Serious Questions Regarding the Economy

Chris Baehrend left a comment on the blog, asking a number of interesting questions. In an earlier post, I referred to the old German system of bank-centered capitalism. In Germany, until recently companies did not rely on raising money on the stock market. Instead they turned to banks. To protect their interests, the banks insisted on considerable control over the companies. Because the few large banks had many interests throughout the economy, they took a broader view of their actions.

Chris also asks: “If the S&P companies hold 2.5 trillion USD in capital (which equates to a huge percentage of world GDP) how much of the US debt are they financing?” Here I confess that I do not know, but it is very interesting question.

Next he asks: “And what sort of leverage does a foreign power to whom we owe trillions hold over us economically or otherwise?” Here, I suspect that nobody knows. A company holding hundreds of billions of dollars of US debt could severely injure the US economy, but to do so would destroy a considerable part of the value of its holdings. Besides, taking such actions would also make their currencies more expensive. For a country like China, which is having trouble finding employment for millions of people, making their currencies more expensive could reduce the demand for their exports.

Chris’s next question also stumps me: “Third, I understand that multi-national corporations hold enormous sums of wealth and that many are based outside the US for tax purposes (etc). Does this mean that wealth is being transferred out of this country? And what effect would that have on our economy?”

Maybe one of you has a good answer.

The last question is also difficult: “My last question is, perhaps, too broad for easy explanation. I presume that a shareholder on average probably holds shares for only a few years. A corporation is legally obliged to make money for its shareholders. Corporations hold more power over our government than at any time since the late 19c. While I recognize that officers and board members
usually live here, have ethics, and may want to have jobs in the long-run, does this mean that corporate influence is, on the whole, necessarily, legally, and irremediably detrimental to the long-term interests of the average US citizen?”

Here, Chris probably knows as well as I do, that corporate officers and board members is have no reason to be socially responsible. Here is a short extract from my book: Manufacturing Discontent:

During the height of the scandal involving Enron’s multibillion dollar frauds, a Wall Street Journal opinion piece entitled, “Corporations Aren’t Criminals,” noted: “Under the common law, a corporation could not be guilty of a crime because it could not possess mens rea, a guilty mind” (Baker 2002). Sadly, the author was correct — at least in so far as the current courts are concerned.

In the eyes of some judges, the law goes even further than merely ruling that corporations that violate the law lack a guilty mind. They insist that corporate managers, who do possess a mens rea, actually have an ethical responsibility to violate the law when doing so will prove profitable for stockholders. Corporate executives might face penalties if they illegally harm their corporate employer, but if their actions harm others, they can rest easily. Conservative legal scholars applaud such leniency.

For example, Frank H. Easterbrook and Daniel R. Fischel, the former a federal judge as well as a senior lecturer at the University of Chicago School of Law, wrote:

It is not true, however, that there is a legal duty to enforce every legal right …. Managers do not have an ethical duty to obey regulatory laws just because those laws exist. They must determine the importance of these laws. The penalties Congress names for disobedience are a measure of how much it wants firms to sacrifice in order to adhere to the rules: the idea of optimal sanctions is based on the supposition that managers not only may, but also should violate the rules when it is profitable to do so. [Easterbrook and Fischel 1982, pp. 1171 and 1177 n]

Richard Posner, another influential federal judge, who is also a prolific author and a senior lecturer at the same University of Chicago School of Law as Fischel, made a similar assertion (Posner 1986). When Milton Friedman, the University of Chicago colleague of these legal scholars, had proposed that the only responsibility that corporations have is the duty to maximize profits without taking any social concerns into consideration, within the bounds of the law, his position was controversial. A few decades later, federal judges now propose that the obligation to earn profits overrides the law, their position does not stir up protests. So we should not be surprised that reputable economists find Posner’s article praiseworthy. As one article in the Chicago Law School’s prestigious Journal of Law and Economics suggests:

Even when top managers have direct knowledge about the fraudulent activities, they may be pursuing projects that, prospectively at least, have positive net present value. That is, managers can commit frauds as part of a value-increasing strategy. As Richard Posner suggests, incumbent managers’ comparative advantage may derive in part from their willingness to commit or tolerate fraudulent activities. [Agrawal, Jaffe, and Karpoff 1999, p. 315]

The University of Chicago has a long tradition of contemplating the economics of crime. In 1968, Gary Becker, long associated with Chicago and like Friedman, a Nobel laureate, wrote his famous article, “Crime and Punishment: An Economic Approach” (Becker 1968). He proposed that the appropriate method of preventing crime is to increase penalties. To my knowledge, nobody within the Chicago orbit ever proposed to make the penalties more stringent.

The management of the firms caught in the recent spate of corporate scandals — Enron, WorldCom, Tyco, etc. — may have deluded themselves into believing that they were increasing the value of their firms, even as they were enriching themselves. They may not even have believed that they were engaging in criminal activity. The sort of calculations that Easterbrook and Posner seem to have had in mind was a situation in which management knew that they were doing serious harm, but persisted because the prospective profit outweighed the penalties.

Easterbrook and Posner reflect a more common view that business is by definition an activity that allows people to operate unconstrained either outside authority or by their own conscience. In the words of one commentator:

A red light, or the upraised palm of a traffic policeman, brings people to stop (at least in places where people tend to obey them) not by the exercise of power — neither a light nor a hand can stop a moving automobile — but by the exercise of authority …. Many citizens who would unhesitatingly stop for a red light, even at a deserted intersection at 2:00 a.m., would painstakingly calculate the relative cost and benefits of breaking laws against environmental pollution, insider trading in securities, of failing to report income to the Internal Revenue Service, and then obey or violate the law according to how the calculation worked out. [Fields 1990, p. 113]

The classic case of a corporation calculating that the probable economic penalties would not threaten potential profits concerns the Ford Pinto. From 1971 to 1976, Ford placed the fuel tank of this car only six inches from the rear bumper. In even a minor rear collision these tanks were liable to be punctured by bolts protruding from the differential housing. Any spark from a cigarette, ignition, or scraping metal could then engulf both cars in flames (Estes 1995, pp. 196-97; see also Dowie 1977). By conservative estimates Pinto crashes caused 500 burn deaths to people who would not have been seriously injured if the car had not burst into flames. Mark Dowie’s classic article on the Pinto suggested that the figure could be as high as 900 (Dowie 1977).

Ford was aware of the dangers. Crash tests showed that a simple rubber bladder inside the gas tank could have prevented fuel from spilling from ruptured tanks. The cost of rectifying the problem would have been a mere $5.08. Another effective change would have cost a mere $11. However, Ford’s cost-benefit analysis showed that the resulting deaths and injuries avoided would be insufficient to justify an outlay of $11 per car (Estes 1995, pp. 196-97).

Ford is not alone in weighing the costs and benefits of lethal design failures. In 1973, General Motors was making a similar calculation, expecting that the company could save money by paying out the costs of 500 deaths from its vehicles rather than fixing its defective fuel tanks at a cost of $8.59 per vehicle (Court 2003, p. 16; Bakan 2004, pp. 61-63).

You might find such calculations despicable. I do, but apparently not everybody does, including federal judges. Just imagine the outrage if some foreign terrorists had conspired to kill more than a thousand people. But, in the business world, knowing that the likelihood of a penalty is small and that the likelihood of a serious penalty even smaller, firms have little reason to fear the consequences of their actions.

In conclusion, although people who defend corporate rights are commonly quick to call for individual responsibility, they are less inclined to demand a comparable degree of corporate responsibility. Instead, they ignore corporate crime or find legalistic excuses for corporate misbehavior. So, if corporations are individuals in the eyes of the law, they are individuals with a special privilege to ignore the law.

Chris Baehrend left a comment on the blog, asking a number of interesting questions.  In an earlier post, I referred to the old German system of bank-centered capitalism.  In Germany, until recently companies did not rely on raising money on the stock market.  Instead they turned to banks.  To protect their interests, the banks insisted on considerable control over the companies.  Because the few large banks had many interests throughout the economy, they took a broader view of their actions.
 
Chris also asks: "If the S&P companies hold 2.5 trillion USD in capital (which equates to a huge percentage of world GDP) how much of the US debt are they financing?"  Here I confess that I do not know, but it is very interesting question.
 
Next he asks: "And what sort of leverage does a foreign power to whom we owe trillions hold over us economically or otherwise?"  Here, I suspect that nobody knows.  A company holding hundreds of billions of dollars of US debt could severely injure the US economy, but to do so would destroy a considerable part of the value of its holdings.  Besides, taking such actions would also make their currencies more expensive.  For a country like China, which is having trouble finding employment for millions of people, making their currencies more expensive could reduce the demand for their exports.
 
Chris's next question also stumps me:  "Third, I understand that multi-national corporations hold enormous sums of wealth and that many are based outside the US for tax purposes (etc).  Does this mean that wealth is being transferred out of this country?  And what effect would that have on our economy?"
 
Maybe one of you has a good answer.
 
The last question is also difficult: "My last question is, perhaps, too broad for easy explanation.  I presume that a shareholder on average probably holds shares for only a few years.  A corporation is legally obliged to make money for its shareholders.  Corporations hold more power over our government than at any time since the late 19c.  While I recognize that officers and board members 
usually live here, have ethics, and may want to have jobs in the long-run, does this mean that corporate influence is, on the whole, necessarily, legally, and irremediably detrimental to the long-term inte
rests of the average US citizen?"
 
Here, Chris probably knows as well as I do, that corporate officers and board members is have no reason to be socially responsible.  Here is a short extract from my book: Manufacturing Discontent:
 

During the height of the scandal involving Enron’s multibillion dollar frauds, a Wall Street Journal opinion piece entitled, “Corporations Aren’t Criminals,” noted: “Under the common law, a corporation could not be guilty of a crime because it could not possess mens rea, a guilty mind” (Baker 2002). Sadly, the author was correct — at least in so far as the current courts are concerned.

In the eyes of some judges, the law goes even further than merely ruling that corporations that violate the law lack a guilty mind. They insist that corporate managers, who do possess a mens rea, actually have an ethical responsibility to violate the law when doing so will prove profitable for stockholders. Corporate executives might face penalties if they illegally harm their corporate employer, but if their actions harm others, they can rest easily. Conservative legal scholars applaud such leniency.

For example, Frank H. Easterbrook and Daniel R. Fischel, the former a federal judge as well as a senior lecturer at the University of Chicago School of Law, wrote:

It is not true, however, that there is a legal duty to enforce every legal right …. Managers do not have an ethical duty to obey regulatory laws just because those laws exist. They must determine the importance of these laws. The penalties Congress names for disobedience are a measure of how much it wants firms to sacrifice in order to adhere to the rules: the idea of optimal sanctions is based on the supposition that managers not only may, but also should violate the rules when it is profitable to do so. [Easterbrook and Fischel 1982, pp. 1171 and 1177 n]

Richard Posner, another influential federal judge, who is also a prolific author and a senior lecturer at the same University of Chicago School of Law as Fischel, made a similar assertion (Posner 1986). When Milton Friedman, the University of Chicago colleague of these legal scholars, had proposed that the only responsibility that corporations have is the duty to maximize profits without taking any social concerns into consideration, within the bounds of the law, his position was controversial. A few decades later, federal judges now propose that the obligation to earn profits overrides the law, their position does not stir up protests. So we should not be surprised that reputable economists find Posner’s article praiseworthy. As one article in the Chicago Law School’s prestigious Journal of Law and Economics suggests:

Even when top managers have direct knowledge about the fraudulent activities, they may be pursuing projects that, prospectively at least, have positive net present value. That is, managers can commit frauds as part of a value-increasing strategy. As Richard Posner suggests, incumbent managers’ comparative advantage may derive in part from their willingness to commit or tolerate fraudulent activities. [Agrawal, Jaffe, and Karpoff 1999, p. 315]

The University of Chicago has a long tradition of contemplating the economics of crime. In 1968, Gary Becker, long associated with Chicago and like Friedman, a Nobel laureate, wrote his famous article, “Crime and Punishment: An Economic Approach” (Becker 1968). He proposed that the appropriate method of preventing crime is to increase penalties. To my knowledge, nobody within the Chicago orbit ever proposed to make the penalties more stringent.

The management of the firms caught in the recent spate of corporate scandals — Enron, WorldCom, Tyco, etc. — may have deluded themselves into believing that they were increasing the value of their firms, even as they were enriching themselves. They may not even have believed that they were engaging in criminal activity. The sort of calculations that Easterbrook and Posner seem to have had in mind was a situation in which management knew that they were doing serious harm, but persisted because the prospective profit outweighed the penalties.

Easterbrook and Posner reflect a more common view that business is by definition an activity that allows people to operate unconstrained either outside authority or by their own conscience. In the words of one commentator:

A red light, or the upraised palm of a traffic policeman, brings people to stop (at least in places where people tend to obey them) not by the exercise of power — neither a light nor a hand can stop a moving automobile — but by the exercise of authority …. Many citizens who would unhesitatingly stop for a red light, even at a deserted intersection at 2:00 a.m., would painstakingly calculate the relative cost and benefits of breaking laws against environmental pollution, insider trading in securities, of failing to report income to the Internal Revenue Service, and then obey or violate the law according to how the calculation worked out. [Fields 1990, p. 113]

The classic case of a corporation calculating that the probable economic penalties would not threaten potential profits concerns the Ford Pinto. From 1971 to 1976, Ford placed the fuel tank of this car only six inches from the rear bumper. In even a minor rear collision these tanks were liable to be punctured by bolts protruding from the differential housing. Any spark from a cigarette, ignition, or scraping metal could then engulf both cars in flames (Estes 1995, pp. 196-97; see also Dowie 1977). By conservative estimates Pinto crashes caused 500 burn deaths to people who would not have been seriously injured if the car had not burst into flames. Mark Dowie’s classic article on the Pinto suggested that the figure could be as high as 900 (Dowie 1977).

Ford was aware of the dangers. Crash tests showed that a simple rubber bladder inside the gas tank could have prevented fuel from spilling from ruptured tanks. The cost of rectifying the problem would have been a mere $5.08. Another effective change would have cost a mere $11. However, Ford’s cost-benefit analysis showed that the resulting deaths and injuries avoided would be insufficient to justify an outlay of $11 per car (Estes 1995, pp. 196-97).

Ford is not alone in weighing the costs and benefits of lethal design failures. In 1973, General Motors was making a similar calculation, expecting that the company could save money by paying out the costs of 500 deaths from its vehicles rather than fixing its defective fuel tanks at a cost of $8.59 per vehicle (Court 2003, p. 16; Bakan 2004, pp. 61-63).

You might find such calculations despicable. I do, but apparently not everybody does, including federal judges. Just imagine the outrage if some foreign terrorists had conspired to kill more than a thousand people. But, in the business world, knowing that the likelihood of a penalty is small and that the likelihood of a serious penalty even smaller, firms have little reason to fear the consequences of their actions.

In conclusion, although people who defend corporate rights are commonly quick to call for individual responsibility, they are less inclined to demand a comparable degree of corporate responsibility. Instead, they ignore corporate crime or find legalistic excuses for corporate misbehavior. So, if corporations are individuals in the eyes of the law, they are individuals with a special privilege to ignore the law.

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