What is an incentive?
An incentive is anything that gives a reason to do, or not do, something. Money is the most visible one: a bonus for selling more, a fine for paying a bill late. But praise, embarrassment, saving time or avoiding hassle are incentives too.
A core idea in economics is that people respond to incentives. When rules or prices change, behaviour changes too, sometimes as intended and sometimes in completely unexpected ways.
Say a coaching centre pays its teachers by how many students enrol, not by how well students do. The teachers will naturally put more effort into advertising and admissions, and less into teaching. Nobody is a bad person; attention simply follows the incentive. The example is hypothetical.
Why it matters to an investor
- To see what lies behind advice: someone who earns a commission on a product has an incentive to sell it. What they say may not be wrong, but it is not neutral advice.
- To understand companies: if managers’ bonuses depend only on one year’s sales, they may chase good short-term numbers even at a long-term cost.
- To understand policy: tax rebates, subsidies and cash incentives change how people save, invest and send money.
- To spot scams: when you hear “guaranteed big profits, fast”, ask where the person telling you makes their money.
A Bangladesh example: the cash incentive on remittances
Expatriates sometimes send money through informal channels (hundi) because the rate seems better or the process easier. To encourage money to come through legal channels such as banks, the government introduced a 2% cash incentive on remittances sent formally from fiscal year 2019-20. From 1 January 2022 it was raised to 2.5%.
It is a clear example of an incentive: the government used a reward to try to change which channel people choose. But how remittances flow also depends on the exchange rate and much else, and economists disagree on how much the incentive achieves. The rate and conditions can change by government decision.
When incentives backfire
When incentives are badly designed, people try to “win” the measure instead of the goal. Economists often put it this way: once a number becomes a target, it stops being a good measure.
- If a salesperson’s target is only “how many policies or accounts were opened”, whether the customer actually needs one can get pushed aside.
- When something is free or very cheap, people tend to overuse or waste it.
- Being insured can make some people less careful about risk. Economists call this “moral hazard”.
Three questions before you take someone’s word
- How do they earn: a fee, a commission, or do they gain whenever I buy or sell?
- If I lose money, do they lose anything, or only me?
- Is the same thing being said by someone who has nothing to gain from it?
Worked example
- Say a worker abroad sends $500 through a legal channel, and say the exchange rate is Tk 120 per dollar. The family receives Tk 60,000.
- A 2.5% incentive: Tk 60,000 × 2.5% = Tk 1,500 extra.
- Total in the family’s hands: Tk 61,500.
Result: if an informal channel offers Tk 3 more per dollar (Tk 61,500), the two routes are about equal in money terms. Safety and legality then become the real difference. That is how an incentive changes people’s sums. The exchange rate and amounts are hypothetical; the incentive rules can change.
Common mistakes
- Taking advice without once thinking about the adviser’s incentive.
- Assuming that an incentive means bad intent. Most people are honest; an incentive just shows which way the pull is.
- Choosing something only for a bonus or tax rebate when it does not fit your own goals.
- Forgetting your own incentives: the pull of quick gains or the fear of losses shapes your decisions too.
To understand what someone says or does, first look at their incentive. People usually move towards where they gain.