Friday, November 20, 2015

The Corrupting Influence of Vilification


What happens when the criminal can't be the villain?

This is the third posting that asks the simple question: Are we looking at an issue from the proper perspective?

Sometimes the words chosen to describe an issue can create a blind spot.  When that happens, one can end up developing a policy that is totally appropriate but totally inadequate.  The policy only addresses the portion of the issue that the language allows.  However, the language does not facilitate the perception of the totality of the problem. 

Consider three words used to describe a financial transaction where one individual makes a payment to another that is not legal: bribery, extortion, and corruption.  Which word is chosen is related to and influences one's judgment about who is undertaking villainous behavior and whose behavior is too virtuous for them ever to be the villain.  Self-interest can play a major role in the definition of the villain and the choice of words to describe the action.

Summary

The Foreign Corrupt Practices Act (FCPA) is an excellent example.  It is designed to pursue a worthy objective but makes the absurd assumption that all corruption originates from the private sector.  That is an easy mistake to make if one assumes that anyone who pursues a profit objective is villainous.  
It helps if one is in a position to ignore potential villains either for convenience or out of self-interest.  It is very convenient and self-serving for the public-sector officials to ignore corruption on the part of other public-sector officials.  They can anticipate that those other public-sector officials will return the favor.

The media has an incentive to write sensationalist, supposedly investigative articles.  There is very little downside to inaccurate reporting if they can paint a picture of villainous activities.  All they have to do is identify who their target audience considers a villain.  Not surprisingly, often they share their audience’s prejudice regarding who is villainous.  Few people in the media or the general public seek information that challenges their preconceived notions of who is villainous.

The net effect is that policy prescriptions often end up only addressing half of the issue.  All the parties involved in a corrupt transaction are acting corruptly.  It is foolish to think that a policy that only punishes one of the parties involved can succeed.  The inherent result of such a policy is to provide an incentive to one of the corrupt parties to continue their behavior.  Without balance, a policy directed at bribery, for example, can end up compounding the misallocation of resources.

The back story

The May 9th, 2015 edition of the ECONOMIST magazine had a number of articles addressing commercial bribery.   The articles provide the back story, but there is a more recent update on some of the relevant information in an October 19, 2015 article in the WALL STREET JOURNAL. 
The WALL STREET JOURNAL article is entitled: “Wal-Mart Bribery Probe Tails Off.”  The government has been working on this probe for over three years and it is not yet over.  Indications are that the probe involved some two dozen prosecutors, agents and investigators from the Justice Department, the Federal Bureau of Investigation, the Securities and Exchange Commission and the Internal Revenue Service’s criminal investigations unit. 

As the WALL STREET JOURNAL article summarizes, “A high-profile federal probe into allegations of widespread corruption at Wal-Mart Stores Inc.’s operations in Mexico has found little in the way of major offenses, ….”   The emphasis is on “summarizes” because although no major offenses were found there were some minor offenses uncovered in Mexico. 

As is often the case when such accusations are leveled, the investigation took on a global scope.  In India there are reports that the corruption involved thousands of small payments to low-level local officials to help move goods through customs or obtain real-estate permits. The vast majority of the suspicious payments were less than $200, and some were as low as $5, but when added together they totaled millions of dollars.

The ECONOMIST magazine provides some idea of the scale of resources used to investigate the charges.  In an article entitled “Corporate bribery: The anti-bribery business” it states: “EVEN for a company with Walmart’s heft, $800m is a sizeable sum. That is what the giant retailer will have spent by the end of this fiscal year on its internal probe into alleged bribing of Mexican officials,”
“By the time bribe-busters at America’s Department of Justice (DOJ) are done with their own investigation, which began in 2012, Walmart’s bill for lawyers’ and forensic accountants’ fees will be well above $1 billion—and perhaps closer to $2 billion. To that can be added whatever fines it may incur, any bills for settling related private litigation, and the harder-to-quantify cost of the tens of thousands of man-hours managers have spent on what has become a big distraction from everyday business.”

The anti-bribery business is truly big business.  There are undoubtedly many law firms, government officials and corporate compliance officers making a nice living off of the anti-bribery business.  However, it doesn't stop there.  The issue provides media talking points for commentators and reporters. 

Keep in mind that the Walmart investigation began in 2012 after the NEW YORK TIMES ran a couple of articles alleging that there was widespread bribery in Mexico.  The Justice Department investigation contradicted some of the allegations in the NEW YORK TIMES articles.  Yet, despite the shortcomings of the NEW YORK TIMES supposedly investigative journalism, they ended up being awarded Pulitzer Prize.

One suspects that neither the NEW YORK TIMES reporters nor the Pulitzer committee members shop at Walmart.  So, a couple of billion dollars of extra cost for Walmart is not coming out of their pocket.  Besides, Walmart, a chain store that serves the working class, is such a convenient target for elitists in the media.

There is a very real risk that the government's response to being unable to find evidence of major corruption, may be to throw more resources at the investigation.  After all, it is a little embarrassing for the government to admit that it has been hoodwinked into such an extensive investigation by an inaccurate press report.  Further, it is often the government solution to a program run amok to just throw more resources at it.  Spending billions of dollars to catch a few million dollars’ worth of corrupt activity is the sort of thing governments do.

The problem

It is not surprising that the government, when passing the Act, wanted to assume, or at least pretend, that the corruption always originates in the private sector.  That they closed ranks with their fellow government employees is not surprising.  If they did not, foreign governments, as well as their own citizens, might call into question their behavior.  It would get quite messy if foreign firms and governments started pointing fingers at the lobbying expenses that US government officials extort from them routinely.

However, governments can acknowledge that there is government corruption.  It just seems that the US is not good at it.  By contrast, the ECONOMIST on Oct 24th, 2015 had two articles that reflect what one finds when a more balanced and objective approach is taken to corruption.  The first article entitled “Business and corruption: Robber barons, beware” discusses the anti-corruption campaign in China.

As is the case with most articles in the ECONOMIST, the full complexity of the issue is addressed.  Nevertheless, the important thrust of this effort to reduce corruption can be summarized with a couple quotes.

“Businessmen targeted so far are mostly senior managers of state-owned enterprises (SOEs), not private firms. In China powerful SOE bosses are also important figures in the Communist Party….Some of those detained are linked to Zhou Yongkang, a former security chief and head of a corrupt network of officials known as the “petroleum mafia”….  Of more than 100,000 people indicted for graft since Mr Xi became leader in 2012, most are politicians and officials—not private businessmen” [emphasis added]. 

It is interesting how when government officials become corrupt they are referred to as businessmen.  One would think that the editors of the magazine would have found it awkward to have to create the distinction between private businessmen and government officials who they have referred to as businessmen.  There is no reason to refer to the corrupt government officials as businessmen other than a bias on the part of the editors that assumes that corruption is a business phenomenon.  They are much in error.  Corruption is very much a government enterprise where force can be employed as opposed to a business practice where transactions are voluntary.  It seems even when the truth is obvious it is hard to admit that government officials can be corrupt.

The second article was entitled “Corruption and natural resources: A fight for light.”  It discusses efforts of NGOs and governments to try to uncover corruption related to mining and energy production.  It notes that “WHETHER the awarding of a license, the sale of state production quotas or some other transaction, dealings in oil, gas and mining are notoriously prone to corruption. This is a problem in countries that have weak rule of law and rely heavily on extractive industries. Sub-Saharan Africa is particularly at risk: its ten largest oil-producing states derived 56% of their public revenues from oil exports in 2011-13.”

The efforts of the Extractive Industries Transparency Initiative (EITI) are complicated by the fact that often the corruption is executed through the establishment of nontransparent shell companies.  The lack of transparency makes it difficult to track the corruption.  Nevertheless, the article points out that “A new report by Global Witness details how in recent years $4 billion was siphoned off to opaque companies, some of them linked to current or former officials [emphasis added], in just a handful of deals in four African countries.”  Global Witness is a Non- Government Organization (NGO) that is trying to monitor the (EITI).

The two articles make it apparent that when one looks at the issue from a broad, global perspective, it is apparent that corruption is not restricted to the private sector.  There is also no logical reason to assume that when a corrupt transaction occurs only one party is acting inappropriately.  It seems more appropriate to assume that both parties are acting inappropriately.  Further, since money is being transferred from private companies to public officials, it would seem far more appropriate to question the motives of the public officials.  

Private companies are not inclined to go around the world with bags of money spreading it widely in order to corrupt governments.  In fact, private companies prefer to operate in countries with honest governments and often have extensive internal controls to avoid the inappropriate use of funds.
Even serious analyses can be led astray

While clearly a media firm, the ECONOMIST magazine often contains serious analyses of economic issues.  Their coverage is broader than just the Walmart case; they discussed Siemens and Alston as well.  Both their assembly of the relevant facts and their interpretations of their implications deserve consideration. 

In the initial article “Bribery: Daft on graft” the magazine pointed out that “A hard line on commercial bribery is right. But the system is becoming ridiculous.”  

The articles in the ECONOMIST make the case for a number of reforms:

“First, regulators should rein in the excesses of the compliance industry and take into account the cost to firms of sprawling investigations.

Second, governments should lower costs by harmonizing anti-bribery laws and improving co-ordination between national probes.

Third, more cases should go to court.

Lastly, anti-bribery laws should be amended to offer companies a “compliance defense.”

All of their recommendations definitely make sense, are much needed and are justified.  However, they are also representative of what can happen when serious analysts fall prey to the language and context of those with less serious and objective intentions.  The ECONOMIST articles have a blind spot that they share with the FCPA.  As a consequence, their proposals are appropriate but are not adequate if the objective is to reduce corruption.

The selection of the word “bribery” in the titles of the ECONOMIST's articles and FCPA’s assumption that they know the villain in such cases illustrate the problem.  If one substitutes extortion for bribery, it automatically changes the context of the issue.  The same would be true if the word corruption were substituted for bribery.  But, the title of the article reflects the assumptions of the FCPA. 

The need for balance

The ECONOMIST article explains the rationale for the desire to end bribery.  The article points out that “Bribery distorts competition and diverts national resources into crooked officials’ offshore accounts.” What it fails to explain is: when businessmen have to make payments to government officials in order to get the officials to do their job (e.g., decide whether to issue a permit, perform an inspection, or even note that paperwork has been submitted) how can punishing the businessmen solve the problem?  The government official is receiving a salary to do the job.  They are also benefiting from the payment.  The businessmen are only exposing themselves to the potential of being fined and branded as corrupt.

If the corrupt official is allowed to keep the money, they have every incentive to continue the practice.  On the other hand, the businessmen have an incentive not to do business in the area.  The absence of the businessmen who were thus deterred also distorts competition.  If the objective is to avoid distorting competition, all parties involved have to be given incentives not to participate in the corruption.  Fining the government officials or the governments involved in corrupt transactions makes as much sense and should be balanced with the fines leveled against the companies.

As soon as one begins to think about a balanced approach that involves recovering the bribes from government officials, it becomes apparent that there are major opportunities to structure the process in a way that is conducive to honest government.  While ultimately the objective is to recover the bribe from the official who took it, the fine need not be directly assessed against that individual.  That is only one approach.  It could also be assessed against the organization responsible for enforcing honest government.  As a last resort, it could be levied against the national government with the proviso that if it is not paid, tariffs on the country’s exports will be used to collect it.  That would make it apparent that the government of the US is serious about honesty in business and government.  If other countries followed suit, it would soon become apparent that honesty is a prerequisite to dealing in the global economy.

Conclusion

Vilification of one of the parties involved in a corrupt act while ignoring the other party does not promote a better allocation of resources.  While it may sell newspapers and be entertaining to some audiences, no one is made better off except the author and publisher.  A serious effort to correct the misallocation of resources that result from extortion, bribery and corruption requires a more balanced approach.

Government policies to address the issue should acknowledge and prosecute all the parties involved.  Honesty is as much a prerequisite of good governance as it is of good business practices.  It is na├»ve to assume that an effort that focuses only on one of the parties involved in corrupt act can accomplish anything other than promote a corrupt industry to deal with the corrupt acts.  That is exactly what we have gotten as an industry has developed around the Foreign Corrupt Practices Act.  What is particularly embarrassing is that serious analysts are questioning whether the US government has shifted from promoting honesty in business to using the Foreign Corrupt Practices Act as a method of developing its own corrupt extortion racket.  A more balanced Foreign Corrupt Practices Act might offend some foreign governments, but it would demonstrate good intentions on the part of the US policy.


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