Ethics and capitalism, after the crash

The banking crash made us think about short-termism, the alignment of the interests of managers and shareholders, intellectual delusions and much else. At the heart of the problem is an almost philosophical issue as to the role of ethics and personal character at the heart of institutions. Characteristically, I think I have the answer to this….

My description of, and solution to, the problem are outlined at the end of this over-long piece. Skip to it, by all means, or trawl your way to my conclusions through a geography of the topic (as sketched in a lively recent IEA lunch).

This note flows from an IEA meeting at which there were 20 thoughtful types, gathered to hear and discuss the ideas of Ted Malloch on The End of Ethics and a Way Back: How to fix a fundamentally broken global financial system.

I didn’t speak, and the remarks (mostly very sharp) of the attendees must remain Chatham Housed.

But we could easily gather an anatomy of the ethical problem.

Golden Age-ism

Golden Age-ism Mark 1: “Everything’s gone to the dogs.” But, actually, what’s new? Every age has seen bubbles and scams, insider-dealing and straight fraud.

Golden Age-ism Mark 2: “Gentleman Capitalism is dead.” But actually, didn’t it produce its own hazards such as insider trading and a clubbish uninterest in outsiders, such as – often enough – customers and clients? (And one might add, weren’t old style bank managers horribly averse to risk?)

Golden Age-ism Mark 3: “Behaviour is worse now”. Actually, we are just more alarmed now. We know more (call it transparency), have higher standards (call it regulatory and other pressures) and care more (call it public involvement). So failings loom very large.


Short-termism Mark 1. Modern markets are technologically-driven toward fast trading (see The Flashboys, which a couple of speakers liked more than some reviewers did).

Short-termism Mark 2: Corporates don’t behave like institutions. It seems to be the case that even the institutional owners of corporates (themselves corporate investors) seem to surf from quarter to quarter.

I think these are two quite separate problems, of which I wonder if the second does not matter far more. Even so, I can’t see why various forms of shareholder activism wouldn’t sort it out.

The Manager/Owner dislocation. This is a dimension of short-termism, but also identifies a specific issue with the POV of modern managers. They do not have skin in the long term heath of the assets they manage. So perhaps they do know only greed and insufficient fear. (Answer: shareholders should incentivise them more cleverly.)

Institutional culture

In some sectors, it would require exceptional courage to constitute an awkward-squad, fighting against short-termism, personal greed, indifference to customers’ well-being. Indeed, it would have required considerable naivety to sign up for employment in such firms without having thoroughly accommodated oneself to the alpha-male culture.

Moral hazard

There is a perennial dilemma between allowing the fear/greed tension to discipline markets, and the two alternative risks of moral hazard in offering state long-stops (which encourages recklessness), and the moral hazard in tick-box regulatory compliance (which invites gaming of the rules).

The customer/client confusion

One speaker lightly alluded to this distinction and I think it is rather powerful. If one conceives oneself as a salesperson, one can in principle be unprincipled. One can shelter behind caveat emptor. (It is not a very ethical shelter for bad behaviour, actually, but the point is that this conception of oneself takes one toward simple selling, and closing deals, with very limited empathy for the person one is dealing with). If one conceives oneself as having clients, one frames oneself as operating for and on behalf of someone else, so one is in principle obliged to put oneself in their position. (This is a relationship which is hugely open to abuse, and especially because it is based on more trust than most merely commercial relationships. It offers more subtle opportunity for, and in principle condemns more robustly, such offences.)

The “IEA” sort of view

True to the IEA, some speakers posited that we should remember the cleansing power of free and informed markets. This is especially true if there are plenty of small players in the market, and low price of entry (unlike the modern banking scene).

Well-informed free markets are free of the moral hazard of state-sponsored bail-outs; they reduce the gaming of regulators by tick-box compliance; they encourage customers and clients to look after – and out for – themselves more effectively; they encourage owners of assets to check that their interests (long or short term, risk-seeking or risk averse) are well looked-after by those appointed to manage them.

This is an attractive view, and even if one can see its limitations, it is at the very least a necessary corrective to a leftist anti-commercial and interventionist tendency.

Several participants wondered what class of institutional change might do the trick, and some of these revolved around the problem or issue of getting institutions or people to behave better (as it were, above and beyond the impulses brought about unaided by a freer market). Most of this latter argument revolved around getting people to want to behave better, without tick-box compliance. This is where I think I have something to say, and here it is.

RDN’s view
(This is what RDN would have added to the debate if not in Trappist mode for once.)

RDN on the ethical problem

Many previous bubbles and crashes were caused by ill-informed herd instincts, sometimes with an element of fraud. But our recent troubles were more clearly actually of three distinct and exceptional kinds in a perfect storm which was unprecedented in its range of threats.

There was the sort of bad behaviour which is discussed in item Six. This is what we might generalise as mis-selling, using the term to cover people flogging stuff to customers which the customer probably wouldn’t benefit from. Then there was the good old straight dishonesty of an Enron (which lied on an epic scale). One could bracket this range with criminality at one end and disingenuous dissembling at the other, but all embracing people who deceive on purpose. (This area is tricky, since, say, all accountancy methods seem to miss some facets of value, and are in any case complex.) Enron was also subject in part to what was a much bigger and perhaps more purely modern feature exemplified by the banking sector: intellectual delusion. It seems that for several years, various faulty intellectual paradigms grew in complexity and influence such that no-one – not firms, regulators, or commentators let alone customers – knew how to question them. (There was the assumption that the Great Moderation was permanent and flowed from some new, deeper, ineffable understandings about markets; and there was the belief that clever people had understood risk in a way which defied the understanding of ordinary mortals – too many of whom could see short-term merit and little personal risk in being blinded by these computer wizards.)

RDN’s proposed solution to the ethical problem

First: Frankness
This is much like honesty, but is more – as it were – activist or proactive. Firms could solve a lot of problems by committing themselves to plain speaking. This requires bluntness, fair-mindedness, robustness.

This approach could begin by throwing out CSR mantras, as being themselves open to intellectual and moral fraud.

Firms should feel free to return to celebrating the profit motive and shareholder value. (If they want a Body Shop or Ben & Gerry mush, or activist rhetoric, that’s up to them, and it must be done with proper frankness as to its being a matter of taste or even a marketing pitch as much as an ethic or a duty.) But even then, they should add commitment to robust frankness, even where commercial advantage might be at some risk. So there would indeed be a downside to the approach.

This new frankness need not throw out commercial confidentiality. One could easily see that a food company’s recipes could be kept secret. But where a company declared that it was – say – (and pace, Shell’s recent history) publishing its reserves of oil, this should be diligently done. To some extent, firms could frankly say that they were not prepared to reveal some aspect or other of their operations, and the market could judge that reticence accordingly.

Robust frankness is powerful. Very few of the failings of recent years would have survived a serious commitment to speaking frankly about what was going on. (In the case of the intellectual delusion, there is a twist: these fantasies would not have survived a robust requirement that what was being said should be capable of being understood.)

In the robustly honest world I want, firms would be required, as a minimum, to obey the law, be competent, and, of course, be frank. (They might be required to be fair – but that is a subtle and difficult animal.)

Second: Character
I do not think one can plausibly make many firms exhibit character in the special sense of being pro-actively moral or ethical. (I do not trust the record or value of those that claim to be so.) In short, one could not expect many to sign up to a strong ethical code, not least because I do not think such a thing can be defined, except as a matter of taste between consenting players.

This drives one to expect or hope that individuals might do the trick for firms. So one has somehow to reinforce the qualities of character – of individual strength – which encourage people to behave well, as enshrined, as a minimum, in the frankness mantra above.

One can, perhaps, protect whistleblowers, and that may be almost all there is to it. Perhaps one should positively incentivise them. (But one should remember that some very fine qualities are dangerous to the public good. Loyalty can be a two-edged sword, for starters. It discourages whistleblowers, for instance.)

Third: Professions
I am very attracted to the idea of professions, as enshrining a code of competence and honesty which – trade by trade – provides a bastion within which an individual is preserved when he encapsulates or insists on agreed standards in the face of commercial pressure. (The employer couldn’t operate without the profession of his trade; the profession won’t allow its members to break its excellent rules.)

But in many areas professionalism is flawed. Professionalising journalism would, I think, be a disaster. Professionalising work which requires non-academic skills (much caring work, for instance) may deter good recruits on grounds of their academic failings. And professions risk the old Guild problem or driving up the price of entry to lucrative work.

A further difficulty is that professions may become bastions of weaknesses such as the tick-box compliance culture we have seen to be dangerous, and they may well fall prey to the CSR mentality. So it is not all clear that professions can be the guarantor of what one might call old-fashioned standards of competence and decency, but without the modern bells-and-whistles rhetorics which have so bedevilled robust frankness whilst advertising a phoney virtue.

Fourth: RDN conclusion
We need an upbringing for young people which talks about character; and celebrates commerce and knows its limits (surprisingly few, actually). And they need to know that, in the end, the well-being of society depends on persons having values, of which the most basic is an understanding of the merit of frankness (sometimes mediated by tact).  This understanding would include the understanding that one’s “good” actions usually (but not by definition) put one at an ostensible disadvantage. These virtues are, as it were, Roman.

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Publication date

01 May 2014