A Word on Moral Hazard

The mainstream media would have us believe that the fundamental ethical issues confronting business leaders today are primarily personal in nature, and that the ethical failures are failures of character.  The view that the various forms of corporate malaise which afflict our society are the collective result of unconscionable decision making on the part of a limited (or even a widespread) pool of bad actors ignores the larger structural issues which precipitate unethical behavior.  To ignore these factors (while not excusing those who make unethical or ethically questionable decisions) is to condemn oneself and society to the role of the proverbial ostrich with its head in the sand.

I will pause for a moment to point out that ostriches don't actually stick their heads in sand, and that the origin of this myth was the product of the instinctive habit of ostriches to move about with their heads inches above the ground, in combination with the instinctive habit of man to draw wildly false conclusions based on limited information- a point which, while off-topic, seems strangely relevant in a charming sort of way.  Nevertheless, let us move on and examine an alternative theory on the root causes of failures in corporate ethics, and attempt to determine whether this theory does, indeed, support a valid paradigm- or if we are merely hunting for subterranean ostriches.

Let's first start with the assertion that, absent other factors, a free market does not reward unethical behavior, provided that force, coercion, and fraud are avoided (we can come back to these later).  Assuming that we are talking about the complex world of ethics through which regulations are allegedly to guide us, rather than the basics of "Johnny wouldn't give me his Twinkie so I socked him one in the nose," by and large bad actors exist.  Fortunately for ethical business owners everywhere, reputation is a commodity, and unethical actors distort markets for only a short period of time, because consumers are very smart when integrated over time- that is, while they may make buying mistakes early, they generally will not make them often.  The ruthlessness of the market ensures that those who act unethically will not stay in business long, and limits the damage that bad actors can do by punishing and ultimately rehabilitating or eliminating them from the market.  If you doubt the truth of this, by all means try starting an internet business and ruthlessly scamming your customers*; tell me how your revenue outlook is in a year.

*Don't start an internet business in order to scam your customers; I am just making a point here.

We might think of the market as a giant sports field, with the market actors including vendors and consumers making up the teams.  The role of Government, then, ought to be that of referee- and at most groundskeeper.  The goal is to ensure a level playing field, not to award points to those that are unable to compete soundly.  It is also most certainly not to accept money from lobbyists from either team in order to ensure that they get the loopholes built into the rulebook that they are looking for.

If unethical behavior is itself punished by a free market (and I submit that it is), then how can it be that even in our highly regulated economy unethical behavior can run so apparently rampant?  Here we must attempt a paradigm shift: aside from fraud, the vast majority of unethical behavior in the business world is not extra-regulatory, or aregulatory, but rather occurs through the exploitation of the regulatory system itself.

Let me repeat that: the regulations are the vehicle which enables unethical behavior and market manipulation. In a society where force, coercion, and fraud are criminal (and strictly enforced), it is only through regulation that companies can truly create uneven playing fields.  For instance, absent regulations, if a market was cornered and prices rise (as they are expected to) there is a point at which the expected profit that might be earned by a competitor outweighs the requisite investment to enter the market, and entrepreneurs and venture capitalists will recognize and act upon the opportunity.  Thus it is only at the mutually beneficial point of selling high enough quality products at low enough margins and providing good enough service that a company could ever come close to cornering a market.  Any deviation from this course is a market vulnerability which will be exploited by a competitor.

However, in a regulated environment, one can imagine a number of ways that advantages can be gained by lobbying for loopholes, manipulating the regulators, leveraging ambiguities in regulatory languages, and so on.  It is in that moment at which Government claims the power to intervene in markets that the moral hazard is created which ultimately contributes directly to ethical failure.  It is because of the plethora of methods which are both practical and legal and which allow bad actors to take advantage of the regulatory matrix that this is the case.

Taking advantage of regulations is true anti-competitive behavior.  It is, to use the sports analogy, paying the groundskeeper to flood the field to slow the other team down, or having an extra timeout awarded to you because you happen to be the home team.  It is having the rules changed to benefit you and not the other market players; it is not competitive behavior, and in the sense of being just and equitable, it is certainly not ethical.  For this reason, it is not the market actors, but rather the system itself which grants the power to choose winners and losers that is ultimately the root of persistent unethical behavior in the marketplace.  We cannot look to individuals to change their behavior within a system that rewards that behavior, but must rather reform the system by removing the moral hazard introduced by intervention.

Public (and Semi-Public) Goods We Can't Afford to Lose

This post will start by picking up on a belated exercise from my days as an undergraduate philosophy major, which Jackie Sparrow and I touched upon over the course of Jimmy P's thread last week. It will conclude with an open question that is more relevant to contemporary political economy in the US. The whole thing is open to debate though, of course.

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Jack previously asked for a more detailed description of what sort of "minimum decency standards" I had in mind when mentioning the critical public goods which merit protection at a macro level through government-designed, programmatic treatment. I don't want to venture into a discussion of how such programs should be structured; in fact, there are live examples for many of them, so it makes more sense to analyze (and criticize) those existing programs rather than immediately jumping to Corporate Citizen-crafted, theoretical solutions. Furthermore, for the record, I don't think these public goods necessarily merit government action across the board, and I personally favor market-based mechanisms for most of the more controversial ones.

Whatever the case, here is a simplified list of what I think those goods are, and why they deserve public protection:

Tier 1: National defense (both international and intra-national, i.e. military and police), rule of law. This tier goes without saying; it establishes the most basic framework upon which an economy is built, involves protection of property rights, enforcement of contracts, and insurance of personal safety, and isn't usually contested by either side of the free market/interventionist debate.

Tier 2: Environment, science. This tier is somewhat controversial. Both are true public goods that have been proven to be inadequately provided for by free market forces on their own; moreover, to me both have to do with survival (at the aggregate, planetary level), and therefore cannot afford to be left to standalone market whim.

Tier 3: Healthcare, education. This tier is very controversial. Neither are true public goods, and the numbers aren't clear on how well the market provides for them. I tend to believe these goods are more public than private, and that they are insufficiently provided for by purely free market forces.

Tier 4: Food, clothing, shelter. I'm gonna guess this one is off the table for at least half our squad. To be clear, I don't think these private goods should just be doled out ad infinitum. However, a minimal safety net makes sense to me, given that these are the most basic human necessities and, again, have to do with survival (although at the private level).

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Question for debate: Do you guys think that companies of a given size or greater should have to provide some form of healthcare for their employees?

You Feel Me? Thoughts On Corporate Empathy and Ethics

It is impossible to definitively prove an obligatory code of ethics.  All sources of ethical code have logical weaknesses. However, there is one human sentiment that can be the basis for ethical conduct: empathy, i.e. the ability to understand and share the feelings of another being.

Empathy may be the only thing that spurred our race to develop a sense of right and wrong. It is the reason that when we see someone wronged, we intervene. If empathy is, thus, the only basis for a human individual ethical code, it must also be the basis for a system of corporate ethics since corporations are simply collections of human individuals. In the most basic form, corporate actors consider the rightness and wrongness of their actions by understanding and sharing in the feelings of the people those actions affect. For instance, a manager may resist a reckless decision because it may cause a capital loss and force him to lay off his employees, with whom he will empathize.

But, two corporate realities get in empathy’s way: 1) lack of human interaction and 2) the narrowly defined goal of a corporation.

Empathy is most strongly felt when a person directly senses another’s feelings, when one sees the pain, or joy, in someone’s eyes. However, a large class of corporate actors may not have the direct interaction necessary for them to feel empathy. For instance, Wall Street traders may not have subordinate employees or know the people who own the money they are trading. They cannot directly sense the feelings of the individuals who bear the brunt of the results of their actions.

Systematic lack of human contact is exacerbated because the corporate goal is, most often, defined too narrowly. Overwhelmingly, corporations exist to make money for shareholders. The result being, corporate actors, who may only have an abstract rational concept of the results of their actions, are given a rational justification to ignore those effects. Outcomes incidental to the paper chase may be ignored and prohibited from triggering one’s conscience.

The resulting loss of empathy by individual corporate actors means that corporations themselves lack a natural basis for ethics. This void should be filled, although a cure may be near impossible to develop. Government intervention is the obvious suggestion, but an imposed code of ethics rings of totalitarianism.  A possible solution could be to consult the business world’s elders. Such tried and true corporate veterans, at the end of their careers without aspirations of further profit, might develop a tome comparable to the American Bar Association’s Model Rules of Professional Conduct. If the business community set forth guidelines for productive and ethical action, corporations could attain a higher form of being where action is not taken in a void without consideration for its effects.

A Tribe Called Quest, “Can I Kick It”

When Mustaches Collide

A functioning market does not require large corporations, only efficient mechanisms of exchange. Economies of scale matter and the word ‘large’ requires definition, but just as governments can stymie efficiency in a market, so too can these concentrated economic interests. The question I keep coming back to, even though my own sail tacks to a free market wind is this: can a purely free market stay that way, or does it inadvertently incentivize conditions that lead to its own collapse?

As founder of a team-sports apparel company with operations in the Philippines, I have seen basic market mechanisms in play up close over the past decade. One argument that seems to have traction goes something like this: by importing sports apparel from the Philippines, I increase the demand for labor, which theoretically puts upward pressure on wages and the standard of living – ultimately in theory toward parity with developed countries like the US. But at the macro level, it still seems slower that one might expect. And governments are not the only entities to blame.  

I know of instances for example in which corporations large and small suppress wages at artificially low levels by threatening to move their business elsewhere intra- or extra-country if wages are raised as market ‘appropriate’ levels. This wage “stickiness” is promulgated by the enormity or cunning of some key corporate players who are able to exercise monopsonistic power. This example of imperfect competition can lead to systemic failure. And while governments are certainly complicit in creating some mind-boggling inefficiencies, this incentive to undermine the “freeness” of the market exists within the market itself when companies become large or influential enough to exercise this sort of price-setting power,

This one example appears a good proxy to consider other intra-market pressures and ”natural” efficiency killers: monopolies, informational asymmetries, externalities, irrationality, and hoarding to name a few. These cancers may make a truly free market – a great idea in the abstract – somewhat chimerical in practice. And if they do, then this question is one worth considering: would you opt for the proverbial devil – centralizing economic decision making into the hands of the few rather than the many – or the deep-blue sea, a collapsing “free” market? 

They may not provide specific answers to this question, but the now famous YouTube rap battles between Keynes and Hayek did lend 21^st century mainstream swagger to this genre of economic debate. And though not as popular as the clip of David Hasselhof drunkenly choking down a cheeseburger, these mustaches arguing dueling economic philosophies did nab the attention of 10 million eyes. To intervene or not to intervene: that may no longer be the question. Instead, we may need to ask this: if purely free markets are prone to implosion – in part because of financial incentives to undermine the market itself – and hence a less reliable long-term resource allocator than usually thought, is the problem perhaps more intrinsic than it is structural?