The long-term influence of short-term incentives

One of the main challenges with incentives is that they are a factor everywhere: our needs, our wants, short-term interests, and long-term goals. Humans generally do not prioritize deferred rewards over those that bring immediate pleasure.

This is a problem in democracies, as Aristotle pointed out over 2,000 years ago. For all their political attractiveness, they are essentially governed by millions of people acting in their own self-interest. And those interests tend to be driven by incentives that offer immediate rewards.

Voters want to hear about policies that will have an immediate, positive impact on their lives. Most have less interest in policies that won’t have any obvious benefits for years or even generations. As Niall Fergusson writes in Civilization, “We love our grandchildren. But our great-great-grandchildren are harder to relate to.” Politicians therefore face pressure to emphasize immediate benefits when seeking voter support. They therefore present platforms highlighting the benefits that will miraculously occur should they win. Due to the relatively short term that people tend to hold political office, it’s difficult for any particular politician to make significant positive change in that time. They’re surrounded by rapid feedback loops that depend on them showing fast results—short election cycles, frequent opinion polls, media reports every minute of the day, and instant social media chatter. The result is a system where politicians have little incentive to think beyond the current election cycle.

In a similar manner, publicly traded companies are incentivized to sacrifice long-term growth in the interest of showing profits on quarterly reports. The short tenure of CEOs and their large bonuses create perverse incentives. As a result, companies have difficulty investing in the sort of improvements that compound over time. For instance, many companies feel the need to jump on every new trend within their market to capitalize on the attention of their customers. This results in a hamster wheel of new tweaks, rather than companies focusing on building timeless products and services.

Some large organizations have budgets that incentivize reckless spending. Federal agencies with use-it-or-lose-it budgets spend an average of 8.7% of their budgets during the last week of the fiscal year, nearly five times the typical weekly expenditure. In addition, projects funded during the last week are between two and six times as likely to be rated as low quality than ones from the rest of the year. Furthermore, variable pay for managers in these organizations is often tied to spending their budget.

When an organization repeatedly favors immediate results over future benefits, examine what its budgets, rewards and reporting cycles encourage. Changing those incentives can help make long-term work viable.