The Power of Incentives

From Charlie Munger’s “Psychology of Human Misjudgment” talk to the Harvard Law School Class of 1948 at its 50th reunion in June 1995, in the section he labels “Reward and Punishment Superresponse Tendency.” Munger frames the maxim as a corollary of Ben Franklin’s “If you would persuade, appeal to interest and not to reason,” and follows it with an anecdote about a house counsel at a major investment bank who lost his job by appealing to a client’s moral duty when he should have been appealing to the client’s self-interest.

Munger does not say “understand incentives” or “use incentives”; he says do not think about something else when you should be thinking about them. The failure mode is not unawareness but distraction at the moment of decision, reaching for moral argument, fairness, or logic when the lever is in the other party’s interest. Earlier in the same talk Munger says he has been in the top 5% of his age cohort all his life in understanding the power of incentives and has still underestimated it. That is the point: the maxim is a corrective for a tendency he diagnoses in himself.