Monday, 14 September 2009

Who guards the investors?

In The Republic, Plato required his king-philosopher to have neither material possessions nor a family that he could favour. He also trusted law enforcement to a caste of guards. He was thus very aware of the problem of incentives. He also confronted the natural question that such idea begged, an idea that Alan Moore explored centuries later in his graphic novel Watchmen: Quis custodiet ipsos custodes? Who would guard the guards? Plato’s answer was that it was necessary that the guards should be highly moral and spirited individuals, able to look beyond their own material interests and able to sacrifice for their fellow citizens (compare that to Moore’s answer!). In the end, despite his advanced economic thinking, Plato placed moral behaviour at the top of the social pyramid he constructed, and gave it the role of that mythical “key stone” that it is said to support the structure of every gothic cathedral.

To a large extent, this dichotomy in Plato’s thinking reflects the two types of proposals made after the recent financial crisis: On the one hand, measures aimed at improving regulations and constructing better incentive schemes and, on the other hand, the calls to a more moral approach to business, to an ethical regeneration of the economic sphere, that allegedly would ameliorate the rampant greed that reigns in international markets.

But unless human nature had changed dramatically in the last two hundred years, I am afraid that these calls to a moral renaissance will be empty. In his wonderful book The Passions and The Interests, Albert O. Hirschman showed how capitalism, and thus greed, emerged precisely from the total failure of traditional moral systems, of those ethical principles based on religion or a shared national destiny; a failure that precipitated the religious and nationalist conflicts of the XVI and XVII centuries. As a solution, Adam Smith wanted to design a “theology without God”, whose centre would be occupied by a governing principle that humans would feel naturally inclined to follow without any appeal to supernatural powers. That force was self-interest. That force was greed. To illustrate this I will use the example I always give to my students: suppose you are a person that belongs to an ethnic or religious minority. You are walking down the street and suddenly a bunch of people from a rival ethnic or religious group start chasing you with very threatening intentions. If suddenly you started throwing £20 notes behind you, this people would immediately stop chasing your and start collecting the bank notes. Self-interest is a very powerful force, capable of overriding other forces of moral or ethical nature.

All this suggests that moral calls to businessmen, investors and bankers will prove useless. The stakes are so big, there is so much money to be made in international financial markets that there will be always someone ready to bend these principles. At the same time, regulation has proved ineffective in preventing these behaviours or at least that these behaviours meet monetary success. The only way out of this catch-22 situation is to acknowledge -the sooner the better- that the game between the regulator and the economic agents is a rat race, a fight in which the beast of self-interest that Adam Smith unleashed will always look for ways to break the chains that Leviathan wants to put on it.

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