Sustainable Incentives Strategies for Economic Development

November 2017

Jeff Paddock

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To reorganize a system of perpetual poverty, one must incentivize developing populations to act differently. A system is a set of reoccurring things working together in a complex whole. If you influence the behavior of one part, you change the system. This is the baseline theory behind incentives. In this article, we are going to look at two tools for changing people’s behavior in a system: hard incentives and soft incentives.

 

First, though, what do I mean by a system of perpetual poverty? People who follow Jeffrey Sachs will think immediately of a ‘poverty trap’ where misfortunate families remain poor for generations due to the conditions they live in – social, political, and economic. If poverty traps do exist, it means the institutions have not figured out how to break these cycles of misfortune and protect the most vulnerable (assuming the poor are doing everything they can to remove themselves). Thus, as development specialists, it is our job to help them change the system and rewrite the rules of poverty. We use incentives to ‘nudge’ people into changing their part of the system.

 

Born of an economic discipline, incentives are still relevant across all the development sectors. They are more than tools for calculating outcomes. Instead, they are ways of thinking, and I like to think of them as hard and soft incentives. Hard incentives are real penalties and rewards, while soft incentives are consequences with psychological effects. These two different types of carrots and sticks are crucial to any program attempting to combat poverty, because they work to change the actions that people do naturally inside the system.

 

Incentives in grassroots development can be very simple in nature. We already have some idea of what’s in our toolkit from our lives as individuals. Think of losing weight. If you eat healthy during the week, you get ice cream on Saturday (hard incentive) or, as suggested by Tim Ferris, give your friend an incriminating before-picture and tell him to share it on social media unless you shed X pounds by this date (soft incentive). While hard devices incentivize us with physical penalties, the soft devices motivate us psychologically to meet our goals.

 

In working with grassroots development, I find rewards are more positive and effective incentives to use than penalties. Healthcare programs often have to be creative when changing behaviors in the developing world. Here, positive incentives are useful to improve the system without disrupting the culture or alienating the NGO itself. A hard incentive device might be offering five free pounds of rice to every household that installs a water filter. A soft incentive device might be a bright ribbon tied to the front of the home that shows this household uses clean water. Soft incentives are mental aids that remind them they are acting to better their lives, reinforcing the hard incentives.

 

In micro-finance, where I spend most of my time, incentives are the name of the game. Micro-finance institutions (MFIs) incentivize small businesses with larger loans like any other bank. If a client has good repayment on their first loan, they will be eligible for a larger amount of capital next time they need to borrow. Not only does this ensure clients pay back the MFI, but it ensures they use the money in the most efficient way possible to generate the most income, pay off the loan, and gain access to more credit/capital. These tangible benefits are perfect examples of hard incentives, but it’s the soft ones that are unique.

 

The psychology of financial behavior is fascinating. One Yale study from 2012 found that test groups in Kenya who received a savings account, were more likely to deposit when they titled the account in the name of their first-born child. This year I helped set up a small screen-printing micro-enterprise in a Honduran community and put this idea to use. There was notable uncertainty in the first group of laborers. In a group discussion, we named the project Mujeres en Acción (Women in Action), a title they decided upon. Thereafter, I saw people motivated by the project, working more cohesively and cooperating as a team. They were invested in making it work, and all it took was a simple, three word, soft incentive device to encourage them.

 

There are two schools of thought out there regarding incentives in grassroots development. Some believe that by meddling in the decision making process we are counteracting what bottom up growth is all about. Incentives can sometimes lead people away from cultural norms that might be the foundation of their community. If you can’t promote a practice that won’t survive once you take away the incentive, then it is not sustainable development. An incentive structure should ensure that the participant is completing the program for the sake of their well-being and not the reward. There is a difference between a prize and an incentive. What’s more, studies have shown few incentive policies in microeconomics lead to job growth.

 

On the other hand, proponents of incentive devices point to the Western world and say that even in developed nations we need incentives to push us in the right direction. I’ll let the reader decide what side of the fence to fall on. Nevertheless, I encourage all of us to take a microscope to our projects and start picking apart the incentives of our own efforts. What routine parts of the system are we attempting to alter? What hard and soft incentives exist in our programming? and where can we incentivize grassroots leaders to better combat their own poverty?

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About the Author

Jeff works on the ethical considerations of economic development and cash aid programs around the world. He currently works in Honduras, supporting local community projects through micro-finance and holds two degrees in Philosophy and International Affairs.