Members of the business community and economists generally think of market capitalism as competition. You build a better mousetrap, and the world beats a path to your door. Competition drives you to explore every possible way to succeed.
This basic philosophy is one reason why we at CED prefer a system of market-based competition among competing health-insurance plans to the current law, including with respect to Medicare. Take the Independent Payment Advisory Board, or IPAB. In concept, such a cloistered committee of smart people thinking about ways to save money while delivering quality health care would be harmless enough. (For today’s purposes, let’s set aside some people’s concerns about the authority of this group to impose its decisions on – rather than merely recommend its ideas to – providers.) But assume in an abundance of fairness that the IPAB bats 1.000 – that every idea it promulgates turns out to be a winner. Could we conceivably stretch our imaginations even further to assume that this limited group would think of every productive idea to deliver quality health care efficiently? Probably not.
So under the current system, IPAB will send its ideas to what is mostly a sea of solo-practice, fee-for-service healthcare providers. If instead we had competing armies of health plans, each with its own designers trying to find new ways to improve care delivery – and to copy every useful idea that they see in every competitor – we quite likely would have a much richer flow of innovation leading to a more rapidly improving overall healthcare system.
So a key point – by no means the sum and total of our argument – is that a fixed agenda of improvements from one entity will be no match for what could emerge from a large number of innovators seeking every possible way to compete and succeed in a competitive market.
But let’s turn back one page to those apparently positive – or even compelling – words: “every possible way.”
Using the proverbial “better mousetrap” image again, suppose that one entrepreneur finds a way not to improve his own mousetrap, but to create a media buzz that his competitor’s mousetrap does not work as well as it in fact does – or that his own works better than it in fact does. He gains business at the expense of his competitor, perhaps even driving him or her out of operation. Is that what market capitalism is all about? Is that what competition is supposed to yield, through Adam Smith’s “invisible hand,” for the benefit of all of society?
Creating such a media buzz could entail illegal activity, such as the perpetration of fraud. But suppose that this entrepreneur found a legal way to create such a buzz – which in this world of instantaneous communication of free speech (you get what you pay for) – might not be all that difficult. Is that what market capitalism is all about?
What protects us from such abuse of the free market – not through outright crime, for which our criminal justice system is the obvious and designated remedy, but rather from the legal manipulation of fellow economic actors? Well, at one level, it is accepted and observed standards of behavior – “norms” is one term that this concept evokes. We may expect that those with whom we do business will behave in the same manner that we do. In fact, we may well count on the mutual observance of such unwritten, even unstated rules to facilitate everyday commerce to long-run mutual benefit.
I’m going to venture my own opinion that a significant part of the deterioration in economic and especially political conditions in recent years has come from an erosion of previously accepted norms – and that once such erosion has begun, there is an unfortunate natural tendency of that deterioration to continue and even accelerate in a “race to the bottom.” After presenting this demoralizing observation, I will try very hard to present some sufficient and efficient remedies for this process. It won’t be easy, because as I speak to you right now, I have not yet thought of very many.
Let’s start with a simple taxonomy of norms. And at the outset, although this story is not cheery, it is not uniformly depressing. There are positive norms, as well as there is negative behavior that degrades norms.
So on the bright side, look at the virtuous end of the scale. Let’s consider positive things that businesses and individuals frequently do, even though those things are not clearly in their own self-interest, because they believe that those things are right or virtuous, and contribute to the community. And let’s consider that the community believes that such acts are good and admirable, and so they become to some degree “norms.”
One example at the purest end of the scale is that individuals give money to others who are down on their luck. The givers receive absolutely no return other than gratitude or a personal feeling of satisfaction.
One step down that ladder, firms and individuals make formal charitable contributions. There is a tax deduction for such gifts, but it merely reduces, rather than totally negating, the cost. Those firms or individuals might believe that they will gain in reputation if the gift is publicly known. They might even believe that the benefit to the community will improve their own lives or business prospects in some way. But there may well remain some element of direct cost which the givers bear because they believe that giving is the right thing to do.
Another step down the ladder of altruism would be expenditures which people hope or believe, but do not know for certain, ultimately will benefit them monetarily. An example might be a business that undertakes a speculative energy-conservation or other environmental project. The business might hope that, with perseverance and innovation, the project ultimately will reduce its costs more than the up-front investment. There may be benefits to the firm’s reputation as well. Still, the return is not assured, and in any event the business bears first-adopter costs that it could have avoided by waiting for someone else to demonstrate the feasibility and make the inevitable implementation mistakes. Again, this activity might be motivated in part by a belief by management, the board, or shareholders that such activity is the right thing to do – and thus follows a norm of behavior.
Now let me take one more step down the ladder, and imagine an activity that has no inherent value of any kind, but might yield a business advantage. Such activities might be characterized as pure marketing, or perhaps product differentiation that is devoid of value. We might conclude that such an activity would violate or degrade a norm.
As an example, those of you who are of a certain age (that certain age being approximately mine) might recall what could be called the automobile “tail-fin wars” of the late 1950s. U.S.-manufactured automobiles (and for all practical purposes there was no other kind in our market) came to be distinguished from one another essentially on the basis of whose tail fins were larger. Some social critics railed that the industry was ignoring quality and durability, and wasting the steel to enlarge the tail fins and the fuel to carry them around. Economists, of course, hesitated to question the consumer’s judgment as to what constituted value, which could include aesthetics. After all, what was the difference between the rear fender of a De Soto, if consumers liked it, and, say, the Mona Lisa, which consumers also valued? (That is a rhetorical question.) But in any event, an arguably deteriorated “norm” came to be widely accepted – and practiced – that resources could properly be devoted to a marketing activity that might be interpreted as having zero – or even negative – value to the consumer.
As another example, consider a legendary advertising campaign for Schlitz beer. An ad man walking through the brewery to get ideas was electrified to see that the empty bottles were being sterilized with live steam. The brewer accompanying the ad man innocently pointed out that every brewery did so. But the ad man argued that what other brewers did was irrelevant; the first claim of this practice as an advantage would sell. So an entire campaign was built around a brewer following the industry-standard method of cleaning empty beer bottles. Some might rank this ad campaign a little further down the ladder of virtue even than the tail fins, on the ground that implicit in the advertising claim was an implication that this cleaning practice was unique to Schlitz – which implication Schlitz’s competitors would have to spend advertising dollars to dispel. So this campaign may have violated a norm that required some measure of substance in advertising.
We can take one more step down the ladder of norms, from our start with the virtuous, and then to the arguably neutral, now to what some might call arguably negative to the community. During the Clinton Administration, there suddenly came to public attention a tax-motivated sale-leaseback of a town hall in Switzerland undertaken by a U.S.-incorporated multinational corporation [see here and here]. The profit from the economically irrelevant transaction came because the U.S. firm could depreciate the Swiss town hall under the U.S. income tax, and could entice the Swiss canton to undertake the transaction by offering it an implicit cut of the U.S. tax savings. With the revelation came gossip that corporate accountants were salivating over the prospect of depreciating every building, culvert, and road sign owned in the public sector – or at least those outside of the United States.
This “loophole” – a so-called “Lease-In, Lease-Out” (LILO) transaction – was shut down. But for this discussion, it is worth considering how such a transaction could arise. Is it possible that the corporation in question was the first to discover the possibility of depreciating foreign public-sector physical assets? Or might someone have imagined the opportunity previously, but been deterred by a “norm” of behavior that defined such activity as out-of-bounds? Or might the sole deterrent have been the prospect of adverse publicity arising from such an undertaking?
In any event, it is possible that once any such “norm” is breached, there will be a growing pressure on others to emulate and even to exceed the violative behavior. If your competitor can reward its shareholders with the profit from such a transaction, your shareholders – or at least some of them – might believe that they are ill-served if you do not so reward them. And in fact, after a few imitations render the previous norm quaint, there might be acclaim for a firm that comes up with an even more audacious financial “innovation.”
In other words – and in an important knock-on effect of such breaching of “norms” – there can be a “race to the bottom” once society’s standards are violated with impunity. Competition can dictate that firms use “every possible means” to outdo their competitors. And once those means undercut what used to be society’s norms, success may require undercutting those norms even further. Arguably, the end result can entail the successful pursuit of individual success at the micro (or individual transaction) level, while leading to an erosion of the values and goals of the entire society at the macro level.
My choice of deprecatory language for this particular family of transactions, of course, is arguable. I have heard some economists contend that international tax competition is good, because it drives out government inefficiency and reduces wasteful spending. Some go on to argue that the pursuit of such so-called tax “shelters” as LILO is merely a safety valve for corporate taxpayers in this ultimately beneficial international tax competition; it signals to a government that its tax policy is a competitive failure. I would not dismiss such a conceptual argument out of hand. But we might question its applicability when the national parties in such transactions, including for example Bermuda and the Cayman Islands, rely for their national security – at no budgetary cost – on the very nation that loses its own corporate income tax revenues through these very transactions.
Or consider another family of arguably norm-violative behavior in corporate “inversions,” which some have called corporate “expatriations.” Through such transactions, and in the simplest terms, corporations have moved at least some of their profits overseas, so that those profits will be taxed at lower rates. Many U.S. corporations have followed this practice. Interestingly enough, though, in one prominent instance a firm encountered substantial public resistance, and determined not to conclude an inversion. Stanley Works, a household-name maker of hand tools, met with such a prohibitive adverse reaction. Even though the firm argued that it was merely following the same course as many other firms with which it competed at least for investment dollars, it was not able to sway public opinion. Why was there such a strong adverse reaction in the instance of Stanley? Perhaps it was the prominence of the firm, and the all-American image that followed at least from its particular line of business. Apple Computer – another “all-American” firm – has recently suffered adverse publicity over similar, but not identical, transactions. There clearly is some “norm” relating to the national identification of corporations – even if it is not imposed by the public in a fully even-handed manner.
Let me raise just one more alleged violation of a norm that is cited by some economists and political scientists as a possible ultimate ill effect of a race to the bottom. Firms can engage in “rent-seeking,” which I would define in this context as the pursuit of protection of one’s own competitive position not by pursuit of higher quality or lower price, but rather by legislation or regulation that prevents competing innovations that would yield higher quality or lower price.
A possible example emerged just last week here in the District of Columbia. I do not pretend to have the most-detailed knowledge of this situation, and so I do not want to venture definitive conclusions or mention any names. However, some new firms have proposed to provide vehicle-for-hire service based on summoning by Internet technology. The D.C. Taxicab Commission is reportedly considering regulations that would greatly restrict the operations of such potential innovators. Most notably, the draft regulations would mandate that the such firms’ vehicles weigh at least 3,200 pounds, be fewer than five years old, and be equipped with premium sound systems, reading lights, and aluminum wheels. The firms in question protest these restrictions, on the ground that they had planned generally to compete on the basis of lower cost, and in some instances to do so by using smaller, lighter, more-fuel-efficient hybrid vehicles.
An apparently analogous situation – again, careful study would be necessary to call a foul – is the current attempt by Tesla Motors to sell automobiles directly to consumers, which they argue is a more efficient way to do business. It is being resisted by automobile dealers, who claim to have franchise laws on their side.
Again, I do not pretend to have studied these situations closely enough to venture what I would allege to be a definitive opinion. But if the claims of the self-described innovators are true, these episodes would fit the classic textbook model of an existing firm or industry using its deep pockets, filled through its past earnings and accumulated wealth, to stifle competition and innovation with potential societal and economic benefits. Another broad class of examples of such subversion of competition is the overbroad interpretation of existing patents to prevent the use of improved technologies and processes in the competitive marketplace.
We might assume that there is or should be a “norm” such that existing firms be willing to take on all comers, and therefore sometimes to adapt their business models and technologies even though that may be painful. The violation of such a norm can result in a truly costly “race to the bottom” in which the economy’s – and therefore potentially the society’s – lifeblood is drained. Progress is replaced by the protection and consolidation of existing wealth and past ways of doing things – which is a recipe for stagnation. I took a memorable history class as an undergraduate – which President Bill Clinton took three years prior, and to which he has publicly referred – whose central thesis was that the world’s leader nations fail when they come to devote more of their energy to protecting existing interests than to innovating and progressing.
Thus far, I have focused on norms that apply to the behavior of private businesses. However, a case could be made that our nation has seen even more of a violation of norms, and even more of a dangerous “race to the bottom,” in the public sphere. Consider some of the troubling behaviors that we have seen in government.
Let me start with a fairly stark episode in the realm of electoral campaigns. In 2010, Delaware held a Senate election to fill the seat of former Senator, then Vice President, Joe Biden. The presumption was that the seat was the virtual property of then-Representative Mike Castle (R). In the primary election, Rep. Castle was challenged by a young woman, Christine O’Donnell, whose resume suggested that her credibility as a candidate for such a high office was questionable. A few weeks before the primary, however, a nominally independent supporter, formerly employed by the O’Donnell campaign, created a television advertisement that repeated what it characterized as a “rumor” that Rep. Castle, who was married, was engaged in a homosexual affair. In subsequent interviews, the maker of the advertisement offered no evidence of the rumor, but said that it was “common knowledge” in Delaware, and that he had no compunction about repeating the rumor about Castle because “he’s a threat to American sovereignty.” The former campaign employee further defended himself by saying, “We asked the question, we didn’t specifically say it… [w]e thought we’d throw it out there.” (The ad maker himself had been indicted, but not convicted, of rape, and expressed indignation when that fact was raised in the press.)
Ms. O’Donnell disavowed any involvement in the advertisement, but made a point in a subsequent campaign debate of urging Rep. Castle to “get your man pants on.” Ms. O’Donnell won the primary in a surprise upset, but lost the general election by a significant margin.
I may be mooning over “the good old days,” but my memory recalls a time in modern U.S. history when behavior such as occurred in Delaware would have disqualified the campaign that placed the ad, not won the primary election. Concerns about a questionable allegation saved until it is too late to respond – the proverbial “October surprise” – have become a fixture of the election process, aggravated by the quickness of the Internet; and the phrase “too good to check” has become unfortunately well known in an advocacy press that could not exist without electronic communications. The norms of behavior in election campaigns clearly have changed – and some would say deteriorated.
I suspect that you, like me, have heard during every recent election cycle some pollster or pundit pontificate that negative advertising does not work, and that the American people say that they do not like negative advertising. I suspect that you also, like me, have heard the television panels after every election in which pollsters and pundits argue over which negative ad, and which “zinger,” really made the difference. Campaigns have become “gotcha” games, rather than serious debates over crucial issues.
That Delaware episode is reminiscent of the impeachment of President Bill Clinton over extramarital activity, when two of the congressional leaders of the impeachment effort subsequently resigned their seats at least in part because of revelations that they had behaved similarly. It led many old-timers to long for the days of the Kennedy Administration, when evidence of that President’s behavior was kept private to allow the government to focus on public business. The sense then was that however regrettable or reprehensible such behavior might be, it was inherently private, and there was a public interest in keeping the public debate on public issues. That norm clearly has gone by the boards.
Issues such as this could affect the public well-being in indirect ways – by preventing qualified candidates from holding office, or by interrupting the public business. However, the deterioration of certain other norms might affect the nation much more directly.
For just one example: Each political party now perceives that it holds a trump card in the big-picture debate over the public debt and the federal government’s budget deficit. Democrats criticize any suggestion of a change to the major source of the long-run problem as “ending Medicare as we know it.” Republicans attack any move to raise revenues – which will be necessary to limit the growth of the debt until a fundamental restructuring of Medicare can take hold – as “job-killing tax increases.” The likely considerable number of both Democrats and Republicans in Congress who know that each of these positions is irresponsible and untenable is both the good news and the bad news. It is good news because it indicates that there is the potential to achieve a compromise that solves our fundamental problem. But it is bad news because it merely reminds of the extent to which our policymaking system is broken, and drives people who know better to hide behind slogans that are both empty and misleading.
I for one remember how during the congressional debate over what became the Tax Reform Act of 1986, Member after Member would come to the floor and repeat the complaint that they heard over and over in their town hall meetings: “When will you Democrats and Republicans work together and get something done for the country?” Today, however, the refrain is totally different: “Don’t compromise with those SOBs. Stand up for your principles.” Many Members know that those “principles” are not viable. But they fear that if they even speak about compromise, they will lose their seats. And that concern is not entirely selfish; if they do so lose their seats, the person who replaces them will by definition be uncompromising and ideological.
In sum, there used to be a norm that demanded that Presidents and Members of Congress cooperate to address the nation’s problems. For years, that norm has been routinely violated; and with each violation, the other side is angered to return the favor in spades. Many who most notably violated that norm have been rewarded with reelection and positions of leadership. As a result, the old norm has deteriorated to the point where every candidate for office understands that the most profitable and rewarding form of behavior is to refuse to cooperate, and to refuse to compromise. We have left problem-solving far behind, and so it is no surprise that we are up to our keisters in problems.
Is there a solution to this deterioration of norms, this counterproductive race to the bottom? How do we turn back the clock, and encourage people to behave in better ways – ways that perhaps were the norm some years ago?
It would be beneficial if there would be an umpire to call a foul when public or private actors violate important norms. And of course, in any realistic sense, the umpire has to be us. Delaware voters determined the outcome of their Senate election – both the primary, and the general – as well as countless other elections that have involved questionable claims and behavior. Public protests affected the decision of Stanley Works – but not the similar decisions of numerous other U.S. corporations. Is the electorate itself up to the task?
In the public sphere, people sometimes call for a third party that would circumvent the clogged behavioral arteries in the two parties that we have. Not to totally discard that idea, many people do not understand the infrastructure that is necessary to run a presidential campaign, much less the nearly 470 congressional campaigns that are held every two years. And a third-party president who ran and won without that congressional campaign infrastructure, the least-unlikely scenario, would come to Washington with no allies, and with two parties in Congress each of which would seek every opportunity to cut him or her off at the knees and regain the upper hand.
Some institutions might help. There could be a behavioral analog to existing and in some measure successful fact-checking entities in the media like Politifact and Factcheck.org. Key, of course, is establishing and maintaining a reputation for impartiality. Perhaps a more-specific model was a quite specialized entity in economics formed by the University of Chicago Booth School of Business. The intent was to create a balanced panel or forum of noted economists, and to put to them questions about public policy issues. An innovation (to my knowledge) was to ask the members to specify by category the degree of confidence that they had about their judgments. If it met its goals, this forum would provide non-economists with a reasonable sense of the center of gravity in expert economic opinion. I thought it was an incredibly cool idea, so it should not surprise you to learn that it has since been disbanded. However, such an institution – perhaps among selected former Members of Congress – might attain traction as a source of credible, balanced opinion on any violations of appropriate norms of public behavior.
If these possible remedies for public behavior seem unsatisfying, brace yourself for a lame approach for the private sector. Consider one example of why this problem is a hard nut to crack. Economists typically are uneasy about the legal minimum wage, because we are reluctant to prohibit voluntary exchanges. If a person has a reason to accept a job that pays a low wage – perhaps because it will enhance the person’s skills, and lead to a higher income in the future – most economists would step out of the way. The concern that leads to the statutory minimum, however, is that one economic actor with power in the market might take advantage of another by creating and enforcing a contract of desperation. Some will dismiss that concern as unrealistic or unimportant. But if you ask a different question – specifically, why our policymaking system has enacted and maintained a minimum wage – I personally believe that this concern is an important part of the answer.
As a result of considerations such as this, we have rules and regulations. We often do not count on norms to dictate good behavior, which could allow individuals the flexibility to agree on low wages in valid circumstances. We do not assume that a universally accepted code of conduct will deter sale leasebacks of Swiss town halls, or corporate international relocations in transactions without economic substance. We feel compelled to dictate good behavior, rather than to count on its voluntary maintenance. That puts a premium on good laws and good regulation.
Some believe that the best federal workforce is the smallest number of people at the lowest possible wage. But you get what you pay for. Few private-sector leaders would send a bargain-basement team to write their own governance rules or negotiate a major deal on their behalf, but some would do exactly that when their negotiating entity is their own federal government. Even if you believe that the nation needs less regulation, that does not dictate that the regulations that you have be written and enforced on the cheap. We may wind up with limited, disruptive, and inefficient regulation. Often, the federal government serves essentially as a training firm for the private sector, bringing its employees up to speed only to have the best and brightest bid away to sit on the other side of the bargaining table or to find their ways around the regulations written by their inexperienced successors. We must do better if we are to have good government.
And as a final idea, we should celebrate the people (and their institutions) who act according to high standards to reinforce, and even establish, strong norms in the realm of business, politics, and policymaking. That is, of course, an important part of what we do and who we are at CED. So it affords one more opportunity to thank our Trustees for their commitment to this important organization.