The Equanimist

The Myth of the Pay Incentive (a follow-up note on innovation)

Posted in *HIGHLIGHTS, Philosophy, Political Economy, Public Policy by equanimist on November 16, 2008

Previously, I wrote a little note (“A Note on Innovation”) in which I argue that US-style “free-”market capitalism is collaboration inhospitable; that so-called “performance-based pay is profit-driven; and, as such, innovation-irrespective “performance-based” pay packages favor cheap, outmoded and proprietary goods and services (what some might call “crap”).

To fill the gaps left in this short note, I submit that “free-”market capitalism is just a feature on the US-economic landscape – a landscape strewn and dotted with (1) legislation (2) efficacy-driven market-share competition (3) strong perceived need and (4) pay promises that are only valuable on innovation, all of which do spur innovation.

Take, for example, the so-called “Big Three” (viz., GM, Ford and Chrysler).

Big Three executives command exorbitant pay packages relative to foreign peers. If innovation were a function of high pay (or vice versa) then Big Three executives should have radically advanced the industry in recent years. Have they? Have US automakers radically advanced the auto industry? The answer seems a resounding, “No.

Focus in on just one decades-old concern, fuel efficiency. Aside from a few so-called “econoboxes”, the Big Three have failed to produce even fuel-efficient vehicles, let alone the most fuel-efficient cars in any class. Legislation, such as CAFE standards that US car makers fight tooth and nail, has advanced fuel efficiency. So, despite Big Three executive pay packages (often multiples of foreign counterparts’ executive pay packages), the Big Three are not generally “innovative” and, the Big Three have consistently fought innovation. As a result, the Big Three have consistently lost market share to foreign rivals who have innovated.

Even in this soft economy, foreign car makers continue to grow market share. Why? When oil prices exploded, “patriotism” (decidedly anti-free market force) and advertising lost out to real efficacy-driven market-share competition and, foreign car companies were ready with many fuel-efficient cars. They were ready not because German and Japanese auto execs command extraordinarily high salaries that spur innovation but because foreign car makers have long competed for market share where gas is costly. That is, efficacy-driven market-share competition – competition, for example, to save consumers real dollars when real dollars really add up – is a powerful economic force.

Still, while efficacy-driven market-share competition may be sufficient to spur innovation, innovation is often product of something altogether other than market forces: strong perceived need (often subsidized by government and government entities). “Necessity,” as they say, “is the mother of invention.”

Since ancient times, battlefields have been rife with innovation. Likewise, at all times, implacable scientific minds and engineers have made manifold innovations (often in so-called “free time”). Some of history’s greatest innovators (often members of the leisure class – often subsidized) have toiled because they “needed” to know – they “had to” – had to satisfy themselves!

Strong perceived need is vital to innovation and much would not proceed if it were not for the very anti-free market force of subsidies that furnish resources and opportunity. Ergo, to this day so-called “free-”market governments fund agencies, academic institutions, departments and scientists within same in addition to private contractors. Why? Because “free-”market forces and “performance-based” pay are insufficient to spur myriad innovations that keep countries like the US one step ahead of the competition.

These government and academic scientists and engineers do not generally receive “performance-based” pay but graded pay (an extreme whereat there is no remunerative reward for innovation). The pay is so bad that many flee the very projects they most cherish to make money in the “private” sector (a sector not known for paying scientists and engineers sums to rival executive pay packages). That is, low pay packages may actually stifle US innovation by driving scientists and engineers away from basic science to more lucrative careers in business, sales and pharmaceuticals (where they have devised a way to make medicine pay: cure nothing, treat everything).

So, legislative (and litigious) processes spur innovation. Efficacy-driven market-share competition spurs innovation. Strong perceived need inspires innovation. Subsidies often make innovation possible. But, in no case does pay per se spur innovation (though, as indicated, too low pay may hamper innovation).

How can remuneration spur innovation? Well, that guy in the garage building a better mousetrap – if he isn’t some wonk like me who simply must satisfy himself – is probably sick to death of slaving away while executives make fortunes off the sweat of his brow. He becomes the so-called “entrepreneur”. That is, the promise of future pay that will only materialize as the result of innovation is a powerful incentive.

Thus, innovation is spurred by (1) reasonable mandates, (2) efficacy-driven market-share competition, (3) perceived need and curiosity and (4) the promise of pay for innovation. Innovation is not a function of regular or so-called “performance-based” pay (i.e., pay packages linked to short-term value of profit shares).

Until and unless (1) government mandates innovation; (2) competition fuels innovation; (3) innovation is cheaper than existing technologies or subsidized; (4) necessity demands innovation; and (5) pay packages are restructured to drive innovation per se, innovation will progress at a sub-maximal rate because “performance-based” pay is both irrespective of and insufficient to spur innovation.

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