Monday, October 15, 2012

People Respond to Incentives

Written by: Brody Hatch, Sustainable Building Associate
                                              Ph.D Economics
Economics is a science that relies heavily on assumptions in order to model and analyze the real world.  These assumptions can range from the idea that people are rational and will act in their own self-interest, to the idea that resources are scarce and therefore subject to the law of supply and demand.  One of the most basic and fundamental assumptions is that of incentives.  A well-known Harvard economist, Gregory Mankiw, ranked the idea that people respond to incentives at number four on his “Ten Principles of Economics” list.  In his book, The Armchair Economist, Steven Landsburg states that “most of economics can be summarized in four words: ’people respond to incentives.’  The rest is commentary.” 

People respond to many different types of incentives, some altruistic, most, not so much.  Some are motivated by a sense of duty or community in how they live their lives or the choices that they make.  The reality, however, is that the vast majority of people and corporations (especially corporations) are driven primarily by financial incentive.  This fact becomes apparent when we examine the popularity and success of super low-cost retailers, like Wal-Mart or Ikea.  Not to say that they are bad organizations, just they neither is a great example of social responsibility, at least currently.

It’s important to note that these same principles apply to the sustainability and corporate social responsibility movements.  While there are some who will willingly invest in sustainable buildings and social responsibility, most will cite the “high cost” associated with doing so as being prohibitive.  This prohibitively high cost could be the reality or it could just be perceived.  In 2007, the organization Building Design +Construction conducted a survey among a sample of its mailing list.  Among the results published in “Green Buildings Research White Paper: Where Building Owners, End Users, and AEC Professionals Stand on Sustainability and Green Building”, the group found that 86% of respondents believed that a green building cost more to construct.  Most said they believed it to be at least 6% more, with another large group saying over 15% more.  The perception alone of higher costs often deters builders and corporations from providing sustainable and responsible products. 

There are two ways to catalyze change in the business practices corporations and the behaviors of consumers for the better.  One is to make social responsibility and sustainable building cost effective for the producers (financial incentive).  If green building becomes cheaper than traditional building, green building will become the norm; the same is true with socially responsible consumer products.  This is slowly becoming a reality in green building.  A 2007 Davis Langdon Study found no significant cost difference green and non-green buildings of the same type.  A 2006 Cost and Benefits study by Greg Kats found that green building was associated with a 1-2% cost premium.  While a 2% premium may in fact represent a large amount of money when you consider multi-million dollar buildings, these increased costs are quickly recouped.  A 2008 study by the New Building Institute found that LEED buildings perform 25-30% better than average in their energy efficiency, translating into an annual cost savings of more than $8k for an average sized elementary school.

Another catalyst for change is consumer demand for change.  Individual consumers have little influence over the manner in which products are designed and produced, but collectively, consumers wield almost infinite power over producers.  In order to remain successful and profitable, corporations must adapt to the changing tastes and preferences of their consumer base.  An emerging “taste” among consumers is social responsibility and sustainability.  A 2010 Edelman Goodpurpose study found that 87% of global consumers believe that business should place and equal weight on society’s interests as on business’ interests.  The Guardian conducted a survey and found that 60% of UK consumers consider ethics when purchasing clothing, over 80% consider the environment when purchasing groceries and transport, and 79% said that companies offering products and services with low environmental impacts would be more likely to win their loyalty.  This increased demand for socially responsible products has created a situation where corporate social responsibility has become a profit maximization strategy.  Either the corporation strives to become socially responsible, or it loses a large segment of its market (financial incentive). 

If we want things to change for the better, we can’t just expect people and corporations to change their behavior “because it’s the right thing to do.” Unfortunately, in today’s day and age, cash is still king.  There must be a financial incentive associated with doing the right thing in order for the movement to truly gain traction and trend mainstream.  As technology advances and consumer preferences shift, this is slowly becoming reality.  As consumers, we can speed up the process by staying informed and demanding accountability and responsibility.  Collectively, we catalyze change.