanding Nature

Spinoza for the Modern Business Person

I.

Business is a field of incentives. People act as they do because of the rewards and punishments they perceive, and the perceptions are often more powerful than the objective structure of the incentives. Spinoza would say that understanding incentives is understanding nature, because human behavior, like all natural phenomena, is determined by causes. The person who is shocked by betrayal, laziness, or greed has not been paying attention to the causes.

This is not cynicism. Cynicism is the belief that people are worse than they appear. Spinoza's position is that people are exactly what the causal structure of their situation makes them. Change the structure, and the behavior changes. The cynic despairs of human nature. The Spinozan analyzes its causes.

II.

Consider a common business complaint: "My employees are not motivated." The complaint treats motivation as a property of the employees, as though some people are motivated and others are not. Spinoza would ask: what are the incentives? Are motivated employees rewarded differently from unmotivated ones? Are there consequences for low performance? Do employees understand the connection between their effort and their outcomes? Is the work structured so that effort can produce results?

In most cases, the "unmotivated" employees are responding rationally to an incentive structure that does not reward motivation. The problem is not in their character. It is in the causes that produce their behavior. The leader who blames the employees for being unmotivated is substituting moral judgment for causal analysis, and the substitution prevents him from fixing the incentive structure.

III.

The same logic applies to every domain of business. Customers who churn are not disloyal. They are responding to a product that does not meet their needs or a competitor that offers more value. Partners who defect are not treacherous. They are responding to a change in their incentive structure that makes defection more attractive than loyalty. Investors who panic are not irrational. They are responding to signals that suggest their capital is at risk.

The language of moral judgment (disloyal, treacherous, irrational) is a defense mechanism. It protects the ego by attributing negative outcomes to the character of others rather than to the causal structure of the situation. The language of causal analysis (responding to incentives, reacting to signals, adapting to changed conditions) is less emotionally satisfying but more accurate. And accuracy, in business, is power.

IV.

The practical discipline is to ask, about any pattern of behavior you do not like: what is causing this? The question assumes that the behavior is an effect, and that effects have causes that can be understood and changed. This is the opposite of the moralistic approach, which assumes that the behavior is a reflection of character and that character must be condemned or reformed.

The causal approach works. If you want different behavior, change the incentives. If employees are not collaborating, examine whether the reward structure encourages individual performance at the expense of team performance. If customers are not upgrading, examine whether the pricing structure makes upgrading irrational. The answers are usually discoverable, and the solutions are usually implementable. The obstacle is not the complexity of the problem. It is the emotional resistance to analyzing it causally rather than morally.

V.

Understanding incentives does not mean treating people as mechanical calculators of self-interest. People are affected by many causes: social norms, emotional attachments, identity commitments, habits, and inertia. An incentive analysis that ignores these causes is incomplete. But the incompleteness is not a reason to abandon the analysis. It is a reason to broaden it.

The businessperson who understands incentives understands nature. He sees the causal structure beneath the surface of events. He is not surprised by behavior, because he has traced it to its sources. He is not outraged by betrayal, because he understands that betrayal, like loyalty, is caused. This understanding does not make him cold. It makes him effective, because he can change the causes that produce outcomes he does not want. The moralist can only complain about outcomes. The Spinozan can change them.