Let's Reason

Pardon me if I am not one of those who would rush to thank and congratulate Jamie Dimon and his other 180 CEO buddies of the Business Roundtable (BR) for having redefined the purpose of the corporation to recognize other stakeholders besides shareholders.  My note to them would instead read: “What took you so long?  Didn’t you learn anything in the august business schools where you got your MBAs?”

Okay, I admit we should not sneer when we see a good thing no matter how slow its coming has been.  But the August 19, 2019 new statement on the purpose of the corporation adopted by 181 CEOs, members of the Business Roundtable, needs a lot of perspective.  Echoing my own reaction to the statement, the letters to the editor of the NYT were highly critical, even cynical, of this belated change of heart by America’s corporate chieftains.  So was WSJ’s opinion.

Why the BR statement is belated.  The stakeholder theory (the idea that firms can attain better value for their shareholders by also serving their creditors, employees, customers, suppliers and community) is at least 30 years old.  Theory and empirical evidence have made convincing arguments for its validity.  Recent surveys have shown wide-spread acceptance among investors for environmental, social and governance (ESG) sustainability.  Large institutional investors, in the US and abroad, have already embraced sustainable investment criteria.  According to a Morgan Stanley paper, investors can now select socially responsible investments from assets worth $23 trillion globally!  As of last year, 1,715 institutional investors (aka shareholders) that managed $81.7 trillion worth of assets had signed on the United Nations Principles for Responsible Investing.  As a matter of fact, the main concern and effort of investors, as well as of corporate executives committed to responsible management, is to persuade all corporate managers to jump on the sustainability bandwagon.  I would submit that instead of celebrating the BR statement as a moment of unique enlightenment, we should see it as a welcome, albeit belated, response to the pressure from investors, responsible CEOs, civic movements and politicians.

Why shareholder profits and sustainability are not incompatible.  Multiple studies have found that business profits and sustainability goals are not a zero-sum choice.  For example, a Harvard Business Review study found that over a 20-year period investing in firms with social sustainability policies would produce twice the profit the same amount would generate in firms without social sustainability policies.  Another academic study found that firms with ESG sustainability policies achieved a 3% higher return on their stocks per year versus firms without such policies over a 20-year horizon.  A large review of studies revealed that 80% of them had found a positive relationship between sustainability and business profits.  Thus, the BR statement invites CEOs to do the right thing by their shareholders and the other stakeholders!

Why it is value and not profits that matter.  Despite all the talk about maximizing short-term shareholder profits as the main goal of firms, academics and successful executives and investors recognize that the right goal is value, not profits.  Value is built on the profits (and their uncertainty) a firm is expected to produce over the long run.  Therefore, cutting corners with, say, employee benefits or protection of the environment for a short-term boost of profits does not fool the market.  If short-term profits were the only thing that mattered, we would not have the billions of dollars poured into new business ideas – many with negative profitability for several years.  Consider Genentech (an early biotech firm), Amazon, pharmaceutical start-ups and many more.  Sustainability of all the stakeholders of a firm can produce long-term value even when implementing responsible policies may entail short-term costs.  The bulk of invested capital is held by pension funds, insurance firms and index funds, all of which have long-term value objectives and are disinterested in the daily gyrations of the market for stocks and bonds.  That’s another reason why these expansive and influential investors favor sustainability policies.

Why corporate governance can be at stake.  Although welcome, the Business Roundtable statement can turn out to be problematic if CEOs abuse its intent. Disguising and misrepresenting subpar business performance to look like the result of pursuing the interests of other stakeholders could very easily weaken shareholder rights and CEO accountability.  That’s why the Council of Institutional Investors gave the statement a cool reception and commented that “Accountability to everyone means accountability to no one.”  In other words, our concern ought to be whether CEOs abuse their new sense of the purpose of the corporation to ignore long-term value creation as in the good old days of American managerialism.  We should not be fooled in believing that CEOs are the victims of the demand for shareholder profits that supposedly denies them the means to be socially responsible.  The evidence I cited shows that executives can run firms which are both profitable and socially responsible.  And many do exactly that.  Let’s remember that the excesses around 2001-2002 (Adelphia, Tyco, Enron, Worldcom, etc.) were caused by the greed of executives which destroyed value and whole firms laying waste to the investments and livelihoods of countless shareholders, creditors and employees who had no active role in these criminal or unethical decisions.  Similarly, the debacle of 2008 had little to do with long-run shareholder value and a lot with imprudent executive decisions and perverse incentives that emphasized immediate gains and ignored risks. To run a firm with a ratio of $33 dollars of debt for each dollar of equity, as Lehman Bros. and other financial firms did, was not a sustainable policy that favored the shareholders.

What was omitted from the statement.   The new statement of the BR would carry more credibility if it were not silent on various major issues of our times.  It should have shown concern for the absurdly high ratios of CEO compensation to median employee salaries; the persistent aversion to labor unions; the resistance to a livable minimum wage; the disappearance of adequate pension systems.  The BR CEOs should also call for the restructuring of America’s corporate boards by decoupling the roles of CEO and chairman of the board that places inordinate power and control in the CEO’s hands.

Finally, as I have written in previous posts, the responsibility of steering corporations toward socially beneficial goals rests primarily on us.  The marketplace gives us the opportunity and power to entrust our savings and investments with wealth managers that follow ESG sustainability criteria and to patronize firms whose operations reflect our values.   Politicians can do a lot through laws and regulations but it is ultimately the citizens’ responsibility to set the course toward a responsible and socially fair economic and business environment.

Below I provide links to some related posts you can find on my blog:

https://lets-reason.com/2019/01/19/managers-and-shareholder-culture-part-i/

https://lets-reason.com/2019/01/25/the-purpose-of-the-firm-confusion-and-challenges/

https://lets-reason.com/2019/04/12/business-ethics-markets-and-personal-responsibility/

What we leave behind with each passing day it’s not time; it’s experiences.  Like albums of photographs our lives are collections of experiences – good and bad.  But that’s not all.  Life experiences do not stay in the past.  They carry their aftertaste into the present.  They leave behind memories and lessons.  What we decide to take along for the journey ahead depends on how well we husband the experiences of the past or how many of them we turn into waste.

It’s Tuesday, right after Labor Day, and in America this signals that the summer of 2019 is done; the curtain has fallen and the summer season has taken its final bow.  Several years back that would mean I had to get ready for another semester.  The lives of academics are ruled by the semester cycle.  But now I no longer have to worry about that.  I now need to fill my life’s album with other experiences.  So, what did I leave behind this summer of 2019?

Well, I left behind Providence and Newport, R.I., Prague, Greece and the lake in Canada.  In Providence I learned that the progressive offspring of a local family that made its money by transporting slaves to the Americas founded a very fine college, known these days as Brown University.  In Prague, I learned that one of its creative sons and national heroes by the name Alphonse Mucha became one of the most celebrated artists of Art Nouveau.  Ironically, Mucha was not admitted to the Academy of Arts in Prague and had to study in Munich and make a name in Paris before returning and rising to a national figure in Prague.  I also learned that for my taste the most reliable Czech dish is the roasted port knuckle.

In Greece I learned once more that walking around in 100-degree weather is not a comfortable experience; actually, it’s sort of masochism.  Even Yabanaki beach, the one I introduced to you a year ago, was not pleasant in that heat.  But our American friends would not care less.  From the gyro and tzatziki to the wide vistas of the blue Aegean from a hotel terrace on the island of Aegina, everything was magical.

In the lake in Canada, I learned that catching and killing fish to eat for lunch is not what I want to do any more.  After the first bass I released the rest of my catches.  My son and daughter tried hard to convince me that the underdeveloped nervous system of fish spares them of physical pain, but I had none of that.  Reading Frans De Waal’s book about animal emotions has made me more sensitive to animal killing.  Don’t take me wrong.  I am not turning into a vegetarian.  All I am saying is that from now on, fishing will be only a sport for me.  Catch and release; not catch, kill and eat.  With lots of moral compromise I will still eat somebody else’s caught and killed fish.

Besides places, I also left behind several books I read.  The Coddling of the American Mind by Lukianoff and Haidt was one of them.  It makes the case of how by trying to protect young people from everything, including uncomfortable ideas, colleges and protective parents prepare a future citizenry that may stifle liberal discourse and be too weak to face the challenges of the real world.  I also read Firefighting: The Financial Crisis and Its Lessons by Ben Bernanke, Tim Geithner and Harry Paulson, the three main protagonists who looked into the abyss of the 2008 catastrophe and did all they could, some of it not well received, to pull us back from it.  Despite the heat and all the visual distractions and with very little help from the inadequate shade and the ice coffee (frappe) at Yabanaki, I managed to finish Stories of Our Life and Others by Ted Chiang.  A collection of science fiction stories each of them sending us into the dark world of technology and its ability to take an oppressive possession of our lives.  We struggle to escape it by trying to take control of it but we fail.  There is no exit from what we create.  A cautionary reminder that not all that glitters is gold.  My last read of the summer was Beloved by Toni Morrison who recently passed at a well-advanced age.  Fortuitously, it turned out to be the right book-end to where my summer had started, visiting the home of slave traffickers.  Only in the lines of a mesmerizing and at the same time soul wrenching story, as written by Morrison, one can feel the full extent of dispossession of human dignity and utter deprivation that slavery was and why it has left behind so many social ills.

So, it was a summer of memorable experiences and a summer of new things learned.  And speaking of life as a collection of experiences, let me leave you with these verses by Longfellow:

No deem the irrevocable Past,

As wholly wasted, wholly vain,

If, rising on its wrecks, at last

To something nobler we attain.

And on we go into the second year of the blog.

Next week will mark 243 years from July 4, 1776 when the Continental Congress issued the Declaration of Independence that marks the birth of America as an independent state.  But it was thirteen years later, in 1789, the Constitution took effect.  Americans will celebrate the day with picnics, barbecues, local parades and fireworks.  But the reality is that although the Fourth of July is when the thirteen colonies formally broke away from the British Crown, it is the Constitution that rules and affects our everyday lives.

Recent political developments, not only those related to Trump’s election and administration, have raised voices of discontent as to how well the two plus-centuries constitution serves the political needs of the country.

Gerrymandering of congressional districts, the circumvention of the popular vote by the electoral college, election rules and procedures left to the states, the over-presentation of states with low populations in the Senate and the Electoral College, and the politicization of the Supreme Court made up of jurists appointed for life are at the center of the discontent.  Although all Americans are impacted by the effects of these realities, it is mostly Democrats who see themselves as the main losers.  But under other circumstances, it could be Republicans.

Add to all that that the Constitution is not always clear or explicit on the boundaries of presidential powers, something that becomes vivid in the case of occupants of the White House willing to push executive power beyond its traditional limits.

But, are the Framers of the Constitution truly responsible?  How could they have predicted the way the country and the individual states would develop in terms of distribution of population and the demographic profile of states over the ensuing centuries?  Their concern was to establish a democratic governance system based on checks and balances.  Fueled by the fervor and enthusiasm of founding a new independent state, they assumed that future generations would also value and protect the institutions that guaranty democratic governance.  Accused of the possibility the Constitution left room for chicanery and shenanigans for political gain, they would retort by saying “We gave you a country and the best government system of our time.  Protect its essential mission and make it work for the common good.”  In today’s political parlance, they would have said that when it comes to the quality of democracy in America, “It’s the people, stupid!”

I have left for last the biggest and most sensitive issue the Constitution did not resolve. It is America’s original sin, that is, the unwillingness of some and the inability of others among the Framers of the Constitution to abolish slavery and give all colonial Americans, black and white, equal political rights.  Despite a Civil War and the Civil Rights Act a century later, we still live with the legacy and consequences of that original sin.  Covert or overt racism still exists and its more or less ugly expressions are a stain on all of us.

Again, it would be easy to blame this on the Founding Fathers.  In some colleges, including Hofstra University where I taught, students demand that statues of slave holder Founding Fathers, like Thomas Jefferson, be removed. With the wisdom and sentiments of our time two centuries later we can and do condemn their failure in that regard.  But to ignore that we are all products of our time fails to do justice to them as well.  They lived in a world in which, as hideous and inhumane slavery is, many practiced and profited from slavery.  Those times, religious establishments, Christian and Muslim, accepted it or did not officially denounced it.  Enslaving humans on racial or non-racial grounds, has regrettably existed for millennia.  We find it in the Greek and Roman times and in the Bible.  At its founding, Christianity made all people, including slaves, equal before God but also preached that slaves should obey their masters.

Let’s remember that many years from now, we are going to be judged by history in regards to whether we protected the planet and its endangered species; how we kept treating women and children; how we fed and clothed the poor; and how we nursed the sick among us.  Our only defense will be the same we should accord those flawed, quarreling, and sometimes mean-spirited Americans – understanding and forbearance. They gave the people a guiding document.  It was not perfect, nor was it much for its enslaved citizens.  But it was a beginning.

Now let’s do our part.

 

In August 2015, I was one of about 10,000 Americans that retired that day.*  For me 42 years of work, 37 of these in academia was good enough.  I had done what I enjoyed.  Academics are like salespeople.  We try hard to sell our students on the idea that reading the class materials and preparing for exams is a good thing for them.  Many resist us to the end.  We try to sell our  colleagues on the brilliance of our ideas on curriculum and other matters in countless committee meetings but winning over a bunch of Ph.Ds, each with his/her grand idea, is like trying to herd wild boars.  For years, I kept my rejected memos as evidence of my futility.  And we try hard to sell our research papers to journal editors but the referees aren’t always in a buying mood.  I published a lot but I also had to lick my chops and nourish my challenged intellect after each rejection.

And then, came the retirement parties.  The three retirement events thrown by my colleagues made me nervous.  I was not sure whether they were celebrating my career or the fact I was not going to be in their hair anymore.  When the speeches of praise and appreciation were over, I told them they had done a great job holding back all this admiration for so many years.  Where were they when my ego needed the comfort of approval?  And what’s with the decorative clocks or watches they give you upon retirement?  Really? We need to keep time lest we missed some important meeting while we are in retirement?  Unless they are given to remind us that time is not on our side and we should expedite whatever we plan to do.  Clocks and watches should be banned as retirement gifts.

But I was not off the hook yet.  Shortly before retirement I had committed myself to co-authoring a book in investment banking, a project I had put off many years.  It took my first two years of retirement to finish it – many days cursing myself for signing the publishing contract.  But when it was done and published, I felt a sense of deliverance.  The thought of an unfinished project would no longer haunt me.

After finishing the book, off I was to my next bucket list item.  That was the blog.  I summoned the help of a former colleague who is good at this sort of thing.  He is a special person.  He is a pancreatic cancer survivor who, lucky to have escaped demise, went on to write a little book about his experience and will to live and then set up a blog Survivingcancerembracinglife.com to tell others that Living Well While Surviving Cancer is very much possible.  I hasten to add the usual disclaimer that any bother the blog might be to some of you it is my sole responsibility not his.

Preparing yourself psychologically to accept the end of your professional life and planning ahead your retirement is important but it eludes many.  Some people are pushed to early retirement after losing their jobs.  Others retire because they hate their jobs.  And others go without much reflection on what comes next.  It’s sad to hear people say “I don’t know what I ‘ll do when I retire.”

A meaningful or otherwise happy retirement is, however, predicated on having the means to live with some basic comfort and dignity.  Things are not quite rosy.  Even in the US, a very rich country, retirees face grave financial insecurity.  Reliance on Social Security, Medicare and Medicaid is not enough to provide for a comfortable retirement.  In the US, the Social Security fund is reaching the point that it will have to dip into its accumulated capital to pay retirement checks, meaning income on capital and new contributions are not enough to pay the bills.

In 2018, the average Social Security pension was $1,413 per month.  In many places in the US this sum is not enough to cover the basic budget of a retiree.  What about other individual savings for retirement?  The news is worse.  The average savings of Americans 60+ years of age is $172,000.  Experts estimate that one needs a nest egg of $1 million to replace 70% of the average annual salary Americans make during their working years.  But again, averages hind the dire reality for many Americans of or close to retirement age.  One third of these Americans are estimated to have saved only up to $25,000 for retirement.  Some have nothing.

Things are not any better around the world.  Early retirement age while people live longer, inadequate contributions to pension funds coupled with actuarially generous pension packages, and shrinking working age populations have kept pensions down or pose risks to the future retirement benefits for everyone.

Some experts blame the lack of financial literacy in large segments of the population for the inadequate savings.  Thus, they recommend financial literacy classes in high school and college.  My credit union, NEFCU and other financial institutions offer savings and retirement seminars to help people plan for their retirement years.  But a research paper has concluded that financial literacy lessons are not effective unless taken at the time a person has to make a related decision.  How possible is such timeliness in teaching financial literacy?

Basic financial literacy can help but not if personal responsibility is lax.  There are a lot of middle-class people who could save more but don’t do it because they cannot putt off instant gratification.  Consumerism is too much embedded in America and other societies and it unfortunately corrupts saving habits.  What we need to teach people is the difference between needs and wants.  Unless we manage our wants better no amount of current income will be enough to build a secure retirement.  As St. Augustin said: “Rich is not a person of great wealth but a person of few wants; and poor is not a person of little wealth but a person of many wants.

Eight centuries before St. Augustin, Socrates addressing Kallikles who advocated unrestrained giving to pleasures retorted: “Compare the soul of such a person to a sieve, because this kind of soul cannot hold anything and thus can never be full with a finite and limited amount of things.” (From the dialogue Gorgias)

Preparing for retirement must start many years back.  It can be fun and it can be a struggle.  And I haven’t said anything about health issues.  But let’s leave it at that.

* This is an estimate based on the number of people reaching retirement age each day in the US.

The topic of inequality in terms of wealth or income has become central to the political debates in western market democracies, and especially so in the US.  CEOs, star athletes and celebrities are rewarded mindbongling sums of money many times those of an average worker, athlete or celebrity.  We often talk of an “winner take all” culture.  At least in the case of wealth disparities, we know that they can be the product of long periods of favorable tax treatment of certain sources of income.

But what about income disparities?  There is no short supply of explanations and justifications for the lopsided income distribution we observe in various industries.  Hiring agents and compensation consultants as well as academic economists have plenty of answers.  Income disparities though are more difficult to explain if one starts reading what animal ethologists (those who study the behavior of animals) and evolutionary psychologists have discovered through observation and numerous experiments.

Let’s start with animals, and specifically with monkeys and the great apes (chimpanzees, bonobos and orangutans).  Capuchin monkeys keep an eye on rewards received by other monkeys and seem to compare them to theirs.  They don’t seem to mind if rewards are given without asking for some effort.  Once though work or effort is required, those receiving relatively less go literally on strike!  They refuse to execute tasks as a condition of getting the reward.  The same reaction, of refusing relatively less reward from another child that controls the split has been reported for children ages three to five.  Feeling slighted when one receives less than others for similar effort is manifestation of “first-order” fairness.

But we also have evidence of “second-order” fairness as in the case of a dominant female or male ape intervening to redistribute something of value between quarreling apes because of unequal sharing.  Or when bonobos are observed to leave food on the “table” when they are watched by fellow bonobos who receive no food.  Chimps also accept that prey food should go first to the catchers than the most powerful chimps, thus prioritizing incentives over hierarchy. Frans De Waal,* who has studied great apes extensively, proposes that first- and second-order fairness originate with the emotion of envy which then turns into the positive behavior of fair sharing in order to maintain cohesion of the group.  He finds fair rules of sharing are enforced more among chimps and capuchins because these species need collaboration to be successful in hunting.

Michael Tomasello,** who focuses on the social and moral development of young children in comparison to apes, also shows how the natural maturation of children endows them from infancy with the inclination for prosocial behavior grounded on fairness and sharing with others.  After the age of two, children start to develop a perspective of others whom they now consider as equivalent to them and, hence, deserving fair sharing of resources (toys, candy).  Gradually, sharing becomes more reciprocal and is limited to the group of partners.  Interestingly, young children start to avoid sharing with free riders.  By school age, children have expanded their sense of fairness beyond those who collaborate with them.  Thus, fairness is now felt and practiced as a social norm.  Very importantly, in addition to how rewards are split, young children become sensitive to the rules of resource distribution.

The analyses of De Waal and Tomasello reveal several important findings.  First, collaboration and in-group cohesion are important drivers in the emergence of fair behavior.  When collaboration and social cohesion are important for survival the trait of fairness is naturally selected.  Second, what matters is not so much the nominal amount of reward as is the relative amount – what I get relative to others.  Third, the sentiment of fairness relates reward to the effort required.  Young children understand that greater effort deserves greater reward.

These findings show that the construct of Homo Economicus, that is, the rational decision maker, driven by selfish interest, and seeking to maximize resources (income and wealth), is not the human type nature has selected for survival.  Apes sacrificing some of their food and children entirely refusing any reward because of an unfair distribution do not describe the Homo Economicus.  Additional proof of that can be also found in the literature of behavioral economics.  In his book Thinking, Fast and Slow, Daniel Kahneman shows how cognitive and emotional biases lead humans to decisions that violate the conditions of rationality and the goal of wealth (or income) maximization.

How can we then explain the enormous disparity in income distribution?  I suspect that although we all start with the same nature-given attribute of fair sharing, cross-cultural differences shape our behavior with respect to sharing as we grow older.  For example, in 2014, CEOs in the US earned 354 times the salary of the average worker.  In contrast, in Europe, the ratio varied from a high of 148 in Switzerland to a low of 28 in Poland.  So, what explains this?

My own most likely candidate is the cultural fascination of Americans with individualism and the value of persons in chief positions.  What this culture ignores is the value of collaboration and the value of social cohesion.  It stretches credulity to believe that the fortunes of a corporation rest only on the abilities and decisions of its CEO and not the collective effort of all employees.  It is also dangerous to disregard the resentment of average people as they observe few to capture the lion’s share while themselves pick up the crams.

People do not begrudge rewards earned by superior work efficiency, talent, and industriousness.  But are we certain that the astronomical incomes of some earners are truly due to these attributes?  Isn’t there a possibility that an uncritical and uninformed analysis of relative effort and value of work has hypnotized people into believing that there is a sound basis for the income disparities?  Are we sure we have not degraded the value of collaboration and social cohesion in American society?  How do we square the idealism of the American dream based on work with the observed reality of fellow citizens barely making a living at the minimum wage?

Adam Smith hit the mark when in his The Theory of Moral Sentiments wrote:

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.

* Frans De Waal, Mama’s Last Hug, (2019).  This is a wonderful book on animal emotions and what they tell us about ourselves.

** Michael Tomasello, Becoming Human: A Theory of Ontogeny, (2019).

The philosopher George Santayana famously said “Those who do not learn history are doomed to repeat it.”  But learning history alone is not enough.  It’s necessary we heed history’s lessons and act accordingly.  Americans may be at or near the point we need to turn to history and reckon with what our future may hold in store for us.  For that exercise, I would suggest we take a look at the historical course of ancient Rome.

Polybius was a Greek historian who lived in 208-125 BCE and recorded the history of Rome from 264 to 146 in his Histories.  He was fascinated by Rome’s quick success that in less than sixty years had led to the defeat of the Macedonian king in 168 BCE and subjugation of Greece and the destruction of Carthage and Corinth in 146 BCE.  But Polybius was more than a chronicler of historical events.  He wanted to explain Rome’s success and even more predict its future as a state.

Based on Aristotle’s political thinking, Polybius inferred that the combination of the three types of government, the rule of one, the rule of few and the rule of many was at the heart of Rome’s success.  Roman government rest power to two consuls as commanders in chief, a Senate of selected aristocrats, and the plebeians (the demos) that elected the consuls and other state officials.  The checks and balances these three poles of power could apply on each other were the guarantor of keeping the system from devolving into the tyranny (rule of one) or the anarchy of the many.

But Polybius was also aware of Plato’s dire prediction in the Republic.  In it, Socrates makes the point that when a political system does not live up to its principles it gradually decays and finally collapses.  Irresponsible pandering to the many (read populism) and self-serving behavior by the rich and privileged (read inequality) eventually pit one against the other creating turmoil, thus, opening the way for a strongman to appear as savior of the state.  But the strongman also gets corrupted by power and is overthrown by envious oligarchs.  When their excesses have offended enough the common sense of fairness, the demos rises and restores democracy again.

Although Polybius reasoned that Rome had become successful due to its system of checks and balances, he also concluded that Rome would inevitably fall victim to the cycle of alternating modes of governance.  Following Polybius’s death, Rome continued to expand its power westward to Spain and the Gaul and eastward to Asia Minor, Syria and Egypt.  None of that success would, however, avert Rome’s march toward the fate Polybius had predicted in his Histories.  By the time Julius Caesar had come into the picture, Romans had started to realize their Republic was losing its vibrancy and foundational principles.  Generals and Senators were plotting for power, politics had become theatrical, and political oratory had ceased to communicate ideas and visions about the state but instead was used for personal aggrandizement (does it sound familiar?).

Cicero was the last politician and intellectual to rally to a fruitless attempt to save the Republic by appealing to the value of a mutual respect among citizens and between citizen and motherland.   To no avail though.  He was assassinated five days after Julius Caesar’s murder in the Senate.  What followed was the rapid devolution of the Roman Republic toward tyranny ending with the declaration of Octavianus as Emperor after his victory over Mark Anthony in 31 BCE.  Augustus Octavianus retained the Senate but only as a cosmetic fixture just for appearances.

Rome as empire remained alive for another 300 years but it had lost its original republican soul.  Poets would continue to compose verses, philosophers would expound on their thoughts and science would continue to develop.  But political power and the strings of freedom were in the hands of single rulers and praetorian backers.

The history of Rome as a republic and its inglorious end as decayed empire rotten from inside is instructive for the US.  For one thing, it was the combination of governance systems (the rule of one, the few, the many) that informed the framers of the constitution when they established a President as commander in chief, a Senate and lower House as representatives of the people and an independent judiciary, and declared this government to be of the people, by the people, from the people.  As the ancient Romans intended to do, this tripartite system was supposed to keep the Republic robust and viable though checks and balances.  The Roman Republic was fatally wounded when the checks and balances were no more.

What are the signs that America may be at the same tipping point that Rome found itself in the last part of the BC era?  We have a president who presents himself as the singular savior of the working class and average citizen; uses fearmongering, falsehoods and lies to shape or bend public opinion to his way; breaks norms out of whimsical and self-serving behavior; defies the Congress and rules by executive orders; values his opinion and intellect over the informed views of his own administration; and interferes, to the point of obstruction, in the wheels of justice to protect himself and those he values as relatives or friends.

We also have a split Congress in which Republican Senators and Representatives refuse to exercise their constitutional obligation to check the President, paralyzed by the stranglehold he has on their party base.  The Senate’s leader, Republican Mitch McConnell, may have concluded that the Trumpian era is destined to be short-lived.  But what if this new politics engenders subsequent demagogues with authoritarian impulses?  What if Congress and the Courts become conditioned to acquiesce to future Presidents’ autocratic proclivities?  Don’t we run the risk to slowly slide into a Roman-style decline of American republicanism?

As Socrates, Polybius and Cicero pointed out centuries ago, political systems survive if their foundational principles are preserved.  Our system’s foundational principle is checks and balances.  The moment Congress turns its back to that mission and the judiciary is politically compromised, we are destined to meet our own Emperor Augustus as the Romans did 2000 years ago.

* The insights of Polybius regarding Rome’s success and potential downfall come from Arthur Herman’s The Cave and the Light: Plato versus Aristotle, and the Struggle for the Soul of Western Civilization (2013).

Correction and Clarification:  A reader of the blog noted that my use of the term illegal immigrants from Central America should exclude those who seek asylum to the US.  She is correct.  The broader point still remains; namely, immigration, whether illegal or for  asylum purposes, will continue as long as the world fails to create the conditions so that the root causes of migration, violence, intolerance and economic, no longer afflict the lives of people around the globe.

My last post presented views about the pros and cons of immigration in the US as well as in regard to its political ramifications for Democrats and Republicans.  In particular, the evidence suggests that low skill American workers are likely to be adversely impacted by low skill immigrants and immigration is also perceived as a threat to cultural and social cohesion.  But we also know that, overall, immigration has been a net plus for this country.

However, as I have pointed in a recent post, statistical assessments based on “average” or “overall” benefits cannot cut it for those groups that feel to bear the brunt of a policy.  So how do we decide which immigration policies are optimal?  Ideally, we would like to design an immigration policy that while it creates benefits for some it does not create losses for anyone else.  This is similar to what welfare economists call a Pareto optimal solution.  It appears, though, that in the case of immigration this is pretty much close to impossible.   Alternatively, we could design immigration policies that increase the total welfare (utility) of society even if some members’ welfare drops.  It seems that this – the so-called utilitarian principle – has been the implicit premise of the US immigration policies.  That’s why we like to declare “immigration is good for the country.”  Obviously, utilitarianism implies a trade-off of welfare among groups.  Trade off some of your welfare so society gains overall.

There is yet a third criterion to consider in evaluating a policy.  Those who are the weakest should benefit the most from a policy.   This would suggest that we put some restrictions to the inflow of low skill immigrants and expand the inflow of high skill immigrants who would compete against native workers with greater job security.  This is what David Frum suggests in his Atlantic piece I cited in my last post.  It is also reflected in the recent policy proposal of the Trump administration.  Should such immigration ideas be enacted they would satisfy the “America First” political motto of Americans with nationalist priorities.  In this case, an official immigration policy would be more favorable to low skill jobs avoided by Americans, as in farming, and to high skill jobs, especially in the STEM (science, technology, engineering, mathematics) fields where there is a serious deficit of native talent.  Of course, such a targeted immigration policy may not satisfy the internationalist view that the US should remain a welcoming destination of migrants without imposing criteria driven by narrow national interests.

The problem with adopting a nationalist approach to immigration rules is that it fails to address the reality of the 11 million undocumented immigrants already in the country.  It would also be severely tested by immigrants who try to enter the country illegally as they flee lawlessness, violence and economic depravity in their home countries.  In recent years, these immigrants have primarily come from Central American countries and have provided the fodder for President Trump’s anti-immigration stance.

Stemming the flow of illegal immigrants who seek an economic and safe haven in the US will require that we go beyond nationalist policies and adopt a more internationalist approach that calls for nation building.  This means we need to have coherent and sustained policies that support the countries of Central America to escape the cycles of crime, economic depression, and state dysfunction.  There is a model of nation building we can follow in this effort.  It’s the European Union.  Financial and state-building assistance without the political ties of the EU.

Despite any cynical view that the core founding members of the former European Community expanded for the goal of creating markets for their industries, the main effect of expansion has been the integration of administratively and economically weak countries with the stable and advanced democracies of Western Europe.  The weaker countries were states that came out of periods of dictatorship (Greece, Spain, Portugal) or from the Soviet Block.  To speed up the growth and advancement of these states, early on, the EU allocated significant capital out of the common budget to promote goals of social, developmental and economic cohesion.  For example, the 2014-2020 plan has allocated 807 billion Euros to be distributed on an as-needed basis to the 28 member states.  Thus, the Czech Republic is slated to receive about 12 billion Euros and its old partner Slovakia another 7.3 billion Euros.  These monies go a long way to upgrade and build new infrastructure, run social assistance programs, improve education, and so on.  No matter whatever else one can say against the EU, the fact remains that it has engaged in a nation building effort the world has never seen before.

Interestingly, the US recognized the need to assist Central America (CA) countries, in particular those in the north end of the region, that is, Guatemala, Honduras and El Salvador (the North Triangle).  In 2015, Congress approved the sum of $2.6 billion to be distributed to these countries through 2019.  Judging from the sharp decline of immigration from Mexico thanks to economic gains following NAFTA, we can conclude that development programs help countries retain their people.  Indeed, third-party monitors of these programs have recorded noticeable progress in various areas, like poverty, crime, law and order, and public administration.  At the same time, the continuing sizable flows of migrants from CA suggests that the US assistance has not been large enough to stabilize these countries.

Worse even, last April, President Trump announced cuts in these programs as a way to punish (!) the CA countries for sending (!) their destitute people up north.  This has been denounced as totally counterproductive but to no avail so far.  It is baffling that “America First” nationalism feels comfortable with the reality of a rich and successful homeland surrounded by small impoverished and dysfunctional countries that we can help but refuse to do so.

It is time we recognized that immigration is a challenging issue that affects Americans differently depending on their socio-economic situation.  A blend of measures that accommodate national priorities and the internationalist spirit that looks at America as a force of good for weaker and needy countries would be a better way of thinking about immigration.

It is a great irony that in a country built by immigrants, immigration has become one of the flash political issues, serious enough to determine election outcomes.  Unfortunately, few people on either side of the debate are willing to talk about it objectively.  More regrettably the mean-spirited and fearmongering language used by Donald Trump as a presidential candidate and now as president makes a level-headed debate even more improbable.

The historical fact is that the world has been shaped by large migration waves ever since the human species moved out of Africa.  In his book Who We Are and How We Got Here David Reich uses results of studies of the human genome to argue that migration waves all the way to the second millennium BCE resulted in such genetic mixing of peoples that the concept of race is just a conventional construct we use to classify people on superficial traits like skin color.  More recent migration waves from within Europe and Asia molded the populations of modern Europe; and likewise North and South America are the product of European migration followed by later waves of migrants from other continents.  The instinct or desire to move about places may have even become an evolutionarily-acquired genetic trait that preceded the development of the human species.  (To Move Is to Thrive. It’s Genetic, NYT, May 21, 2019)

It makes then pragmatic sense to accept migration as a human phenomenon that will not go away.  According to UN data, 258 million people or 3.4% of the world population migrated in 2017.  As expected, the bulk of migrants came from countries with depressed economies or political and civil strife, primarily located in Latin America, Africa, Asia, and even Eastern and South Europe.   The top destinations were, of course, Western Europe and North America.  Another thing we need to accept is that migration does not always occur under the most lawful circumstances.  Desperation and desire of better living drives people to use any means to get to their destination.

Despite the dire language used to describe the severity of the immigration problem for the US, we hardly stand out in terms of numbers.  Between 1960 and 2017, the US absorbed 49.8 million of immigrants or 15% of its 2017 population.  During the same period, Australia took in 29%, Canada 21.5%, Germany 15%, UK 13.5%, and France 12%.  (Source: The Migration Policy Center.)  What sets the US apart, though, is that in the UK, Germany and France the anti-immigration nationalist pushback came from opposition, often fringe, parties, whereas in the US it came from the presidential candidate of a major governing party who later became the president and has continued to campaign on a fierce anti-immigrant agenda.

Nonetheless, just because migration is an enduring phenomenon it doesn’t mean we should ignore its consequences.  Two informative articles that have appeared in The Atlantic help us understand a lot of the misconceptions carried by both sides of the political divide.  In its July/August 2017 piece, Peter Beinart exposes the liberals’ bias toward emphasizing the benefits of immigration while diminishing its negatives.  For example, the evidence points that Americans are likely to lose wages to immigrants when both groups compete for low-skill jobs.  Political scientists at Harvard and elsewhere have also found that demographic diversity erodes social trust and cooperation among all members of a community, native and foreign.  These findings echo past experience where new immigrants to the US were perceived as threats to the social and cultural cohesion of the country.  Disturbing, but human nature is what it is.

In this April’s issue, David Frum presents a challenging view on the pros and cons of immigration that would make liberals uncomfortable.  He points out that discomfort with unchecked immigration is equally shared by elderly and young Americans.  Accepting low-skill and, thus, low-wage immigrants will, over their lives, burden the safety net more than it will help it.  Those who benefit the most from immigration, especially undocumented immigration, are the employers while those bearing most of the cost are native working-class Americans.  Undocumented immigrants, now numbered around 11 million, have no rights to due process making them reluctant to complain about working conditions, thus allowing employers to behave badly toward all workers, whether native or foreign.  Without the right to vote, immigrants are also taken out of the equation as far as speaking out along with their native fellow workers on issues of mutual interest.   He also points out that recent immigrants bring low rather high work skills.  Frum does not ignore the benefits of immigration.  First, it is the only reliable source of population growth given the below-replacement birth rate of white Americans.  Placed strategically around the country can revitalize decaying communities.  Second, no matter how low the skills and education of the first-generation immigrants are, as the country’s experience shows, fresh immigrants become the seeds for the ongoing advancement of the country as second-generation immigrants move toward higher levels of attainment.

Conservatives and liberals also seem to miscalculate the political benefits of immigration.  Conservatives fear that fresh immigrants are inclined to vote Democratic once they gain citizenship.  Thus, Republicans are reluctant for endorse bold plans that would put millions of undocumented immigrants on the path to citizenship.  Democrats, on their part, tend to overestimate the durability of the immigrants’ loyalty to their party.  They ignore that future generations of immigrants move to the middle class as professionals or entrepreneurs.  At that point, they are more likely to align their interests with social and economic peers who may very well go Republican.  Reihan Salam makes this point in his essay The Next Populist Revolution (Sept. 2018 The Atlantic).  More troublesome for Democrats is that second-generation Latino immigrants still lag white Americans in education and, hence, their cohort political group may be the same populist group that powered Trump’s drive to the White House.

Finding a generally acceptable solution to the immigration problem requires that we strike a balance between idealism and pragmatism.  My next post will explore this conundrum.

If you follow the financial news, you already know that Uber seems to have a better model for its ride-hailing service than its stock.  After priced at an offer price of $45 the stock opened at $42, a rare rebuke for a well-known and so eagerly anticipated IPO (initial public offering).  Four days later, it still trades under water.  It looks like Professor Mihir Desai of Harvard got his wish when he titled his NYT OP-ED piece “Let’s Root for Uber’s IPO to Fail.”

Interestingly, Professor Desai expressed a wish for an outcome that goes against the average performance of IPOs, which usually gain in price immediately after they are offered to the public, a performance identified as underpricing.   Setting a price for an IPO stock before the market has opened is a great challenge to the underwriting banks.  That’s why they organize presentations of the IPO firm to investors around major centers of finance in the so-called roadshows.  It is through this process that underwriters get a feel of the market’s receptivity of the new stock.  In Uber’s case the investors had reportedly placed (subscribed for) buy orders three times the number of shares offered, a sign of strong demand.  Despite pre-offering estimates about Uber’s stock value exceeding $100 billion and the oversubscription it garnered, the lead underwriter Morgan Stanley still decided to price the stock conservatively giving it a total market value of $76 billion.  To everybody’s surprise, however, even that lower offer price (of $45) wasn’t conservative enough.

The market for IPOs, which along with new issues of already traded stocks comprises the new issues market, is one of the most challenging types of markets to analyze and understand.  The hundreds of academic and practitioner papers written on the pricing of new issues can only tell us what we would expect to see on average.  Much less can be predicted on a stock by stock basis.  Thus, we know that on average IPO stocks are underpriced, that is, they are offered below the price the market sets when trading starts.  And this pattern is a global one observed around the world.  The main reason is that new stocks, no matter how known to the public, are surrounded by uncertainty that is perceived differently by the selling firm and the prospective investors.  The firm cannot know with certainty where demand and supply for the stock will balance to produce a price.  Investors, on their part, cannot know what the future prospects of the firm are because they can glean some but not all the information about the firm from the prospectus (i.e., the document that explains the operations and finances of the firm).  When sellers and buyers have different information about a product, economists call this asymmetric information.  (George Akerlof won the Nobel prize for analyzing such markets – an example of which would be the used cars market.)  Therefore, to entice investors, especially those less savvy about investments, to buy the new stock, underwriters set the price below what they expect the market will be willing to pay at the offering.  It’s like listing your home at a price below its estimated fair value.

But even with the roadshows and all their years of experience underwriters sometimes fail spectacularly.  Facebook, for example, was offered at $38 in 2012.  It closed the first day barely up at $38.23.  Then it fell and stayed below its offer price for the next 420 days.  Actually, the IPOs of Uber and Facebook defied the empirical evidence that stocks of firms with greater buzz about them are welcome by the market at much higher prices than their offer price.  Exhibit A of this phenomenon are the IPOs of internet technology-based firms whose IPOs in the dot.com mania years of 1999 and 2000 yielded initial market prices in excess of 77% of their offer price.  Unfortunately, publicity and anticipation did not work at all in that way for Uber.

The second thing we know about IPO stocks is that, on average, are poor investments for the first several years following their offer.  This means, if you buy IPO stocks at their market price the day they are first offered and hold them for three to five years you will earn a lower rate of return than if you buy a portfolio that is broadly diversified, like the 500 stocks of the Standard & Poor’s Index.  Again, this is a global phenomenon.  However, what holds for the average IPO stock does not hold for every individual IPO stock.  For example, after trading in losing territory for over 420 days, Facebook’s stock climbed over its offer price and never looked back.  It is now traded at around $185.

The longer-term under-performance of IPO stocks is a combination of two factors.  One is of behavioral nature.  In forecasting the future, we have a cognitive bias toward putting too much weight on recent events.  Investors look at the recent usually good news and performance of the IPO firm and extrapolate this good performance into the future ignoring the fact that eventually everything reverts to a more subdued normal level.  This law of reversion to the mean echoes the everyday saying that what goes up eventually comes down.  The other reason is that firm managers decide to have an IPO when news are still positive before negative developments sour market receptivity.  This is to say, managers time the IPOs.  When, subsequently, the negative news comes out investors sell the stock and the price falls.  But again, not every IPO stock falls victim of the bias or the timing.  Microsoft, Google, Apple, Facebook are examples of stocks that proved to be big winners for investors over the long haul.

The failure of the Uber IPO is noteworthy because the reputation of the lead manager (Morgan Stanley) and the co-managers (Goldman Sachs and Bank of America) as well as the financial backing of Uber by big venture funds should have added credibility of the offer price.  But, as in elections, you need to count everybody’s choice (in this case the investors’) before you know what the outcome is.  Perhaps the market is sensing that the gig economy in which Uber wants to operate is not settled enough to support reliable predictions.  However, Uber has just scored a big victory in this regard.  On Tuesday (5/14/19), the National Labor Relations Board determined that the Uber drivers are not employees and, hence, not eligible to unionize.  As a result, the price has jumped by about $2.  Still, however, the jury is out on how well Uber will do as the poster stock of the gig economy.

As for Professor Desai’s wish, did it come through?  He wished for a broken Uber IPO, that is, one with a market price falling short of the offer price, as a rebuke to large venture capital funds, like the Softbank Vision Fund, which tend to provide plenty of financing to glamorous firms like Uber at the expense of other noteworthy startups.  He apparently assumes that such funding bias is not driven by sound fundamentals and hence hurts the efficiency of the market in allocating capital to businesses.  On one level, Prof. Desai’s wish came through.  Months before the IPO, Uber’s shares were estimated to be worth between $100 and $120 billion.  At current prices, they are worth closer to $70 billion.  This means Uber’s financial backers were terribly off the mark regarding the value of this business when they sank money into Uber.  Therefore, Prof. Desai got his wish.  Will this chasten venture capitalists and make them more efficient in valuing startups?  It remains to be seen.  On another level, Uber’s broken IPO worked in favor of its backers and other shareholders.  They sold new shares at $45 when shortly afterwards the market determined they were worth only $42.  This means they sold overpriced shares!  This was a gain to them.  As more stories come out, we are learning that some dark clouds had already moved into Uber’s blue sky before the IPO.  It is very plausible that influential Uber shareholders (like its venture capital backers) pushed a higher offer price on the underwriters, thus, contributing to the eventual overpricing.

As I said, when it comes to a specific IPO, it’s difficult to make predictions.  As in other areas of economics and social sciences, we can recognize patterns that hold on average but can never accurately foretell how a particular case will break out.  Dismal sciences indeed.

On May 6, the United Nations released its Global Assessment report with truly devastating findings regarding the state of plant and animal life on earth.  Over the past 100 years, grazing, farming, logging, fishing, poaching and mining have dealt an unprecedented catastrophic blow to our planet’s biodiversity.  Hundreds of animal species have become extinct, millions of acres of forests have been cut down, and seas are been fished at depleting rates.  As arable land is being extended into formerly forested areas, its over-exploitation leads to its degradation and eventual uselessness.  The degrading of natural resources and life because of economic activity is one more threat to human life in addition to climate change.

Meanwhile the human population is projected to grow from its present size of 7 billion to 11 billion by 2100.  If population growth to the current level has inflicted such a devastation, imagine what it can do to the planet earth when 4 more billion humans compete for natural resources.  More consequential than the population growth itself is the certain prospect that billions of people will move from the third World to the second and first Worlds in the not too distant future.  As incomes rise, so will consumption and resource usage.

It’s time, therefore, to seriously think and act on the imperative of sustainability.  These days we talk about sustainability on various levels.  Sustainability of capital resources; sustainability of human resources; sustainability of natural resources; sustainability of climate.   Sustainability is satisfied when “a living system operates in a way that it does not use up resources more quickly than they can be naturally replenished.  Or a sustainable economic system operates in a way so that expenditures are either equal or less than the income.”   For example, as workers, we spend energy on our jobs, but if we have enough rest, nourishment, and recreation, we can restore our physical, mental and emotional stock and continue to be productive at the same or even higher level.

The above description of sustainability echoes the definition of income from capital the British economist Sir John Richard Hicks (a Nobel Prize winner) gave in his book Value and Capital eighty years ago.*  He defined it as that amount we can spend without depleting the capital.  Applied to sustainability, it requires that we recognize the natural world and the climate that sustains it to be our capital.  Thus, we need to determine how much we can take out of this capital without impairing its ability to restore itself.  But before I go further down on this line of thought, it is useful to talk about the concept of positive and negative externalities because of their serious impact on our lives and pockets

A positive externality is when I do something good but receive no monetary gain.  For example, I buy a hybrid car.  I pay relatively more and refueling it is more burdensome.  My good choice helps the environment and, hence, everybody.  But I don’t get any monetary break.  So, I pay for a positive externality from which all others benefit as free riders.  Hence, why do it?

For a negative externality, think of a factory that pollutes the air.  The price of products the factory makes does not factor in the damage to air quality.  That cost is born by all of us.  Without any laws or regulations, the factory will continue to do this, profit from it, and pass the cost to us.  Unfortunately, unfettered markets fail to monetize the positive externalities or capture the cost of negative externalities at the individual level.  But as we say in economics “there is no such a thing as a free lunch.”  When the air gets to be too foul to breath and sickness multiplies, it is society as a whole that pays the price in higher health insurance premiums, higher medical costs, etc.  The market fails to preserve the air quality because it fails to pass the cost as part of a higher price to the individual consumer of the factory’s products.  The point here is that the inability of markets to incorporate the positive and negative externalities of various economic activities contributes to the problem of degradation of human and natural resources.

Environmental sustainability can be also discussed in the context of the theory of the commons.  Commons are goods, like pastures, forests, sea areas, that belong to all.  In a 1968 influential article published in Nature, Garrett Gardin coined the term The Tragedy of the Commons.  He argued that if each individual, driven by personal gain, over-exploits a commons resource, like a pasture, that would lead to its demise.  Similarly, if we think the air is part of the commons, each factory owner can foul the air in pursuit of profit without effective self-regulation through the market system.  The solution to the problem is collective collaboration among the people having jurisdiction over the commons.  The economist, and 2009 Nobel Prize winner, Elinor Ostrom, an advocate of collaborative management of the commons, has documented many examples of collaborative and effective management around the world.  Peter Barnes also advocates to treat our natural resources as the commons in his book Capitalism 3.0.

It is time, I believe, we treated our natural resources, biodiversity, and climate as commons.  In some cases, it may be enough to leave the custody and management to a local community or a state.  In other cases, we may need international, even global, collaboration.  Of course, we should be prepared to hear the opposition voices.  Some of them will come from big corporate interests that want to remain unaccountable custodians and users of all available resources.  Others will come from the ideologues of unfettered markets who are divorced from empirical reality and pragmatism.

We also need to acknowledge the challenges.  Restricting our total consumption to the “income” that can sustain our natural capital may mean we live with less than our voracious wants demand.  The biggest challenge is that most of the remaining untouched natural resources are in less developed countries whose populations rightfully desire to match our standard of living.  How are we going to convince them to refrain from exploitation of their natural resources, when it was the exploitation of ours that propelled us to this prosperity?  That will require a global coordination and assistance so these countries can attain prosperity by means other than those that degrade nature.  Are we at this point in our current state of world affairs?  Not really, considering that our own government wants to open up our national parks to commercial exploitation.

The good thing is that sustainability in its various forms has acquired a momentum of its own.  Institutional investors, like pension funds and investment companies, do offer us opportunities to invest in firms based on their environmental and social responsibility.  And a multitude of organizations (think of the Sierra Club and Greenpeace) around the world strive to promote sustainability.  For the good of the planet, their cause must become our cause.

 

*  I am not sure whether Hicks was the first to define capital income this way, but I cite him because it’s a definition that stuck in my head since the days of my undergraduate studies.