Separating Economics and Ethics?
July 12, 2009 by admin · Leave a Comment
The clearest explanation of the role of economic efficiency that I know of comes from an anecdote about a press conference held by Robert Fogel right after his 1993 Nobel Prize was announced. During the press conference, a reporter expressed outrage. One of Fogel’s controversial hypotheses was that slaveholders had limited their abuses of slaves, because slaves were valuable economic resources. Fogel asked the reporter whether a relative of the reporter had passed away. The reporter answered that his grandmother, indeed, recently had. Fogel then asked the reporter why he had spent thousands of dollars on funeral expenses, when economic efficiency would have suggested selling the corpse as dog food. Of course, Fogel’s goal was not to suggest more efficient methods for corpse disposal, but to point out that, just because an action is economically efficient and just because someone explains that an action aids economic efficiency does not mean that the action should be adopted. Economic efficiency is only one side of the coin. Never forget this! In these two cases—slavery and corpse disposal—efficiency seems like an entirely unimportant point. Incidentally, Fogel’s hypothesis is also just that—a hypothesis, not a fact. Given ample evidence of severe abuses, it may be difficult to believe either that slaveholders limited abuse, or, even less credibly, that slavery was an efficient means of production.
A good economist’s argument that counters many “ethical appropriateness” considerations is that it is better to first achieve the economically most efficient solution, and then use the money thereby saved/earned later for “better purposes.” In the reporter’s case, it might mean a cheaper funeral and donation of the saved money toward causes that grandma would have liked.
The same suggestion of “efficiency first, charity separate and later” appears in many economists’ A living wage?
arguments. For example, in Scenario 24 on Page 182, we consider the living wage, which is the salary necessary to maintain an average family. Assume that paying above minimum wage gains you no extra economic benefit, and assume that there are more than enough applicants to allow you to pay minimum wage. Should you pay a living wage to your employees? If you do, your firm’s profits will be lower. Your products may become more expensive. Your firm may lose market share, or even go out of business. So, most economists would suggest that you should pay market wages (minimum wage), and then spend the earned profits in a lump sum transfer payment to the most deserving causes (e.g., the poorest people and/or most deserving workers).
But unfortunately, our economists’ solutions are not as idyllic as we like to suggest. First, virtually every transfer creates allocation distortions and distorted future incentives. If paid once, why would it not be paid again? In the real world, there are no non-distortionary lump sum transfers. Second, who are the most deserving recipients? Your poor workers? Poorer non-workers? Even poorer people in the third world? There is good evidence that too many choices lead to “no-choice.” Indeed, in the real world, the economists’ voluntary lump sum transfers usually just do not occur.
An Insider Trading Case With Twists and Turns
July 12, 2009 by admin · Leave a Comment
Let us dive into a case in which all sorts of interesting economic and ethical issues arise. On Christmas 2002, Sam Waksal, CEO of ImClone, learned about negative interim F.D.A. test results on ImClone’s promising cancer drug Erbitux. He promptly informed his family before the test results became public knowledge, who sold their shares and thereby avoided millions of dollars of losses. In 2003, Waksal was indicted and sentenced to 7 years in jail for insider trading. (Ironically, the interim results only caused a delay. Waksal’s Erbitux seems to work and will probably save thousands of lives.)
Economists are divided on whether insider trading should be prohibited. First, informed trading aids market efficiency: it moves stock prices more quickly towards their correct values. Second, the zone between what constitutes illegal trading based on inside information vs. legal trading based on superior business knowledge can be rather gray. Third, the social cost of making sure that inside information neither leaks nor is exploited is very high, and we currently criminalize even many innocent slips.
But ignore for a moment whether insider trading should be legal or illegal. What is the right penalty for this currently illegal activity? Sam Waksal is one of the world’s top biotech experts. Some patients consider him a saint, though perhaps one with mild flaws, because his work has saved the lives of thousands of people. His incarceration will slow down the ongoing work of ImClone—a fact that could cost the lives of thousands more people who will no longer be able to benefit from what Waksal might yet have done. (What if Waksal’s efforts had saved or could save you or a family member?) Is it better to allow Waksal to forfeit a part of his fortune and thereby stay out of jail? The victims of his insider trading (the shareholders who bought the shares at too high a price) could be made better off. Cancer patients could be made better off. And Waksal would be made better off.
But there are problems with the financial penalty suggestion: If forfeiture became the sole legal remedy, would this be enough to deter future offenders? Could future insider traders avoid penalties if they sheltered their fortunes in shell companies? Would companies just make up the penalty for executives convicted of insider-trading?
More generally, should richer people, or people who have contributed more to society, or people who would contribute more to society (an economic gain that incarceration would destroy), be allowed to pay in order to get away with actions that others cannot get away with? We already can see some of this differentiation today: bail is more easily met by wealthier people, and many penalties come in the form of a choice to the offender: pay X dollars or go to jail. So, should we go so far as to allow richer people to commit crimes if this “can make everyone better off,” e.g., if we then had them pay ample compensation to the victims? What if they commit parking violations? breach of contract? speeding? fraud? rape? second-degree murder? first-degree murder? Where do we draw the line? (Consider that the victims could receive a lot of money that they might not otherwise receive. And consider that you could be the victim!)