“If a builder builds a house and the house collapses and causes the death of the owner of the house-the builder shall be put to death. If it causes the death of the son of the owner of the house, a son of that builder shall be put to death. If it causes the death of a slave of the owner of the house-he shall give to the owner of the house a slave of equal value.”
— Excerpt from Code of Hammurabi
Hammurabi was a king of the Babylon, reigning from 1792 BC for 58 years. Hammurabi is best known for having issued the Code of Hammurabi, and is seen as an important figure in the history of law.
It is among the first law codes to place greater emphasis on the physical punishment of the perpetrator, and as well establish the presumption of innocence (one is considered innocent unless proven guilty).
Although the punishments look extremely harsh by modern standards, they are suggestive of being responsible for one’s deeds, and being liable for their failures. The code forces one to have “skin in the game”.
In fact, if you observe it closely, it is less about punishment, and more about providing disincentives in case of harm done to others during the fulfilment of one’s profession.
But any means, I am not suggesting that a builder should be put to death if a building falls on somebody, but our current systems rarely penalise one for being irresponsible, not doing their duty properly, and engaging in risky behaviour.
Take banks, and Govt. jobs. They have unlimited upside and literally no downside. Therefore Govt. employees have zero motivation to excel in what they do, and no matter how bad they are at their job, there’s only a minuscule chance of getting fired. It’s as stable a life as you can ever get. Steady salary for no job well done.
Banks, however, have a lot of opportunity to get involved in risky schemes, and thereby bring the whole economy down. And they never have to pay the price for such mishaps. Taxpayers have to take up the burden instead. The Govt. is always there to bail the banks out, and restore sanity in the market. This is far worse as somebody else is forced to pay the price for their misdeeds. This is what Taleb calls transfer of fragility.
Our current financial systems do not incentivise people to create wide margins of safety. Instead, they do the opposite-they encourage dangerous risk-taking. Such lack of disincentives create disasters like the 2008 financial crash.
Disincentives act as stressors. They force you to get better, and also put you in check. The bonus systems in companies are usually structured to reward an employee for excelling at work. But there’s no anti-bonus, one where a part of your salary is taken away if you underperform.
The result: a poor performer ends up earning almost as much as an OK performer. Eventually they might get fired, but till that day comes, they’ll happily collect paycheques, and look for other jobs.
On the other hand, the founders incur heavy risks when they start a company. No bad decision goes unnoticed by the market. There’s tremendous upside if they can get a good mix of luck and good decision making skills, and there’s tremendous downside as well if they get them wrong. They lose the company, the money, and the valuable years if they fail. This constant stressor keeps them on the edge, and forces them to perform.
To talk about absence of stressors, take the police system or the courts. Nobody is penalised for not being able to solve cases, which results in millions of pending cases.
Disincentivization not only keeps check on poor performance, but also helps in reducing corruption. Corruption is a result of poor system design, not necessarily because people are evil.
But some career fields have a strict system of incentives and disincentives, both official and unofficial. Doctors get promotions and respect if they do their jobs well, and risk heavy penalties for medical malpractice.
The same goes for military and security personnel. We trust the military with our lives, yet we don’t give them lavish bonuses. They get promotions and the honour of a job well done if they succeed, and the severe disincentive of shame if they fail. Military personnels are revered and respected universally. They have a lot of loose if they start acting recklessly.
Incentives backfire when there are no negative consequences for those who exploit them. When you align incentives in both positive and negative ways, you create a balanced system that takes care of itself.
As the great Charlie Munger has said, “Never, ever, think about something else when you should be thinking about the power of incentives.”