Monday, December 28, 2015

Profit motive drives business to bend rules

Sometimes I think economists are people who believe fervently in private enterprise and the profit motive, but have never actually met a business person.

That doesn't apply to economists working for business, obviously, but it applies very much to the econocrats who give advice on economic policy and even, I suspect, academic economists.

Living in Canberra doesn't help.

One of the advantages of spending your entire career in the private sector, as I have, is that it disabuses you of the notion of business people as model economic agents rather than hugely fallible human beings.

The economists' neo-classical model has an anti-government ideology hidden within it, which leads economists working in the public sector to idealise business people. They're rational operators and when they seem not to be that's only because governments have distorted the incentives they face.

Business people rational? Oh, you mean like the bosses at Fairfax Media? You mean the period when we had chief executives in and out the door in the space of a year or so? The stories I won't tell.

Business people don't have any better fix on what the future holds than anyone else, so often make decisions that turn out to be dumb. But they'll often realise that long before they pull the plug. And when they do they invariably blame the economy or government policy.

The economists' model and methodology lead them to ignore all motivations bar monetary incentives. Since most people have plenty of other motives – worthy and unworthy – for the things they do, this leads the economists to a host of wrong predictions.

But business bosses – from big outfits or small – would have to be the most money-motivated among us. Success is judged by the size of your package (even if it leaves you with no time to spend the stuff). Managers learn when they realise their staff isn't as money-hungry as they are.

Public sector economists say they believe in the profit motive, but they have no conception of what a powerful force it is and what unpleasant surprises it can give you when you unleash it.

It turns business bosses into short-term maximisers, willing to risk their company's future to make a quick buck. Alan Greenspan confessed that "those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief".

Years ago economists realised that public companies have an "agency problem" because the incentives facing the agents of its shareholder owners (otherwise known as chief executives) can conflict with the interests of those owners.

The economists decided the answer was to use incentives such as share options and performance bonuses to align the interests of agents and principals. It's been downhill ever since.

Why? Because money-hungry managers haven't been able to resist the temptation to game the system. It has probably done more harm than good.

Business people are so motivated by the profit motive they're always looking for loopholes and bending the rules.

This year's revelations about the behaviour of seemingly respectable firms in the way they pay casual employees suggests they may even go further than that – and that the designated regulators are mighty slow in doing their job of policing the regulations.

The econocrats don't seem to have realised that when you give people a chance to put their hand in the government's pocket, they go as crazy as people who take home all the shampoo and soap sachets from the motels they visit.

In the rush to get new homes built before the goods and services tax was imposed on them in July 2000, punters pushed up home prices by a lot more than the 10 per cent tax they were avoiding.

For an example of business people doing crazy, destructive things to get into the government's coffers, look at the operators willing to risk the lives of the kids installing pink batts.

This kind of money-madness seems to happen every time the other-worldly econocrats persuade the government to "contract out" the provision of some government service and invite private businesses in on the act.

The latest is for-profit providers of vocational education exploiting the government's HECS loan scheme by offering students a free laptop if they sign up for dubious courses.

By now, such an outcome was eminently predictable. Government incentives often induce people, whether punters or profit-seekers, to do greedy, dishonest and even self-destructive things.

Working for government seems to convince economists that, if they couldn't only get to meet a business person, he or she would be a wonderful, caring human being.