397.  Power, dependence, control and trust

Economists shy away from discussions of power, because power should not play a role in supposedly anonymous market forces. Economists do talk of market power as a disturbance of markets by monopolies, oligopolies and firms erecting entry barriers to markets. That is to be fought by competition authorities. But power is more widespread. Power creates dependence. But it can also be positive. Even monopoly can be beneficial.

I use the (customary) definition of power as having influence on the choices of others. It can be positive, in an extension of options for choice, and freedom of choosing from them, or negative, in reducing them.

If for choice one is dependent upon another, than he/she has power over you. One can avoid or reduce that by avoiding him/her or by creating counter-power, by constraining the actions of the other. Trust is leaving room for conduct for others, control is constraining it. Control can result in a vicious circle of accumulating mutual constraint. A danger looms of excessive oversight and control.

What forms and sources of dependence are there? One is that the other has a unique offer, with few adequate alternatives. That is the power of monopoly. Or there is no way out, no exit: you are locked in. That is the power of enforcement. Or there are incentives to submit to power, for the sake of income, position, protection or prestige.   

How to deal with power?

One can fight negative power by constraining the room for power play, and punishing it by means of contracts, legal coercion. However, the specification of activities, rights and duties constrains action, and can act as a straightjacket that inhibits innovation. Contracts are also costly and may be difficult to enforce, particularly if it is difficult to monitor the partner’s conduct.

One can also exert direct hierarchical control by taking over the partner, becoming his/her boss. That is a cop-out: one does not face the challenge of collaboration between independent partners. 

One can also employ a reputation mechanism, where the partner will not cheat for fear of losing his reputation. Or one can use a hostage, in the form of some commercially sensitive  information one has of the partner, with the threat, often implicit, not pronounced, to divulge it when the partner misbehaves. The hostage may also take the form of a package of shares that one has in the partner’s business that one can sell to someone with the intent of a hostile take-over of the partner.

There are also more constructive, benevolent ways of dealing with power.  

In relations of collaboration there is the following ‘paradox of specific investments’. To create unique novelties, in innovation, connecting each other’s competences, one typically needs ‘specific investments’, dedicated to the relation, that have no use elsewhere. That makes dependent: if the relation breaks, the investment is rendered useless. If the investment is asymmetric, mostly on one side in the relationship, dependence is one-sided. On the other hand, if the investment makes you special, offering something unique, that gives countervailing power. A monopoly, in fact. This can generate a race not to the bottom but to the top: partners keep investing in themselves to maintain a unique offer.        

Another possibility is to demand shared payment and ownership of the specific investment. Yet another is to make the partner dependent in some other way, by offering some other unique benefit, such as access to a market, a brand name, special knowledge, technology, or a patent, or to some other resource (a lobby, perhaps).

One may also rely on other sources of reliability that are not oriented towards control, such as trust based on ethics or personal bonds of friendship, family, clan, or custom.

With the latter, however, one can get caught in systems of paternalism and enforced loyalty that do not allow for exit, thus imposing another constraint from power. Obligatory bonds limit the variety and freedom of outside contacts needed for learning and innovation.

Sometimes there is no alternative to such personal bonding, as in countries where there is no institutional basis outside personal relationships, such as a legal system to support contracts, reputation systems, or a shared ethic and morality. I found that to apply, for example, for different reasons, to Japan and the Ukraine.

In Japan the reason is a strong tradition of family values, which is now weakening. In the Ukraine the reason is widespread corruption and lack of a reliable legal and democratic order and justice.     

396. From optimal to adaptive

The assumption, in economics, that people exhibit rational choice that leads to optimal outcomes yields an excuse not to look at processes that may or may not yield optimal outcomes. That may contribute to simplicity, avoidance of complexity, but also leads to neglect of important realities, of actual decision making, conduct, market imperfections, and differences between industries. And when optimality is impossible, due to uncertainty, one needs a different, adaptive stance.  

It is needed, for government and management of firms, to act on the basis of insight in those realities. There is a myth afoot that for management it does not matter where you are manager, because it supposedly is the same everywhere, and that is not the case. Economic variables such as economies of scale, concentration, integration in mergers/acquisitions or alliances, entry barriers to markets, transaction costs, transparency of product quality, technology, knowledge intensity, uncertainty of markets, investments and their lead times, type of labour, importance of teamwork, fluidity of knowledge, etc. vary with industries.

On the macrolevel it is useful to see the economy and industries as evolutionary systems of variation, selection and transmission of what survives. State interference is then seen as exerting influence on those processes, rather than direct interference in conduct, though the latter may have to be part of it. In any case, an evolutionary, adaptive approach is modest concerning planning, especially planning of innovation. That  would be as if evolution planned, designed new species. There is little scope for ‘intelligent design’, as in biology.

In economies, variation arises from entrepreneurship and invention, selection is performed by markets and institutions, and the transmission of success lies in growth of successful forms, imitation, publication, and teaching. One can influence variation by enabling entrepreneurship, with financial and fiscal measures, and employing it in the innovation of public policies and services. One can further the selection by markets by preventing monopolies and oligopolies, entry barriers to markets, and other conservative ploys of existing firms. One can further transmission of success with policies concerning communication, information, education and training.

In the further filling in of the processes of variation, selection and transmission, important differences arise in comparison with biological evolution. There is artificial variation in combining genes other than by breeding, in genetic manipulation. Firms can influence selection by markets and institutions by political action, such as lobbying. They can test products before they are brought to market. Invention still involves trial and error, but it is not entirely random, as variation is in biology, because it is fed by learning, logics of inference and science.

The logic of adaptation in evolutionary systems avoids the problem of rational choice, on the basis of calculation, with probabilities attached to possible outcomes, that it cannot deal with uncertainty that is ‘radical’, in the sense that one does not know all that can happen. Given the impossibility to predict, due to uncertainty, and the consequent impossibility to find an optimal strategy, one can make use of scenario’s, alternative imagined possible futures, and seek a strategy that performs reasonably well across them, without optimality in any single one of them. One can use computer modelling, simulation, for this. In the development of products one can mimic evolutionary processes of variation and selection, as happens, for example, in the development of robots and algorithms.

On the level of the individual also, uncertainty has its implications, requiring adaptiveness. One should grow up to be robust under unforeseeable setbacks, be resilient, learn to fall and stand up, have reserves to fall back on, and be flexible and creative in taking new directions when needed, even when they are not known in advance.     

395. Individual and social

The theme of self and other has been discussed extensively in this blog, and a bundle of items on that theme can be downloaded from my website www.bartnooteboom.nl  A combination of elements from the blog and my 2012 book ‘Beyond humanism: the flourishing of life, self and other’, and my 2015 book ‘Beyond nihilism: imperfection on the move’, with the title ‘Beyond nihilism: self and other between Nietzsche and Levinas’ can also be downloaded from that website. Here I give only a brief summary. 

The human being is individual but not autonomous, as economists would have it. It is socially constituted, on the basis of interaction with others, and shared culture. Culture here is anthropological: habits and customs, but also an ethic and morality. While those may be shared, what is made from it becomes individual, along a personal path of life.

That yields diversity, or what I called ‘cognitive distance’, and that may hinder mutual understanding but also offers an opportunity, to learn, and to escape, more or less, from personal prejudice and myopia. For this, one needs to develop the ability to understand people who think differently, intellectually and morally. That also yields economic advantage, in a better ability to innovate by combining different ideas.

For its development, the human being needs recognition, acceptance and respect, in local communities with some stability, needed also to develop and maintain trust, but those communities also need some external contacts and some entry and exit of inhabitants, not to get mired in rigidity, myopia and prejudice.

Strong bonds of interaction and mutual understanding are difficult to achieve on a national level. That requires decentralisation of governance to municipalities or city neighbourhoods, with an elected mayor, council and citizen panels, with or without political parties. That carries problems, as discussed earlier, but those are not insuperable (see item 347 of this blog).

A second need is to put an end to the present excessive flexibilization of work, with more continuity of work and teams. That is good for the quality of labour and the quality of products, which require ‘specific investments’ in mutual understanding and trust, for which some continuity of relationships is needed, in order to recoup those investments, which otherwise would not be made.

For this, and for innovation, the environment, and a just future for the young, a perspective of the long term is needed. No longer the obsession with profit in the next quarter. If shareholders cannot muster this, then they should not have a majority in supervisory boards. Those would also contain membership from employees, customers, suppliers and the local community. The latter especially with a view to protection of the environment.

Economists will comment that then the price of capital will increase, because opportunities for profit are foregone, which would lead to lower prosperity. Yes: that would have to be accepted: a bit less prosperity for the sake of a more humane and sane society.

394. Rationality and heuristics

How could one still maintain, as economic theory did, that people make rational decisions?  Already long ago (in the work of Herbert Simon), theory took bounded rationality into account, but only in a limited sense. The idea was that the capacity for rational thought is limited, and should be used where priority is highest.

A distinction was made between substantive and procedural rationality. Procedurally, it is rational not to evaluate everything in a substantively rational mode. That makes sense and still applies. One encounters it again in Kahneman’s distinction between ‘system 1 and system 2’. The first is based on unreflected routines where one acts without conscious deliberation, while the second entails conscious, critical reflection.

Without routines, life would not be practically viable. Imagine that in walking, or driving a car, one must reflect on it. Then one would not have attention to where one needs to go, and why, and to talk with another passenger.

But there is more, as understood in more recent ‘behavioural economics’, which has adopted insights from social psychology, in the form of decision ‘heuristics’, shortcuts for fast decisions, which are procedurally but not substantively rational. Here is a survey of some of them.

The heuristic of ‘availability’ is that people pay attention to what is ‘available’, in the sense of forcing attention, being emotionally laden, as a threat or opportunity. That can go wrong, in an excess of impulse, neglecting less salient but still important issues, but it helps in setting the agenda for scarce attention. Also, the danger of routines is that they are also practised where they do not apply, and then emotion of danger or opportunity is needed to catapult one into critical awareness.

Another well-known heuristic is that of ‘loss aversion’: a perspective of loss (‘loss frame’) weighs more heavily than that of gain (’gain frame’). One goes to greater extremes of conduct to keep what one stands to lose than to gain what one does not yet have. In evolution, that contributed to adaptiveness: loss leads sooner to death or harm than gain does. This has a stabilising effect on relationships: the one who wants to break the relationship does it to gain, the other stands to lose, and will go to extremes to prevent it.

Another heuristic is to raise incidents tot the level of laws: ‘You always with your …..’, while it happened only once or twice. That is unreasonable, but can have survival value to respond in time to threats.

A fourth heuristic is that of ‘escalation of commitment’: the more loss one has incurred in a certain position, the more one commits to it, since ‘otherwise the losses would have been in vain’.  That is not rational: the past is water under the bridge and cannot be changed; one should look only at possible further losses in the future. That heuristic also works in favour of the continuation of a negative relationship. A classic example is that of George Bush, for whom it was difficult to withdraw from Irak, because then all the American deaths ‘would have been in vain’. It would also amount to an admission of having made a mistake, in entering. A new president, Obama was needed for withdrawal, and then he made the same mistake of increasing the commitment in Afghanistan.

A fifth heuristic is that of engaging only upon incremental deviations from existing policy, even if the initial position does not make sense, and a radical turnaround is needed.

A sixth is ‘cognitive dissonance’, where after a choice one only has attention for information that confirms that it was a good choice, not to what denies that. In a difficult to end relationship one only wants to hear the good things of the partner, and when one has broken the relationship only the bad things.

393. Openness, transparency and trust

Here I give an intermezzo, in the present series on economics, on an issue of trust that I came across.

In a Dutch newspaper it was said, recently, that transparency, with demands for openness about what is going on, is antithetical to trust, is a form of control.

By contrast, I have been arguing, in this blog and elsewhere, that openness is necessary for trust.

What now? Who is right?

I argued that openness is needed to demonstrate trustworthiness, in admitting errors before t

hey are detected by the partner, trying to mend the problems that result, and promising to make an effort to prevent similar errors in future, in the exercise of ‘voice’. It is voluntary

By contrast, transparency is imposed, not voluntary, indeed a form of control. It reduces the room for action for the other, and that is the opposite of trust, which is giving room.

The difference lies in what the partner is to be open about, and whether it is imposed or voluntary.

Now one might argue that if openness is needed for trust, it is no longer voluntary but necessary, imposed. A might demand that B be open, ‘or else’.

But A cannot enforce this: how does he know whether B is holding something back? He can only enforce his demand by specifying what B is to be open about. And the whole point of openness is that relations are uncertain, and you cannot specify in advance what can happen, so that it has to be left to B to tell what comes up and needs to be reported.

Demanding transparency, specifying in advance what needs to be reported, is part of the old control mode of managing relations, as if one knows what may come up so that one can manage it.

The point of professional work is that it cannot be caught in specific protocols, as argued and shown in the literature on ‘communities of practice’.

The discussion on transparency in the newspaper came up in the context of politics. That yields another point. There, the claim of transparency is that in a democracy politicians have to be open about policy making and negotiation while those are going on. That yields another problem.

Politics in a democracy is a messy business of finding a compromise between standpoints that at the start seem irreconcilable. In groping around for a solution one has to test concessions one might make, to see what concessions will be made in return, to try and achieve some balance. If during that process every move has to be in the open, in the trials and errors of compromise before a balance has been struck, constituencies will rise in protest, blocking the process.

How about openness there, then? After a balance has been struck one should bring the arguments into the open, with pros and cons, and put that to the electorate. And then one needs to be open in not parading it as better than it is, raising expectations one cannot fulfil, because that is most destructive of trust.

392. Greed and urge to manifestation

Theories of capitalism usually depart from the assumption of greed: the urge towards profit and income. People are driven to pursue them to survive, in a job or in a market, under the regime of competition, in shareholder capitalism.

But perhaps more important than greed and survival is the urge to manifest oneself: to ‘make a difference’, to be noticed, acquire attention or power. Salaries are not only sources of income but also signals of success in a power game.

The philosopher Plato spoke of reason as a charioteer that tries to reignin two horses: one of eros, desire, and one of thymos, the urge to self-manifestation. The philosopher Spinoza called it conatus. The philosopher Niezsche claimed that the urge to power is stronger than the urge towards survival.

One can appreciate that: it is also the urge of ambition, to ‘make something of your life’, and to ‘make a contribution to society’. That is also, more than profit, a drive for independent entrepreneurs. And they feel wronged when set aside as mere money grabbers.

An outcome of a mountain of research on happiness is that happiness consists of a combination of ‘pleasure and purpose’, in giving ‘sense’ to life. That concerns something bigger than yourself, or transcendence. That can be vertical, towards a God or heaven, but also horizontal, towards society. Not one’s own immortality but a contribution to what you leave behind at death. And if in that you make the best use of your talents, that can be pleasurable.

Then the drive to manifestation can be a virtue, and virtue ethics makes room for it, provided it is accompanied by, or is held in check, by the charioteer, in virtues of reason, moderation and justice.

However, success often leads to a neglect of such virtues, in self-aggrandisement, a feeling of being superior, elevated, ‘beyond the law’.

Money and manifestation are both addictive, not only for managers but also for stars in thirst for applause, and for scientists in search of publication scores and citations.

In capitalism, both greed and the urge for self-manifestation have become institutionalised, ingrained, in business culture, fed by managers having followed courses in economics in which they were told that self-interest rules supreme, as the motor of the economy. It has become an internal ethic that drives careers, salaries, and bonuses.

When confronted with increasingly vociferous critique from society, the inmates of these institutions honestly feel treated unfairly: they are only doing what society needs. Even supervisory boards of firms, having the task to correct management, go along, because those boards are recruited from the wider population of managers of other firms, sharing the same internal ethics and habits of thought.

So, part of the change needed is to compose such boards differently, with people not only from other firms, and not only as representatives of shareholders, but also from other groups of ‘stakeholders’, such as employees, customers, suppliers, local communities, and society at large, in particular with a view to the longer term future, in the interests of future generations and the environment.               

391. Ethics in economics

Economists claim that they do not make value judgements, but only indicate the economic consequences of policy. But the theory they use does implicitly harbour an ethics, even though many economists are not aware of it. Of what sort is that ethics?

There are several systems of ethics. Liberalism, and with that economic science, rests on utility ethics. That only looks at outcomes of choice and action, in this case utility, in the form of the greatest good for the greatest number of people. The ethical quality of other considerations, such as honesty, justice, forbearance, solidarity, etc. are irrelevant. ‘Greed is good’ as long as it leads to a higher level of prosperity, and the equity of its distribution is less relevant.

That stands in sharp contrast with duty ethics (going back to the philosopher Kant), where the issue is the ethical quality of motives of action, regardless of their consequences in terms of utility. The claim is that moral rules are universal, valid under all circumstances. The central principle is the ancient golden rule: One should (not) treat others as one would (not) want to be treated oneself. Here, that became the categorical imperative: an act is good if you would want to raise it to a universal rule. Lying is good if you would want everyone to do it. You don’t want that, so you should never lie.

I don’t go along with that because what is good or bad depends on circumstances. And what I find good for myself is not necessarily good for another: needs and demands vary.   

A third system is virtue ethics, going back to the philosopher Aristotle. Virtues are character traits, dispositions to conduct. Many virtues are eligible, depending on circumstamces. The classical ‘cardinal’ (pivotal) virtues are: reasonableness, courage, moderation, and justice. There is nothing wrong with pleasure, but it should be in combination with moderation and justice. That is missing in present theory and practice in economics.

Resistance is increasing against the conduct of a number of large firms, such as banks and pharmaceutical companies, those firms are suffering from it, and they come up with plans for self-regulation. The key question is whether when push comes to shove and this leads to less profit it will be accepted by shareholders.

For this I give an anecdote. Two years ago I was asked by a colleague in Scotland if I would want to take part, as advisor and possibly as a teacher, with a bank, in the teaching/training of employees in trustworthiness. Trust is one of my subjects, so I accepted.  The first step was a skype meeting for an exploration of ideas. We agreed that I would develop a proposal. In the discussion of that, in a second meeting, I asked whether it was part of the plan to educate employees to be trustworthy also to customers, not to sell them opaque products that work out to their disadvantage, as was customary among banks in the crisis of 2008. ‘Of course’, they answered. ‘But what if that leads to foregoing opportunities for profit, would that be accepted by shareholders?’. I received no answer and the meeting was abruptly ended. I tried to get in the comment that if you are the only bank that can make good on the promise to such trustworthiness, that might be very profitable, but it could no longer help.

In the course of the present series on economics, in this blog, I will argue for a transformation of economics, with as the most fundamental part replacement of utility ethics by virtue ethics, where utility still counts, but next to considerations of moderation and justice. That is needed for justice but also for protection of the environment, which under the present regime of economics seems unattainable.