ASSA Symposium on Trust in Australian Institutions, Canberra, Tuesday, November 13, 2018
I’m not at all sure I’m the right person to be speaking on behalf of economists on the question integrity, corruption and trust. My accustomed role is to provide outsiders with a critique of economics and economists, whereas academic economists tend to be quite defensive. So I can’t promise you that most economists would agree with all I say.
The plain truth is that, historically, trust has not been an issue of central concern to economists. Their workhorse model of markets takes for granted a high level of trust between buyers and sellers, producers and consumers. Only as economists have become aware that levels of trust seem less than they were have they become more conscious of the economic value of trust and trustworthiness to the smooth functioning of the economy or, to put it the other way, of the greater costs that are incurred when, for example, it can’t be taken for granted that everyone walking away from an airport luggage carousel actually owns the bags they’re carrying. At the macro level, economists have found some evidence of correlation between high levels of trust, or low levels of corruption, and higher rates of economic growth. Over the past 20 years or so a small number of economists – prominent among whom is Luigi Zingales of the Booth School of Business in the University of Chicago – have been studying trust but, on my reading, their findings are still at an early stage. The field of public choice theory, earlier led by James Buchanan and Gordon Tullock, and the associated literature on rent-seeking, has done much to explain the incentives that create risks of corruption among politicians and senior bureaucrats, and institutional corruption, including regulatory capture.
But now I want to turn from academia to the contribution of economic practitioners, particularly econocrats. The OECD has established Trustlab, to collect and improve measures of trust, so as to understand what drives it and how policymakers can attempt to restore it. So far it has data from seven countries measuring interpersonal trust, trust in immigrants and people from another religion, as well as trust in institutions such as parliament, government, the judicial system, the police, the media and financial institutions. It finds levels of trust in other people and in government rise with levels of education and income. Perceptions of high-level government corruption and government reliability and responsiveness are the strongest determinant of trust.
The Productivity Commission’s report, Shifting the Dial, noted survey evidence that the majority of Australians do not have trust or confidence in government, and that the degree of trust has fallen significantly. A recent speech by the chairman of the ACCC, Rod Sims, acknowledged a significant amount of law-breaking by companies.
But now let me give you my own views. I believe that much of our loss of trust in governments, the banks and business is justified, because there has been a deterioration in the vigilance of regulators and the behaviour of businesses. Some part of this may be explained by failures in the experiment with the deregulation of many industries which, it was expected, would lead to increased economic efficiency – to the benefit of customers - without any change in standards of honest dealing with customers. Unfortunately, heightened competition in markets may sometimes lead to a race to the bottom, in which firms feel under pressure to adopt the questionable practices of their rivals, or are reluctant to be the first to give up such practices for fear of losing business to less scrupulous rivals. Regulatory bodies were quietly encouraged to be more conciliatory and less aggressive. Often their funding was cut. It may be no coincidence that the surprising number of allegations of “wage theft” in recent years came after the reduction of unions’ right of entry to the workplace, including their right to check wage records to ensure industrial awards were being adhered to.
It’s predictable for a decline in the public’s trust in firms to treat their customers fairly to be followed by demands for greater government regulation of business behaviour. I have sympathy for such calls, but economists know that using regulation to achieved improved behaviour can easily involve unintended adverse consequences, which add more to costs than they do to improve outcomes. In his interim report, the banking royal commissioner noted that most of the misconduct he had uncovered was already unlawful, suggesting that a raft of new laws was not needed. Rather, he implied, a better approach would be for regulatory bodies to enforce the existing laws with greater diligence. This might well involve them being given greater funding to do so.
There is an amoral calculation in economics which says that a “rational” decision on whether to break a law involves weighing the expected benefit from doing so against the expected cost of doing so, which is the amount of the penalty multiplied by the probability of being caught. Since the probability of apprehension is usually low, penalties need to be high – much higher than at present - for the deterrent to be effective. Sometimes economists, who are used to reducing everything to monetary calculations, forget that penalties involving a jail term, however short, may be a far more effective deterrent.
At this stage in the discussion business people retort that you can’t legislate to make people honest. This is only half true. If you make the expected penalty high enough, you will induce businesses to change their behaviour. And behavioural economists have learnt from social psychology that if you can bring about a change in people’s behaviour, they will seek to reduce their cognitive dissonance by changing their beliefs to fit with their new behaviour. This tells me it is possible to change group norms of acceptable behaviour – what today is called “business culture” – for the better. Were that to happen, it’s reasonable to hope that the public’s trust in our economic institutions could eventually return.