Thursday, May 27, 2010

Incentives vs. Government Waste -

What if bureaucrats could benefit financially from finding cost savings?

Why are profit-seeking corporations so much more efficient and innovative than bureaucracies? A significant part of the answer to that question lies in the fact that bureaucracies are often hamstrung by legislation, and amending legislation is always a cumbersome and politics-ridden process. But another significant part of the answer lies in the phrase "profit-seeking."

Corporations exist only to create wealth. The more they create, the more their stockholders and employees prosper. Thus it's a corporate manager's job to look for ways to increase profits. More, their personal success depends on doing so. For the employees who come up with the really bright ideas prosper even more than their fellow workers, being rewarded with raises, bonuses and promotions.

But there are only three basic ways to increase profits: raise prices, cut costs or innovate. Raising prices is easy. Just cross out $19.95 and write in $22.95. Unfortunately, in a competitive economy, raising prices is going to cost you market share and is thus self-defeating. So corporate employees have no choice but to pursue the far more difficult second and third options, searching for ways to make the same product cheaper or to create a better product at the same cost. They do this hard work because they are highly incentivized by self-interest to do so.

Bureaucrats, alas, are not. In fact, they are highly disincentivized to increase efficiency and to innovate. In business a penny saved is a penny earned, the savings flowing directly to the all-important bottom line. But in a bureaucracy, a penny saved is a penny likely to be cut from next year's budget. And prestige in a bureaucracy comes not from profit but from the size of one's budget. So even accidental savings are likely to be suppressed with make-work.

[Bureaucrats] can certainly find new ways of doing their jobs that are cheaper and better than the old ways, especially if they are handsomely rewarded for doing so.

Self-interest is an immensely powerful force in human affairs—the very engine behind capitalism's success. Harnessing it to save money and increase innovation in a bureaucracy, just as the Royal Navy harnessed it to capture enemy ships, would be the biggest innovation of all and save the government billions.

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