People with training in economics will tell you that the system works because we’re able to channel selfishness into public gains. That is unarguably part of the system, and a very important part. But it is far from the whole story.
The economists’ simple model of a person is the selfish maximizer. He pursues gains right up to the point where the costs equal the benefits. If he tries to get what he wants by trading, and certain other conditions apply—in terms of how much information is available, how competitive the market is, and so forth—he will help enrich us all while working to enrich himself.
Problems arise very quickly when this model encounters the world. Rather than directly compensating people for what they produce, workers and employees are compensated either hourly or on an annualized salary, to an overwhelming degree. Rather than being directed by the residual claimants, an extraordinary amount of resources are commanded by corporations with a wide pool of shareholders, run by managers appointed by a board elected by these shareholders.
Areas of vulnerability to opportunism seem rampant.
Agency theory was developed in direct response to the shareholder-manager relationship, which they refer to as a principal-agent problem. Agency theorists focus primarily on the information asymmetry between managers and shareholders, arguing the former can milk their position for personal gain at the expense of the company’s bottom line in ways that are hard for shareholders—a more distributed group—to monitor.
The response to agency theory within economics has typically progressed in two directions. One involves a call for regulation, making penalties for defrauding investors steeper and requiring greater public disclosure. The other points to the way in which market discipline can be brought to bear against managers; mergers and hostile takeovers are among the mechanisms that can be used. Henry Manne was the pioneer of this line of argument, with his “Mergers and the Market for Corporate Control”.
Among the Virginia Public Choice School, it is also argued that regulators and politicians are selfish maximizers, too, and this must be taken into consideration when calling to expand their powers. As Eli Dourado has half-jokingly put it, governments, as well as markets, need to be robust against “methodological cynicism;” that is, the assumption that everyone involved is a cynical opportunist.
I think he doesn’t go far enough. Let’s examine the world under conditions of what I’d like to call “methodological terribleness.”
Assume that everyone is terrible.
By that I don’t just mean opportunitists, though that might be one way their terribleness manifests itself. But they could also be arbitrary and spiteful and abusive in a way that works against their own interests. “Terrible” is a very versatile word, and I don’t think I need to pin it down—I’m fairly sure you get the idea, or you will, if you pay attention.
In a world under methodological terribleness, all governments seem horrifying—all of those weapons and prisons, and people just let them have their way for the most part? Who came up with that idea? If any of these terrible people manage to overcome their mutual loathing and get organized, it’s a recipe for death camps, massacres, and pointless wars! On a good day they’ll probably wreck whole ways of life through absurdly high taxation and burdensome regulation, just for the power trip.
What, you think the voters wouldn’t let them get away with it? Voters are terrible! They completely look the other way when bad things happen to someone else, and half the time don’t even notice it being done to themselves. Completely asleep on the job, when not being actively malicious.
Businesses are right out. Too much leverage—what if they sexually assault an employee who really needs the job? What if they emotionally abuse employees just to see how much they’ll put up with?
Heck, throw all of commerce out the window. Customers are terrible. In retail and the restaurant business, they can enjoy their status as petty despots over any employee or manager eager to provide good service and build a reputation. And sellers are just as bad, selling defective products for the hell of it.
And the family—forget it. “Family” just means “trapped together under a roof,” and we’re all aware of the terrible ways that arrangement can go wrong.
What is the point of this little exercise?
If humans were thoroughly and uniformly terrible, human society would be impossible. In fact, even if they were just thoroughly selfish maximizers, it would be impossible.
Joseph Heath’s paper on agency theory has the best discussion of this. Drawing on criminology, he argues that in general the evidence is that people are not terrible or maximally opportunistic. Instead, they are conventional; they believe in doing the right thing for a fairly lukewarm, widely held version of what that means. They tend to rationalize their actions when they deviate from that standard, but in general it’s more or less what they strive for.
However, he argues that agency theory is a useful tool, even if not literally true. It helps to identify “fault lines,” where people are most likely to misbehave. But it’s only because most people do not misbehave to any great degree that we can have any hope of policing such behavior. When it is a relatively rare deviation from the norm, it is not only easier to spot and more manageable to punish, but the relative goodness of most people makes it acceptable to punish the right people for the right reasons. In a world of selfish maximizers, punishment is only ever a pretext for someone else’s advancement; a cynical front. In a world of pure terribleness, punishment is only ever the work of a temporary collusion of sadists, or someone with a chip on their shoulder, or some perceived slight.
The fact is that all of these scenarios can and do play out. We do live in a world where people are often immorally opportunistic or petty or cruel. But our great accomplishments and our ability to live together in commerce, society, and state, are possible only because of the goodness in us all. If we often fall short, we also often strive to do better. If we give in to temptations, we also support the people in our lives during their moments of weakness. If we are sometimes cruel, we often are fair and loving—and forgiving.
Laws, and agreements of all kinds, are pointless without ethos—without a population that is more or less the right kind of people for living and working and governing together.