Category Archives: Other

Tax: can we find someone to blame?

If you’re a regular reader, you may know that I work in Luxembourg, and in tax. To many, those key words are enough to see dollar signs rolling in front of your eyes. So when the ‘LuxLeaks’ scandal broke out, it provided justification to many around the world: “those quasi-tax haven countries are unjust”; “they cheat”; “they’re becoming more and more powerful”; “they’re being utilised more and more by an increasingly wealthy elite to evade tax”. Do you think that’s true? Then did you also think the same about Panama?

A journalist organisation recently unleashed nearly 40 years of a Panamanian law firm’s records, which exemplifies how many prominent political figures and wealthy people have used offshore bank accounts to conceal assets. The Prime Minister of Iceland lost his job over the scandal. But it’s also tarnished the reputation of more than 140 other politicians and public officials from around the world – Ukraine, Argentina, Russia, China, Britain, and many others.

Some people ask so what? They quote Judge Learned Hand:

“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.”

It’s a great quote, since it unveils the hypocrisy of many critics. Yes, people do make voluntary donations to the state. But they’re the minority. Most people use every available legal tool to lessen their tax burden, and if they had the wealth to invest somewhere with less tax, would do so in a heartbeat. What’s more, capitalism encourages people to do whatever is legally permissible in order to maximise their capital assets. Thus within the rules of the game, it is not only perfectly reasonable, but more than that positive, to see people increasing their wealth with tax. Is there someone to blame?

Let’s take the example of British Prime Minister David Cameron’s late father. As a multi-millionaire stockbroker, he registered his own investment fund in Panama, and personally managed it until his death. Through this fund, the elder Cameron was a client of Mossack Fonseca – the Panamanian law firm in question. And even the fund’s prospectus explicitly stated that the fund intended to remain resident outside of the UK for tax purposes. So did the elder Cameron do wrong by using taxes to maximise his capital within a system called capitalism? Or is that system at fault?

Richard Hay, a specialist legal counsel to various British offshore centres, summarises the question well:

“There’s no surprise that criminals carry on activities in financial centres, because that’s where the money is. The real question is whether it is systemic.”

One of the main reasons why this story in Panama has attracted such attention is the widespread assumption that such criminal, or at least borderline criminal, activity is widespread. Although Mossack Fonseca itself claims that it applied all KYC (Know Your Customer) and AML (Anti-Money Laundering) due diligence procedures, the ICIJ (International Consortium of Investigative Journalists) reported that many banks, law firms and third parties involved in the transactions referred to failed to adhere to legal requirements. In other words, they did not carry out sufficient due diligence to ensure that their clients weren’t involved in criminal enterprises, tax evasion (illegal), or political corruption. Some of the documents even show that intermediaries deliberately acted to conceal certain transactions.

As a FATCA and CRS specialist, it’s my job to put due diligence procedures in place, and ensure they’re 2016-04-28 (2)implemented. So I have sufficient insight into this world to understand that it is not only possible, but indeed highly probable that sufficient due diligence was not carried out. Yet please don’t read any sort of conspiracy into what I say. It’s great that more focus is being given to the issues at hand in the press, and by politicians. But international cooperation on this matter is already getting better at a break-neck pace, and has has been for many years – especially following the 07/08 financial crisis. Indeed you need only take a random snippet from the FATF recommendations (international standards on combatting money laundering and the financing of terrorism and proliferation) to have a guess at how many institutions around the world will/will not be able to accord with such requirements in the next couple of years:

“Financial institutions should be required to maintain, for at least five years, all necessary records on transactions, both domestic and international, to enable them to comply swiftly with information requests from the competent authorities.”

Given the number and complexity of new laws and regulations that companies need to comply with, and the fact that none of the due diligence work is funded by governments, it’s no wonder that application varies from one institution to the next. And can individual countries even monitor all the data that’s currently being requested? Of course they can’t!!

Therefore, although responsible individuals always have to take blame, I have to say that the ultimate fault, or problem, lies with the system itself. Yes, the days when secrecy was one of the main selling points for ‘tax havens’ is fast becoming history. But nonetheless the lack of a truly global tax organisation – similar to the WTO, but for tax purposes – is a significant hindrance to any truly synchronised efforts at tackling tax evasion. Such a tax organisation (and no the OECD does not, and cannot fill this requirement) would bring FATCA, CRS, UK CDOT, BEPS, and perhaps even model tax conventions, and bilateral tax agreements under its umbrella. With such oversight it could easily replace many of the complicated requirements with a simpler, and at the same time more rigorous, set of compliance requirements. But more than that, it could work towards rebalancing the existing inequities of the international tax system, which presently give huge bias to certain countries (and not just tax havens).

Are Corporate Networks Growing or Shrinking in Power?

A corporate network (of people, not computers) is in form similar to any other type of network. It’s a series of connections, linking various corporate interests together. As such, history, composition, and influence, vary significantly from network to network. But treated as a whole, there is a popular assumption that of course corporate networks are increasing in power. This view is challenged by: ‘The Power of Corporate Networks: A Comparative and Historical Perspective’ edited by Thomas David and Gerarda Westerhuis.

David and Westerhuis describe how certain global trends can be identified:

  • Late nineteenth century – End of 1920s

The second industrial revolution (railroads, factories, steel and oil industries, electricity etc) triggered the rise of large businesses, and directors of these firms in many instances sat on the board of several different firms. Despite the fact that “during this period the emergence and rise of corporate networks can be observed for almost all countries” (p13), David and Westerhuis explain that the nature and extent of those networks were hugely influenced by politics, and also the strength of facilitative intermediaries such as banks, third party business groups, and colonial firms. In other words they were nationally based, not globalised. Therefore the form of these networks varied from one place to another.

Germany legalised cartel organisations (formal organizations of sellers or buyers, who agree to fix selling prices/purchase prices, or reduce production). Yet the United States (in the Sherman Act of 1890 and the Clayton Act of 1914) passed competition laws that prohibited cartels and monopolies, and outlawed direct interlocks with competitors (the most prominent example of interlock is where directors serve on the board of each firm). As a result of these laws, the “density and centralisation of the network increased [in Germany] in parallel with the growing degree of cartelisation, whereas in the US, mergers were preferred to cartels, and the density of the network declined” (p14).

Banks also played an important role in the rise of corporate networks; providing loans, becoming shareholders, underwriting securities issues, and giving advice. “The density of the Italian network peaked in 1927, when the influence of the larger banks […] reached its apex.” However it wasn’t always banks that played the crucial role. Business groups and colonial firms often acted to facilitate various economic activities. But it was noted that in each example a facilitative organisation was present to support growth.

    • 1930s – WW2

During this period some countries (the UK, Switzerland, France, Finland, Bulgaria and Argentina) continued to experience a densification of corporate networks, whereas others (the US, Italy, the Netherlands, Germany and Portugal) experienced the reverse. For the latter countries, the authors note that this was to a great degree the result of the Great Depression, and the falling number of interlocks between banks and firms resulting from banks’ weaknesses. Legal and political context also played a role. For example Portugal (1935), Italy (1936) and the US (the now famed ‘Glass-Steagall’ Act of 1933) passed legislation designed to weaken the interlocks between banks and firms. And in addition to Germany’s legislation, its expulsion of Jews from the country also expelled many directors with pivotal positions in the corporate network.

    • 1945-1980

The authors speak of an implied consolidation of corporate networks during this period. For Germany and Japan, occupation brought with it a series of US style laws, which resulted in decartelisation and de-concentration. For single party countries such as the USSR, satellite states, and China; firms were interlocked through the party, and the economic plans. Banks also experienced a great deal of growth during this period, particularly in Japan and the UK. Banks therefore contributed to the consolidation of the corporate network, financed a great deal of the post-war recovery, and in various countries contributed to the strengthening of the corporate network.

  • 1980 – Today

The authors speak today of a declining corporate network in many respects. Globalisation has led to less integration within national business networks. Neoliberalism, privatisation and increased focus on shareholder value has led to the shrinking of boards e.g. in Argentina the corporate network collapsed in the last decade of the twentieth century due to privatisation. The fall of the USSR destroyed the party through which many corporate networks were facilitated in the eastern bloc. Moreover, since the financial crisis of 2007/08 there has been a shift in values. David and Westerhuis explain:

“Legal concerns due to new regulations regarding directors’ liability seem to have undermined the social status and prestige conferred to big linkers, which explains the decreasing number of interlocking directorates during this decade.” (p21)

During the Great Recession the roles, power, and prestige, of banks has changed significantly. New regulations such as the Basel accords (and their national equivalents) require banks to hold more tier 1 capital, and bigger capital buffers. This means banks can leverage their assets less, have less available liquidity, are lending less, and can function less ably as global network intermediaries. But beyond this, after the scandals surrounding banks in the crisis, many elites are less than keen to be so closely associated with them. There are other explanations offered by the authors too, such as the use of alternative social networks, or the possibility that corporate elites are acting to hide their networks. But the conclusion is essentially that national corporate networks are now in decline.

Conclusion

The book’s proposition, that national corporate networks are, particularly in countries such as the US, becoming more disperse and less interlocked, is well evidenced. However there is much less attention given to multinational networks. Indeed “global network” comes up nowhere in the whole book, and “multinational” comes up only 7 times. Yet examples of multi-national corporate networks abound:

  • Alumni networks come from every university (and many schools and colleges) around the world. A quick google search for business networks brings up Oxford Business Alumni Network, which has ten thousand members, and of whom a significant number are likely to hold powerful jobs. The Texas Alumni Network (the Aggie Network) has hundreds of thousands of alumni. The University of Pennsylvania’s network currently includes Donald Trump, Warren Buffett, Noam Chomsky, and nine Nobel Prize winners, along with more than 130 clubs around the world. Regional clubs within this network can often boast their own successes. The co-founder of Venmo, CEO of Givology, Executive Director of Apex for Youth, and a Professor Emeritus at the university, are all cited on Pennsylvania’s Asian Alumni website.
  • News based networks are strong within the upper echelons of management. As big media companies deliver news to many of the world’s most successful people, it’s not a big step to use those contact details in order to build a business network. The Economist’s Network is one such large example with a global reach, and a heavily elitist weighting. 88% of its members are senior management level or higher.
  • Industry specific networks are also a significant piece of the pie, and many are quite new. G-Med for example, only founded in 2014, for doctors worldwide. It has over 15,000 members already, and a strong business slant. Type “GMED” into google and the first thing you’ll see is how well the company’s stock is performing. Moreover, many of these industry specific networks are often formed within multi-nationals as opposed to between them. I work in a multinational bank, and even they have recently built an internal social networking site (banks aren’t often high on Forbes’ list of innovative companies).
  • Online networks might not immediately spring to mind as networking tools for the elite. The news stories focus on facebook, twitter, Qzone, Google+, Instagram, Tumblr, Sina Weibo, Vkontakte and Snapchat. But with more than 300 million members, Linked In also high up this list, and it is there not because of the ability to share silly videos, but rather as a professional network. It facilitates introductions, headhunting, and the maintaining of business relationships over time and distance. There are other less well known business networking sites too. But the one thing that all of these sites has in common is that a decade ago, no one even imagined they would be so prominent today.
  • There are also many generic business networks. Business Network International is the biggest among these, with over 170,000 members worldwide. It claims to be able to generate billions in revenue for its customers.
  • Moreover, although not exclusively business related, it would be remiss of me not to mention sites such as Angel’s Club, Affluence.org, Netropolitan and ‘A Small World’. All of these sites ask huge membership fees, and are based upon exclusivity for the rich and famous. Indeed, ‘A Small World’ recently cut its membership from 850,000 to 250,000, in order to maintain the perception of exclusivity.

Therefore the book does not conclusively answer the question as to whether corporate networks are growing or shrinking in power. What the book is successful in doing is showing that national corporate to corporate networks have not, according to this analysis, proved to be the source of that influence since the 1980s. Indeed Cadernas (2012 p315-16) grouped countries based on cohesiveness. In countries such as Italy, France, Germany and Spain, the combination of a bank-based financial structure, interventionist state, firms with blockholders (owners of a large proportion of the firm’s equity and/or bonds), and low economic internationalisation, all lead to a power structure based on unity, concentration and control. Whereas in countries like Canada, Australia, Switzerland, the US and the UK,  a non-interventionist state, market based financial structure and widely held corporations result in a dispersed power structure, in which the corporate network is fragmented. Between 2010-2014 the average GDP growth rate of the former group with a dense corporate network has been (-1.9+0.3+0.1+-1.2)/4) = –0.675%, whereas in those countries with the dispersed power structure the average rate has been (2+2.5+1.9+2.2+1.7)/5) = 2.06%. Given the other factors in play, causality cannot be attributed in this case. However the comparison is indicative of a common consensus among academics: a sparser intra-corporate network does not seem to impede growth. Therefore the shift from dense national networks, to sparse international ones, may not signify the decline of corporate networks, but rather a simple transition from the age of national corporate aristocracy, to the age of global corporate empires.

What’s your opinion? If you have a personal story to share about the strengthening or decline of corporate networks, it would be great to hear from you.

Tax: Missing The Point in Luxembourg

Over the last few days an international investigation has hit the news following the leak of 28,000 tax documents from Luxembourg, mostly from PWC. It’s triggered a worldwide frenzy of journalistic and political criticism of Luxembourg’s political elite (and to some extent PWC). This is significant for the EU, because Jean-Claude Junker jean-claude-juncker-2-540x304is the current President of the EU Commission (the executive branch), and yet when many of the above documents were written he was Prime Minister of Luxembourg. Worse than that in fact; after 18 years as PM Junker came out with a speech saying that as EU Commission President he would:

“Try to put some morality, some ethics, into the European tax landscape.”

So the story is now that we have a villain and a liar at the head of the EU, as well as a proven tax haven at the very heart of Europe (Luxembourg was one of the EU’s six founding countries). Indeed the news is now peppered with talk about pressure on Junker to step down. BUT, this story is both naive, and also the story that tax avoiders actually want you to buy into. It is a story which harms international cooperation, and prevents focus from being where it actually should be if we want to resolve the problem of lost tax money.

As argued in the tax debate, focus on individual countries, and especially on the political elites, is part of a false and misleading narrative. I work as a Luxembourg Tax Analyst full time (more to assist compliance with government legislation than advice provided to companies, but I know several tax advisors – some of whom work in PWC). In this capacity I have helped to re-organise one of the tax payments systems used. Do companies always pay the cited national level of Corporate Income Tax? No, annoyingly far from it. I remember coming home from work numerous times and complaining to my wife that even in nominal terms we pay many times the amount of tax paid by big corporations. But let me ask you this: do you think companies in the US pay the national rate? How about the rest of Europe outside of Luxembourg? Or indeed anywhere else?

Moreover, I also work as a Political advisor in my spare time. In that capacity I have analysed, and spoken to, a lot of different politicians. My experience is limited, and perhaps it would be different were I to circle with the true elites. But nonetheless, I have never encountered anyone who’s actually clued up about the way that the international tax system works. They all know it’s a problem. But in reality it’s just too complicated for most elected politicians to fully understand. So the problems get shunted off into the administrative elements of the tax system. These administrations are left to understand vague and ambiguous political directions, to which private institutions spend huge sums pandering towards. But, and this is why today’s story misses the point, Tax Administrations around the world all play by the same rules!

This story on the news right now pertains largely to ATAs (Advance Tax Agreements). Within the parameter of these agreements Tax Advisors recommend new structures to clients that will save them tax. Sometimes these structures are complicated. Other times they’re relatively simple. But every time one of these agreements is taken to the Tax Authority, the tax advisors can:

  1. Make an argument of comparison to cases in other countries (appealing to the country’s sense of competition within the rules of the international ‘game’)
  2. Use asymmetrical information to make their argument (local tax authorities have information about their state, and not others – it’s the tax advisors who come to the table having already analysed the big picture)
  3. Make a sales pitch based on whatever ambiguous political values come down from the political elite

Shire is a good example. It’s a multinational drug firm, specialising in treatments for ADHD, Crohn’s disease and rare genetic disorders. Its structure, set up upon advice from tax advisors, sees offices in Ireland, Jersey, the UK and the US. By paying internal loans between these offices (sub-businesses), Shire is able to avoid paying tax on interest payments from countries where tax is high, on the understanding that tax is paid where the interest income is received. But, based on a chart showing money flowing from the company’s headquarters in Ireland, through two Luxembourg sub-units, and ultimately to to other Shire companies around the world; the Luxembourg sub-units could be presented to the Luxembourg Tax Authorities as simply an intermediary between other, larger businesses elsewhere. As part of this presentation, tax advisors can draw up an Advance Tax Agreement (sometimes called a ‘comfort letter’). There, they argue that the onus of taxation falls not on Luxembourg, but really on the final recipients of the interest income, because the loans are really only flowing through Luxembourg.

To the Luxembourg Tax Authorities this idea of tax transparency seems quite normal. Most countries recognise tax transparent companies, where the onus of taxation is not on the company, but rather on the final beneficiaries from the company’s income. In other words the company exists for administrative purposes, and tax just flows through. Moreover, Luxembourg is of course a very small country. It seems easy to believe that it is indeed being treated as no more than a flow-through entity. Therefore, Luxembourg’s tax collectors agreed that they did not need to perform a rigorous tax assessment of Shire’s operations, because the assessments should really be performed elsewhere. Of course this is a very positive light in which to paint these activities. But what I wish to press is that these arguments are easily made, information is often incomplete, and similar things happen all the way around the world. Moreover, every single act now perceived to be immoral was perfectly legal, and not only that, but encouraged under the existing corporate and capitalist systems in place.

The American system of Corporate Governance is the one which dominates almost all global corporations (Germany is a sometimes cited exception because of the power it gives to employees, but even there the pattern of change is towards the global consensus, and not away from it), and it says that the corporation’s primary goal should always be maximising shareholder value. Given that this defines the goals of almost the entire global network of competing businesses, is it really any wonder that Shire was able to justify its actions as below?

“Shire Holdings Europe No.2 Sarl [the Luxembourg sub-unit], is part of our overall treasury operations. We have a responsibility to all our stakeholders to manage our business responsibly; this includes managing our tax affairs in the interest of all stakeholders.”

If someone beats you in Monopoly, do you cry out that they were cruel and unfair to leave you bankrupt? Of course not! They were supposed to do that, because that’s what the game asks. Besides, if you target one player in the game and continually criticise them as being unfair, then you will probably find that while you’re distracted, someone else is even more busily trying to bankrupt the both of you. This is why, when political leaders such as US President Barrack Obama and UK Prime Minister David Cameron come out in speeches labelling multi-national tax-avoiding corporations as “unpatriotic”, they sound to many in the corporate world like the Monopoly player whining about their losses, and in a world where they have as much power as anyone else to affect real change in the rules of the game. This is why it is crucial that we focus on tax reform where it matters most: in the arena of international taxation.

The OECD’s Base Erosion and Profit Shifting Initiative (BEPS) is trying to resolve problems such as these (and many others) right now. The latest update relating to BEPS came just a few days ago, with the OECD releasing a discussion draft pursuant to action 7 of BEPS, in which they call for changes to the definition of ‘Permanent Establishment’ (one of the legal requirements necessary to set up residence in a country). So let’s focus on initiatives such as this. Let’s bring them into the limelight. Let’s raise their profile. And let’s challenge their fundamental assumptions too. The OECD is effectively a rich country’s club, as you can see from the map below.

OECD_member_states_map.svg

Talk about tax fairness is commonly about compliance with the OECD Convention, and the OECD’s rules on tax transparency (which countries like the UK and US are not compliant with). But what is not normally recognised is the fact that the OECD Model Convention stands contrary to several principles initially laid out in the 1928 League of Nations Treaty, and later promoted by Keynes when the Bretton Woods Institutions were being set up. These principles gave substantial taxing rights to source countries (where the income comes from). The OECD model benefits developed countries in which investors choose to reside their companies e.g. Luxembourg, the US, the UK, Switzerland, the Cayman Islands, Hong Kong and others. In fact the UN had to create an alternative model in 1980 to more fairly deal with the source countries.

If we’re going to be realistic about what we can do, and we do actually want to support tax fairness globally, and not just for ‘us’, whoever that us happens to be, then we’re going to have to:

  1. Bring the UN in on the BEPS initiative.
  2. Raise the profile of international tax
  3. Work towards a much broader state of cooperation, such that we can found an International Tax Organisation, with similar institutional capacities to the World Trade Organisation

The campaign for tax fairness is not a battle that can be fought and won. There will always be vested interests spending countless hours trying to find loopholes and exploit tricks of the system. An International Tax Organisation would ultimately be able to monitor these efforts, and provide assistance to all states seeking to protect their legitimate taxable incomes. But as that organisation is a long way off, then let us cooperate more on what is on the table today. And let us not turn to childish bickering and the age old classroom ‘blame game’. If we do go down that route i.e. the blame game; our problems will be worsened, not solved. The players don’t need to be changed. The rules do!

Alternatives to Neoliberalism

The Financial Crisis of 07/08, followed by the ensuing ‘Great Recession’, has hugely undermined faith in Neoliberalism. As Colin Crouch argued in his 2011 book “The Strange Non-Death of Neo-liberalism”, it seems that in many ways neoliberalism is actually stronger than before the crisis. Indeed, the main groups attracting protest votes are very much neoliberal, and heavily influenced by the neoconservative (the two ideologies often go hand in hand) scepticism about the stability of multi-cultural and multi-religious societies. Yet 2011 was also “the year of the protestor” thanks in large part to people’s frustration with its dominance. Moreover, if you listen to the left then No Alternative to Neoliberalismneoliberalism might be in for a fall. Even mainstream (left wing) opposition groups (e.g. Labour in the UK and Die Linke in Germany) now voice their opposition.

But what are the alternatives? After all, when the UK Labour Party was in power between 1997-2010 it governed from within the neoliberal consensus, and its elite became more as opposed to less convinced in the truth behind that consensus as time went on.

To answer this question first let us define neoliberalism. Essentially, it is a political and economic ideology very close in thought to classical liberalism. Andrew Heywood’s “Key Concepts in Politics” defines it as an ideology of the “new right”. It uses models based on the rationality of markets and individuals, places faith in the capitalist economic structure, and espouses a limited role for the state given the capitalist market’s natural tendencies towards long term growth, and the balance of supply and demand. In terms of policy it emerges as a preference for privatisation, de-regulation, low taxes, and anti-welfarism (e.g. austerity cuts to public spending and benefits).

The espoused alternatives are commonly thought to be some sort of mix or variety of Mercantilism (whereby the state makes all economic decisions) and/or Socialism (whereby control is collectively managed without regard to socio-economic differences). However applications of these alternatives don’t take the big picture into account. And in this sense it is right that they are heavily critiqued. Neo-liberalism is the antithesis of the collectivisation and nationalisation seen in the USSR, and perhaps also an echo of the corporatist third way first employed in fascist Italy. To oppose it by lurching back towards the USSR’s tactics is ultimate folly, since the same reasons why we rejected that path in the first place still stand today.

Instead of choosing between letting the state dominate the economy, and letting private capital holding elites dominate the economy; we should be looking for a third choice – and a novel one! There are plenty of new ideas out there without us constantly looking back to the twentieth century. Moreover, it’s no wonder neo-liberals have found it simple to convince people of the economic strengths of their model. Capital holding elites, and especially since the so-called “managerial revolution” and the rising strength of managers and corporations, give high priority to increasing the amount of capital. Indeed the dominant model of corporate governance around the world is that which has one prime goal: maximising shareholder value. States don’t seek the same thing, and so it’s no wonder why people have become convinced that neoliberalism is a necessary evil to keep our economies strong. But answers are out there. The German model of Corporate Governance for example, also empowers the workers, and gives them say over corporate governance. So should we all seek to copy Germany? No.

Solutions must always be adopted, and tailored, relative to local demand. But the German model of corporate governance does carry the seeds of an interesting idea. It recognises that there are other stakeholders besides state and economic elites, and it also recognises that empowering other stakeholders can potentially regulate the excessive short-termism and risk-taking that especially ambitious managers, are often willing to take.

capitalism-is-not-democracySo what would the optimal solution be for Europe? Simple. The neoliberal consensus, which has been growing since the time of Reagan and Thatcher, has reversed our prior agreement that capitalism must conform to democracy as opposed to it being the other way around. To reassert democratic control, we must seek to empower all stakeholders in the economic system (e.g. consumers, suppliers, employees, shareholders, neighbours, and the broader public). Rather than socialism or capitalism, this would be an economic democracy; a model and an ideology that has thus far been unrealised in practice, and should reflect the new counter-argument to the modern neo-liberal consensus.

How do principal-agent relationships evolve within a context of structural contradictions?

The principal-agent relationship is a very simple one. It simply means any relationship in which one party (the agent) is contracted by another (the principal) to do something on their behalf. So when you take your car to the garage for example, you, as owner of the car and the person hiring, are the principal. The car mechanic, as the person being hired to do work on your behalf, is the agent.

As society has grown more complex and specialised, principal-agent relationships have become increasingly important to modern day life. The reason for this is that they exist when one party does not have the time, resources and/or expertise necessary to carry out a certain task, and must seek an agent to do it on their behalf. Therefore, Dilbert - principal-agentbecause such relationships are so widespread, and because they create problems such as moral hazard, asymmetrical information, adverse selection, and agency rent (see notes at the bottom if you wish to know what these are), they are always evolving.

In thinking about how relationships evolve, the common approach is to think in terms of utility, attachment, and the basic emotions which drive us to maintain those relationships. In other words we tend to conduct relational analyses in an individualistic light, looking predominantly at the agents (when described in agency-structure terms both principal and agent are agents) who take part in the relationship, more than the structure within which that relationship evolves. Yet structures are built by individuals, and they are built to achieve certain things. Therefore, structures have intentions just as much as do individuals.

So what does it mean when principal-agent relationships evolve within a context of several overlapping structures? Does it cause a synthesis of those structural intentions? Or was the Bible (Matthew 6:24) right when it said that “no man can serve two masters”; implying that, if structures can be considered as Masters, then either one or both will have to be chosen over the other at various times.

Let’s take the structural contradictions between liberalism, capitalism and democracy as examples. Can a principal-agent relationship evolve within each of these structures, and at the same time better achieve each structure’s goals? What’s the aim of each? I have to be very clear here; what I’ve written below is purely my interpretation of these concepts, and some people would disagree.

Liberalism aims to maximise freedom of the individual, insofar as said freedom does not impinge upon the freedom of others; and thus it treats all individuals as being equal under the law. An utopian liberal principal-agent relationship would therefore be the most anarchic of all structural relationships. Its theoretical ideal would be that principal and agent collaborate together on an equal footing, towards a Pareto-optimal outcome in terms of marginal utility gains (an outcome in which no stakeholder’s level of satisfaction deteriorates). However its intentions as a structural framework would not be to create a Pareto-optimal outcome, but rather to allow it. This is why many people think that liberalism and capitalism go hand in hand, because liberalism is more concerned with equality of input i.e. legal rights, than output i.e. wellbeing, power etc.

Capitalism aims to maximise productivity, by ceding power over the means of production, distribution and exchange of wealth to private individuals who express competencies through their existing capital holdings. An utopian capitalist principal-agent relationship would perhaps behave in a Darwinist fashion, as a great deal of Darwinist thought was absorbed into the then youthful notion of capitalism.The ideal capitalist principal-agent relationship would at face value seem very conservative, as it would seek to maintain, and further, the power held by the ultimate capitalist principals i.e. the capital holders. And yet it would be ruthless about letting those who squander their power fall.

Democracy is slightly more collectivist in its thinking than those other two structures above. Where liberalism is slightly anarchic about its definition of principals i.e. everyone should have equal rights; and where capitalism selects individual capital holders as the ultimate principals; democracy finds the majority electorate to be the ultimate principal. An utopian democratic principal-agent relationship would therefore seek to empower the electorate.

Although many well-renowned figures have argued that democracy and capitalism go hand in hand e.g. Schumpeter and Friedman, the aims of democracy and capitalism are immediately and visibly contradictory if the above definitions are used. So what does this mean for the evolution of principal-agent relationships? If you were writing a contract governing a principal-agent relationship today, what would you do? Would you instinctively employ one structural understanding over another? Would you seek to serve the interests of multiple structures at the same time?

My expectation is that as principal-agent relationships evolve, they’re led by social, state and international structures towards one or other particular ideological structures. So for example in the period after the Cold War ended I might expect to see that principal-agent relationships evolved towards being more capitalist, as this period of history saw many people believing that capitalism was the best system that we would ever find. Whereas when a left wing government takes power, and proves to be successful with the economy, I would expect to see that principal-agent relationships become more socialist.

I’m now thinking about starting a PHD in exploration of this question, in which I would explore recent theoretical developments, and the thoughts of those elites working in the field, to test whether or not these structures do seek to pull the evolution of principal-agent relationships in different directions. Given that this is a huge question, my initial thoughts are to limit the parameters of this study as described below:

Geographical restrictions Comparison of Luxembourg with an individual UK constituency of a similar sized population
Restrictions in terms of people Economic fiscal relationships between decision makers on the one hand, and the principals of both capitalism and democracy on the other (I added liberalism above as a further example of the many competing structures that affect our thought, but it would be too broad to encompass more than 2 within a PHD)
Restrictions on the types of relationships Specific fiscal decisions made by key individuals, and how the decision makers interacted with their agents and principals in making the decisions. It doesn’t matter whether those decisions were made into law or not. It could simply be a decision to vote in a certain way. The focus will be on what influenced that decision and how e.g. were measures taken to mitigate the principal-agent problems, and if so did they better help capitalism or democracy?
Temporal restrictions The longer the timeframe the better the data will be in terms of building a trend in the evolving direction of said principal-agent relationship. However this will of course depend on what data is already available.
Restrictions on the type of research Secondary theoretical analysis will be required in order to test what I see as the study’s main weakness i.e. the subjective theoretical interpretations against which data is analysed. And if feasible it would be great to verify any hypotheses which emerge as a result of this research en masse via crowd-surfing. However most data gathered will be in the form of individual interviews with the key stakeholders involved.

Such a study would not only provide invaluable data on the evolving trend of principal-agent relationships among political and economic elites, but would also prompt further research questions into the impact of competing ideological structures on decision making among elites. However, the idea behind this research is at present only that: an idea. No research proposal of any shape or form has yet been drawn up. Therefore, I would be immensely grateful to you if you could share your thoughts with me. It doesn’t matter how educated those thoughts are. What do you expect that I’d find? Is it a worthwhile idea? Is it feasible? Whatever your thoughts are, I would truly love to hear them!

 

P.S. If you’re interested then please see the below definitions of the major problems in a principal-agent relationship:

Moral hazard is a situation in which the contract arranged between principal and agent makes one party more likely to take risks, which might adversely affect the other party. An interesting example today is bank deposit insurance. If a bank shows signs of trouble, and individuals’ deposits in that bank are not guaranteed by the government, then depositors/investors are likely to run on the bank (withdraw more than the bank holds in reserves, and prompt bankruptcy) out of fear. Yet if the government says it will insure deposits in the event of a crisis, then banks feel more able to take risks, because should the worst occur then they would not bare the costs. In the principal-agent relationship, the agent may have incentive to act inappropriately if the agent’s and principal’s interests are not aligned, and depending on the nature of the contract. For example collective cabinet responsibility creates moral hazard, for it means that the results of high levels of risk created by one Minister (agent) will be shared by all other Ministers, and the Prime Minister (principal)

Adverse Selection refers to the process through which undesirable selections could be made, usually as a result of when principal and agent have asymmetrical information. In agency terms, adverse selection often occurs because those least qualified for a post are often the keenest to be hired. For the same reason, the most ambitious are likely to try harder, and so to obtain posts more quickly than those who are perhaps more able. Yet they could also be more likely to policy shift if they think it will get them a better job in the near future. In political situations adverse selection may often be more likely, as it could occur without asymmetrical information. For example election results could require a coalition, or party factions could necessitate certain, otherwise undesirable appointments.

Agency Rent describes the opportunity for agents to extract ‘rent’ (in material or policy terms) that the principal would rather not pay. This rent can be extracted within the agent’s ‘bargaining range’. For example even if there are other perfectly suitable candidates for the job, so long as there are costs involved with replacing the agent, there is always bargaining power to be had. Rent can be extracted in material terms where the agent has the power to request more resources/pay than he/she actually needs, in the form of leisure i.e. agent shirking, or in the form of policy i.e. policy shifting.

Agent shirking is a situation when the agent is not putting in the required effort to get the job done, which is possible in the Principal-Agent relationship because the agent can observe what he/she is doing much more closely than can the principal. Dilbert - principal-agent 2

Policy shifting occurs with the presence of asymmetrical policy goals between principal and agent. As the agent does not share the same preferences as the principal, they may not lead in the direction that the principal would wish. For example ministers may have different policy ideas to their principal: the Prime Minister.

320px-Principal_agentAsymmetrical information means no more than to say that both parties do not have the same information. But the most commonly described problem here is what Gary Miller describes as Weber’s asymmetry i.e. the agent, as the specialist, holds an informational advantage over the principal, who thusly feels a need to make use of his/her authority to incentivise the agency to act according to his/her interests. For example when you take your car to the garage, you know that the mechanic knows more about the car than you do. You don’t know that when they say they’ve fixed the problem, they haven’t created another dozen, which will require you having to go back to the garage within a few months. So you, as principal, might want to ask for some sort of insurance e.g. that if there is a problem in the same area of the car within the next six months, that they will fix it.

“We should be too big to take offense and too noble to give it.” Do you agree?

Modern society places great emphasis on not giving or taking offence. It is the reason why so many people support, and so many others are annoyed by, the idea of ‘political correctness’. But should we?Offence

The quote was from Abraham Lincoln; and we have a prima facie (at first sight) urge to agree with it. But this does not mean it is beyond dispute. In fact the statement is both imbalanced, and also inconsiderate of human emotion. The taking and giving of offense is both part of human nature, and also purposeful. Indeed as Thomas Carlyle once said:

“No man lives without jostling and being jostled; in all ways he has to elbow himself through the world, giving and receiving offense.”

Offense giving and taking are most often the least honourable courses to take. And nobody likes the person who’s quick to give or take offense. But let’s face it; emotions get a point across as reason just never could. And taking offense is an emotive reaction. Imagine you’re a Palestinian or an Israeli person, and while you live in London you meet someone who doesn’t know anything about Israel and the holocaust, or Palestine and the human rights crisis (if you don’t know already, you should note that the number of Palestinian refugees stands at a similar figure to the number of Jews killed in the holocaust). Imagine not taking offense when that person makes stupid remarks about people in the region. Wouldn’t that be a good time to start taking offense, in order to ensure that such stupid remarks are not repeated?

In the political world, umbrage seems to be a powerful tool in twenty first century politics. Announce that the opposition’s or media’s tactic is outrageous and offensive, and you will immediately frame a public response; not in terms of whether that opposition/media point has logic, but rather, whether or not they are in the wrong. In other words it shifts the negative focus somewhere else, and leaves only sympathy behind. After all, who can’t empathise with someone who’s been offended?

There are two responses to such umbrage in politics. One comes from the logic of Voltaire:

“I disapprove of what you say. But I will defend to the death your right to say it.”

The quote actually comes from Evelyn Beatrice Hall in her 1906 biography of Voltaire, whose opinions she was attempting to summarise. It was her interpretation of Voltaire’s attitude towards Claude Adrien Helvétius, and his controversial book De l’esprit. But nevertheless, the quote has gained a great deal of attention, and been repeated many times by those who believe that we should be entitled to both give and take offence as we please.

The second response is captured by widespread laws and conventions against denying the Holocaust (it is illegal inRacism in tabloids Germany, Austria, Romania, Hungary, Belgium, France, Israel, Luxembourg and many other places – in Austria it can earn you 6 years in jail), by Germany’s ban on the publishing of Mein Kampf (to be lifted in 2015), by the Islamist reaction to a series of Danish cartoons depicting the Islamic prophet Muhammad, and by even neo-liberal groups who aim to censor the press as a means to mitigate the spread of false and misleading information such as is spread about by tabloid papers.

The two opposing views understandably create quite a bit of animosity, and trigger a lot of offence.

against press censorship

But the very fact that a debate on whether or not we should be permitted to offend causes a torrent of offence giving and receiving, surely proves that it is both natural, and also to an extent unavoidable. In the economist’s ‘ultimate game’, designed to teach us about human nature, Player A is given 20 $1 bills, and told that in order to keep any of the money, A must share it with Player B. If B accepts A’s offer, they both pocket whatever they’ve agreed to. If B rejects the offer, they both get nothing. Economists expected pure rationality at first; A would propose the lowest possible amount i.e. 1 dollar. And B would accept, knowing it was better than nothing. But in fact what happened was that when the amount given was 7 dollars or less, most people took such offence that they preferred rejecting the offer in order to teach A a lesson, rather than taking the lower amount. Indeed in Descartes’ Error, neurologist Antonio Damasio argues that humans who behave purely rationally are in fact brain-damaged. Now one could of course argue, as I would, that punishing player A based on the offence caused was in fact entirely rational. But the offence which lies at the heart of the matter still seems to call the shots.

The question that remains for you to answer, is, should such offence giving and taking be calling any shots? Was Lincoln right that “we should be too big to take offense and too noble to give it”?

Is Society Sick?

I heard it said once that people who are overly competitive are showing signs of insanity. It was a native American tribe who held this view, and it is a view that I immediately sympathised with, even if I would never have used the word ‘insanity’. Many of my strongest political convictions are reflected in this view; that homelessness and extreme poverty should be eradicated, that all people have value to contribute within society, and that extreme capitalist and individualistic thinking has corrupted our pursuit of happiness.

However it was when I set up the Democratic Reform Party that I really started thinking about our mental/spiritual health as a society. The more I learned, the more it seemed to me that our entire socio-Anorexiceconomic system is designed to defeat itself. We are taught in homes and schools alike what “success” actually is, not explicitly of course; but we nevertheless emerge at the end with three distinct ideas: the first idea of success is fame and fortune; the second is a highly paid job, a house, a marriage, and kids; and the third is to become a hero, but we are warned away from this latter route by dint of the fact that for every hero there are a thousand failures. In fact a quote of Dorris Lessing springs to mind:

“Ideally, what should be said to every child, repeatedly, throughout his or her school life is something like this: ‘You are in the process of being indoctrinated. We have not yet evolved a system of education that is not a system of indoctrination. We are sorry, but it is the best we can do.”

Through this indoctrination we, in our ‘careers’, are encouraged to pursue one thing above all others: money. It is polyp_cartoon_Rat_Racethis pursuit that drives so much of us into competition, that eats up our free time, limits the pursuit of leisure, results in more emphasis on career than social relationships, and indeed encourages us to move away from friends and family in the name of money. So it encourages us to spend more resources on ourselves, and also in ways which, statistically speaking, are in fact more likely to limit rather than increase, happiness.

Since this experience I have not learned anything which has shaken these ideas and thoughts from my mind. I’ve known many friends with severe depression, several of whom have attempted suicide. I received a message only two days ago from the mother of a close friend, saying that my friend needed help. I have even experienced the loss of one of my family members in a manner which seems to me certain to be linked to the depression which plagued his mind. It was hard writing that. It’s been quite some time now, and I have talked about it, if fleetingly; yet even a sentence brings tears to my eyes.

So yesterday, when I heard Tim Macartney (social entrepreneur and leadership expert) talking at the London School of Economics about the ‘Children’s Fire’, I thought that this is definitely something I wanted to blog about. The ‘Children’s Fire’ was literally a small fire placed at the heart of decision-making councils in some ancient native American tribes. It served as a reminder to those present that no decision should be passed which might harm a child, irrelevant of whether that child be human or animal.

Tim Macartney told his audience that he had once introduced this idea to a council of leaders, and been told that it was a little naive, and perhaps even childish, to think that we could employ the same idea today. Yet Tim responded by asking the audience to think in the exact opposite manner. He asked them to think of a society where that fire was never used.

“Don’t you think” he said, “that this society without the children’s fire, is sick?”

A few years ago I read a report explaining that clinical depression would, on current trends, become the world’s second most disabling condition behind heart disease by around 2020. I felt saddened, and immediately wanted to raise money for charities working to help people with depression. Yet I, like many others I guess, held hope that the trend would slow. In fact however, it sped up. In late 2013 experts reported in the journal PLOS Medicine that depression had already become the second biggest cause of disability in the world! You can see the BBC report here: http://www.bbc.com/news/health-24818048.

Based on the work of psychiatrists, psychologists and academics such as Fuller Torrey and Judy Miller, this trend in fact seems to be much broader than depression. They published a book in 2007, arguing that the rapid increase of mental illnesses since 1750 was an invisible plague that urgently needs to be tackled. The prevalence of insanity for example, according to their research, was once considerably less than one case per 1,000 in the total population, and yet by today has risen beyond five cases in 1,000. If true, the implications of such findings are quite scary.

sick_society_quote-text11875

Unfortunately the data over the period analysed by Torrey and Miller is sketchy, and so we can’t be sure of the validity of this argument. However we can be a lot surer of records gathered since the 60s and 70s. Based predominantly on census data from the period stretching back to 1971, researchers at the University of Sheffield found that a staggering 97% of communities studied in the UK have become more fragmented and “rootless” over this period, and also levels of “anomie” (social instability caused by erosion of standards and values) have risen significantly. In the US, over a similar period, it was also found that the rate at which Americans invite people into their homes has declined by 45%. Indeed findings such as these are not hard to find. Robert Putnam, in ‘Bowling Alone’, reported significantly increasing levels of dis-cohesion and social fragmentation. Cacioppo & Patrick published similar findings in 2008. Carne Ross had a significant rant about such statistics in his book published in 2011, ‘The Leaderless Revolution’. Professor Mark Stein drew the conclusion in a ‘Psychoanalysis of the Financial Crisis’ in 2012 that Western Society has been behaving neurotically for 20 years (http://www.businessinsider.com/a-psychoanlytic-guide-to-the-financial-crisis-2012-6). And I could cite many more sources!

Statistically speaking, happiness is no higher today than it was in the 1950s. And what’s worse is that our replacement for it i.e. the pursuit of money, isn’t helping us either. Since the 1970s the average income of the most wealthy has skyrocketed. But the median income of the average person has if anything fallen slightly. What does that suggest to you? Is our system broken? Is society itself sick?

Of course we could take any time or place in history, list the problems, and somehow come out with an argument that society is sick. So maybe these problems aren’t nearly so huge as they seem. But to me personally, they certainly seem to be pretty huge. How do they seem to you? Is society sick?

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