Unbridled and concentrated financial incentive might be a driver of economic activity, but it produces a ripple effect that can be detrimental to society. Self-interest, without doubt, drives entrepreneurs to do things that ultimately benefit society: they build companies that employ people, pay taxes, generate economic activity and even solve societal issues. But does that mean we should conclude that greed is good?
Self-interest and greed are not synonymous. Greed, in a financial or economic sense, speaks to an extreme form of self-interest that demands personal returns well beyond the innovation, effort or risk-taking invested. It exacerbates inequality and, perhaps more importantly, it weaves cynicism into the fabric of society. The repercussions of greed as a paradigm are numerous and reverberate throughout the economic, social and political aspects of our lives. We’ll focus on three:
An inverse correlation between inequality and social mobility. As inequality increases, social mobility decreases. It’s not supposed to be that way. Economic systems that reward entrepreneurship and hard work should create societies where individuals can move more freely from one stratum of society to another. Yet that’s not being borne out in practice. Inequality secures social benefits for the few. We can see this played out in higher education: spots in the best schools don’t really go to the best students from across the social spectrum. Deserving and talented students from difficult backgrounds often get stuck at the bottom. (Philanthropic efforts to counter such shortcomings exist precisely because the system itself does not).
Inequality increases pathology in a society. Income inequality predicts higher rates of violent crime within countries (and between countries). That shouldn’t really come as a surprise if we look at the missing link of fairness. A sense of unfairness is one of the first emotions we feel as young children and it does not dissipate in adulthood. It causes anger and despair. Anger at unfair inequality, and the despair that often accompanies it, results in crime, particularly in societies where the inequality is obvious.
The unfairness of inequality promotes cynicism. Only a small percentage of people commit crime due to anger or despair at inequality. A more common, lower order reaction to the unfairness of inequality is cynicism. In many societies there is an increasing view that the system is unfair and operates for the benefit of those at the top or for other ‘special interests’. Indeed, cynicism has a much more corrosive influence on society than inequality by itself, and even the crime that it generates, because it impacts so much of the basic infrastructure of society. We see it today vividly in the breakdown in trust between electors and the elected and in a declining trust of news media, right at the time we need the media to be holding politicians to account. The downward spiral is obvious. We are also beginning to see a backlash against perceived excesses by the technology giants, driven by cynicism engendered by their hegemony.
If these are symptoms of too much, or unfair, inequality in society, can we really go further and say that individual greed is a contributing causal factor?
Part of the problem with greed is that it distorts the notion of just reward. Greed is generally accompanied by an almost total failure to acknowledge the role of luck in financial success. Luck seems like an abstract excuse for events beyond our control. But luck is a real economic factor and it can even be quantified from the perspective of an individual. It is the difference between what is fairly deserved, for effort, ingenuity or the creation of equity, and what is actually received and it can be positive or negative – i.e. amounts lost through ‘bad luck.’ If society and individuals more openly acknowledged the role and quantum of luck, notions of unfairness, inequality and cynicism would be reduced.
In an economic, ethical and political sense, a proper debate could begin around what are justifiable economic incentives and returns in today’s society. This would have important implications for the economy, ranging from how to reward corporate executives to the regulation of banks and taxation policy.
Take share options: The concept of granting share options to managers is certainly well-intended, aligning interests with a view to increasing shareholder value. But extraneous factors often materially impact the value of those options – good and bad. Should the manager be rewarded because the economic policy of an incoming government causes a rise in the value of the stock of the company? Should a manager be penalized because of a ‘black swan’ event causing market panic? The problem is we are psychologically pre-disposed to disbelieve our success is down to factors beyond our control, i.e. good luck. (Although we seem to be OK with attributing our failures to bad luck).
Another area of the economy which might benefit from a refresh on the notion of balanced incentives is financial services. In certain segments, such as investment banking and private equity, one can argue that the incentives have tilted too far away from objective notions of just return. The fees are high, not as a percentage, but as an absolute number, because the deal sizes they attach to are so vast. And moreover, deal sizes increase directly in line with the expansion of the economy, meaning the absolute numbers have exploded, whilst the effort and ingenuity involved are the same as a generation ago. They are no longer, objectively, just. The excess amount of fees received by the participants today is simply the luck of being in the right place at the right time.
Pathological greed is self-evidently bad for society, but ‘benign greed’ can be too. Our notions of fair incentives should be reoriented by an acknowledgment of luck’s role in success and a sense of objective fairness. Successful individuals who have studied hard, worked hard, taken risks or been ingenious should be free to enjoy the fruits of those labours, risks and ingenuity. Society must encourage enough self-interest that extraordinary efforts, ingenuity and equity creation are rewarded with extraordinary personal wealth; the sort of wealth that can result in early retirement or philanthropy. The sort of wealth that we all recognize is deserved. In encouraging such rewards for individuals, the invisible hand will continue to provide the wider economic and societal benefits that Adam Smith had in mind. The kinds of benefits that citizens of rich countries have come to expect and those in developing countries aspire to. In doing so, we must have the humility and wisdom to ascribe an element of our success to luck. It will lead to better societal outcomes. Luck, for lack of a better word, is good.