In Mixed Signals: How Incentives Really Work, Uri Gneezy explains why incentives often fail and demonstrates how the right incentives can change behavior by aligning the signals for better results. Here, he talks with us about incentives gone wrong, how companies can use signaling insights to their advantage, and how to achieve personal goals through simple rewards.
Mixed Signals follows your co-authored bestseller, The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life. Does this new book challenge or expand on your previous conclusions?
UG: The Why Axis (co-authored with John List) discussed how using field experiments can improve our understanding of economic interactions in the real world. The book covered topics from our own research such as gender and competition, discrimination, and online behavior. The main argument of the book is that executives and policy makers may believe they are basing their decisions on data, but often the data they use is not showing what they believe it does. To avoid this problem, they need to use data that can directly measures causality to inform their decisions.
Mixed Signals has a very different focus. The book is about the signals that incentives send and how understanding and framing these signals can increase the effectiveness of incentives. In the book I discuss how incentives shape the story we tell, distinguishing between social signaling from self-signaling. The book highlights how incentives that send mixed signals often have unintended consequences and how understanding this problem of mixed signals can be used in designing incentives that achieve their intended goals.
Your goal is to show readers how to design incentives that are simple, effective, and ethical. Can you talk about an incentive gone wrong?
UG: I have a strange hobby—collecting stories on incentives gone wrong. These funny anecdotes show that, when it comes to gaming incentives, people are much more creative than we usually give them credit for. Studying these mistakes is also a bit sad because you learn quickly that people who design incentives repeat the same mistakes time and time again. It’s a pity, given the powerful potential that smart incentives hold.
A famous example that I like is the “Hanoi rat massacre.” Back in 1897, Paul Doumer was appointed as the governor of French Indochina, an area based in what is now known as Hanoi, Vietnam. In a truly French fashion, he immediately set out to modernize the city, with the crowning achievement being the introduction of toilets. Unfortunately, the delicate French colonists weren’t the only ones who liked this addition to the city’s infrastructure—the rats of Hanoi did too. The sewer system that ran under the town was quickly overtaken. Resilient and innumerable, even professional rat hunters failed to stop their proliferation. Something more drastic had to be done, effectively and quickly.
Doumer and his team got together and came up with an innovative solution: deputize the citizens of Hanoi by offering one cent per rat as a reward. The citizens were required to submit the rats’ tails to the government offices as proof; there, a poor fellow was tasked with counting them and paying out the rewards. Tails started to pour in. Just as Doumer and his team were ready to call it a success, intriguing reports started coming in: tailless rats running amok in the city. As it turned out, enterprising citizens had realized that cutting off a rat’s tail and letting it live and breed made more financial sense than killing it. A rat without a tail could have rat babies with tails that could then be cut off and submitted for a reward. The citizens’ creativity didn’t stop there. A new, profitable profession came into existence: farms dedicated to the breeding of rats. Some especially innovative citizens began importing rat tails from faraway places!
The incentive failed because it solely targeted quantity and ignored quality. The governor wanted people to kill the local rats to stop their proliferation, but that wasn’t what the incentives actually rewarded. The mistake was targeting quantity instead of quality.
There are many photos and illustrations in Mixed Signals. Are visual signals often more effective than financial ones? Why or why not?
UG: Everyone is competing for attention. It is hard to get us interested and involved, because we constantly have distractions. I always have my phone and check my messages, google something, etc. I often find myself reading few pages and then stop, realizing I don’t recall what I just read because I didn’t pay attention.
Funny cartoons and game trees can help with getting the message across, because they are better at grabbing our attention.
In the book, you discuss how Toyota prioritized a unique design for the Prius that signaled the environmental consciousness of its drivers, winning out in the hybrid market in the early 2000s. What signals do you believe are necessary to accelerate the turn towards clean energy?
UG: In the book I ask how might a large organization or company use signaling insights to its advantage? If it knows that individuals use signals to reveal their preferences, abilities, and characteristics, could it turn that observation into a profitable strategy? Toyota did exactly that back in the early 2000s.
In 1999, just a few months apart, Toyota and Honda introduced their hybrid cars to the US market. They were the first, and much anticipated, hybrid cars in mass production. Although there was a bit of competition in the beginning, Toyota won the market in just a few years and made its Prius one of its best-selling cars ever. Honda’s hybrid lost. How did Toyota convince so many customers to purchase a hybrid car? And why did Honda fail?
There were two important elements to understand. First, the early hybrid cars were bad in nearly all dimensions, apart from fuel consumption. They were more expensive and offered less speed, acceleration, comfort, and safety than similarly priced nonhybrid cars on the market. You would imagine that offering such a bad car would not help Toyota win over customers. However, while these shortcomings certainly posed challenges, they also presented an opportunity, because getting an eco-friendly car, despite the car’s being objectively “bad,” sends a strong signal about the driver’s environmental intentions. Consumers who chose to buy hybrid cars in the early days were making it abundantly clear that they were environmentally conscious and were willing to pay more for less to help the environment.
What, then, did Toyota do that Honda missed? Honda based its hybrid car on the best-selling Honda Civic. Toyota, on the other hand, chose a different strategy that proved to make all the difference. The Prius had one crucial change that propelled it to success. Instead of making the car look like any other sedan, with only a small plate on the back distinguishing it as a hybrid, the Prius was redesigned to have the distinct look that we are all familiar with now.
When you drive into the parking lot at work with the newly designed Prius, everyone can see that you own a hybrid. This distinctiveness is extremely important for the people who buy the car to signal how much they care about the environment. After all, what’s the value in signaling to others if they don’t notice it? A small plate doesn’t send much of a signal, because the receivers simply don’t notice it—it’s not that useful as a signal. A completely redesigned look, on the other hand, is nothing if not noticed everywhere and by everyone.
You tackle why students in the United States underperform on standardized tests compared to students in other countries. How can public policy makers address this incentive gap?
UG: Many standardized tests have very little consequence to the students who take them. We use incentives to identify whether differences in such tests are only due to abilities (as is commonly assumed), or also due to motivation. We find evidence that a large part of the advantage of Chinese students relative to US ones is due to how much effort they put in the test itself, and not a difference in ability.
In an experiment, we demonstrated the importance of identifying the problem correctly by using incentives as a diagnostic tool. I am not suggesting here that we should pay students to work hard on tests; I just say that incentives for a small sample can help us diagnose the problem. The first stage in solving the problem is to correctly diagnose the problem, as is the case when visiting your doctor. Don’t simply assume you know what the source of the problem is; use experiments to test your intuition whenever and wherever you can.
How can an employer tell who really wants to work in the company and who’s faking?
UG: You need to create situations in which, instead of asking people questions that will probably yield answers meant to please you, they’ll be incentivized to reveal their true preferences.
One such way is using a “Pay to Quit” strategy—offer your employees a financial incentive to leave their job voluntarily. You can tell them something like “we’d like you to stay with us, but if you want to leave, we’ll give you a $10,000 gift and depart as friends.” The goal of this strategy is to learn which of your employees are fully committed to their work and encourage the others to quit.
Sounds crazy? I think it’s a clever way of putting employees’ excitement to the test by forcing them to put their “money where their mouth is.” Pay to Quit makes faking excitement about the job expensive. It might be enough to push some unhappy employees out the door in a friendly way such that both the company and the employee are ending up in good terms, reducing hard feelings and the risk of sabotage. It also benefits the company in two other ways. First, because the employees who turned down the temptations credibly signal that they are committed to the company. Second, the psychology of the situation suggests that sunk costs can affect subsequent behavior. By giving up the bonus, the employees signal to themselves that they are serious and motivated. They will feel a need to justify to themselves that it was worth it to give up the bonus and stay by working harder and being committed to a long-term goal.
How can readers incorporate incentives into their lives to achieve personal goals?
UG: One way is to try and incentivize yourself. It’s funny, but our brain can be modeled as multiple “agents” with different motives. A simple example is the “now” agent who wants to have the piece of cake after dinner or doesn’t want to get off the sofa and go to the gym. This agent is in conflict with the “later” agent who cares about dieting and exercising. The later agent cares about the long term—can we help this agent do better in the competition with the now agent? In other words, how can we use incentives to break our own bad habits and create good ones?
Consider John, who wants to exercise for an hour a day. When he first visits the gym, he has a rough time. He struggles to exercise for even 10 minutes, and goes home sweaty and spent. He wakes up the next day extremely sore, still more flab than ab. But if he keeps going to the gym, he’ll build up his “habitual stock,” which is a fancy way of saying getting some practice and experience. Exercising may become more enjoyable (or less painful) as the benefits become tangible, visible, and clear—he will feel better and stronger in daily life, lose a couple of pounds, and actually be able to see the faint outlines of leg muscles. Evidence suggest that starting is the hard part.
As such, incentives can help getting people to start, and by that build up this stock of behavior. Hopefully, with time, the later agent will do better in the competition with the now agent. If John earns a reward each time he visits the gym, he will have stronger motivation to start going to the gym. Even if he’ll suffer a lot at the beginning, he will eventually suffer less, or even start enjoying it, and be more likely to continue even after the incentives are removed.
Uri Gneezy is the Epstein/Atkinson Endowed Chair in Behavioral Economics and professor of economics at the Rady School of Management at the University of California, San Diego. He is the coauthor of The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life.
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