Talk about corruption in developing countries -- and in some developed ones -- is running rampant. In the past, corruption was usually said to be located within the ranks of public servants, and this was used as a partial justification for privatization, especially in developing countries.
Cheerleaders of the private sector, however, failed to reckon with the ability of company bosses to indulge in corrupt practices on an almost unfathomable scale, something American corporate capitalism has demonstrated amply of late. Corrupt bosses put to shame petty government bureaucrats who steal a measly few thousand dollars -- even a few million. The scale of theft achieved by those who ransacked Enron, Worldcom, and other corporations is in the billions of dollars, greater than the GDP of many countries.
My research over the past thirty years focused on the economics of information. With perfect information -- an assumption made by traditional economics, though one not fully appreciated by free market advocates -- these problems would never have occurred. Shareholders would instantly realize that the books were cooked, and roundly punish the offending company's share price.
But information is never perfect. Because of tax advantages and inappropriate accounting practices firms richly rewarded executives with stock options. With these in hand, company bosses could ensure that they were well paid without doing anything to benefit their company's bottom line.
All they needed to do was boost the stock price, then cash in their option. It was a system almost too good to be true: while executives received millions in compensation, no one seemed to be bearing the cost.
Of course, this was a mirage: by issuing such options shareholder value was diluted. Moreover, this was worse than dishonest: stock options provided managers with strong incentives to get the value of their stocks up fast. What mattered was not a company's long-term strength but its short-term appearance.
Corporate officers respond to incentives and opportunities. Over the last decade-and-a-half, executive compensation in America soared. So, too, did the fraction of that compensation that is tied to a company's stock price, to the point where the fraction related to long-term performance is quite small. It was as if managers were actively discouraged from looking at fundamentals.
The proponents of markets are right that incentives matter, but inappropriate incentives do not create real wealth in the economy, only a massive misallocation of resources of the sort we see now in such industries as telecoms. Overinflated prices lead firms to overinvest.
As research over the past three decades demonstrates, when information is imperfect -- as it always is! -- Adam Smith's invisible hand, by which the price system is supposed to guide the economy to efficient outcomes, is invisible in part because it is absent. With the wrong incentives, with the kinds of incentives that were in place in corporate America, a drive for the creation of the appearance of wealth took hold, at the cost of actual wealth.
By the same token, auditing firms that make more money from consulting than from providing auditing services have a conflict of interest: they have (at least in the short run) an incentive to go easy on their clients, or even, as consultants, to help their clients think of ways -- "within the rules," of course -- that improve the appearance of profits.
Or analysts at investment banks that earn large fees from stock offerings may -- as we have seen not so long ago -- tout stocks even when they are dubious about them. If these banks also have a commercial bank division, they may have an incentive to maintain credit lines beyond a prudent level, because to cut such lines would put at risk high potential future revenues from mergers and acquisitions and stock and bond issues.
Moreover, a distortion of private incentives affects public incentives as well, and the two become intertwined. As "money talks" in politics, private incentives distort public policy and prevent it from correcting market failures in ways that, in turn, further distort private incentives. America's Securities and Exchange Commission's head recognized the problems posed by conflicts of interests in accounting, but his efforts to put in place rules to address the problem met with overwhelming resistance from the industry -- until the scandals made change irresistible. Similarly, the accounting problems with executive stock options were recognized by the Financial Accounting Standards Board, but again early efforts at reform met with resistance, from the obvious sources. Here, political pressure, including from the US Treasury, was put on the supposedly independent board not to make the change. These problems arise at both the national and international levels.
Some countries try to fight against this vicious circle. For example, because we rightly suspect government officials who move too quickly into private sector jobs related to their public roles, many democracies have rules against such "revolving doors." To be sure, there are costs in imposing such restrictions -- they may, for example, deter qualified individuals from accepting public employment -- and the restrictions seldom eliminate conflicts of interest altogether.
But restrictions of this kind -- affecting both private and public sectors -- are often necessary because of imperfect information: we cannot really be sure what motivates an individual, even if the individual seems of the highest integrity. The loss of public confidence that may result from not acting may be even higher than the cost of governmental regulation -- indeed, this loss recently resulted in billions of dollars of reductions in the value of shares.
Conflicts of interest will never be eliminated, either in the public or private sector. But by making ourselves more sensitive to their presence and becoming aware of the distorted incentives to which they give rise, as well as by imposing regulations that limit their scope and increasing the amount of required disclosure, we can mitigate their consequences, both in the public and the private sector.
Joseph E. Stiglitz is professor of economics and finance at Columbia University, the winner of the 2001 Nobel Prize in economics, and author of Globalization and its Discontents. Copyright: Project Syndicate
Concerns that the US might abandon Taiwan are often overstated. While US President Donald Trump’s handling of Ukraine raised unease in Taiwan, it is crucial to recognize that Taiwan is not Ukraine. Under Trump, the US views Ukraine largely as a European problem, whereas the Indo-Pacific region remains its primary geopolitical focus. Taipei holds immense strategic value for Washington and is unlikely to be treated as a bargaining chip in US-China relations. Trump’s vision of “making America great again” would be directly undermined by any move to abandon Taiwan. Despite the rhetoric of “America First,” the Trump administration understands the necessity of
US President Donald Trump’s challenge to domestic American economic-political priorities, and abroad to the global balance of power, are not a threat to the security of Taiwan. Trump’s success can go far to contain the real threat — the Chinese Communist Party’s (CCP) surge to hegemony — while offering expanded defensive opportunities for Taiwan. In a stunning affirmation of the CCP policy of “forceful reunification,” an obscene euphemism for the invasion of Taiwan and the destruction of its democracy, on March 13, 2024, the People’s Liberation Army’s (PLA) used Chinese social media platforms to show the first-time linkage of three new
If you had a vision of the future where China did not dominate the global car industry, you can kiss those dreams goodbye. That is because US President Donald Trump’s promised 25 percent tariff on auto imports takes an ax to the only bits of the emerging electric vehicle (EV) supply chain that are not already dominated by Beijing. The biggest losers when the levies take effect this week would be Japan and South Korea. They account for one-third of the cars imported into the US, and as much as two-thirds of those imported from outside North America. (Mexico and Canada, while
The military is conducting its annual Han Kuang exercises in phases. The minister of national defense recently said that this year’s scenarios would simulate defending the nation against possible actions the Chinese People’s Liberation Army (PLA) might take in an invasion of Taiwan, making the threat of a speculated Chinese invasion in 2027 a heated agenda item again. That year, also referred to as the “Davidson window,” is named after then-US Indo-Pacific Command Admiral Philip Davidson, who in 2021 warned that Chinese President Xi Jinping (習近平) had instructed the PLA to be ready to invade Taiwan by 2027. Xi in 2017
RSS