Snow Job in New Jersey: Crony Capitalism Comes in Many Sizes

23 02 2015

The Wall Street Journal recently ran a piece called Regulation is Good for Goldman Sachs. It was occasioned by remarks made by the firm’s CEO in a recent conference call with investors. During the call, Lloyd Blankfein suggested that the burden of new government regulations was a net benefit to the bank, since its competitors were less able to carry the associated costs.  “More intense regulatory and technology requirements have raised the barriers to entry higher than at any other time in modern history,” said Mr. Blankfein. “This is an expensive business to be in, if you don’t have the market share in scale. Consider the numerous business exits that have been announced by our peers as they reassessed their competitive positioning and relative returns.”

This article is a reminder of the sheer importance of regulatory capture in explaining the emergence of crony capitalism and concentrations of economic power. Regulations that are often intended to protect the weak and the powerless often end up being perverted into measures that enrich particular groups of wealthy individuals at the expense of both other firms and society as a whole.

Spare a thought, though, for the impact of regulation on the degree of competition in humbler sections of the economy. Regulation can protect incumbents and reduce competition in banking, but it can also do so in the world of snow removal, a type of economic activity that is rarely if ever discussed in the financial press.  Banks and their regulators are always in the media spotlight.  Relative to their share of GDP, the zillions of obscure guys who do the vitally important work of removing snow get fewer column inches, at least most of the time.

The New York Times reports that two New Jersey teenagers have been stopped by the police from offering snow removal services to their neighbours.  Needless to say, this sort of harassment will cause future would-be entrepreneurs to think twice before handing out snow-removal flyers to their neighbours. Unfortunately, the Times story does not reveal whether the reporter investigated the possibility that the cops who stopped the teenagers are linked to any of the existing snow removal players. It may be that the cops have friends who are incumbents in this industry, although they also may simply have been on a little power trip.

For the impact of excessive occupational licensing in the United States, see this piece by Matt Yglesias. The website of the Cato Institute’s Police Misconduct project is also worth reading.

Peter Klein, Carmen Segarra, and Hard Evidence of Regulatory Capture

29 09 2014

New York Fed

Back in August, I published a blog post in which I discussed a new paper by Peter Klein on the microeconomics of central banking. (This paper appeared as a chapter in a new book edited by David Howden and Joseph Salerno, The Fed at One Hundred: A Critical View on the Federal Reserve System (New York: Springer, 2014). The title is “Information, Incentives, and Organization: The Microeconomics of Central Banking.” You can read a version of the paper here). In the paper, Klein rightly says that we need to take a hard look at the incentives of the individuals who run monetary policy, as many conflicts of interest may exist here.

I said that I really liked Peter Klein’s paper.  I pointed out that while a great deal has been said about way bankers’ compensation is structured, there is very little popular or scholarly discussion of how central bankers (e.g., Bank of England Governor Mark Carney) are compensated and how that compensation structure might influence their decisions about monetary policy! However, while I praised Klein’s paper, my instincts as a document-focused historian caused me to urge caution at the same time. Historians are like investigative journalists, we want to see a paper trail before making definitive conclusions. I wrote that

Klein makes a very strong a priori case for the thesis that the Fed’s actions are influenced by the private interests of the individuals who control it. However, I think that he has run up against a brick wall related to the availability of primary sources. The Fed and other central banks are reluctant to release information about the employment contracts, compensation packages, and so forth of their current and past employees. All they publish are the headline salaries. If we want to examine how the incentive structure for central bankers has evolved over the last 100 years, we would need access to the appropriate archival materials, which would involve looking at both the personal papers of the central bankers, the papers of their family firms, as well as the archives of the central banks. For a start, we would need to compare the terms of the employment contracts given to successive central bankers.  Speaking as a business historian, I think it may be difficult to get access to all of these materials.

I found that Klein’s paper provided lots of soft evidence of conflicts of interest but not so much hard evidence of the sort we historians (along with investigate journalists) crave. In the last few days, however, an astonishing new source of data about the incentives and socialization of key officials at the Fed has become available.  That’s because Carmen Segarra, a former employee of the New York Federal Reserve, has released 41 hours of secret recordings of her conversations with her colleagues that appear to demonstrate that Regulatory Capture was indeed at work. See here and here.  The associated episode of This American Life is well worth listening to, especially if you are the type of person who is skeptical of the ability of regulation by the state to protect the public interest.

The Adam Smith Institute, Business Ethics, and the Ayn Rand Lecture

23 06 2012

Gordon Gecko’s mantra was “Greed is Good.” In the 1980s and 1990s, there was a tendency, especially among people on the right of the political spectrum, to celebrate the pursuit of money as the driving force behind social progress. I suppose that was the culture of the Reagan-Thatcher era. Since the Enron scandal in 2002, there has been a growing realization that capitalism without ethics is a bad idea.  The GFC in 2008 and the evidence of corporate dishonesty and that has accumulated. For instance, it was revealed that a manager at Bear Stearns described, in a 2005 email, some of the securities the firm was trying to sell to investors as a “sack of shit” (i.e., a product they knew was massively overpriced).

The revelations of recent years have intensified the demands for businesses to be more ethical.  Yes, there have also been demands for tougher laws, better auditors, etc. But many observers think that laws mandating ethical behaviour are not enough: shifting behaviour will involve changing norms and institutional cultures as well. That’s why there has been so much attention given to the question of how business schools train future executives in ethics. When he was appointed Dean of the Harvard Business School, Nitin Nohria announced that business ethics were going to be a mandatory part of the curriculum. Nothia believes that future executives must be taught that the quest for profits must be counterbalanced by the other considerations, such as the interests of other stakeholders and society in general. The message is– go ahead, make a healthy profit, but not at any cost.

Of course, business people don’t stop learning about ethics the moment they graduate from their MBA programme. They continue learning about ethics on the job. If they go to Goldman Sachs, a company that is, or at least was, famous for its strong ethical culture, they will learn a different set of values than if they land their first job at some Enron-style company where most of the apples in the barrel are already rotten. [In his famous resignation letter of March 2012, Greg Smith claimed that the traditional culture of integrity at Goldman Sachs had been undermined during his twelve years at the company].

Businesspeople also pick up messages about business ethics through life-long learning events, such evening lectures in the financial district. For those who are religious, the sermons they hear at church or synagogue may influence their behaviour on the job.   Studying the messages about ethics that businesspeople absorb on and off the job is clearly a really important task for academics. Within my own discipline, business history, there is growing interest in the history of corporate social responsibility and corporate ethics.  There is a growing body of social-scientific research showing how culture and ideology influence present-day managerial decisions. For instance,  we know that investment managers in the US who are registered Democrats are more likely to avoid investing their clients’ money in tobacco companies than their Republican counterparts. See here. Managers don’t park their personal values at the door when they arrive at work in the morning.

This brings me to my next point. The Adam Smith Institute, a think-tank in London, is named after a distinguished economist and moral philosopher. Although Smith wrote in the eighteenth century, his ideas are still very relevant today. Personally, if I were in charge of ethics education at a business school, I would make the students read and debate passages from both Smith’s Wealth of Nations and his Theory of Moral Sentiments. One of the messages of the Wealth of Nations is that greed (i.e., the pursuit of self-interest by individuals) can, in certain circumstances, be good for society as a whole. In Smith’s other classic work, the focus was on charity, benevolence, altruism, and the duties of a citizen.

Reading the two books together would be a good way of getting students to debate how individuals and corporations go about achieving the right balance between selfishness and altruism. I don’t think that anybody expects the managers of for-profit companies to behave like Mother Teresa. We certainly don’t expect households to give 100% of their incomes to charity. At the same time, executives should be taught to limit the pursuit of short-term self-interest at the expense of shareholders, workers, and other stakeholders. Similarly, a private individual who went through life without ever giving a penny to charity would be pretty hard to respect.

Precisely what the right balance between greed and altruism is a question I certainly don’t have the answer to. However, I believe that thinking about the two great works of Adam Smith is a great way of getting people to think about these fundamental issues. It makes you a better person. Adam Smith has been criticized for being an inconsistent thinker, someone who said that greed was legitimate in some circumstances and not others. Smith favoured the free market in most cases, but he also supported a certain number of government regulations in the economy. Nineteenth century German philosophers were particularly exercised by the apparent contradictions between Smith the author of The Wealth of Nations and Smith the author of the Theory of Moral Sentiments. They spilled buckets of ink trying to reconcile the ideas in these two books.  Personally, I think that this alleged inconsistency is one of Smith’s great virtues. Smith represents the great Anglo-American tradition of “muddling through,” of pragmatically judging each issue on a case by case basis rather than trying to impose some deductive continental European ideology that has a snap answer for everything. As long as we live in a mixed economy that consists of private, public, and charitable sector, Smith’s idea will remain relevant.

It is, therefore, most unfortunate that the Adam Smith Institute in London does so little to help disseminate the complex ethical ideas of its namesake. Recently, it has promoted the very different ideas of Ayn Rand. Last Thursday, the Adam Smith Institute hosted the Ayn Rand Lecture, which was held at Drapers’ Hall in the City of London. (Drapers’ Hall, it should be noted, belongs to one of London’s historic guilds).

I suppose the Adam Smith Institute has endorsed the ideas of Ayn Rand because they are congruent with the classical liberal ideology of the think-tank.  Whether or not its decision to use Rand’s ideas as intellectual ammunition is a politically strategic one is something only time will tell. To my mind, a far more important question is this: to what extent would disseminating Rand’s ideas in the City of London have on the prevailing ethical standards in that community. This is a vitally important question for any number of reasons. For one thing, foreigners flock to the City of London to do business is that the people there have long had a reputation for honesty and fair dealing.

Let’s say for the sake of argument that large numbers of people in the financial district become followers of Ayn Rand. Would that be good for the ethical tone of the City?

Let’s take a look at Rand’s message. Ayn Rand was a Russian-American philosopher who celebrated greed, denounced all forms of religion, sneered at charity, and has had a major impact on American culture.  Rand expressed her philosophy is a series of novels and non-fiction works. Rand’s writings were characterized by the extremism and dogmatism for which her homeland is famous. For instance, Rand did not advocate trimming the budget for welfare by a certain percent or making it harder for the able-bodied unemployed to claim benefits, policies that traditional Anglo-American centre-right political parties might support. Instead, Rand advocated the abolition of all welfare-state programmes, along with the abolition of the Post Office and publicly owned roads.

Although Rand’s ideas were, in a sense, deeply alien to the Anglo-American political tradition of moderation and compromise, they have become popular in the United States. As the University of Virginia historian Jennifer Burns has noted, Rand’s ideas have had a major impact on US politics since the 1950s. Rand’s influence contributed to the rise of an extreme form of free-market fundamentalism within the Republican Party.

Randian philosophy has inspired a generation of libertarian activists who believe that any form of progressive taxation is evil and that it is truly immoral for the government to spend any amount of charity for the disadvantaged in society. The Randians have marginalized the moderate, Eisenhower-style Republicans and have shifted political discourse in the US far to the right. In his period as chairman of the Federal Reserve, Alan Greenspan, a follower of Rand, encouraged US policymakers to dismantle many of the financial regulations that were imposed after the Great Depression.

Burns’s focus is on Rand’s ideas on the political life of the US, not the activities of business people. However, I would speculate that the small minority of business people who identify with the belief-system of Ayn Rand are probably more ruthless than their counterparts who subscribe to more mainstream political ideologies or to one of the major organized religions.

It would also be interesting to measure whether followers of Rand were more or less honest than businesspeople who subscribe to other belief systems. We know that religious people are less likely to cheat or display other anti-social behaviour when playing games with fake monopoly money in a laboratory setting. See here. There’s actually a vast literature on the behavioural economics of religion.  Of course, not all religions have the same economic teachings. One would imagine that followers of a religion that permits lying would be, say, more likely to cheat on their taxes than someone who goes to a church that teaches that lying is wrong under all circumstances.

I bring up this point because Rand’s message on the legitimacy of lying was a bit muddled, for while she condemned dishonesty in her non-fiction works, her novel Atlas Shrugged celebrates a conspiracy by rich industrialists who live in a tax-haven in the Rocky Mountains that is hidden from the outside world by a sort of invisibility ray.

To my knowledge, no behavioural economist has conducted a study to determine whether fans of Ayn Rand are more or less dishonest than other economic actors. One theory is that fans of Atlas Shrugged would more honest than other people. Another interpretation is that they would be more likely to engage in different types of dishonesty.  For instance, they might emulate the heroes in Atlas Shrugged and hide their cash in offshore tax havens, such as the Cayman Islands. [Sadly invisibility rays do not yet exist].

I’m unaware of any research on this subject, but would welcome any suggestions/links to papers if my readers know of work on this subject.