Corruption, 2016

Transparency International is a non-governmental organization, headquartered in Berlin, with a mission to document and root out public corruption worldwide. The organization defines corruption as “the abuse of entrusted power for private gain. It can be classified as grand, petty and political, depending on the amounts of money lost and the sector where it occurs.”

For more than two decades Transparency International has produced an annual Corruption Perceptions Index. The most recent edition of the index (here) ranks 176 countries from the least corrupt to the most corrupt. The index ranges from a scale of 0 to 100, “where a 0 equals the highest level of perceived corruption and 100 equals the lowest level of perceived corruption.” The Index  “aggregates data from a number of different sources that provide perceptions of business people and country experts of the level of corruption in the public sector.”

CPI2016_Map_web

The least corrupt countries are Denmark, New Zealand, Finland and Sweden. They always stay at the top of the list. The most corrupt countries are Syria, North Korea, South Sudan and Somalia. Denmark’s score is 90 while Somalia’s is 10. The United States is number 18 on the list, with a score of 74, below Canada, Germany and the UK. That’s alarming. Not that the US is below other countries but that the US is more than halfway to the midpoint of the CPI scale (Slovakia and Croatia have scores of 51 and 49 respectively).

Corruption matters because it erodes public trust in government and business, and trust is very important for promoting economic growth and well-being. For example, note the following figure I produced showing the correlation between corruption and per capita gross domestic product. Of course, correlation does not mean causation. And we can debate whether corruption produces low growth or whether low growth invites corruption, but the correlation is stark. Highly corrupt countries are very poor. Moreover, for every 10 point improvement in a country’s perceived corruption, GDP per capita increases by more than $7,000 (that’s what the equation in the figure shows).

CPI-GDP2016

Transparency International also draws a connection between corruption and social inequality. As noted on their website (here): “it’s timely to look at the links between populism, socio-economic malaise and the anti-corruption agenda. Indeed, [US President] Trump and many other populist leaders regularly make a connection between a ‘corrupt elite’  interested only in enriching themselves and their (rich) supporters and the marginalisation of ‘working people’. Is there evidence to back this up? Yes. Corruption and social inequality are indeed closely related and provide a source for popular discontent. Yet, the track record of populist leaders in tackling this problem is dismal; they use the corruption-inequality message to drum up support but have no intention of tackling the problem seriously.”

In other words, we preach virtues but don’t practice them ourselves.

Which reminds me. After discussing these ideas in my applied ethics class I suggested that students can obtain an automatic A in the class if they leave me a $100 bill with their name written on it in pencil. Some students laughed while others wanted to negotiate the price. Apparently they didn’t learn anything.

It’s best to be far on the right side of the line, not close to it

I am reading Maureen O’Hara‘s book, Something for Nothing: Arbitrage and ethics on Wall Street. Professor O’Hara is a financial economist at Cornell University. In her book she explains how modern finance works and what led to many of the contemporary ethical scandals of Wall Street. I’ll probably have more to say about the book after I finish it, but I enjoyed this tidbit:

Some people want to stay as close to the legal line as possible, while remaining on the “right” side of that line. However, Professor O’Hara says, “laws reflect moral standards, and over time the laws change to reflect what is acceptable to society. … But that also highlights why a strategy of being exactly on the line of legality is a poor business practice; when the lines shift, you go from being a weasel to being a felon, even when you have done nothing differently.”

Adopting an ethical standard is a higher one than merely following the letter of the law. So being on the right side of the ethical line, even close to it, can keep you from falling into the “weasel” category. But adopting a strategy of staying close to the ethical line can cause problems. There are differing ethical perspectives, and these don’t always agree or even provide clear-cut answers. Therefore, if you really want to follow a strategy of ethical conduct, it is best to stay as far away from the ethical line as possible–if there really is such a thing as an ethical line anyway.

When is an increase in price fair?

In my previous post I wrote about the fairness of drug companies that dramatically increase the price of their products. I suggested, and public reaction confirmed, that these price increases are considered unfair.

When is a price increase fair? When is it unfair?

The economic principle of profit maximization tells us that firms ought to increase prices when there is an increase in demand or a decrease in supply, regardless of whether the change is short-term or permanent. So if a hurricane is closing in on the East coast of the U.S., then suppliers of lumber, bottled water, gasoline and other supplies that people will need should and will increase the prices of these things … a lot. But is that fair?

Daniel Kahneman, Jack L. Knetsch and Richard Thaler published a paper on this topic 30 years ago in the American Economic Review. They argued that people’s perceptions of fairness will (or ought to) constrain impulses to take advantage of short-run increases in demand or other reasons to increase prices, under certain conditions.

Their discussion entails two elements. One has to do with reference points and the other has to do with reasons for gaining at the expense of others.

First, a reference point is the basis upon which people create expectations about the fairness of a transaction or a change in prices. If transactions or price changes are consistent with the reference point, then people will judge the transactions or price changes as fair. In other words, reference transactions and reference profits are considered fair. If there is a deviation from the reference point, then assessments of fairness will be made based on whether good reasons exist for the deviations.

The authors define the reference points as follows:

Market prices, posted prices, and the history of previous transactions between a firm and a transactor can serve as reference transactions. When there is a history of similar transaction between firm and transactor, the most recent price, wage, or rent will be adopted for reference unless the terms of the previous transaction were explicitly temporary. For new transactions, prevailing competitive prices or wages provide the natural reference.

For example, if a gas station has been selling gas for $1.99 a gallon for several weeks, then the reference price is $1.99 a gallon, and people will expect that to be the price the next time they get gas. If the price of gasoline increases, say to $2.09 a gallon, then people will likely consider the price increase unfair unless they understand there to be a good reason for the change. Good reasons have reference points, too. For example, raising prices at the expected rate of inflation is not considered unfair, since inflation-based price increases can be a reference point. We have historical experience with that, so there is no basis for claiming unfairness. The same about price changes in gasoline. If the reference point for price changes is 5 cents a gallon, then people won’t be bothered by finding the price of gasoline is higher by 5 cents the next time they buy gas. But if prices increase by more than 5 cents, then they might believe or expect something unfair is happening at their expense.

Understanding reference points for transactions, pricing and profits can help us understand why unfairness might be claimed when businesses increase prices. For example, if employees had previous experiences of getting pay increases when competitors raised their employees’ wages, then a reference point is created for employees. But if the employer has not historically increased wages when their competitors have, then the reference point for the employer will differ from that of the employees, resulting in disagreements about fairness.

Second, an important principle of fairness is that one should not gain by imposing a cost or harm on others.

Raising the price of lumber, bottled water, gasoline and other supplies that people will need when a hurricane is imminent can be considered imposing a harm on others to acquire a short-term gain. It doesn’t matter that economics dictates that price increases are needed to resolve shortages that will arise when there is a sudden increase in demand. There is usually no viable reference point for such behavior.

Raising prices because a business experiences an increase in costs is different. Such behavior is not considered as imposing a harm on others merely to benefit at their expense. Businesses are not gaining substantially, if at all, when they increase prices to cover their rising costs.

The implication is that people are willing to accept as fair an increase in price to cover rising costs. They also consider it fair for businesses to maintain prices when costs decline. But people consider raising prices when demand increases or without explanation or justification to be unfair.

Most people have no reference point for drug prices rising 5000 percent or even 500 percent. Such behavior is very unfair.

Business leadership and the making and punishing of unethical employees

A study published in the current issue of Business Ethics Quarterly links ethical leadership with improved engagement of employees at work, greater employee voice and lower intentions for employees to exit. In other works, when employees perceive or know their leaders to be ethical, they are more likely to feel good about being at work, more willing to communicate their opinions, recommendation, concerns or ideas to their supervisors, and less likely to leave or intend to the leave the business.

In this context, an ethical leader is someone who is a moral person and who models high moral standards at work. The specific indicators of ethical leadership used in the BEQ paper draw from research by scholars at Pennsylvania State University. If valid, the indicators are informative. There are 10 of them. Ethical leaders

  • conduct their personal lives in an ethical manner
  • make fair and balanced decisions
  • can be trusted
  • ask what the right is when making decisions
  • listen to their employees
  • discuss business ethics and values with their employees
  • have the best interest of their employees in mind
  • set an example of behaving ethically at work
  • discipline employees who violate ethical standards
  • define success by the way results are obtained in addition to results.

I would add one more item to the list. When designing and implementing performance measures and incentives, ethical leaders are careful to ensure that they are promoting incentives rather than pressures to perform. The line between incentive and pressure can be thin. Leaders who are not careful may find that their efforts to motivate workers create pressures for them to lie, cheat or steal.

The CEO of Wells Fargo is learning this lesson the hard way. According to the Wall Street Journal’s report of John Stumpf’s testimony during a Senate Banking Committee hearing yesterday (September 21), the Bank is accused “of fostering a culture where low-paid branch employees were pressured to meet impossible sales quotas to keep their jobs, and so signed up customers for products without their knowledge.” Pressure does not create an environment where employees behave ethically. Even well-meaning employees may find the temptation to fudge numbers or behave inappropriately too strong in such an environment. The Bank reported that it fired more than 5,000 employees for wrongdoing.

So, Wells Fargo created unethical employees and then punished them.

Reminds me of the statement by Thomas More in his book, Utopia, made famous by Drew Barrymore’s character Danielle (aka Cinderella) in the movie Ever After. Danielle is arguing with Henry, the Prince of France, for the release of her servant, who is bound with other poor and destitute prisoners for the America’s. Here is the exchange:

Danielle: A servant is not a thief, your Highness, and those who are cannot help themselves.

Henry: Really! Well then by all means, enlighten us.

Danielle (quoting More): If you suffer your people to be ill-educated, and their manners corrupted from infancy, and then punish them for those crimes to which their first education disposed them, what else is to be concluded, sire, but that you first make thieves and then punish them?

Henry: Well, there you have it. Release him.

That’s quite a commentary about one of the nation’s most prominent banks.

Potash peril

Potash refers to a variety of compounds that contain potassium. Plants require potassium (chemical label is K) for their development, along with Nitrogen (N) and Phosphorus (P). These three chemicals are the key ingredients of fertilizers and are thus widely used in plant agriculture.

The largest potash producer in the world in terms of production capacity and market value is Potash Corporation of Canada. It has a market value of roughly $14 billion and controls 15 percent of global production and 19 percent of production capacity, according to the company’s website. There are larger companies in minerals and mining (e.g., the UK’s Rio Tinto Group), but none dominates potash production like Potash Corp.

The Wall Street Journal reports today that Potash Corp is merging with Agrium, also a Canadian fertilizer company, the combination of which will be a company with $21 billion in annual revenue and controlling 23 percent of global potash production capacity but 60 percent of capacity in North America. The two companies justify the merger as we might expect–stabilizing prices, lowering production costs, accessing other markets, etc.

Now, if US farmers want to buy fertilizer, they will likely have to get if from the combined company. Farmers are concerned, as they should be. According to the WSJ, “The deal likely would sow further unease among North American farmers wary of reduced competition and higher prices as top seed and pesticide developers pursue their own tie-ups. Already grappling with a three-year slide in major crop prices, some farmers are concerned that mergers between some of the world’s largest farm-supply companies will consolidate pricing power among fewer players and lead to higher costs at a time when farmers are scrimping to eke out profits.”

Efficiency is good, as are lower costs. But as I noted in a previous post, so is choice. Where do we draw the line when struggling with efficiency versus choice? Will the combined company pass on the cost savings to farmers by lowering prices of fertilizer? I hope so. But then I hope for $100 bills to rain on my home, too.

Vulnerabilities

News stories about children dying from handguns or alleged abuses by the TSA are inevitably followed by debates in the media about the tradeoff between safety and civil liberties. If we restrict handguns in the name of protecting our children, for example, then doing so entails a reduction in Constitutionally-protected rights.

This is a false tradeoff. The debate really ought to be about vulnerabilities we face in society, and what to do about them.

The problem with the safety-liberties debate is that it perpetuates the belief that vulnerabilities decline as safety measures increase. They do not; they only shift. Instead of being vulnerable to terrorist attacks, increased security measures at airport screening stations make us vulnerable to incompetent and corrupt screening processes (think groping and misuse of scanner images). Instead of being vulnerable to dying by gunfire, we become vulnerable to intruders who invade our homes not expecting armed resistance.

Vulnerabilities are ubiquitous in life. Too often we overlook this fact. Even more, we tend to think vulnerabilities are a bad thing. On the contrary, vulnerabilities are necessary, because without vulnerabilities there is no basis for trust, which forms the foundation for all economic, political, social and personal relationships.

For instance, we trust banks by putting our money in their institutions, knowing there is a chance banks will misappropriate or mismanage the money, resulting in the loss of our wealth. The fact that government insures banking deposits only shifts our vulnerability somewhere else. We trust the government’s ability and willingness to make good on their commitment to insure our deposits (up to $100,000, as most banking institutions tell us).

We trust public corporations by purchasing stocks and bonds, making ourselves vulnerable to the loss of our investment. The 50 percent decline in the price of Facebook shares following its IPO several years ago illustrates why vulnerability is central to all economic activity. Economic growth only occurs if individuals and organizations take risks. I will invest in you in the hope that you will turn that investment into a good or service that makes money for me, but sometimes that trust is misplaced. When people are trustworthy – that is, when people don’t take advantage of the vulnerability of others – Adam Smith’s invisible hand ensures that such investments improve society.

Vulnerability and trust are the foundation of effective political relationships. When facing a potential military adversary, showing one’s empty hands is a universal signal of vulnerability and a crucial step toward the establishment of peace. Of course, sometimes such vulnerable actions are misplaced, and the opposing side takes advantage of the peace signal by attacking. But this only illustrates why peace offerings are fundamentally about making oneself vulnerable. Will Israel and Iran avert war? Only if one side first takes a vulnerable position and the other side follows by not taking advantage of the vulnerability.

Vulnerability is pervasive in social interactions. A friend is someone in whom one can confide, which means that the foundation of friendship is a willingness to be vulnerable. Social ties are superficial when one does not make him or herself vulnerable to others. This is why talking about the weather is an easy way to initiate a conversation with someone you don’t know, but it is not the basis for a long-lasting friendship. For trust to develop between potential friends, one needs to offer something more vulnerable than an opinion about the chance of rain.

Vulnerability and trust are fundamental to the development of a healthy and long-lasting marriage. Married couples can sense the quality of their marriage based on the perceived willingness of partners to make themselves vulnerable to each other. While extramarital affairs are harmful to marriage, they need not be sexual to exploit the trust of one’s marriage partner. For instance, what kind of signal does a married man send if he regularly confides personal concerns or details about himself to someone other than his wife?

Social conservatives decry the decline in public morality, but they have not been clear in explaining why this is a problem. Social and personal relationships are enhanced when one person first places him or herself in a vulnerable position with respect to someone else, and then when the second person reciprocates by honoring and respecting the trust placed in him or her. This leads to a greater willingness of the first to make a vulnerable commitment, thus perpetuating a deepening and virtuous cycle of trust and mutual respect. But declining public morality clouds our sense of vulnerability and makes it difficult for others to respond with honor and respect.

This is why pornography is so damaging to society. Pornography breaks the cycle. Although one could say that by exposing one’s body to others through pictures or video is a vulnerable action, it is only a counterfeit vulnerability, because that vulnerability does not result in a reciprocal response of honor and respect to the person making the vulnerable offering.

A similar argument can be made about modesty in dress and appearance. Over the years women’s fashions have become more revealing. Plunging necklines, exposed midriffs, and hip-hugging jeans send a socially damaging signal about one’s willingness and ability to be vulnerable to others. By exposing herself in public through the clothing she wears, a woman is saying that she has nothing to hide, which is another way of saying that she does not perceive herself as vulnerable. Some may claim that fashion is about signaling personal strength and confidence, but it is really just the opposite. A woman who dresses modestly recognizes her vulnerability, exposing herself only when she has good reason to believe that such trust will be honored. That takes real courage and strength.

Of course, some men’s fashions deserve the same criticism. Men who wear underwear-exposing baggy jeans send the same signal as women who expose cleavage or midriff. Modesty in dress by men and women preserves one’s vulnerability, which is essential to the development and maintenance of trust in personal and marriage relationships.

Which is why the marriage honeymoon used to be a significant event. But not anymore. Couples who have already seen each other naked and have been intimate before marriage have little to gain from the marriage relationship, aside from the legal and tax benefits that marriage provides. Marriage is an institution where two individuals can share the most sacred, intimate and personal vulnerabilities they have with someone else. When offerings of vulnerability are made within a marriage, by removing of one’s clothing and presenting oneself in an intimate way to a spouse, for example, the trust needed as the foundation of a healthy marriage can develop. The definition of marriage as a union between a man and woman has been weakened because the honeymoon has lost its significance as a stark contrast between being unmarried and married.

In our quest for greater security, we should not become complacent about the vulnerabilities we face. Failure to recognize and respect vulnerabilities can result in mistrust – trusting when one shouldn’t (such as telling a secret to a known gossip) or not trusting when one should (such as not confiding a personal struggle to a faithful spouse).