“Incentives matter” says Econ 101. Reality, however, says otherwise. Here’s a new study:

Agents do not provide high effort when prize spreads are larger. When we take into account agents’ risk aversion, we find that while the effect of large spreads is not significant for risk-prone individuals, it is strongly detrimental for the performance of risk-averse individuals.

This is based on the performance of Italian students in exams. It is yet more in a long line of evidence that high-powered incentives can and do backfire, for example:

- They can encourage outright dishonesty such as fiddling performance figures or Libor rates.

- They encourage workers to do jobs which are easily measured and incentivized rather than ones which are less observable but which have longer-term payoffs, such as preserving the company’s reputation or solvency. Incentives, for example, gave us PPI mis-selling and banks’ issuing “liars’ loans.” As Benabou and Tirole show (pdf), bonus cultures can cause “significant efficiency losses, particularly in the long run.”

- The urge to meet targets can crowd out innovation and creativity. As John Seddon has said:

“Best practice” in the service of big ideas promulgated from the centre and inspected for compliance is, in fact, worst practice, a nail in the coffin of innovation. For innovation to flourish the locus of control must shift to the frontline where people deliver public services. Innovation requires freedom to learn and experiment.

- Big incentives can signal that a job is very difficult. This might encourage some to simply give up (pdf) and others to take big risks to meet their targets. Or they might have an adverse selection effect: only the irrationally overconfident would want to take on such jobs.

- The Yerkes-Dodson law tells us that that big incentives can and do lead to choking – as we see when golfers miss easy putts and footballers important penalties. As Dan Ariely and colleagues say, “high reward levels can have detrimental effects on performance.”

All this poses the question: if high-powered incentives can so often fail or backfire, why do they still exist in some places? I suspect the main reason is that whilst the idea that big rewards are necessary to elicit good performance might be often wrong, it serves as a useful justification for inequality. What we have here is ideology masquerading as economics.