5. Economics and the Ethics of Greed

If (a) the most important mission of economists in the world is to alleviate poverty, and (b) the Development as Virtue theory is even partly true, and an important cause of poverty is the lack of trust to facilitate exchange, then economists might have a duty to preach morality, and persuade people to be honest and generous, so that the economy might grow, and the needs of the poor met. But that goes against the grain, for economists have a long tradition of doing almost the opposite, of tolerating, taking for granted, even at times encouraging, widespread selfish greed.

The tradition can be traced in part to Adam Smith, and it is most famously expressed in this passage from The Wealth of Nations:

Man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Was Adam Smith right? Certainly the last sentence, if taken literally, is false. If I go to the meat counter in the supermarket, I tell the person behind the counter what I need, not what’s in it for them if they provide it. But I do pay, of course, and from what I and others like me pay, they get their wages. However, it does not follow that “it is not from the benevolence of the butcher” that I expect my dinner. Just because he is paid, and has to be paid if he is to cover his costs and stay in business, does not mean he is not sincerely benevolent, and motivated by a desire for his customers to eat well. One can’t really know, from the mere fact that he provides meat and gets paid, what his motives are. He might want to get paid, and providing meat is just a means to that end. Or he might want to provide meat, and getting paid is just a means to that end. He may be equally motivated to provide meat and to get paid.

If money for meat is a fully transparent spot transaction, or if reputational or legal incentives are sufficiently strong to motivate appropriate quality controls purely for commercial advantage, I may not need to rely on the butcher’s benevolence towards me, even if it might be, for all I know, present in a high degree. Let him love me or be indifferent, he will sell me meat in the same way. But if I cannot easily ascertain the quality of the meat that I am buying, and if he, with his superior knowledge, could hand me lower quality meat than I’m paying for without my knowing it, the butcher’s benevolence might matter a good deal. I might be able to eat a really delicious steak, on Christmas Day for example, or on my birthday, only because the discerning eye of my benevolent butcher secured for me meat of a quality I could never have found for myself.

Still, Adam Smith had a point, even if he overstated it. The invisible hand of the market does induce people to serve one another in ways that they don’t understand or intend. And sometimes the market operates so efficiently that it’s actually counter-productive to let virtuous impulses interfere with it. There are times when greed is good, or at least, when rational selfishness by all parties leads to the best feasible outcome.

It would be easy to multiply examples too obvious to be interesting. People sitting around a well-laden dinner table may eat their fill as selfishly as they like. People caught in the rain, but all carrying umbrellas, may freely indulge their greed for keeping dry. But there are more counter-intuitive examples, where the insight of the economist can really come in handy by dispelling unhelpful scruples.

Let my first example be called the Gas Price Parable.

Once upon a time, gas prices had long hovered around $2/gallon, when a surging economy in China, a weak dollar, and a war in the Middle East suddenly drove them up to $5/gallon. Cash-strapped consumers resented “gouging” by oil companies, and pleaded eloquently for relief. The conscience-stricken oil companies yielded to public pressure, and with many grandiloquent speeches about “community” and “responsibility” and “patriotism,” they announced, to general applause, their determination not to let arbitrary market conditions tempt them away from charging the “fair price” of $2/gallon that they have been charging for years.

The result is shown in Figure 1:

Figure 1

The result of the “fair price” was a large shortage of gasoline, and long queues at the pumps. The “deadweight loss” resulting from the self-imposed price cap set by the oil companies was equal in value to regions C+E in the chart. Furthermore, since the willingness-to-pay of the marginal consumer was now well above the equilibrium price of $5, the time they were willing to waste in queues, so as to make them indifferent being buying and not buying more gas, had a value equal to regions A+B in the chart. Alas, not only would the oil companies have earned higher profits by charging what the market will bear, but even consumers, the intended beneficiaries of the “fair price,” were harmed by getting less gas, and effectively paying more for it, with the cost in wasted time far exceeding the money savings.

The moral of this story seems to be: BE GREEDY. Forget generosity and fairness. Ignore the outcry of public opinion. Don’t worry about fairness. Just maximize profits, rationally, a little ruthlessly, and let the chips fall where they may. The market will sort it all out. You’ll actually make things worse by trying to be virtuous. Virtue just muddles things and wreaks havoc. Greed makes the world a better place.

But now consider my second example, which I’ll call the Team Production Parable.

Once upon a time, there was a small manufacturer called Middlevale Widgets. It shut down every summer to save on air conditioning, but for the other nine months, it was a busy place from 9AM to 11PM every day, and half the town had worked on its assembly lines at one time or another, to earn money for college, for example, or to save up for a down payment on a home. Wages are mediocre, and the work is dull, so turnover is high, but everyone is glad the factory is there.

Over and above the twenty or thirty comparatively transient floor employees are five long-term staff who stick around even in the summer, getting ready for the next season, and who have regular meetings to make Middlevale Widgets’ decisions. All of them are indispensable if the factory is to operate. They are shown in Table 1.

Table 1

Person	Function	Salary	Outside Option Pay	Replacement Pay
Alex	Machinist, repairman	$62,000	$31,000	$107,000
Bill	Computers, databases	$57,000	$26,000	$81,000
Cindy	Accounting, finance, and HR	$44,000	$42,000	$135,000
Dan	Marketing and product development	$109,000	$77,000	$183,000
Eleanor	Supply chain and logistics	$92,000	$38,000	$99,000
Total		$364,000	$214,000	$605,000

In addition to function and salary, Table 1 shows the “outside option pay” for each of the core staffers, i.e., what they could earn at some other job if they didn’t work for Middlevale Widgets, and the “replacement pay,” which is the salary Middlevale Widgets would have to offer to recruit someone else with the same skills.

Middlevale Widgets sells about $3 million of product each year, and pays out $2.5 million for floor employee wages, raw materials, utilities, replacement of depreciated capital, debt service, and a few other, smaller, necessary costs of doing business. Out of the remaining $500,000, the five long-term staffers’ salaries are paid, and whatever is left is distributed to shareholders.

Note the following:

1. All five core staffers are paid more than their outside option. They benefit from Middlevale Widgets being in operation.
2. The salaries of the five core staffers are rather random. The pay differences seem inexplicable and without pattern. The amounts of “producer surplus,” so to speak, that the five staffers get by being at Middlevale Widgets rather than somewhere else, vary wildly, from Cindy’s $2,000 to Eleanor’s $54,000.
3. Any of the core staffers might demand a raise, on the reasonable ground that he or she is being paid less than it would cost to replace them. As long as the salary demanded was less than the replacement pay, it would be in the immediate interest of the others to concede to the demand.
4. But Middlevale Widgets cannot afford to pay all the core staffers their replacement pay. If they all insist on large raises, the factory will go broke.

By the way, the Team Production Parable is, I think, channeling an argument made by Bengt Holmstrom in his 1982 paper, “Moral Hazard in Teams.” Cue the sycophantic academic blather: “seminal contribution,” etc., etc. I haven’t read the paper and I don’t intend to. I heard the argument second-hand and immediately understood it, so why read the paper? But Google Scholar shows 358 citations, so probably somewhere in subscriber-only journals there are exchanges of ideas somewhat parallel to the thoughts I’m jotting down now. Forgive the digression. Back to the argument.

The moral of the Team Production Parable is very hard to discern, if we first tie our hands by the supposing, in the silly-clever fashion characteristic of economic theorists, that Alex, Bill, Cindy, Dan, and Eleanor are possessed by a spirit of myopic greed, blindly indifferent to the welfare of everyone around them. At first, it seems that each should demand a large raise. Then it seems that each will demand a large raise, so the factory is doomed. But since that’s disastrous for everyone, they might try to hit on some cooperative-greedy compromise whereby the raises are somehow shared out while staying within the budget constraint. But can that be managed? And suddenly the factory becomes a strategic problem, and more details are needed about how they make the joint decisions, and what each expects the others to do, and how much they care about the future vs. the present, and it’s all very complex and difficult. The prisoner’s dilemma stands as a proof of concept that there might be no way for self-interested people to avoid a breakdown in cooperation. I have made the story complex and vague enough to give it a flavor of realism. I could not describe the rules of decision-making, or the goals and states of mind of the players, with sufficient detail to satisfy a game theorist, without in the process destroying the realism of the example, for it is part of the nature of life to be a game in which we do not know all the rules. Yet if I did describe them, it would probably result in a game with many Nash equilibria (I’ll explain what that means in a later post) and all would still be uncertain.

But here’s the real point. If we assume that Alex, Bill, Cindy, Dan, and Eleanor are normal, sensible people, who care somewhat about one another, somewhat about the work of the factory for its own sake, somewhat about being well-liked and respected, somewhat about the floor employees and the town, and a little even about Middlevale Widgets’ customers and shareholders, then the moral of the Team Production Parable is: DON’T BE GREEDY. Don’t encourage, or condone, greed in others. Cry “shame!” whenever you hear a rumor of it. Greed is a wrecking ball that destroys, that impoverishes everyone. Cling to anything, any custom, any arbitrary rule or protocol or tradition, any ritual or polite nothing or taboo, that might restrain greed and keep if off the table. Better for everyone to be irrational and stupid, than to let greed in the door. Just be thankful for what you have, and keep on working.

The moral of both these scenarios, together, is that sometimes economic reasoning can show, contra intuition, if not why greed is good, at least why certain scruples that restrain it are misguided, while at other times, it lucidly confirms and reinforces the popular prejudice that greed is bad, and underlines how urgently it needs to be contained.

Now, what I want to suggest, perhaps quixotically, is that it is a kind of negligence to look at the Team Production Parable and not praise virtue and denounce greed. It is like doing an incomplete sum, carrying the 1s and jotting down a couple of digits, then shrugging and walking away. The argument demands to be carried through to that conclusion.

Economists practice a curious double standard, whereby they love to search for policies, that is, public policies to be adopted by governments, that are “Pareto-improving,” that is, that make everyone better off, and then exhort governments to adopt those policies, yet they do not engage in a similar search for moral rules, that is, private policies to be adopted by individuals, that are Pareto-improving, that is, that would, if widely adopted, make everyone better off, and then exhort individuals to adopt those moral rules. Economists are quite bold in advocating free trade or condemning rent and price controls. They are much less vocal in advocating honest dealing or denouncing opportunistic greed. I don’t really see how the practice can be defended, but I'll hazard a few guesses as to how the practice came to be current.

First, I think economists understand the Gas Price Parable and its moral very well, while they either don’t know about, or don’t understand, the Team Production Parable and its moral, or else they think it is less important and general. I think it is more so. Some version of the Team Production Parable is usually relevant in any organization, and most of us spend more of our time working in organizations than trading in markets.

Second, I think economists don’t see moral exhortation as their forte, their turf. Perhaps there’s an intellectual division of labor, and it is the economist’s business to explain the team production problem, and the moral philosopher’s business to discern whether, finding themselves in such a scenario, people ought to eschew opportunistic greed. Yet that won’t quite do. Economists know how to borrow from other fields. They’ll happily consult a lawyer to understand whether a certain contract is legally feasible, or an engineer to understand how much a trebling of capacity lowers the unit costs of a ship or a building. Why don’t they just ask the moral philosophers what Alex, Bill, Cindy, Dan, and Eleanor ought to do, and then finish the team production parable by saying, “... and several moral philosophers have reported to us that a person ought not to demand a pay raise in circumstances like these?” Probably one reason is that whereas lawyers and engineers usually agree, moral philosophy has gotten on the wrong track and been stuck in a quagmire of interminable arguments for centuries, to echo the dour diagnosis of Alasdair MacIntyre, so economists can’t defer to the authority of moral philosophy because it lacks a united voice.

Yet I think the inhibition here is not so much that economists don’t want to try to be moral philosophers, as that they don’t want to try to be pastors. When an economics professor denounces protectionist trade policies, he is denouncing politicians, who are probably not sitting in his classroom. But if an economics professor denounced dishonest dealing or opportunistic greed, he would be denouncing some, or most, of his students. That might make him unpopular. However, priests and pastors have been denouncing the sins of their congregations for centuries, and yet have retained a substantial popular following. How do they manage it? They do that by hating the sin while loving the sinner, and by provoking men not only to feel shame at their sins, but also to hope in God’s mercy and the promise of paradise. An economist might follow suit after his own fashion, by inspiring his class with rosy visions of the prosperous world that would arise if everyone were virtuous, even as he made students painfully aware of how they impoverished their fellow men through their own laziness or dishonesty or greed. But that’s not how they’ve been trained. It goes against the grain.

A third factor, I think, is political correctness. The Development as Virtue theory which I suggested in the last post may have much or little truth in it, but that aside, it is very politically incorrect. It blames the poor for their poverty, not necessary as individuals-- an important clarification-- but certainly as nations. It suggests that Indians, Chinese, and Africans are less virtuous, on average, than Westerners. This will strike many modern, generous, morally relativist people as intolerably judgmental. It’s much better to argue inoffensively that the wealth of the West arises from education, or democracy, or climate, or well-designed laws.

A fourth factor may be that economists want to be seen as “scientists,” and to that end, try to create an aura of scientific detachment in the way they talk, which they feel to be incompatible with moral exhortation.

Finally, economists may be in a subtle, usually unconscious rivalry with the Christian churches, whereby they are led, as if by an invisible hand, to win popularity precisely among those who are tired of being preached at and told to be good. Let’s think again about the students in that economics class. Who are they? Why are they there? For many different reasons, of course, but they are probably a bit less likely to be there if they aspire to the ministry or the priesthood, and probably a bit more likely to be there if they want to make a lot of money. They’ve probably heard, moreover, or got the impression somehow at second hand, that economists are rather tolerant of greed and self-interest, and are not particularly preachy or puritanical, but tend to have a rather irreverent and worldly ethos. That’s what they want. So if an economics professor were to begin denouncing greed, he might feel a kind of chill emanating from the seats of the classroom. That’s not what we came for, professor, he would feel his students silently saying. Let’s talk about money.

To think through all these biases only makes me more convinced that economists tend to neglect the moralistic conclusions that a properly conducted science of economics, starting from sociobiology and game theory and continuing on to markets without embracing the fiction of “perfect competition,” would constantly point to. Virtue makes the world a better place, and economists are well-equipped to remind people of that, and show them why, and how.

Let me conclude by raising an ethical question, somewhat remote from most people’s experience, yet really of quite sweeping importance. Should corporations maximize shareholder value?

Economic theory tends to assume that companies do “maximize profits,” a principle which, if translated into an intertemporal problem in the context of large, liquid financial markets, becomes shareholder value maximization. How to actually make corporations maximize shareholder value is a tricky problem, since it is characteristic of corporations to separate ownership (by the shareholders) from control (by the board and the CEO). Some kind of separation of ownership from control is necessary if the resources of many savers is to be pooled to finance large commercial ventures enjoying economies of scale, while allocating risk to those who can bear it, and taking advantage of the benefits of financial diversification, and at the same time giving the commercial venture a sufficiently centralized and rapid decision-making structure to operate effectively. But it creates principal-agent problems, and it’s very hard, in fact it’s impossible, to align incentives so that shareholders can fully trust the corporate manager they hire to run their company to serve their interests rather than his own. And so, while the mantra that a corporation’s goal is to “maximize shareholder value” is often seen as epitomizing an ideology of corporate greed, it is a kind of ethical ideal. It involves a chief executive solemnly promising to keep his own greed in check, and faithfully serve the greed of the shareholders, whose greed may often seem justified, if the shareholders are middle-class workers saving for retirement, or universities and charitable foundations who need a steady stream of income to pursue their lofty and altruistic goals.

While acknowledging that this argument has a certain strength, I nonetheless dissent. It might be convincing in a world of complete market efficiency, as envisioned by a certain style of pure economic theory, but the real world diverges quite far from that vision in many, many ways, and the result is that a corporation that maximized shareholder value would probably, among other things, miss many opportunities to do good, for which there doesn’t happen to be a way to recover the corporation’s costs. Is there a way to avoid missing these opportunities to do good? Is a world possible in which corporations served the greater good of mankind, even when it doesn’t happen to coincide with the lesser goods of their shareholders?

Let me explore the question by means of a third example, which I’ll call the Tale of Johnny Upright.

Once upon a time, the Fabridor Corporation, a vast multinational empire of manufacturing plants linked by cutting-edge logistics, was looking for a new CEO. One of the candidates, named Johnny Upright, came before the board, and after a long presentation describing, with dazzling acuity and vision, the corporation’s organizational strengths and weaknesses, its assets, its opportunities, and how they can best be marshaled to do better what they’re doing while acquiring new capabilities and penetrating new markets, he concludes with this manifesto:

“Friends, if you hire me, I will not make it a priority to maximize shareholder value. I will run the Fabridor Corporation in the broad interests of mankind, seizing as many opportunities to do great good as I can, within the limits of what is financially and operationally feasible for us to accomplish. I will also try to increase the financial and operational capacities of the Fabridor Corporation, so that it will be able to accomplish even more good in the future. Any cash that we don’t have a good, practical use for, I will return to the legal shareholders, and may they use it to serve their fellow men to the best of their ability. I think it quite likely that the Fabridor Corporation’s share price will do well under my leadership, as a side-effect of my accumulating money and building capacity for the purpose of doing good, but I don’t really care if it does or not, and you shouldn’t either. In a higher moral sense, in the truest sense, every man, woman, and child on Earth will be a shareholder of the Fabridor Corporation, for through our work, we will serve them all, every one, to the best of our ability, without partiality.”

Should the board hire Johnny Upright? Is the board likely to hire Johnny Upright?

In its deliberations, board members raise several points. On the one hand, while not pure greed machines, they are somewhat greedier, in their own right or on behalf of the shareholders, than Johnny Upright. They actually do care about the company’s share price, and they would prefer for the Fabridor Corporation’s CEO to be at least somewhat partial to the interests of the Fabridor Corporation’s shareholders, and to attach a bit more importance to the welfare of that part of mankind that owns Fabridor stock, than the welfare of the part of mankind that doesn’t. On the other hand, they have no doubt that Johnny Upright’s sheer managerial talent is far superior to that of the rival candidates. They’re quite sure that he won’t steal the company’s assets through Swiss bank accounts or corrupt insider dealing, and his lofty, altruistic vision promises to be a wonderful PR asset, helpful in getting favorable treatment from politicians, and in recruiting bright, young, idealistic talent to consider a career at Fabridor. If, as seems possible, Johnny Upright decides to play Robin Hood and give the company’s assets to charity little by little, shareholders might blame the board for hiring a CEO after such a manifesto. Yet they think the odds are good that an audacious mastermind like Johnny Upright will happen to bring in enormous profits as he accomplishes his visionary and transformative goals, and send the share price soaring.

I’ll end the tale there, since one ending (the board hires Johnny) would be cloying, and the other (it doesn’t) tragic. But note that it matters what the competition offers, not only in terms of talent, but in terms of objectives. Corporate boards might choose less talented, but also less idealistic, candidates, but they can only do so if such candidates are available. What if no one offered to maximize shareholder value? What if all the people remotely qualified to run big corporations insisted that to be asked to set aside the interests of the rest of mankind in favor of those of the shareholders was ethically unacceptable? Maybe such an ethical revolution in corporate leadership would reduce share prices across the board. Then again, maybe each corporation’s altruistic behavior would create positive spillovers that would boost the productivity of other corporations, and there would still be just as much money to return to shareholders, and share prices might be just as high as they are today. We might end up with as many, and as thriving, corporations as we have today, or even more.

I think there could be a world in which shareholder value maximization, like slavery, was transcended by moral progress. I think, tentatively, that it would be a better place.