I just heard an interesting story on Marketplace Radio.  The story was an interview with a behavioral economist who tried to explain why people oppose the bailout of the global finance industry when their misbehavior got us into this predicament.  Marketplace interviewed Dan Ariely, a behavioral economist from Duke University and author of Predictably Irrational.

I think Dan has it exactly right. He argues that people oppose the bailout because even though they know it may cost them money — a lot of money — they want to punish those whose terrible greed got us into this predicament. It is hard for us to determine whether the financial system is really in such dire straits, but with the recent escalating LIBOR, money is beginning to freeze up. It isn’t as if money isn’t out there looking for a home, but deregulation in general and deregulation of financial institutions in particular — something neoclassical economists and financial interests have promoted for decades — has led to a collapse of trust in the financial system. While we may have “nothing to fear but fear itself,” fear has a lot of street cred in an unregulated economy.

The application of behavioral economics to this particular problem is instructive and important. This economist’s explanation of why people do not support the bailout shows exactly why we need to regulate the behavior that underlies market transactions. People want to punish the transgressors, and the fact that PET scans show that these parts of our brains light up when we think about doing so makes this deep-seated behavior predictable, whether or not it is economically rational. Indeed, I would argue that rational policy makers must engage a wide range of expected behaviors that arise in a complex society like ours, and expect to incorporate predicted behaviors within their institutional models. After all, the fear of legal sanction is a primary element in developing the rule of law that is the foundation of our civilization, so this need to get revenge against transgressors may not be so irrational.

In fact, I would argue that the need for revenge does not mean that people are “irrational” (the inference from the title of his book), but that they do not follow the assumption of economic rationality on which the standard neoclassical model is based. In other words, rational people are not just profit maximizers; rational people have a basket of standards. In other words, they are rational, but behaviorally so; they choose to exact revenge on those who violate social norms. That is why we pay so much to put cheaters in prison — not (as the Quakers claimed) to reform them but to punish them and set an example of others who might violate social norms.

Wall Street financiers have enriched themselves at the expense of “Main Street” and people are angry and will pay to punish them. Professor Ariely’s suggestion that we build future retribution (for these and future greedy charlatans) into our policy response to the current crisis is absolutely rational for two reasons. It satisfies our behaviorally rational need to punish transgressors, and it builds punishment that creates an economic and social penalty designed to discourage them from doing more of the same. Up to now, with a deregulated environment, it has not made economic sense for them to act prudently, and their imprudence led us to the abyss. We need to build rational disincentives into the system and certain punishment for violations of social norms.

Deregulation of labor relations has led to the same problem in the employment relationship. An imbalance of power between employers and employees, and on a global scale, between national interests and global markets — the deregulation of trade and a broad range of economic activity — has led to collapsing human rights standards in America and elsewhere in the developed world. Employers commonly violate workers’ human rights and systematically deny them the right of freedom of association while all the while claiming that they are protecting the workers’ individual rights not to associate with unions that might just increase their bargaining power.

While this may have created a voiceless — and therefore politically silent — economic crisis, the nation has been overwhelmingly opposed to the bailout because growing unequal opportunity and unequal employment outcomes has created a tinder dry environment in which the current crisis has lit a prairie fire backlash. Our nation’s inequality is comparable to that of China, and the Chinese at least know they have a problem and are trying to do something about it. This kind of backlash is dangerous because it can lead to the kind of economic environment the world faced in the 1930s along with the kind of political environment in the same era that fed totalitarian tendencies. It is the enemy of democracy itself.

Recognition of a wider concept of rationality, along with the recognition that civilized societies and markets require civilized regulation, might pave the way for a more sophisticated understanding of the kinds of institutions that might allow us to create a balance between efficiency and equity suited to the 21st Century. Indeed, it might get us back on the road to being a nation of laws, rather than a nation of men without respect for law and without social responsibility.

China, and Chinese industrial relations, has attracted increasing interest during the past few years. With China’s growing role in the global economy, the fact that the Chinese have approximately 25% of the world’s workforce should make those interested in global labor markets stop and take notice. Markets drive inequality and absent institutions to mitigate it, China not only will become unstable domestically but will drive growing inequality and instability worldwide.

The CIA Fact Book shows that Chinese inequality now matches that of the U.S., one of the most unequally distributed economies in the industrialized world. The Gini Index for family income – the most widely recognized measure of distribution – for the U.S. is 45, while the Gini Index for China is 47. By comparison, Sweden has the lowest inequality index (23) and Namibia (70.7) has the highest; the European Union overall has a Gini Index of 30.7 and India’s index is 36.8 (see https://www.cia.gov/library/publications/the-world-factbook/index.html).
While America continues to become one of the world’s most unequally distributed economies, how China resolves its emerging inequality problem will tell us a great deal about the future of global inequality during the 21st Century.

Many people have proposed solutions to the industrial relations challenge but most of them do so from an explicit Western framework and, even more to the point, with the assumption that Americans have gotten it right and the Chinese should emulate us.

First, Westerners should acknowledge our own failings first before suggesting what the Chinese should do. That is both an ethical and a practical necessity. The Chinese are very sensitive to invidious comparisons between themselves and the West, and their historic humiliations at the hands of the west, beginning with the mid-19th Century Opium Wars fought by the British to force the Chinese to sell British opium, the most egregious of many. For a current review of this issue, see Orville Schell’s article in the August 14 issue of the New York Review of Books: http://www.nybooks.com/articles/21715.

Second, Americans see ourselves as providing substantial worker protection, but this may well stem from diffuse pressure and modernization within the U.S., as well as our national wealth, rather than some general ethical standard. The growing epidemic of safety lapses in the U.S., ranging from the crane collapses and mining “accidents” to the escalating number of fatal falls from cell towers (at least a dozen in the past couple of months) points to a less-than-robust set of protections, once we remove regulation.

The Chinese know that while the U.S. vocally promotes human rights around the world, it has only signed two of the eight International Labour Organization Conventions on Fundamental Human Rights, putting us in a rarified rank along with Myanmar, Brunei Darussalam, and three tiny Pacific Island nations, among the most non-compliant (http://www.ilo.org/ilolex/english/docs/declworld.htm). When the Chinese proposed to transform their Employment Contract Law, effective January 1 2008, U.S. business interests opposed it vehemently. The European Chamber of Commerce did so as well, but backed away when European unions called them on it; the American Chamber of Commerce in Shanghai stuck to its guns and opposed this reform, which has become associated with broader Chinese official attention to equity for workers.

In a very significant way, the Chinese look to the U.S. for leadership, if for no other reason that we are the richest and most powerful nation on earth. If we came to be the world’s top empire in this era — something to which the Chinese aspire and something to which they believe they have a natural right — and we did so by ignoring these worker rights, why should they not follow our example? For ethical and practical reasons, we have some explaining to do to convince them. In particular, since we neither recognize the core right of Freedom of Association, either in the U.S. or in ILO Conventions, on what basis do we accuse the Chinese of failure?

This suggests a dual agenda for labor rights and human rights in the era of global trade. From the perspective of the Chinese, we need to get our house in order before we have the legitimacy to criticize them. The United States needs to join the modern nations of the world in recognizing and ratifying the eight International Labour Organization Conventions on Fundamental Human Rights, along with the other such Conventions (we have signed 14 of 187: http://www.ilo.org/ilolex/english/newratframeE.htm). This action would set an example that shows that the U.S. government is serious about these rights and is serious about labor conditions, regardless of utilitarian or libertarian consequences.

Second, having signed these Conventions we are in a better position to collaborate with them on the means by which they mitigate their own growing inequality problem.

The problem of unequal outcomes challenges all market economies, and this problem is especially true in China and India, the other emerging 21st Century economic powerhouse. China has introduced successful experiments that empower both their unions and some domestic NGOs to educate and represent the interest of workers – especially migrant peasant workers – and there is evidence that these changes are beginning to make a difference (see “Industrial Relations Experiments in China: Balancing Equity and Efficiency the Chinese Way”, at http://papers.ssrn.com/abstract=1135082).

With changes that get our own house in order, the U.S. puts itself in a position to influence the balance of global trade. With China and India together possessing about 45 percent of the world’s workforce, our efforts to promote equity there will be critical to our own successful transition to an efficient and equitable global economy.