Mitchell’s Musings 12-11-2017: Be Careful What You Wish (and Incentivize) For

09 Dec 2017 8:22 AM | Daniel Mitchell (Administrator)

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Mitchell’s Musings 12-11-2017: Be Careful What You Wish (and Incentivize) For

Daniel J.B. Mitchell

I want to start by drawing on two labor market and labor relations observations and then move to lessons from them for the world of contemporary politics.

First, there is the Wells Fargo scandal in which the bank’s employees created accounts for customers without their consent. Their employer wanted its employees to “sell” customers on additional accounts and rewarded employees who appeared to do so (and penalized those who didn’t). Of course, incentives for sales personnel are often found in the retail world. But obviously, with hindsight, something went awry in this case. Presumably, Wells Fargo – had it foreseen the eventual consequences (reputational damage, lawsuits, fines and penalties) - would have designed its reward-and-penalty system differently.

However, Wells Fargo is not the first, nor will it be the last, retail employer to see perverse results arise from a so-called pay-for-performance system. Pay-for-performance is an abstract concept that sounds good. It seems to solve what economists call the principal-agent problem. How does the principal (in this case the employer/bank) ensure that its agents (employees) do what it wants? In practice, it turns out that the details of the system matter. Just setting up an incentive system and putting it on auto-pilot without adequate monitoring and control can easily produce bad behavior. But monitoring and controlling add to the cost of administering the system. And even with use of monitoring and controls, there are problems.

It was known by the late 19th century (if not before) that a simple piece rate system can produce incentives for quantity over quality. “Scientific management” – which came along in part to correct that problem – introduced time-and-motion studies to exercise detailed monitoring and control over what workers were doing. But for such controls to work, those conducting the studies had to determine what pace could normally be expected from workers. However, armed with the knowledge that the studies could lead to a faster pace of work, there were incentives for workers to collude and slow down when the inspector came around so that easier norms could be established.

The bottom line is that all incentive systems, no matter how they are designed, have flaws and can lead to perverse behavior. And the notion of what are incentive systems has to be expanded beyond just pay and bonus formulas. All organizations have practices and institutions – whether or not they are outlined in official personnel handbooks – that determine how individuals “get ahead.” A new employee will do well to figure out what those arrangements are, and then act accordingly. Whether intentionally or not, typically employees are in some sense competing with one another within organizations for promotions and other benefits. Under such circumstances, there are incentives to upgrade yourself, possibly at the expense of others. Office politics and related perverse practices that can undermine team cooperation to the ultimate detriment of the employer may be the result.

Lesson #1: Always pay attention to the structure of incentives, broadly defined. Incentive systems always have the potential to lead to bad behavior.

My second observation comes from union-management relations and specifically the arbitration of grievances (“rights” arbitration). Almost all union contracts contain some form of arbitration to deal with disputes over the meaning of contractual terms. And almost all contracts require some form of due process in cases of employee discipline (including terminations). If there is a dispute over whether discipline in particular case was “for cause,” the matter can ultimately be taken to arbitration.

Under arbitration clauses, a neutral arbitrator – who is selected by mutual agreement of union and management – hears complaints that the contract has been violated. The arbitrator receives evidence from both sides, written and oral, and then makes a binding decision. In the case of employee discipline, the arbitrator determines, based on the specifics of the contract and other evidence, whether the discipline was justified. The arbitrator can uphold the employer’s disciplinary action, prescribe a lesser form of discipline, or simply void the discipline entirely.

An important element in the arbitration process is that the arbitrator is neutral. He or she is neutral, not only in the sense that there is no connection with either the employer or the union, but also in pay. The fee and expenses of the arbitrator are split 50-50 between the two sides. So, in principle, the arbitrator is not indebted to either party.

Lesson #2: When someone is accused of bad behavior and disputes the accusation, it is useful, where possible, to have a process for review, especially by a neutral outsider.

Okay. Armed with these two observations on incentives and arbitration, let us add a third observation related to politics and to the current circumstances in which various prominent (male) politicians are being charged with improper acts ranging from sexual harassment to various forms of sexual assault. A number of politicians have resigned after such allegations were made. Some of the accused have simply admitted that the allegations are true. But others have resisted resigning and have denied the allegations. Or they have given other interpretations of their reported encounters.

One case in particular involves Roy Moore, the Republican candidate for U.S. senator in Alabama. At this writing, I do not know what the outcome of that special election will be. But Moore has denied the allegations made against him and has continued in the race despite calls for him to drop out. In connection with the Moore contest, there was a recent situation in which a woman reported to the Washington Post that Moore had impregnated her when she was a teenager.

There is a lot at stake in the Alabama election including continued Republican control of the Senate. So the incentives (there’s that word again!) for discrediting the Washington Post are very high. There are those who would like to see the Post discredited, both in connection to the Moore election and with regard to various reports in that newspaper in connection with President Trump and the Russia affair.

It turned out that the woman who approached the Post was an agent of a group that was hoping the Post would accept her word without investigating and publish the story. Evidently, the plot was to get the allegation published and then to reveal it was phony, thus discrediting the newspaper. But the reporters at the Post looked for evidence, found that the allegation was suspicious, and determined its source. The plot failed because the reporters followed good journalistic practice, did not assume that the allegation was genuine, and looked instead for evidence. They followed a process.

There have been arguments that when women have made allegations of sexual misbehavior in the past, both in Hollywood and politics, their stories were disbelieved and therefore now we should switch to a regime in which the default should be belief. In fact, neither automatic belief nor disbelief will produce good results. The argument that no one would lie about being the victim of sexual misbehavior may well have been an approximation of the truth in the past, but it isn’t true now – as the Washington Post episode clearly demonstrates. Institutions and incentives have changed.

In the past, the institutional arrangements were such that women who were victims risked further victimization in terms of career advancement if they talked. And they were sometimes offered money in exchange for silence. Or they were threatened by lawyers and others. So past allegations – which would have been made despite the incentives that existed then – had particular credibility. But we have entered a world now in which that assumption cannot be made. Coming forward now produces different results, at least in Hollywood and in politics. It now often leads to the end of the career for the alleged perpetrator, not the victim. Once the institutions change, the incentives are different.

If we enter a world in which evidence is not required, the results will be perverse. There is no substitute for evidence. And the determiner of evidence should be as neutral as possible. For the accused and terminated Hollywood types, at least some of the resolution may eventually take place in court. As noted in a prior musing, it’s hard to believe that the celebrities whose careers came to an abrupt end didn’t have contracts that spelled out what would be required for early termination. However, I am less worried about Hollywood celebrities than about politicians; the fate of the nation does not hang on TV and movie personalities.

One notion that has been put forward is that if several women make similar allegations, that similarity is the default proof of truth. But, again, in the current high stakes world, if that standard becomes the rule, the new rule becomes known also to groups such as the one that sent the one lying woman to the Washington Post. All they would have to do to bring down a politician is send two or three women making allegations instead of just one. There is little doubt that – if the stakes are high enough (control of the U.S. Senate, for example) – the money will be there to hire as many people making allegations as the standard seems to require. The incentives now and in the future have changed from what they were in the past. What was credible in the past is not necessarily credible in the new regime.

As decades of arbitration practice demonstrate (and as years of good journalistic practice demonstrate), there needs to be a process and a standard of proof that is more than just an allegation. It doesn’t have to be as extreme as the oft-cited “innocent until proved guilty,” the standard used in criminal cases. But whatever the standard, it should involve more evidence than an allegation. And the determiner of evidence should be as neutral as possible.

Now let’s get even more specific. Although both Democratic and Republican politicians have stepped down after sex-related allegations, based on recent events, it appears that the evolving rule of stepping down after allegations are made is going to favor Republicans. In the Moore case, for example, although top Republicans have called for him to step down, he has continued in the race. The president – who himself did not step down when allegations were made against him – continues in office and has endorsed Moore. Meanwhile, Democrats have forced the resignation of Minnesota Senator Al Franken.

Franken at first did not want to step down and wanted instead to have the Senate ethics committee investigate his case, i.e., to use the process available, but the Democratic leadership nonetheless forced him out. (It would be a Good Thing if the internal processes in the House and Senate were reformed to use an outside neutral as decision-maker, but that is the topic of some other essay.) Franken represents a potential swing state where the seat he now occupies could eventually go Republican. In contrast, if Moore had dropped out, it would have left only a Democrat on the state ballot. Moore gets to use a process with the result determined by outsiders – the election. Franken doesn’t get any process.

There is less at stake in the House than in the Senate. So, not surprisingly, it is there where we see resignations of both parties – e.g., John Conyers as a Democrat and Trent Franks as a Republican. Neither resignation will affect control of the House. Both individuals will likely be replaced by members of their respective parties.

It looks as if only one political party understands the incentives that are now in place and knows how to weigh them against the stakes involved. Republicans resign if it doesn’t matter. Democrats resign whether it matters or not in the hope that somehow doing so will shame the other party into doing the same. But there is no shame. Republican officially distance themselves from candidates such as Moore, but provide him with de facto support and, in the case of the president, explicit support.

If those are the arrangements and incentives that have been created, the same interests that sent the lying woman to the Washington Post will undoubtedly take note and will act accordingly in the future. If you think that state of affairs is fine, so be it. If you believe it is a problem, but you think that Democrats should be consistent and moral above all other considerations, so be that, too. But is it really moral when someone denies an allegation to provide no process for examining the evidence? And isn’t there a famous quote about consistency, hobgoblins, and small minds?

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