LINDA WERTHEIMER, host:
As President Obama tries to get the economy going, he may want to ponder the importance of getting the economic incentives right.
NPR's David Kestenbaum of our Planet Money Team has been visiting the academy and offers this history lesson.
DAVID KESTENBAUM: Alex Tabarrok begins his Econ. 101 class at George Mason University with a simple story - a puzzle actually.
Professor ALEX TABARROK (Economics, George Mason University): I start by telling them this: As many people know, the British government once hired sea captains to ship convicted felons off to Australia.
KESTENBAUM: This was in the 1700s, and the captains on the ships were not taking very good care of the convicts. It was not unusual for prisoners to arrive in Australia dead.
Mr. TABARROK: About a third of the males on one particularly horrific voyage died, and the rest them arrived beaten, starved, and sick. I mean, they were hobbling off, those who were lucky enough to survive. So, it really was terrible, terrible conditions
KESTENBAUM: This, he tells the class, was a scandal back in England. Sure, the passengers were criminals, but this treatment was inhumane. So, the government tried to fix it - over and over.
Mr. TABARROK: So, they tried things like, you know, require the captains to have a doctor on board, to have them, you know, have the lemons, you know, prevent scurvy, all kinds of things. The clergy were appealing to these captains, for humanity's sake, to take care of these guys, and it just wasn't working.
KESTENBAUM: Not surprisingly, the hero of this story is an economist.
Mr. TABARROK: So, I tell them that the economist suggested something new. Can you guess what this economist suggested?
KESTENBAUM: Usually there is silence, silence - then hands go up, often offering things that had been tried: inspections, raising the captains' salaries. But then someone will get it.
Mr. TABARROK: And then there's like a gleam in some of the students' eyes and they think, aha and they brighten up, and they think, ah, I see it. I think I see it.
KESTENBAUM: You ready? Here is the answer.
Mr. TABARROK: Instead of paying for each prisoner that walked on the ship in Great Britain, the government should only pay for each prisoner who walked off the ship in Australia. And in fact, this was the suggestion which in 1793 was adopted and implemented. And immediately, the survival rate shot up to 99 percent.
KESTENBAUM: Ninety-nine percent from...
Mr. TABARROK: Ninety-nine.
KESTENBAUM: ...and you said on one boat, a third of the people had died.
Mr. TABARROK: Exactly. And one astute observer commented that economy beat sentiment and benevolence. So, this really is the first lesson of economics: incentives matter.
KESTENBAUM: Reward the captains for keeping the passengers alive and, voila, they arrive alive. The incentive question is at the heart of all kinds of things. Everything in the tax code is an incentive or a disincentive. When we change the regulatory rules for banks or credit card companies or mortgage lenders, we're trying to change the incentives to change their behavior. But it can be tricky to get those incentives right.
Mr. TABARROK: The captains had good incentives before. It's just that they just had the incentives to do the wrong thing, like keep food from the prisoners, and then sell the food in Australia. So, they had incentives. It's just that they were the wrong incentives.
KESTENBAUM: Get the incentives right, you can reduce pollution, improve health care, save lives, keep the economy on track. Alex Tabarrok tells the class good social order aligns self-interest with social interest. Class dismissed.
David Kestenbaum, NPR News.
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