On Incentives

"Never penalize those who work for us for mistakes or reward them for being right about markets. It will go to their heads, is counterproductive and, in any event, material compensation will not correlate with their ability to predict the future next time."

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The Case:  Inflation is Dead — or at least
in extremis

How does one argue, much less prove, that inflation is “dead” in the United States?  The conclusion borders on the irresponsible and surely makes too much of anecdotal or pop wisdom.  Yet, though we have seen changes in our physical and political environment which have shaken our fundamental beliefs about how things really work, our language and clichés still seem rooted in a different time and place.  We still talk about “pre-emptive strikes,” “better too soon before too late,” and “unsustainable growth.”  It all sounds so responsible.  But language is not reality.  It tells us mostly about the persona of the speaker -- not the reality of the world about us

So perhaps it might be useful to assess what we really believe about the world around us.  I would argue that, despite some qualifications, if we were required to mark the statements below as true or false, the overwhelming number of responses would be “true.”  That in turn should lead us to an inexorable conclusion:  If inflation isn’t dead, it is in extremis.  So here’s the test:


  • The power of the U.S. labor movement to put upward pressure on wages/benefits has diminished because of the employer response to strikes by hiring replacement workers. 
  • Outsourcing of services has become widespread and tends to put a lid on wage pressures from permanent employees.
  • Part-time and temporary workers are increasing as a percentage of the total labor force, reducing the need for the hiring of permanent, higher cost employees.
  • There is increased anxiety over jobs as technological change makes employment uncertain and weakens employee negotiating power.
  • The recent shift of pension benefits from a benefit guaranteed by the employer to an employee market risk has lowered employer costs.
  • Recent immigration has resulted in a large and critical mass of unskilled workers, particularly in agriculture and lower-skilled manufacturing occupations, thereby reducing the wage bargaining power of both recent immigrants and native low-income populations.
  • A growing underground economy has put a ceiling on the costs that larger and more visible companies can pass on for goods and services for a wide range of products.
  • Brains and skilled human resources are now transferable worldwide, particularly through modern technology, thereby providing access to high quality services from low-wage countries in Southeast Asia and Latin America.


  • There has been a systematic world wide dismantling of monopolies and monopolistic pricing.
  • Low-cost, “low-frill” providers, have come on stream in basic industries, e.g. airline and truck transport, phone services, retail consumer outlets, communication networks, etc., offering lower cost alternatives.
  • Highly specialized companies with low overhead have unbundled services and products once provided by large mega suppliers, resulting in lower costs of administration and overhead and lower charges to consumers.
  • Consumers have learned to substitute away from more costly goods and services by brand and product and to purchase generic goods, which reduces costs to consumers and tends to act as a ceiling on higher cost products.
  • The changing method of purchasing -- catalog sales, bulk purchases, discount stores -- has lowered costs and prices, serving as a constraint on pricing in traditional outlets.
  • Development of synthetic materials and copycat products puts downward pressure on prices.


  • China’s export economy is almost fully integrated into the world global markets with an average manufacturing wage of 24 cents an hour, thereby producing stable, if not downward, pressure on wages in Western economies.
  • There has been a virtual complete dismantling of barriers between high- and low-wage countries permitting, for the first time in history, significant direct strategic investments, international flow of capital and plant, and portfolio investment in countries with low wage rates, low costs of production and rapidly increasing productivity.
  • The development of  labor as a political or potentially destabilizing force has not come about in Asia.  These remain exploitative economies with little likelihood of wage pressures, given their vast populations coming on stream -- particularly from rural areas.
  • Western companies throughout the world, in the tens of thousands, have moved plant and equipment to low wage/cost countries, thereby providing a safety valve in the event of either high domestic plant capacity utilization or wage pressures.
  • There is significant manufacturing over capacity in Europe and high unemployment, partly in reaction to a reduction in defense expenditures, partly because of competitiveness from lower cost Asian countries and from southern Mediterranean countries.
  • The European Union has already accelerated competition, reduced monopolistic practices and high cost subsidies in member industrialized countries.
  • There has been a move away from state-owned enterprises throughout the world toward privatization and a profit and loss­­­­ orientation which has driven down costs and tended to stabilize prices.
  • The collapse of political trading blocs since the dissolution of the Soviet Union and the globalization of Asia’s exports now permits raw materials and finished goods to flow into and out of countries which were not previously part of the global trading system, putting pressure on prices and wages in industrialized countries.
  • Reduced government stockpiles of commodities and materials in Western countries have put downward pressure on prices of raw and strategic materials.
  • There is increasing plant over-capacity in Asia and Europe (e.g., automobile, basic industries and consumer electronic production), in response to a fall off of domestic consumer demand.
  • The widespread devaluation of Asian currencies will permit them to export their low wages even more effectively.
  • High domestic expenditures over the last two decades in oil exporting states have caused OPEC to produce significant amounts of oil which, along with increased oil exploration and finds, have, in effect, put a ceiling on the cost of energy.
  • The prospect for broad based energy sources, such as the shift to nuclear power and, at the other end of the spectrum, the use of coal, particularly in Asia, puts downward pressure on the prices of oil, natural gas and other energy sources.

*  *  *

We all know, despite the foregoing, that it is easy to latch on to some ad hoc event, random signal or piece of data which will justify a pre-emptive strike, say, by raising interest rates.  It is far more difficult (and courageous) to admit that tomorrow’s dangers and challenges may be quite different from those we were trained to fear.

Pace requiescat.

Mr. Rotberg formerly served as Vice President and Treasurer of the World Bank.