Incentive to cheat

January 10, 2018

(This article was originally published at Statistical Modeling, Causal Inference, and Social Science, and syndicated at StatsBlogs.)

Joseph Delaney quotes Matthew Yglesias writing this:

But it is entirely emblematic of America’s post-Reagan treatment of business regulation. What a wealthy and powerful person faced with a legal impediment to moneymaking is supposed to do is work with a lawyer to devise clever means of subverting the purpose of the law. If you end up getting caught, the attempted subversion will be construed as a mitigating (it’s a gray area!) rather than aggravating factor. Your punishment will probably be light and will certainly not involve anything more than money. You already have plenty of money, and your plan is to get even more. So why not?

Yglesias’s quote is about Donald Trump but the issue is more general than that; for example here’s Delaney quoting a news report by Matt Egan regarding a banking scandal:

These payouts are on top of the $3.2 million Wells Fargo has paid to customers over 130,000 accounts over potentially unauthorized accounts. That works out to a refund of roughly $25 per account.

From an economics perspective, this is all standard stuff, falling under the category “moral hazard”: When the expected benefits from cheating greatly exceed the expected costs, there’s an incentive to cheat. If the difference between the expected financial benefits and costs is small, then the incentive is small or even negative, as there are reputational costs to being caught cheating, and most of us feel bad about cheating, also it can be difficult to persuade others to collude in an illegal scheme. But when the gap between expected benefits and costs widens, eventually people will grab the opportunity, and then others, seeing the rewards, will join in. Etc.

As the freakonomists say, “incentives matter.”

One question, then, is why is this sort of thing not discussed more in pop-econ? We heard a lot about why inner-city drug dealers live with their mothers—something to do with economics, I recall—but no corresponding chapter about how suburban pharmaceutical executives (that’s another kind of drug dealer, right? And I say this as a person who works in pharmaceutical research myself) are motivated to misreport drug trials. We heard about the incentives that encourage real-estate agents, auto mechanics, and doctors to rip you off, but not the ways in which the legal system gives an incentive for wealthy and powerful people to break the law.

This is not about Freakonomics, which is the product of two creative, hardworking people who can feel free to write about whatever interests them the most. I’m just using them as a convenient example.

Really my question is about how this particular incentive-to-cheat identified by Delaney and Yglesias is not discussed more. Why is it not the standard example among economists when talking about the effects of incentives? An incentive to systematically break the law—that’s a pretty good one, right?

Why don’t economists don’t talk more about the incentives for white-collar crime? I suspect it’s because many economists think of business regulation as fundamentally illegitimate. Not that they think all regulation is bad, but just about any regulation can make the typical economist a bit uncomfortable. Hence weak enforcement is perhaps viewed as a feature as much as a bug, and perhaps the mainstream view in economics is that it’s just as well that people in business will push against the rules.

Even if you oppose a law, it’s still a relevant point of economics and political science that weak enforcement gives an incentive to break the law—but maybe there’s something uncomfortable about making this point in a textbook or general presentation of economics. I don’t see it as a left-wing or right-wing thing, exactly, more that there’s something so upsetting about thinking that the system is set up with incentives to cheat, that we avoid talking about it unless we really have to. Cheating among sumo wrestlers, real estate agents, even doctors—sure, that’s unfortunate, but at least we can see our way to economics-based solutions. But a legal system that’s set up to reward cheating—that’s just scary, so better not to think about it. Or, at least, not to consider it as part of economics or political science, at least not most of the time.

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