Investment Initiatives » Enterprise, Risk-taking, and Regulation

01.30.09

Enterprise, Risk-taking, and Regulation

Posted in Blog at 1:09 am

As any aficionado of the the classic British country-house mystery can attest, there are three great wellsprings which render otherwise respectable, law-abiding individuals capable of murder. Greed is of course the primary motivator, and jealousy—especially the jealousy arising from romantic betrayal—is another. But the third, of growing importance in the evolving society of the post-World War I era, was the fear of loss of social standing in an increasingly bourgeois society. The more the British class system softened, the greater this fear could become, and the more often it was expressed (fictionally, at least) as a motive for murder. The opportunity to rise economically and socially carried with it the commensurate opportunity to fall, but at least in the Britain described by these novels, the psychological punishment spawned by the prospect of a decline on the social ladder was not merely symmetrical with the relatively minor (at least from a criminological point of view) reward from higher social status; rather it was nearly symmetrical with the great rewards of financial (or romantic) success. In other words, fear of a major decline in social standing was capable of being as strong a motivator to crime as the prospect of great economic gain. Thus, at least, was the pattern portrayed by the authors of these mysteries. Of course, the British murder mystery was a fictional construct, and Britain remained, throughout those years, a country with an astoundingly low rate of violent crime. I leave it to serious students of criminology to sort out whether this asymmetry of motive can actually be found in the annals of homicidal behavior in the United Kingdom.

The United States was always rather different, with social status much more closely linked to wealth than in Britain or other older societies rooted in aristocratic structures. (One may see this in the very different structure of the mystery story in America.) With the much greater economic (as well as social) mobility afforded by the new republic, it is arguable that there was less disgrace involved in failure in the United States, as well as more opportunities to recover from economic setbacks. And in fact, most American tales of crime—both fictional and historic—seem to revolve more about greed and sexual jealousy than they do about fear. Nonetheless, it is worth bearing in mind that the tremendous variability in economic outcomes necessarily requires that there be huge variability in the security of both income and social status. Using the analogy of the classic mystery story, Americans have always, literally, had greater inducements to try to get away with murder.

The point of this analogy is the important implication that stronger—not weaker—regulation should go along with the greatly expanded opportunities provided by the system. Socially-sensitive models which attempt to explain criminal behavior by a prevalence of ‘injustice’ (i.e., distributive injustice: the inequality of outcomes for similar behavior) or an almost total absence of opportunity for a social subgroup, do not explain why criminal behavior, especially economic fraud, is more frequent during periods of rapid economic growth and dynamism in the economy. This is true in many societies, and not only in the opportunity-oriented United States.

If the rewards for committing economic mayhem are greater, and the penalties for failing to keep pace with the competition are greater, one has to conclude that there will be more corner-cutting, rule-bending, and especially much more running of otherwise socially-unacceptable levels of risk, both to avoid the negative valence which is the result of opportunity not seized in an opportunistic and competitive environment, but also because the fear of significant economic retrogression remains very high or even rises in such a competitive environment, along with the almost automatic loss of social status which accompanies it. Indeed, what one has seen during recent expansionary bubbles in the United States is exactly that pattern: as the rewards increase, so do the punishments for under-performance, which in some business environments can simply be the misfortune of having a few subordinates or competitors who have (thus far) successfully run even greater risks than one has done in the recent past.

This innate temptation to exaggerated risk-taking, and the fear of economic regression which accompanies it, are very much greater in a system which depends so heavily upon rewards and punishments to stimulate economic performance. It is precisely the society which offers the greatest opportunities which has the most need of effective regulation. Those who wish to foster greater economic dynamism often oppose more (and even merely improved) regulation as an unnecessary weight which drags down personal initiative and discourages entrepreneurial attitudes. Often, such a call for relaxed regulation is itself a manifestation of the fact that opportunistic conditions have created increased incentives to game the system: a bubble may already be in the making. But it must be emphasized in responding to such calls for general relaxation that the need for effective regulation is also one of the costs of enhanced opportunity, the result of the concomitant insecurity which always accompanies a regime of high opportunity.

There is, of course, unnecessary, superfluous, or wholly counter-productive regulation, and there are regulations which have little to do with enforcing ethical business behavior or discouraging socially and economically dangerous levels of risk. If, as is certainly possible, the weight of regulation is found to be exacting too much of a toll upon the ordinary run of business activities, reductions in the regime should and must be considered. But, ceteris paribus, any significant lightening of the regulatory regime must reflect a real reduction of the risks and economic insecurities on the part of industry participants which create major inducements to cheat. Otherwise, the lightened regulatory regime will also result in a rise of abuses, scandal, and the eventual dysfunction of the industry originally targeted for strengthening. The need for regulation, and the degree of opportunity offered by the regulated system, cannot be considered in isolation; one is the mirror image of the other.

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