Complicating labor markets

Over dinner tonight, I had an interesting interdisciplinary conversation with a sociologist who studies organizational behavior. I thought I’d share just one main portion of the conversation, because it has a takeaway that I think serves as both a compelling and an accessible critique of some classic economic theory. So here goes.

The sociologist I spoke with told me about some of her research on “leadership” in business contexts. I told her that I frankly thought most “leadership studies” were bullshit, motivated primarily by people who had to justify their own high pay and lofty positions without any reference to a tangible skillset. I also told her that I thought the field suffered from a lack of cynical descriptive realism — i.e., if we actually looked statistically and dispassionately at what defined “leaders” in large organizations (senior executives), we would come up with more traits like “over 6’2,” “related to and on friendly terms with lots of other rich people,” and “high levels of hormone x,” & etc. and fewer teachable character traits and maxims fit for best-selling books. She laughed and agreed, but said that there was some actual interesting descriptive social scientific research being done on leaders that wasn’t just mindless boosterism or maxim-hunting.

For example, she said, there’s been a lot of interesting research to pin down what makes star upper-middle level managers in organizations work very well. Think of the person who’s not quite in the c-suite, but whom employees might identify as a motive force behind the actual work that gets done among the mid-level engineers or whatever. Like a very exceptionally good project-manager. What’s so great about these people? What do they have right? Well, one interesting takeaway from the research is that these people don’t, themselves, seem to have anything — or at least it’s not something they have that makes them so exceptional. And the reason we know this is that it’s a very common occurrence to find that, when these people are hired away to other firms, they do not perform exceptionally well in those other contexts. And this indicates that the success of these upper-middle level managers hinged on their embedment within their particular social and organizational environment. So this evidence — that star upper-middle managers often fail when moved to different organization contexts — suggests that probably they were effective leaders not just because of anything inhering in their character itself, but because they’d built up networks and linked chains of trust, credibility, and authority, through a long (and, probably, at times, somewhat lucky and random) cumulative process.

Let me try to illustrate this idea with a story. Suppose Abigail’s been at The Company for 10 years. In year 1, she won the trust and admiration of her co-worker Benjamin through her hard work and personal kindness. In year 5, she got a promotion, which Benjamin viewed as entirely fair, given her hard work. She then became Benjamin’s boss, but they remained friends, and she even helped him through a tough time. Eventually, in year 10, the two of them both moved up another step, and Benjamin got his own hire — now Clarence, an engineer, is working for him. Clarence saw from his first day on the job how highly Benjamim thought of Abigail, and so he immediately started to admire her as well. From day one, he saw how the two seem mutually invested in each other and their shared projects, and so he learned to feel the same way. More, Benjamin, having long enjoyed a good relationship as Abigail’s subordinate, manages Clarence in the same harmonious way that Abigail managed him. Altogether, Abigail, Benjamin, and Clarence make a really great, harmonious team at The Company. And it’s not just about their collective organizational functioning. Clarence is even more creative on his individual projects as an engineer than he was in his previous job, because, now, the smooth and trusting way that he and Benjamin and Abigail all seem to flow together makes him feel rewarded, confident, and at ease — all stimulating his creativity.

So you can see how, in this story, this very functional team isn’t really dependent upon Abigail’s charisma or character traits, or whatever, but on the surprising ways in which her good deeds toward, and hence her good reputation with, Benjamin diffused throughout her hierarchy. She becomes a trusted leader and authority figure not simply by the logic of her own innate abilities, but by the logic of accumulating social network factors that take on a life and momentum of their own.

Now suppose that Abigail gets hired away to another firm, called The Other Company. The Other Company had been considering an internal hire, named Delilah, but eventually passed over the internal candidate for Abigail. So from the moment she shows up, Abigail feels some waves of resentment and hostility from her new immediate subordinate, Delilah, which diffuse down to the team beneath Delilah, many of whom also feel disengaged from their work by their feeling that they have not being given sufficient recognition by senior management, & etc. A vicious cycle of dysfunction, alienation, disengagement, and declining credibility commences, and, at this point, there’s nothing Abigail can really do to stop it.

In the real world these same basic kinds of processes take place through much more complex interactions among much larger networks, influenced by many more factors. But hopefully my story illustrates the basic idea. To put this more simply, it is a mistake to think as if “there are people who are leaders, and we can put them into a context in order that they may lead.” Rather the research suggests that is more accurate to say, “social contexts, themselves, create leaderswho are like nodes in a network that largely has a logic of its own.” In this conceptual vein, it doesn’t even analytically make sense to talk about a leader per se independent of a context. Leadership doesn’t inhere in a person her/himself; it inheres in networks in social and organizational contexts, and just who happens to fit in the right node is probably influenced by a lot of random, unpredictable, and surprising things.

***

This all strikes me as true, and was perhaps obvious to my readers who are less immersed in classical economic theory than I. But the idea stuck out to me as so marvelous and interesting precisely because it is so contrary to classical economic models of labor markets. I wrote about the basics of the economic theory of labor markets in my post on the theory of the minimum wage. But here’s another brief review: Imagine a competitive labor market in which workers of different skill levels can use capital and technology owned by firms to produce profitable goods. In this competitive market, your wage must approximate your “marginal productivity,” (i.e., the actual value-add of what you produce for the firm that employs you), because if your firm were paying you less than that, its competitors would stand to profit by hiring you away, paying you up to just as much as your marginal productivity. In economic thinking about labor markets, then, your compensation gets set not by any abstract notions of desert, or anything else, but in the same way that the price of any other asset gets set — by the intersection of the demand for and supply of the good. This theory comforts us that we don’t need to get caught up in tricky moral, ethical, or political debates about what various workers deserve, because these questions are answered by competitive markets, with your wage set equal to your marginal product.

But according to the ideas we’ve discussed above, your “marginal productivity” is not a fixed quality of you as a worker, but varies from one social and organizational context to another. And this seriously screws with the economic model of labor markets, in which workers’ wages are kept at the level of their marginal productivity by their ability to take that productivity elsewhere. Think about it this way: Suppose Abigail has a value-add (a marginal productivity) of $200,000 a year to The Company; but suppose that The Company and its competitor The Other Company have both read this blog post and so they know that she would only be worth $50,000 a year in the context of The Other Company. In this case, if these facts are all known, then The Company could get away with paying her only $51,000 a year — depriving her of 3/4 of her value-add. (And this suggests that also in a lot of other less extreme cases, the same basic mechanisms can keep workers from enjoying the full fruits of their productivity.)

It might be more realistic, though, to consider a world in which none of these facts is really known. That is, The Company isn’t sure how to quantify Abigail’s value-add, and The Other Company doesn’t know anything about Abigail either, nor about how she would perform in their work environment. So not only is it not the case that “the value of Abigail’s labor” is a fixed definite quality; it’s also not the case that there’s really any bidding for her labor going on. So what, then, determines Abigail’s wage and compensation in the real world? My conclusion is that the answer must, inevitably, be, “people, and their ideas.” These ideas include abstract ideas about desert, the needs of the employee (people get raises when they have families, even though this detracts from their productivity), etc., etc. Economists might have trouble with labor markets working this way, because it’s next to impossible to precisely model, and hence precisely understand, a world in which some prices get set by “people’s vague, imprecise, and highly biased ideas about what seems about proper,” but an ordinary person would note that this is obviously the way the real world works.

***

This, by the way, reminds me that I had  a conversation with my girlfriend this past summer, over a two-martini, one-cigar lunch (she’s a babe), in which she basically tried to articulate the ideas I’ve been talking through in this post, and I pushed back, and insistently mansplained the classical theory. So, sorry babe. Public apology here.

***

This all seems like an important insight to me, but I want to make clear that it’s not immediately obvious what the big takeaways from this line of thinking are. A pet peeve of mine is that many people seem to think that any good criticism of classic market-based economic reasoning immediately makes the case for more government regulation of markets — and they often don’t make the basis of that inference completely clear.

For example, here, one might reasonably argue that the fact that there does not exist a “competitive market” for the value that upper-middle managers create in their local organizational networks, such that these managers are not protected by their ability to move with their feet and so can get paid less than their “marginal product,” strengthens the case for legal regulation of payscales — e.g., forbidding firms to cut the pay of employees with 10+ years’ experience. At the same time, our reasoning here might also reasonably suggest that we would want to make it much easier for firms to fire people — because management’s desire to fire them is probably evidence that they did not have a high “marginal product” in that particular organizational context, and so we as a society should want them to leave and end up in a firm where they’d be better matched and more productive. And even these two arguments are very much on the level of abstract theory, without regard to the difficulties of legal implementation.

To me the major takeaway is that we have by no means reached a world in which markets are so well-functioning that we can now all stand back and allow the logic of competitive markets to make all of our decisions for us. We still need to depend on people willingly choosing to make ethical and moral decisions even when markets and governments aren’t forcing them to. If there is an upper-middle manager who has accumulated enough authority and trust that she is worth $300,000 a year to my company, but her productivity is so locally-embedded that other firms will only pay her $60,000 a year, I could get away with paying her 1/5th of her value-add. But I shouldn’t do it, because that would be the wrong thing to do. And she depends on that. That factor — morality and interpersonal trust — still needs to be there for our economy to function.

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Cut Law School to Two Years

Apparently, some important and influential people are considering rule changes that would allow prospective lawyers to take the Bar exam after only two years of law school, rather than three. Two legal professors have endorsed this rule change in an op-ed in the New York Times. I agree with the reasoning in the editorial (so do go and read!), but I would just add three extra points to it:

(1) Information technology should change how we think about credentialing for a lot of professions, particularly law. I work in academic research, and I and my co-workers have a saying about information/data: “If I can’t find it in 10 minutes of Googling, it almost certainly doesn’t exist.” As more and more data comes online, and as online platforms become better and better at organizing it, it will soon become the case that, “if I can’t find it in 2 minutes, it certainly doesn’t exist.” Why does this matter? Well, part of the idea behind the formal certification of lawyers (i.e., requiring three years at an accredited law school plus passage of the Bar exam) is that, once upon a time, information was less handy, and so you wanted to guarantee that the people who advertised themselves as lawyers actually, well, knew the law, and had mastered the relevant knowledge up front. But today we have  fabulous, superior “extended minds”–with more memory and more data-storage capacity than our actual brains–available at our finger tips in the form of iPhones and PCs. So now, mastering a large body of knowledge and consolidating it into the memory in our grey matter is less important, because we can extract the information more easily and reliably with a few searches. Does this mean that there should be no accreditation, and anyone should be able to declare herself a lawyer now? No, certainly not. But it does mean that the things that law schools need to focus on imparting are different.

In brief: As long as you can access and search legal information very quickly and easily, your up-front mastery of a body of knowledge becomes less and and important, and four other things become paramount: #1, your basic raw intelligence, and the ability that gives you to quickly understand, interpret, and argue about the legal information in front of you; #2, your work ethic and conscientiousness; #3, your familiarity with and commitment to upholding the ethical standards of the profession; and #4, your practical knowledge of whatever specific legal area you’ll actually be working in. Prospective employers can already get plenty of information on how well you score on #1 and #2 by looking at undergraduate transcripts and LSAT scores, and interviewing you. #4 is something you gain only from actually getting a job and working your way up in a specialty. So #3 seems to me to be one of the only things we really need law schools specifically and primarily to impart. And I for one think they should be able to do so at less expense than $200,000 and three years of a bright young thing’s life. (Obviously, the scheme I’ve laid out is imperfect — interpreting legal writing mostly requires a lot of raw intelligence, but getting cold-called by legal professors and debating with your classmates for a while can’t hurt in laying the groundwork. And, on the other hand, a good employer, not just professors, will also teach you to respect the ethical standards of the legal profession.)

(2) A general pet peeve of mine is that there seems to be a kind of taboo against talking explicitly about the economic and moral value of cheapness. The writers of the editorial above give a lot of lofty justifications for two-year law schools without talking directly about the most immediate one. Law is so lucrative, and legal services are so expensive, precisely because the supply of lawyers is constrained by the difficulty and expense of obtaining a legal degree. So if you make it easier for talented people to enter into and compete in the legal-services market, you would definitely drive down the price of legal services. (And you also probably improve the quality of legal services (by encouraging more innovation, as more creative young minds compete to find new and better ways to deliver legal services.) Prospective lawyers will require lower wages when they’ve sunk less of their life and debt into preparing for the profession. We consumers of legal services — and we consumers of goods that are provided by businesses that pay for legal services — will pay less. Cheaper legal servies should be reflected in extra cheapness almost everywhere else, and make life for middle-class people easier. And that’s a really good thing that shouldn’t be forgotten or denigrated.

(3) Have you ever actually talked to a third-year law student? They all confirm that being a 3L amounts to a $70,000 year-long vacation. This is great deal for law students who aren’t very eager to make their way into the working world and for law professors whose services are consequently in higher demand — but it’s bad for pretty much everyone else.

Toward a foundational business ethics

One thing that bugs me is that intellectuals are generally pretty uninterested in the business world. This is really bad for two reasons. (1) It means a lot of business ideas lack intellectual rigor, since they haven’t been subjected to sufficient scrutiny. (2) The human/social world is mostly the business world—business is what most of us spend most of our waking hours doing, it’s how most of our needs are met, etc. It seems a little crazy that modern moral philosophy is more frequently used to set a foundation for political theory, as opposed to business ethics, given that in modern global capitalism, private firms control far more of our resources and are just generally responsible for more of the activity going on in the world. If we want to create an ethical society, then, it would seem more immediately urgent to elucidate the ethical obligations of businesses than governments.

So this post will just be a little preliminary sketch, where I’ll try to link up some fundamental moral philosophy to some ideas about the obligations that firms in the private sector have. This sketch will be (naturally) sketchy, but I hope it will provide a sort of skeleton that later, more specific discussions could flesh out.

 

All of moral philosophy, in brief

Most of the contention in contemporary moral philosophy boils down to, essentially, the trade-off between deontological moral obligations and consequentialist moral obligations. We usually elucidate this trade-off using a lot of grotesque thought experiments involving fat men on train tracks, brains in vats, etc. But I want to use some less unpleasant thought experiments involving pie.

Suppose you have a piece of pie which you cannot divide, and you have to give it to one of two people. These two people are pretty similar, with one exception: Adam is absolutely crazy about pie—he just goes wild for pie. Brian likes pie alright, but he’s not crazy about it. To whom should you give the pie? Clearly, you should give it to Adam. He’ll get more pleasure and happiness from it. The sum total of human happiness rises more when Adam has the pie, and you might infer our moral obligation is to promote the ‘greatest happiness for the greatest number’ of humans and other sentient creatures. This is a ‘consequentialist’ justification for giving Adam the pie. Suppose now that you have to choose between giving the pie to Cecily and Delilah. They both like pie an equal amount, but the main difference between them is that Cecily is poorer and hungrier than Delilah. Clearly this time you should give the pie to Cecily—because her basic needs have not been met as well as Delilah’s, she’ll get more extra marginal happiness from the pie. So this is, again, an argument from the ‘consequences’ on total human welfare and happiness. Or suppose now that you have to choose between giving the pie to Edward and Frederick, who are equal in every way, and this time you can divide the pie. The ethical choice would seem to be to split the pie in half, both out of respect for fairness, and because there are ‘diminishing returns’ of happiness for each extra bite of pie you eat, so you achieve the most total happiness by giving each person half.

In each of these cases the ethical choice seems to make sure that pie gets allocated to people in a way that maximizes human happiness. This is our ‘teleological’ or ‘consequentialist’ moral obligation. So does ‘be ethical’ just mean ‘maximize the sum total of human happiness’?

Not always. Let’s change up the first thought experiment. Now this time, you’ve already promised that you would give the pie to Brian. You would still maximize the sum total of human happiness by giving the pie to Adam, but this would require violating your promise, and we intuit that this is intrinsically wrong. Or suppose this time, Brian has a piece of pie on his desk, which you have the ability to steal and give to Adam. Since Adam likes pie more than Brian does, this theft would increase the sum total of human happiness and welfare in the world. But should you do it? Most of us would say no. We intuit that this theft would be intrinsically wrong in itself, as a violation of Brian’s natural rights, and that the moral obligation to respect Brian’s property and rights overrides the moral obligation to maximize human happiness. In short, the means don’t justify the ends. In modern moral philosophy, we call these restrictions on the means we can employ in achieving an end our ‘deontological’ obligations.

BUT (!) then again, there are also times when ‘consequentialist’ factors get so big that they override ‘deontological’ concerns. For example, if you’ve promised the pie to Adam, but Brian is literally starving, then you clearly should, in this case, violate your promise in order to save Brian’s life.

Most of modern moral philosophy, it seems to me, is just one long continuation of this endless series of thought experiments that seek to clarify when, where, and how strongly we put deontological overrides on consequentialist obligations and vice versa.

 

What is a firm?

How does this foundational moral philosophy link up to businesses? There are two basic ways you can think of this. First, a business is a human institution, and its decisions are ultimately decisions made by real people—people’s fundamental moral obligations qua people don’t go away the moment they assume a professional role. Second, a corporation is also, in a sense, a tool of its owners (investors), and since tools are extensions of our agency, we’re responsible for what our tools do in the world. For example, if I make a robot as a tool to fetch my lunch every day, I can’t disclaim all moral responsibility if the robot runs an old lady over and kills her on the way back to my office. I can’t say, “the robot did it, not me!” because I was the moral agent behind its deployment in the world, and I should have taken steps to make sure it was safe before I started using it. In the same way, if I as an investor make a corporation as a tool to double my wealth, I can’t disclaim total responsibility for what this tool does to the world.

So firms’ moral obligations have to be linked up, somehow, with our obligations as human beings. I would argue that it’s that simple. Just like people, firms have deontological obligations to keep promises, respect contracts, and not violate any human rights; and just like humans, firms have consequentialist obligations to maximize human welfare whenever this is consistent with not violating their deontological commitments; and, just as with humans, there are a lot of tricky spaces where deontological obligations come into conflict with consequentialist obligations, and it’s not clear what’s right.

I want us to keep that paragraph, above, in mind. But now I’m going to go off on a brief discursion about two common arguments I’ve heard about corporate social responsibility and business ethics which I think don’t stand up to analytical scrutiny. So after I’ve disposed of those, I’ll go back to the above paragraph and explore its implications.

 

Some unsound arguments

(1) One argument I’ve heard recently is that corporations’ fundamental moral obligations—or, to use vogue term, Corporate Social Responsibilities (CSR)—derive from their ‘agency relationship with society.’ Business-school academics like to put it this way, because we commonly talk of the ‘agency relationship’ between stockholders and firms. That is, we conceive of a corporation as a collection of stockholders getting together and pooling their savings together to take ownership of a firm, and then hiring a management team to run the firm in a way that will maximize the value of their shares. Because managers are agents of the stockholders, and the capital the company deploys actually belongs to the stockholders, managers are obligated, by their very acceptance of their employment, to serve the stockholders’ financial interests rather than their own.

If a business does have an ‘agency relationship with society,’ where does it come from? Business academics often rely on the argument that corporations are legal entities that are chartered by state governments, which then privilege the corporation with the rights it requires to make its profits. So because the government—which is an agent of society—endows a business with the things it needs to exist, a corporation is an agent of society in addition to its stockholders. That’s the idea.

This argument sounds nice, but I don’t think it’s analytically sound. First, the argument is fundamentally circular. For example, it’s easy to imagine a world in which things exactly like corporations existed, but weren’t chartered by state governments. In this world, private companies that wanted to raise capital from the public could go directly to private stock exchanges, and these private stock exchanges would have an incentive ( in order to protect their own reputations as good places to trade) to require the private companies to adopt certain internal controls that would protect their prospective shareholders. So a corporation qua corporation in the abstract does not itself require a state charter in order to exist; rather, companies pursue state charters precisely because the government legally requires them to do so in order to list publicly. So the argument ‘because corporations require state charters from the government, they become agents of society,’ is circular, because it is the government that requires public corporations to get state charters in the first place. This would be like the government requiring you to register for permission to breathe, and, having generously granted you that permission, inform you that you have consented to military conscription—“after all, were it not for us, you would not be able to breathe.” I, for one, would argue that I had a right to breathe prior to the government’s generous permission.

Second, the argument has troubling implications. If firms’ obligations come from being chartered by governments, do sole proprietors have no moral obligations to society? After all, a sole proprietor’s business is not legally distinct from her self. There’s no charter, or anything, involved here. Does this mean that we as a society have no right to expect a large sole proprietorship to, say, internalize the costs of its environmental externalities? I think the answer is clearly no, and so my foundational argument—that businesses have moral obligations because they are made of people who have moral obligations—is a much firmer basis for thinking about corporations’ obligations.

(2) Another line of argument I hear frequently hearkens back to Adam Smith, who famously wrote,

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

In other words, firms do good things—satisfying our needs and wants—by pursuing their own ‘selfish’ profit-motive and so, given that, it’s stupid to get all romantic about their moral obligations. People go from this to say something like, ‘the obligations of firms are economic, not moral.’ (This statement, of course, is self-refuting (‘obligation’ and ‘moral’ mean the same thing), but people say it.)

I think Smith’s basic idea is descriptively true. By and large, firms engage in economic transactions between consenting adults, and compete to do a better job meeting our needs and wants—all terrific moral things that are directly coincident with their economic interests. This is by and large true. The problem is that this argument does not say anything about foundational ethics, and so it does not provide any guidance for what we should do in the cases where this is not the case. For example, it does not tell us what to do about a firm that pollutes the air I breathe (which I do not consent to), nor does it speak to my intuition that, actually, sometimes I do rely on the benevolence of private firms—for example, in my hope that a firm will not immediately fire me if my productivity declines due to an unpredictable illness or pregnancy, even when this would be the ‘economically rational’ thing to do.

 

My argument

So I think both the ‘agency relationship with society’ and the ‘moral language is not useful for understanding and directing business activity’ arguments are analytically unsound. So what do I propose as a better approach? Very simply, it’s that people’s moral obligations don’t disappear when they take on a management role or invest in a company, and so figuring out what companies should do just involves figuring out how to properly apply, in a business context, the fundamental moral obligations that the people involved (managers and investors) already have as people. I’m going to try to make some fundamental applications clear with some thought experiments, and then see how that applies to some real things.

Suppose you agree to a business arrangement with a friend wherein she gives you $100, and you promise to walk across the river and put the money into a machine that magically makes it into $200. You’ll return the money to her, and she’ll give you cut of the profits—$20. You’ve made this promise—a contract. Now suppose that as you cross the river, you encounter a graduate student who asks you for the money—and he’s a lot less rich than your friend, so actually $100 would make him a lot happier than $180 would make her. Do you have an obligation to give him the money? I don’t think so. Being a poor graduate student sucks, but it doesn’t suck enough to compel you to violate your promise to your friend and give away her money without her consent. If you think the graduate student’s case that he deserves the money is really strong, you have another option. You could go to the money machine, get the $200 bucks, bring it to your friend, claim your $20 fee, and try to convince your friend to give away some money herself—and even throw in some of your fee.

Now suppose that, as you cross the river and approach the money machine, you see a burning building in which three children are trapped. You know that if you try to rescue them, the cash will get singed and be unusable. Do you rush in? Of course you do. This is a no-brainer. Three innocent freaking lives versus your promise to bring $200 to your rich friend.

As you can sense, I’m trying to make this a close parallel to the relationships between stockholders and the firms they own. Individuals place their own money under control of the firm’s managers, delegating to them the task of producing a good return. And this act gives the management a deontological responsibility to make good on their implicit promise to shareholders, but it does not negate their responsibility to caveat that when the consequences are high enough. This means, in short, that a firm should not just go around doing every good deed imaginable, considering itself  personally responsible for the happiness of local graduate students, but nor can it stand by while innocent people to come to physical harm while it pursues superior profits. When the costs and/or benefits to humanity are sufficiently high, a corporation is obligated to sacrifice its investors’ interests—but it shouldn’t otherwise be a busy-body do-gooder.

In between those extremes, there’s a lot of ethical fuzziness, just as there is for people. And, just as with people, the way for firms to approach these situations is to try to figure out what to do by conversing empathetically, openly, transparently, and rationally, and with thought experiments.

So let me think about a trickier situation. Suppose now that, having finally crossed the river and arrived at the money machine, you realize it is more complicated to operate than you had presumed. You realize you’ll need to hire somebody to help you. Unfortunately, there’s a lot of unemployment in town right now, so people are quite desperate for work. You know that you could find someone to do most of the work in cranking the money machine for $1—5% of your total fee. This raises two ethical questions. First, how much are you obligated to pay your hire? This is unskilled labor, in higher supply than demand, meaning it’s cheap—but it’s also not pleasant labor. Your sense of fairness might compel you to want to roughly split the fee–$12 and $8 or something. Then again, maybe you wouldn’t have taken the job if you’d known you’d only come away with $12, and you know that you alone can’t really do much about the plight of the poor and unemployed in the town—who are the responsibility of society as a whole—so you consider paying your hire only $2.50. If you go through with this, how do we evaluate your choice? It surely wasn’t grossly immoral—the hire agreed to work for $2.50, so surely she believed she was being made better off. But what seems worst in this arrangement isn’t just that the worker gets so little, but that you and your friend get so much from it. Have you done a moral wrong? And second, has your investor-friend, who hired you for this job, been morally implicated in the exploitation of this worker?

As you can sense, this parallels a lot of the really tricky issues in management compensation–tricky both for the people who set compensation in the firm, and for investors in firms with grossly unequal payscales. Economic inequality in the U.S. has risen to truly unseemly levels; exploitation of workers is easy in periods of long, sustained unemployement. And compensation practices for senior management at major firms are seriously morally problematic—boards of directors sign off on the bonus recommendations of compensation consultants who used skewed and self-fulfilling samples of peer compensation and who have themselves been hired by management, and, incredibly, these same managers may sit, or expect in the future to sit, on board that sign off on the bonus packages at firms where their directors serve as managers. In short, compensation for senior managers at major firms in the U.S. often looks less like a competitive market for extremely skilled leaders, and more like a self-serving insiders’/old boys’ club. There’s a lot of work to be done for shareholders’ rights activists to make executive compensation actually competitive.

But it’s not clear what can be done, on the other end, for the bottom of a firm’s compensation scale. If you as a shareholder or manager try to get your company’s workers paid a lot more, and your competitors don’t, the extra cost could put you out of business—no favor to your employees. If the government tries to raise the minimum wage too high, it could potentially accelerate outsourcing, or incentivize firms to substitute more capital for labor. Again, no good for your workers. One option would be for workers to try to unite in solidarity internationally, but I’m not sure that’s always worked out in the past… The best option would be for deeply ethical managers to willingly accept modest salaries,with offsetting boosts to their workers’ wages. But the problem with this is that “people should willingly choose to make enormous personal sacrifices for those less fortunate than themselves” is theoretically a great solution to every problem. In other words, it doesn’t happen.

So the point of these thoughts on compensation is there are some basic, clear ethical things we can say about businesses, and then there are some areas where all the implications of these basic things get bewilderingly complicated. The basic clear thing maxim is, “a corporation should devote most of its effort to meeting its commitments to its owners, by earning a profit through the sale of goods and services to meet customers’ demands. But in the process, it may not effect any gross outrages against human dignity, and it should try to do what good it can, when this is consistent with its primary obligations.”

 

Implementing business ethics

So now that we’ve sketched the underlying theory about fundamental obligations, let’s keep progressing toward more realistic thought experiments. Suppose you’re a major shareholder in a major corporation. Suppose you’re from a second-tier rust-belt city where the company has some plants, and you really love and romanticize your hometown. Does it make sense for you as a shareholder to use your votes to get the firm to make some big community-effort push to revive your city? I would say: certainly not. And there’s a very simple reason for this. The cost of any charitable effort like this would inevitably come out of profits, which ultimately belong to shareholders, including yourself. So what makes most sense—not as a matter of fundamental moral theory, but just a matter of practicality—is for you to encourage the company to return as much value to shareholders as possible, then pocket your dividends and capital gains, and lead the charitable effort to revive your downtown yourself. This is the most moral and practical thing to do. First, other shareholders in the company might have good reasons for not thinking that a hopeless attempt to revive your city’s downtown is the world’s highest moral priority, and you should respect that view; second, the company’s management doesn’t live in your city and so they have less local knowledge about the city than you do, so they’re less well-positioned to invest wisely in its revival.

The point of this thought experiment is that it is strange, for me, to hear shareholders encouraging firms to give more to charitable causes. After all, the cost of that charity has to come, eventually, out of shareholder equity, and so it would just make more sense for the shareholders to demand that management go about maximizing that value, while letting the shareholders themselves choose to which charitable uses they wish to put it. And a big takeaway from this line of reasoning is that a lot of unambiguously-good sounding exhortations to firms to “do good!” don’t actually make a lot of sense when you think about their underlying economics.

When does it make sense for a firm to do something charitable? I would say there are a couple of conditions under which it makes sense. The first is whenever a charitable effort is consistent with improving shareholder value—if sponsoring an arts festival improves your brand image enough to compensate you for its costs, that’s win-win. You did a good thing that also returned more value to your shareholders, who can do their own good things with it.

The second condition is when your company is, due to either its expertise or position, uniquely well-positioned to do a particular charitable good deed—i.e., when the company can do a charitable thing that its shareholders would not be able to do if the money were in their own hands. In these case, you could borrow from the language of trade economics to say the firm has some ‘comparative advantage’ in a particular ethical task. For example, I think savings and financial literacy are really important for low-income people. Unfortunately, I lack the ability to set up my own charity to provide financial education and special high-incentive bank accounts for low-income people. In this case, it makes a lot of sense for me as a shareholder in any given bank to use my vote to encourage them to set up a pro-bono division that provides those services. Since finance is their line of business, they’re the best people in the world to provide this kind of education. Similarly, it makes a lot of sense for an operations consultancy to do pro-bono work on disaster relief, since they’re highly expert in supply chains, etc. It makes sense for a coffee company in Colombia to pay above-market wages if they can, since we shareholders, located mostly in the U.S., have a lack of charities that could boost Colombian workers’ wages more directly…

But otherwise, I shouldn’t expect a corporation to do lots of charitable good deeds and donations. I should expect it to give me my dividend, and I should do them myself.

How to beat the market in happiness: Find your weirdest useful proclivity

The coolest thing about economics is that once you learn to construct and reason with simple models of how markets work — with suppliers and users of goods competing to bid up and down the value of goods until supply matches demand — you can apply these models to gain interesting new understandings of a wide variety of phenomena outside of what we normally think of ‘economics.’ So today I want us to learn just a little bit of financial theory, and apply that theory to the question of “What the hell should I do with my life?”

So, here goes: One of the most basic, fundamental ideas in financial theory is that in a competitive market, every asset should, controlling for risk, have the same return over time. And the explanation of this is actually incredibly, incredibly simple. If two assets were equally risky but one asset was bringing a higher return (a higher yield if a bond, or a higher reliable dividend flow if a stock), everyone would want to get out of the lower-yielding asset and into the higher-yielding asset. So they would bid up the price of the higher-yielding asset, and bid down the price of the lower-yielding asset, until the two assets had the same return/yield. It’s very simple. And this theory can be extended outside of what we normally think of financial markets — the stock market, etc. — to include all kinds of investment in all kinds of things. In this simplified theoretical model, we should expect a single “rate of return” on all capital invested across all businesses and industries and asset classes as long as they are competitive and liquid. There are more or less only two ways you can beat such a competitive market: (1) you can be willing to take on a lot more risk than other people (in which case you’re not truly beating the beating the market, just tolerating more uncertainty than most, which is probably unwise overall); (2) you can be right about some prediction about the future of an asset when everybody else is wrong. Keep in mind #2 here — it’s not enough to make an accurate prediction that “this company is going to get big.” You need to make that prediction correctly when most people are arguing against it. Because if you’re right about your prediction, but other people are too, then they’ll have bid up the price of the asset. So, bottom line: you need to be right about an unusual, countercultural prediction, to beat the market. Keep this in mind for later.

Now we can do a very basic extension of this idea into another field — geography. There’s a theory in regional economics that suggests that, in a mobile world, there should be “spacial equilibrium in happiness” across different regions. Think of it this way. Every person faces the choice of whether to live in a less dense suburban/rural area or a dense city. Dense cities offer a lot of cool amenities — legacy cultural institutions, hip coffee shops, other people to network and sleep with, etc. But these amenities attract a lot of people to them, which in turn bids up the price of real-estate, makes congestion unbearable, etc, which, once  it reaches a certain point, cancels out the value of some of those attractions. It’s not obvious which option — city or suburbs or country — provides an average representative person with a better quality of life. Indeed, if it were obvious, then lots of average, representative person would move from city to suburbs, or suburbs to city, thereby changing the price and congestion factors above, up until the point where the next average, representative person stayed put. You can apply this same basic idea to think about how people choose whether to live in Boston, with bad weather but lots of nice legacy cultural institutions, or Florida, with great weather, but less culture. So we predict “spacial equilibrium in happiness” across regions in this simple model.

Now, I anticipate a couple of good objections from readers. These objections will require us to modify, not completely overturn, our model here. Objection #1 is: “This can’t be true — surely people in Silicon Valley are happier than people in Detroit, Michigan.” And I’m sure they are. But this happiness differential can’t be explained by anything inhering in the regions themselves — if it were, Detroiters should simply pick up and move there. Rather, the reason people in Silicon Valley are happier is that they are largely lucky enough to have acquired a skillset that gives them a lot of power in labor markets in our technological era, allowing them to demand things they want (high income, lots of freedom) in return for their skills. That is, the people in Silicon Valley (not the place per se) are different, and that’s what makes them happier, and that’s also what makes Detroiters unable to pick up and move there. So we can have differentiation in levels of happiness so long as people have different skills that benefit them to different extents, and only some regions have industries that attract the most highly-skilled. Objection #2 is: “No, there’s no equilibrium. I am definitely, definitely a city person.” And I certainly understand this. I’m the kind of person who, at this stage in my life, feels this way. But what I’m really saying by thinking this is not, “there is no spacial equilibrium,” but rather, “I am the idiosyncratic kind of person who requires less space but more stimulation than the average person, and so that means the city is the right place for me.” That is, a rational choice about where to live involves thinking not just about what is objectively the best location, but how you idiosyncratically differ from the regular, median person who’s at equilibrium between the options. And your idiosyncracies can certainly vary over time — most of us put more weight on stimulation in our twenties, and more weight on space, decent schools, etc., in our thirties. So as long as people have variation in preferences – i.e., idiosyncracies — there can be a clear superior option for any one of them.

But the basic takeaway here is that, given that “markets” in mobility should keep different areas about equally desirable to an ordinary person, your thinking about the question “where should I live?” really hinges on the question “How am I different from the median American?” In a vague and indirect way, this parallels how you have to think about financial markets: In order to invest well, you can’t simply ask, “What industry is growing?” You have to ask, “What is everyone else wrong about?”

A very interesting application I’ve been thinking about recently, obsessively, all the time, is my career choice, which I expect to make within the year. Here’s how I’m thinking about this, theoretically. Suppose you’re a twenty-something in college. You’re pretty sharp, and expect to graduate with a decent GPA but you’re not a huge math/science/computer whiz, and don’t think you could tolerate six years of graduate research in a PhD program. Two careers that have likely occurred to you are teaching and the law. Suppose your only criterion for making this choice is: “Which will make me happiest?” Well, an interesting implication of the market reasoning we’ve been doing so far is that, if most other prospective lawyers/teachers are like you, and if they’re also asking “what will make me happiest?,” then we should expect the two to make you equally happy. Again, the reasoning is very simple. The two careers trade off different goods. Law gives you much more money and more room for promotion. Teaching gives you maybe more intellectual creativity/expression, more freedom, more personal/moral fulfillment, and less risk from taking out huge loans for law school. If it were obvious that, given this trade-off, law gave people more personal happiness, then you would expect most bright young kids like you to flood into law as a career choice. This competition to get legal jobs would, in turn, drive down the wages, or drive up the hours, of young lawyers until it was no longer so clear that law was the better option.

Now I hope you can see what I’m getting at here. If there are lots of  people like you “competing” to find happiness, and people like you have a certain set of career options, you should expect all of those careers to provide about equal amounts of happiness. If one were a much better option, people would flood to that career, increasing the ‘supply’ of labor in that market, which would weaken each individual worker’s position, until the two careers provided equal happiness. So we expect “happiness equilibrium” among the careers available to a given person. Am I saying that people in different careers are equally happy? No. I’m sure Google software engineers are generally happier than tax drivers — but this differential is explained by differences in skill sets, influenced by luck and path-dependent choices that trace back to early childhood. That is, it is explained by the fact that, at this point, a cab driver cannot become a programmer and thus restore equilibrium.

So let me make the relevance clear here, by going from theory to my actual dilemma: I need to decide what to do with my life. I need to think about a couple of things. First, there’s one fundamental constraint: I need to supply the world with a good that it demands, in order to make a living, and in order to be an adult. Beyond that, I want (who wouldn’t?) to achieve above-average happiness. Now, our theory suggests this should be hard to do — since there are a lot of other people like me competing for happiness, they’d all have shifted into any career path that would have made me especially happy. How can I ‘beat the market’ in happiness? Let’s go back to our two examples so far. The way to beat a financial market is to (1) take a huge risk, or (2) find something that everybody else is wrong about. (1) isn’t for me. I’m frankly risk averse — being in a position to provide for a family within the decade at the latest is pretty much a non-negotiable priority for me. (2) would be great, if I could find it — but, if I think I’ve found a career everyone else is wrong about, I would need need to have very good reason for thinking I’m right and everyone else is wrong. So let’s keep (2) in mind. Now think about the geography example. How did we beat the spacial equilibrium in happiness between regions? Again, the key is not to think about regions per se, but to think about how I differ from the median person — not, “what do I value,” but, “what do I value more, relative to others?” This seems very applicable to a career choice. If I’m unusual in some way, that gives me a way to get past the career equilibrium in happiness. If I really, genuinely, care about money much less than a typical person, that fact makes me different from the median person who is keeping those two careers in happiness equilibrium, and I should choose teaching over law.

So I need to find something that I can do that (1) is useful to the world, as represented by people being willing to pay for it, and (2) that particularly appeals to my particular idiosyncracies. In other words, I need to find some weird  thing about me that is useful. I need to find my own personal monopoly, to prevent other people from competing away my above-market rate of happiness. Weird — idiosyncratic to me — and useful to the world. Those are the keys to career success. I should also keep an eye out for (3) a career that, maybe, for some strange reason, people are really wrong about.

As a middle-schooler I thought I wanted to be a professional long-distance runner; as an undergraduate, I thought I wanted to spend the rest of my life reading and writing essays on German philosophy. But criterion #1 eliminates these career options — it’s hard to get people to pay you to do these things precisely because people’s unmet needs in these spaces (4-minute miles from wan, gangly runners, and commentaries on Nietzsche) aren’t very large. #1 even may eliminate the possibility of journalism — it’s not clear what unique role full-time journalists have in the modern era, in which experts can reach the public directly via their blogs and Twitter feeds, and this is precisely why it’s so hard to get paid for writing as a career. So what else? Well, let me start out with criterion #2. Here’s something that’s weird about me: I really, really, genuinely love a lot of ideas in economics, business, and finance that other people think are really boring and dry. It’s one of the strangest things about me. Another weird thing about me is that, I’ve been told, I’m decently good at explaining these ideas to others. So if I can find a way to make providing these ideas useful to the world, that would seem to be my answer.

What are some options for doing that? One path seems to try to become a business-school professor — it’s not exactly the future I envisioned when I was dreaming of Olympic glory and Nietzsche’s reinvention of Dionysus, but it may be the place where the particular, idiosyncratic goods that I can supply best match up with the goods that the world is demanding. And the world is demanding more business education. Lucky kids like me get to dabble in liberal arts for four years and land on our feet. But, with our relatively bleak economic future, more and more people will want education that will, first and foremost, prepare them for a job. Managing supply chains, understanding markets, knowing how to do basic accounting — these things don’t sound super glamorous, but the people who do these things support the economic system that preserves the affluence and comfort and security ordinary people enjoy in America today. I’d be happy and proud to teach and prepare people for these functions in business careers.

Here’s one last thought on my career choice: We understood above that the best way to do well in a market is to find something that other people are really wrong about, or not competing for, for some reason. There’s a funny, salacious example of how this actually plays out. Economic theory suggests that every industry, asset, and product should, over time, provide about an equal rate of return and profit over time, due to competition. But I’ve read that there’s one product that, apparently, provides an abnormal rate of return: condoms. The reason for this is something we could call “embarrassment premium.” A lot of firms simply can’t find a way to announce in their annual reports that they are entering the relatively virginal territory of the condom market, without blushing. So the prices of condoms and other “embarrassing” goods haven’t been competed down fully. Can I find something similar in a career choice? My latest — somewhat inchoate thinking — is, yes. “Accounting” — the word itself — is such a turnoff to so many people, that business schools face a shortage of accounting professors, even though “accounting” refers very simply to the study of business information, and so the field provides the opportunity to research almost anything in economics. So my market reasoning suggests that the ideal career path involves finding the place where your personal idiosyncracies meet up with the world’s needs, and maybe finding something a little embarrassing, too — finding, in short, your weirdest useful proclivity.

***

This has been a kind of long, ranging, and at times personal post. But I hope the major takeaways for my readers are not about these specific issues (and certainly not about myself!) but about how to apply market-reasoning in surprising places. The basic financial theory — that competition should drive all assets to, over time, provide approximately the same value — can be applied to a lot of other arenas in which we face competition. A lot of parents these days think they can give their kids a leg up by teaching them Mandarin and computer programming. Teaching kids these skills is, I think, useful for its own sake, but it probably won’t give them advantages in the future, for the simple reason that other parents are also thinking the same thing, providing their kids with the same skills, which will compete down the value of those skills in the future. In order to give your kids a leg up, it’s not enough to find something that will be useful to them in the future — you need to find something that other parents, who are competing with you to provide their kids with useful skills, are missing/wrong about. Before you start your own business, it’s not enough to ask, “Is my business in lucrative and growing field?” You have to ask whether there is some reason that you are uniquely well-positioned to provide a particular good — otherwise, your profits and income will get competed away.

Etc.

***

One last caveat: All models are imperfect. But I think the greatest imperfection in what I’ve written here is that I’ve written as if people’s preferences and idiosyncracies are static. That is, this post accepts a kind of Platonic ideal in which a person has a permanent True Self with permanent qualities and characteristics, and that attempts to change or alter our tastes and idiosyncracies are an inauthentic betrayal of self. But I think the truth is that our brains are plastic and flexible, and we can, through effort, force ourselves to develop new tastes and likes and idiosyncracies. I think this is important for every young person to keep in mind in thinking about career choices. And I also think that, given that, our society ought to be doing a better job of urging young people to try to develop tastes for things that will also be useful to the world. Looking back, at my now-advanced age of 24, I wish that when, as a college freshman, I had said, “I do not like computers; I only love Nietzsche,” someone had told me, “Well,  work your ass off at an introductory programming course, until you do love it. You are capable of loving it, as some do; and if you did, it would be extremely useful to you. So screw your courage to the sticking place and try to change yourself into a person whose loves are more compatible with the needs of the real world.”