Business
Putting Economics to work to solve social problems

by Analyst
Modern economics provides new insights into human behaviour. The classical economists based their analysis on the assumption that man was selfish and self-interested. He would also act rationally in choosing alternative means to achieve his goals. Economics does not rule out non-material goals and hence accepts that a person can pursue spiritual goals too, but assumes even in the pursuit of such goals he will act rationally in deciding between preferences.

Sociologists have observed that more and more people are oriented towards material goals like seeking pleasure from the purchase of goods and services. There has been a decline in moral values throughout the world and people have become increasingly oriented towards materialism and material goals in life. We may lament about it but have to be realistic and accept it as a fact of modern life although religious men should undoubtedly seek to reverse this tendency as it is not in accordance with man’s deep-seated quest for spirituality.

Self-interest and policy

If people are taken to be increasingly selfish and self-interested, then only measures that appeal to their self interest should be adopted to influence their behaviour in directions that we regard as desirable. This should be the objective of policy. Appeals to moral values and the good sense of individuals don’t seem to work in our society today. The economists have in the last three decades obtained very useful insights into human behaviour through such analyses as conducted by the Nobel laureates Gary Becker and James Buchanan. They advocate the provision of incentives to make people act in ways desirable for society and disincentives to deter them from acting against the social interest. If it is to their advantage, people will co-operate in activities whether they are to steal or to invest or engage in some economic activity or other.

Collective interests and individual motivations

It is said that at the beginning of the 20th century goods in China were transported by barges. A team of six men, who were rewarded handsomely if the goods arrived in time, pulled each barge. If they did not keep the deadline, they got nothing. Each man in the team calculated that success would depend on the efficiency of the other five members and if everyone else pulled hard, he could shirk and still benefit. On the other hand, even if he pulled hard there would be no success if the others did not. Since everyone would make the same rational calculation and all would shirk ensuring the non-arrival if the goods in time, nobody would get paid.

How did the team solve its problem? They hired a seventh person whose job was to whip the shirkers. (From "The Armchair Economist" by Steven Landsburgh.) This illustrates the problem of getting people to co-operate in their common interest. This problem arises in a cartel arrangement such as the OPEC, which seeks to keep the price of oil up by fixing production quotas for each producer. Although it is in the collective interest of all to maintain the production quotas, it’s in the individual interest of each to cheat without getting caught. But if everyone cheats the cartel breaks down as so often happened to OPEC.

Polygamy

Consider a society where men and women are in equal numbers and polygamy is practised. Suppose each man can marry four wives. Then three men will be short of wives. So when each man gets three wives the competition for women becomes acute. Unmarried women would have many suitors and dowry would have to be given to the woman by the man and not by the woman to the man. But there is also the danger that men short of wives will seek to woo even married women. This will undermine the institution of polygamy. Husbands will have to be deferential to their wives to prevent them being drawn to other men. But that is not enough, since unmarried men have a strong incentive to woo even married women owing to the shortage of women who are not married. So the men have come to an unwritten agreement that they will not seek the wives of other men.

But while it is in the general interest of all men to follow such a code there is a strong incentive for an individual to cheat by looking for other women. So it is necessary to punish severely the women who commit adultery. During the time of Jesus Christ, only the women who committed adultery were stoned to death and not the men. The institution of polygamy will collapse unless strict punishments are meted out for adultery. Where such punishment is not imposed, polygamy cannot be upheld. The men in a polygamous society are in a conspiracy under which each man restricts his attention to other women in an attempt to increase the bargaining position of all men to marry four wives. But like in all restrictive practice agreements, while it is in the general interest of all men to keep to it, it is the rational calculation of each one that he stands to gain if everybody else follows the agreement while he cheats.

The cartel then needs legal sanctions, which must be enforced. Polygamy cannot be sustained as an institution unless adultery is severely punished. This is why in countries like ours where adultery is not punished by the courts, polygamy is weak and dying out as an institution with the practice being limited to a small minority.

Gary Becker has explained that many aspects of human behaviour in marriage, divorce and decisions like having children can be explained by economic theory. Economists work on incentives to motivate human beings.

It is observed that there is an inordinate delay in hearing and disposing of cases in our courts. The economist would suggest a reward for judges who hear and determine cases speedily and some monetary penalty for those who delay disposing of cases beyond a norm. An economist in USA showed statistically (although there were criticisms of his statistical methods), that the death penalty was effective in reducing crimes. But it is even more important that the prospective criminal should calculate that there is a high degree of probability that he will be detected and convicted too. If not the death penalty will not be an effective deterrent.

It is said that only half the crimes are successfully investigated and of those charged in courts, only 7.5% are convicted. This means the probability of punishment for murder is only about .035%. This is close enough to zero so that a man planning murder might think he has only a very small chance of being convicted and punished. If we wish to bring down the crime rate, then a higher rate of conviction is as necessary as better police investigation and solution of crimes.

Legalisation as an alternative to cope with corruption

Some years ago applicants for passports had to wait a long time to get them. A bribe speeded the process. A wise Controller of Immigration decided to legalise the corruption and distribute the enhanced fee for same day issue among the clerks. The issue of passports since then has been quick and corruption eliminated.

Corruption in the distribution of public goods like education or health care are a re-introduction of market forces into the provision of these services. There is Dr. Uswatte Arachchi who bemoans the suggestion to introduce choice in the selection of schools through vouchers on the ethical ground that it favours the rich and discriminates against the poor. Perhaps there is some truth in that argument; but the problem already exists in the system of "donations" and the corruption that prevails in the admission of children to the prestigious schools. The so-called donations are a form of reintroduction of market forces to the allocation of education. They bring back the distortions the original intervention was sought to avoid by free education.

Since education in different schools is not of the same quality — not equally good, in the jargon of economists free education was never going to achieve its goal of equality of opportunity for all although some people who did not have access to quality education before would benefit at least in the beginning of the scheme and others already in good schools would benefit from the abolition of school fees. Whenever the government introduces free or below market price education, the price will go back to the market price for quality education and the poor will be priced out of such market. This is bound to happen. There are also the costs of the apparatus that must be set up to detect such corruption by way of all the rules that must be drawn up and the records that must be kept - the dead weight paper trail.

Principal-agent relationship

Economists have come up with solutions to what is called the principal-agent relationship, which is common in the economy. The owners or shareholders of a company appoint a manager and expect him to act in the interests of the shareholder/owners. But there is no real incentive for the agent to act in the interest of the principal. How to align the interests of the agent with that of the principal is the problem to which the economist seeks an answer. So companies have introduced share options for managers who will then find it in their interest to increase shareholder value by increasing the share price of the company’s share through better earnings which they strive for. This will benefit the managers of the company since they hold shares bought at a previously prevailing prices.

Company owners are principals; workers and managers are agents. Owners or principals do not have complete knowledge of the operations and therefore managers and workers may pursue their own goals and reduce profits. In fact the agent may even ignore completely the interest of the owner and follow his own interest only. Employee Share Options is a way to align the self-interests of the managers with the interests of the shareholders. But recent corporate scandals in USA have shown that the managers can fudge accounts and report false profits to boost earnings and with it the share price.

Workers may not work hard and may cheat and steal. The law provides for dismissal in the case of fraud. But the legal process may impose large and unnecessary costs and hence may not be economically efficient. Principal-agent incentive problems can be dealt with through market based contracts. Contract laws must be written to accord with the needs of the two parties. But sometimes contracts cannot be performed and "fire exits" must be included in contracts. What is important is to have incentive based management.

The corruption problem

Corruption is a common problem. The economist suggests the designing of incentives for the bureaucrats to act honestly. The Port Authority has for a long time accepted the giving of bribes to their staff as more or less normal behaviour. The only solution is to legalise it.

It is sometimes argued that if bureaucrats were paid adequately there would be less corruption. The argument is that then even a small chance of losing their job would discourage them from being corrupt. But what if the probability of losing the job is zero as in the public sector today. Then however much the salary is raised there is no incentive to forego corruption. On the other hand if the wages were inadequate to provide a living for his family the bureaucrat however honest he is will be tempted to resort to corruption to maintain his standard of living. While this line of thinking tells us something about paying adequate salaries it doesn’t tell us what level of salaries are required to make the bureaucrat hesitate to take a bribe. But one thing is clear, given the present situation in the public service where there is no punishment for any acts of misconduct and where there is no risk whatever, of being dismissed for lapses, paying higher salaries to public employees will not reduce corruption. It is necessary to hold them accountable first by dismissing those who steal or pilfer or otherwise misconduct themselves.

Prison labour

The LTTE calls Sri Lanka a "failed state". John Kenneth Galbraith, when he was US Ambassador in India, referred to India as an organised anarchy. These descriptions fit our state and society today. Our prisons are bursting at the seams. Economists would suggest putting the prisoners to constructive work for the benefit of society. According to a feature article in the Hindu newspaper some time age, a number of States in USA, have passed laws that allow commercial organizations to use convict labour. They are easily got rid of, retrenchments are not a problem, and there is no sick leave, vacation leave and no overtime payable. And no unions to defy the management. Quality control is made easy and there are no restrictive practices.

The result is that in the present globalised competition, US Corporations are at an advantage. Corporations working for profit run privatised prisons in USA. American Federal and States which run prisons allow — often invite — private enterprises to use prison labour. Even if the prisons are not private, the State can hold down prison labour for private gain and its own benefit. China too uses prison labour on an extensive scale. So it’s time our authorities use prison labour in productive enterprises at least in the public sector. The country cannot afford to maintain a large number of prisoners and they should be made to pay for their keep.


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