The failure (at least temporarily) of President George W. Bush’s immigration bill Thursday evening had one overwhelmingly powerful cause: the American people don’t trust the Bush administration to enforce immigration laws, so the tough enforcement provisions in the new bill were nugatory. This atmosphere of distrust is partly generational but highly damaging, particularly in the economic sphere.
In an ideal world, in which laws were obeyed or enforced and there was little leakage, the economically optimal immigration policy for the United States would be only moderately restrictive, allowing a fairly large number of immigrants annually, with a strong preference for those of high intelligence or special skills. There might be a modest preference for immigrants from countries with comparable living standards to the United States, sparing the world the spectacle of Bosnian doctors cleaning latrines in Queens.
From the point of view of the world as a whole, the economically optimal U.S. immigration policy would be closer to “open borders” but with an auction system for immigration permits, the money raised being split between the U.S. government and the government of the immigrant’s home country, to help defray the cost to the latter of the immigrant’s education and childhood upbringing.
Neither of these systems nor any compromise between them is ever likely to be put in place because of the leakage in the current immigration system and the consequent lack of credibility of any enforcement mechanisms that might be legislated. If the two sides to the debate believe respectively that the pro-immigration crowd has no interest at all in enforcement and the anti-immigration crowd is a bunch of racists whose ideal society was Apartheid-era South Africa, no compromise is possible.
The mutual distrust that prevents compromise is nevertheless rational. On the one side, the U.S. history of racial discrimination is sufficiently recent and widespread (covering Asians and Hispanics as well as African-Americans) that a distrust of motives is natural. On the other side, the total failure of the enforcement provisions in the 1986 Simpson-Mazzoli legislation, and the laughable failure by the Clinton and Bush administrations to enforce laws against employing illegal immigrants, even after the 9/11 attacks had demonstrated that border control was a serious security problem, naturally destroy the credibility of new enforcement provisions. Had existing immigration provisions been enforced with reasonable rigor, there would be far fewer illegal immigrants – and far fewer empty and unnecessary McMansions, rotting in the sun as the housing downturn hits.
Trust is an essential to commerce. I have written previously how oligarchic markets in some respect work better than fully competitive ones, because the level of trust between the participants is higher, and so there is less need for extensive legal documentation and less likelihood of catastrophic error through malfeasance or misunderstanding. Throughout human life, transactions become more difficult and perilous if trust is not present. Even in personal interactions a propensity to fabrication can doom the most promising relationship.
The commercial revolution of the eighteenth and nineteenth centuries was built largely on the ability of participants to trust one another. “My word is my bond,” the motto of the London Stock Exchange since 1801, was not simply a polite fiction, it was essential to dealings between participants who did not know each other well and whose transactions either did not follow well established legal ground or in some cases (options dealings before 1822) were on the face of it unenforceable as gambling contracts. (This problem arose again on the invention of the interest rate swap market in the early 1980s; much legal talent was expended in finding a way around the apparent restrictions of the 1710 Statute of Anne which made gambling debts unenforceable.)
The Victorian and Edwardian periods didn’t only introduce restrictive sexual morality, they also codified a commercial behavior pattern that involved very high levels of trust. J.P. Morgan testified to the Senate in 1913 that “a man I do not trust could not get money from me on all the bonds in Christendom.” Thus in the London market in particular but also in New York, by 1900 it was essential to be trusted by ones business associates, and lack of such trust was a generally fatal obstacle to business success.
This pattern persisted until well after World War II. David Kynaston’s “City of London” has harsh words for the oligarchic City of the 1950s and 1960s, in which Morgan Grenfell Chairman Vivian, Lord Bicester could in 1954 ask the Bank of England to prevent the takeover of British companies by the untrustworthy, but the system worked very well, producing by 1980 most of the innovations of modern finance, at a cost in terms of GDP a small fraction of the bloated financial services sector of today.
After 1980 or so, things changed. A number of factors were responsible for this. Generationally, the cohort which had indulged in sexual and psychedelic experimentation in the 1960s, and had rejected the morality and lifestyle of its parents, began to control a major portion of the financial system. In London, the merchant banks were wiped out by the abolition of the Accepting Houses Committee in 1981 and by the Financial Services Act of 1986. Globalization brought companies much more closely into competition with entities from other cultures with different behavior standards (Japanese behavior standards were at least as high as Western, but the “signals” were different.) The rewards for success for CEOs soared, as did the penalties for failure (no mainstream CEO before Enron’s Jeff Skilling was given a 24 year jail sentence for going bankrupt.)
Most important, financing became cheap and relatively easy for outsiders to obtain. No longer did old Pierpont have to trust you; if you had a plausible track record, however doctored the figures you had used to generate it, you could leverage yourself into a major corporate purchase. In 1987 the Washington Post published a cartoon of a hayseed explaining that with no qualifications and no credit he had previously been unable to get a loan, but now the bank would help him buy any major US corporation he wanted. In 2007 that cartoon isn’t funny.
As Bush has just discovered, a world without trust is a pretty hostile place. In the long run, without adequate levels of trust, economic prosperity must inevitably disintegrate. So the questions arise: how quickly can trust be regenerated, in the business world at least? (the political world is not my specialty.) What factors will cause trust to regenerate, and how can we nurture it?
Generationally, we may have some hope of improvement. The 1960s are not going to happen again, thank God, and the generation that was nurtured by them is finally passing from the boardroom. Subsequent generations have shown themselves in youth far less prone to rebel against the political, social and ethical norms of society, as evidenced by declining crime, drug use and illegitimacy. It is likely that as the current generation rises to power in the business world it will come to find itself less attracted by the quick wealth promised by hedge funds and the like, and more attracted by the chance of building something worthwhile in the long term.
This won’t happen while cheap money remains, however. If starting salaries working for a hedge fund are three or four times starting salaries working for a conventional corporation, any reasonably able and ambitious graduate will gravitate towards the hedge fund. More than a third of the Harvard Business School Class of 2007 have accepted jobs at hedge funds and private equity funds. That does not reflect the students’ ethical choices, it is simply a reflection of the economics they face – it is, incidentally an almost perfect “sell” signal for those institutions.
Only once cheap money has gone, and the inevitable shake-out in the short term return businesses of Wall Street has occurred, will Harvard Business School and other well qualified students make their choices based on their own underlying values and not on a huge immediate differential in earnings. At that point, the outcomes are likely to be very different. Contrary to the leftist dream, HBS students will not rush off to join charities, but major corporations that show signs of both stability and a high level of innovation will prove attractive destinations.
However, more than the end of cheap money will be needed for trust to return. For one thing, the end of cheap money is likely to lead initially to a surge in bankruptcies, which will inevitably be accompanied by innumerable toe-curling sagas of corporate malfeasance. For several years, very few people will trust the corporate sector at all, good, bad or indifferent. That, like the disruption caused by bankruptcy to the lives of innocent employees, is the inevitable denouement of an era of artificially cheap money and bubble-hood.
Corporations will regain their good name, and their ability to be trusted, by acting in a trustworthy manner. Stability will eventually return to the corporate structure, so that the median corporation exists for half a century and not half a decade. Top management must stop using accounting shenanigans to deceive shareholders about the excessive remuneration they are extracting – needless to say this will also require them to stop extracting excessive remuneration. Leverage must be cut back sharply – those corporations which do not do this will in any case not survive in an era of tight money. Business plans must be rationalized, and not become mere tools of empire building and corporate dealmaking. Consultancy usage must be cut back, and eliminated altogether from such areas as top executive compensation in which it is ethically inappropriate.
In a decade or so, the corporations emerging from the downturn will finally be trustworthy, and will in their business dealings put two-way trust relationships at the top of their objectives, where they belong. They will not look like the corporations of 1965; for one thing they will be far more multi-national, bound together by the marvels of modern communication, and they will manufacture primarily in locations where labor costs are much lower than the United States, and yet quality is as good. However between their multinational workforces internally, and between the multinational workforces of corporations that do business together, trust will be established at an extremely high level.
The technology would be incomprehensible to J.P. Morgan, and the diversity of race, national origin and indeed sex somewhat repugnant. However if Morgan returned to 2027 he would see, as in 2007 he would not, that the central principles of trust in which he believed were alive and well.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)