Galbraith’s Economics of Innocent Fraud

A Synopsis of J. K. Galbraith’s final book:

The Economics of Innocent Fraud: Truth for our Time

      Late in life, at the end of his long career as an economic advisor to governments, as a Professor of Economics at Harvard, and as the celebrated author of nearly two dozen previous books, John Kenneth Galbraith published his short final book titled The Economics of Innocent Fraud. In this book Galbraith intended to bring into sharp focus the truth about certain pernicious economic myths that have led to some dangerous economic and social effects—effects that have led in turn to some serious social injustices. It was Galbraith’s hope that exposing the truth about these myths might help free the discipline of Economics from many of the current sins committed in its name.

      Galbraith called these myths “frauds,” because they are false and because they have been used to enable and justify accretions of wealth and political power that previously would not have been acceptable in a truly democratic society. He called these frauds “innocent” because in some cases their falsity, and their pernicious effects, are not recognized by those who continue to perpetuate them. Galbraith recognized however that many of those who do perpetuate these myths do so with a less innocent intent, knowing these myths to be conveniently false. For such people, be they economists or bankers or corporate executives or politicians or business school academics, these myths generally help to assure them of their own continued comfort, wealth, and power.

      Houghton Mifflin published The Economics of Innocent Fraud in 2004. It contains twelve short chapters or essays that occupy just 60 pages of print. The book has received generally admiring and favourable reviews, more for its important content than for its style and presentation. Although the book is succinct in many respects, nowhere does Galbraith actually list the myths that he discusses, nor does he name them consistently. I experienced the writing in this book to be repetitive and at times quite unclear and puzzling. It is written in a casual style, a style that might properly be characterized as “first-draft-shorthand.” Nonetheless, the importance of what Galbraith was trying to teach in this final book justifies its close study. I have summarized below what appear to be the primary lessons or truths that concerned Galbraith as he wrote. Each of these lessons he addressed in various and scattered locations throughout the book.

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      Among the frauds that Galbraith begins to describe early in this book is one that I will call the fraud of misdirection through mislabeling. The language used in economic discourse is often carefully managed in ways that make appropriate criticism of it more difficult. It is often a language designed to create an aura of scientific respectability, but one that is unearned.

      Galbraith begins his book with this theme by examining the history of the use of the word “capitalism.” In the early decades of the industrial revolution the excesses of unregulated “capitalism” led both to the subjugation of, and to the exploitation of, many workers. It also led to the burst economic bubbles that precipitated the Great Depression. These events severely tarnished the reputation of corporate free-market “capitalism” and those economic policies that had supported it.

      Today economists and others invariably speak not of capitalism, but rather they refer to it as “the market system.” This empty and benign term, with its suggestions of a neutral, mechanistic inevitability, is used to preclude any close examination of, or regulatory tampering with, the modern capitalistic status quo, a status quo that again shares many of the features of earlier oligopolies with their attendant monopolistic behaviours and effects. “The market system,” Galbraith makes clear, is neither a natural nor an inevitable economic entity. It has been carefully fashioned over many decades, by earnest lobbyists and friendly governments, to suit the preferences of those in society who are more fortunate, articulate, and politically powerful.

      Galbraith also discusses mislabeling of a different sort, used to camouflage the existence of any modern monopolistic corporate behaviour. Economists now argue that there can be no monopolistic corporate abuse because “today the consumer is sovereign.” The so-called “economic demand curve” is said to guarantee that consumers have control over prices and supply, because consumers can always refuse to buy what they don’t want or what seems to be priced unfairly high. Galbraith, however, points to the many ways that, in reality, this is false. He argues that increasingly it is large corporations that now decide what will be produced, and what prices will be thought to be acceptable. “Marketing” departments work hard, and advertise effectively, to create “consumer demands” that fit the wishes of the corporate producers, all the while claiming these are only responses to public preferences. The hidden assumptions that appear to justify the so-called law of the economic demand curve are unrealistic and overly simplified.

      Galbraith gives another example of manipulating words, useful for misdirecting any criticism of the comfortable status quo that is enjoyed by the very wealthy. He argues that in reality “work” can be divided into two general types: one type applying to jobs that are boring, difficult, and stressful, and one type applying to jobs that are self-fulfilling and enjoyable. The former type generally pay rather little, and the latter type generally pay very well. The better paid people (who would resist being called “workers”), include many who do not work at all because they enjoy generous rents and dividends and annuities. Such people are often now praised for being “self-sufficient.” But those who don’t work, even if only because they are unable to work, people who “require welfare” to survive, have come to be condemned as social spongers and characterized as basically lazy.

      Galbraith notes that over time society, helped initially by Veblen’s book The Theory of the Leisure Class, has been encouraged to accept great wealth and ostentation as both proper and commendable. Today the word “work” has come to refer to something essential for the poor, but not for the rich. Moreover, it has become accepted that the most generous wages and benefits should go to those most enjoying their work, while low wages are appropriate for stressful “unskilled” jobs, and even for teachers and nurses, police and firemen. Society has been increasingly inhibited from questioning wage policies and labour policies, whenever that questioning threatens corporate and individual convenience.

      The carefully managed use of another word which Galbraith examines is that surrounding the word “bureaucracy.” This word too has come to embody negative connotations of inefficiency, delayed action, poor customer service, and general incompetence. In particular, corporate executives and certain economists argue that governments are bureaucratic, while corporations are organized much more efficiently, making them far better than governments at taking effective rapid action whenever that is called for. Galbraith argues that corporate assertions of this kind are a myth, and that the managerial structure of corporations are at least as complex and bureaucratic and inefficient as are many branches of government.

      Galbraith points out that in a corporation your status and pay is almost always a direct function of the number of employees who work under you. Thus there is a strong incentive for managers to increase the size of their work group and their corresponding responsibilities. This of course can be equally true of some government departments, as corporate managers delight in pointing out. But bloated and inefficient bureaucracy is hardly limited to governments. Galbraith goes on to develop this criticism further when he looks at how corporate management gathers control of profits and decisional powers to itself, all the while falsely claiming to be answerable to stockholders and directors.

      Later in his book, Galbraith interrupts a discussion of corporate power and management to take up another form of misdirection and mislabeling. He looks at the use of the concept of the two market sectors: the “private-sector” (corporate) and the “public-sector” (governmental). For Galbraith, the distinction between these sectors has today evaporated. Corporations and governments have become equally bureaucratic, and equally subject to effective corporate control. They both have marked inefficiencies, and for many of the same reasons. Private-sector “supply” of goods and services is loudly touted as less costly and more effectively available when needed, but the reality is generally otherwise. The private sector is focused on ensuring profits. Government departments are normally focused not on “profit,” but on public service, as are other non-profit, non-governmental, organizations.

      Galbraith concludes by pointing out that the largest single segment of public-sector spending in the USA is by its military, amounting to close to 50% of all US discretionary government expenditures. But military spending is largely directed by military lobbies with the consent of congress and the department of defense. It is paid almost entirely to corporations, not to government employees. Even government “security forces” are often contracted from private corporations today, rather than supplied by governmental armed forces. The so-called public-sector has long since become privatized.

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      Another myth that Galbraith examines I will call the fraud of economic metrics and their hidden agendas. Initially he treats this topic with the example of how economists and governments and statisticians have managed to enshrine GDP [the measure of “Gross Domestic Product”] as the single most important metric reflecting the economic health of a society. Galbraith points out that there are many assumptions and decisions that underlie how the GDP shall be measured, and these are rarely examined or debated. The “product” measured for GDP is largely confined to paid goods and services. It does not reflect the unpaid “products” of, for instance, housework, or nursing of sick relatives, or volunteer services of a thousand types.

      The “economic health” of a society, when measured by GDP, reflects no values of, and no accounting for, educational or medical or artistic and cultural contributions to general social well-being. Moreover, GDP tells us nothing about the degrees of poverty, or unemployment, or crime, or severe illness that a society may currently suffer, or, might have recently managed to reduce. In fact, GDP focuses attention only on narrow economic goals in a fashion that often makes social problems worse. To call the GDP a measure of the success, of either a society or an economy, is thus a fraud. Yet corporations and financial advisors and economists typically perpetuate their convenient myth that only “growth of the GDP” reflects the road to economic and social well-being. They want governments and voters to quake at the thought of any policy said to threaten a decline in GDP. We must expect “growth” to continue, without limit or difficulty.

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      Galbraith also discusses what I will call the fraud of economic expertise and predictability. He observes that “in the economic, and especially the financial world, …prediction of the unknown and unknowable is a cherished and often well-rewarded occupation.” [pg. 40] Galbraith emphasizes that there are always too many important, unknowable, and highly unpredictable factors that play a role in determining the direction of economic trends and market behaviours. Thus, economic and market predictions always depend heavily on multiple, risky, simplifying assumptions that underlie the resulting predictions. Some of these assumptions are recognized, but many of them are not recognized, and all of them are potentially fallible. Sooner or later every economic model and strategy fails. The apparent and claimed successes in economic prediction have always been temporary, always successful for reasons that include unrecognized lucky effects that are likely to disappear soon.

     And yet, there remains today a strong and well-paid demand for economic predictions and claimed expertise: i.e. a demand for investment advisors, for political advisors, and for advice to managers and bureaucrats. All are assured that they can rely on “expert” predictions of things that are fundamentally unpredictable. Galbraith emphasizes that sometimes those who pay for economic advice do not care if later it proves false, so long as it is temporarily helpful in achieving the aims of those who have paid for it.

      Galbraith continues this theme with a specific discussion of the reputed “expertise” of the U.S. Federal Reserve Board. Like most central banks, the U.S. “Fed” is charged with protecting the U.S. economy from recessions and high unemployment on the one hand, and harmful inflation on the other hand. Its tools for doing so primarily involve adjusting lending rates for and between banks. Galbraith explains some of the false economics assumptions that suggest these actions will work as intended. And he points to the many historic occasions on which the actions of central banks have not worked as intended. He concludes that “Quiet measures enforced by the Federal Reserve are thought to be the best approved, best accepted of economic actions. They are also manifestly ineffective. They do not accomplish what they are presumed to accomplish. Recession and unemployment, or boom and inflation, continue.” [pg. 44]

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      Galbraith focuses much of his attention in this book on the public portrayal of corporations, by economists and by the media. In general these portrayals protect various myths surrounding what I will call the fraud of corporate benevolence and natural self-control. Galbraith begins by observing that academic economic theory still holds to its historical roots, and so it portrays all corporations as if they were medium-sized small business, with the owner/founder still in control, just grown a little bigger. But the modern corporation, be it “small-cap” or global, does not obey that dated economic model, to which existing small businesses may sometimes still appear to conform.

      Galbraith notes that “The corporate management illusion is our most sophisticated, and in recent times one of our most evident, forms of fraud.” [pg. 26] He refers here to the illusion that owners, shareholders, and investors generally can and do play a controlling role in determining the direction taken by, and the behaviour of, the corporation. But in truth these people have no effective powers at all. Corporations quickly become too complex, and too extensive, for any such group to be able to control, or even simply to monitor, corporate behaviour.

      Boards of Directors are no exception to this rule, contrary to current economic dogma. Directors are crucially dependent upon what the corporate management allows them to know. They invariably depend for their appointments on friendships with the top management and with other Board members. Often they manage companies of their own and reciprocate with offers of memberships on their own Boards. Their pay and bonus incentives for service on the Board depend on recommendations made by the management and vice-versa. Conflicts of interest are very common. In practice it is almost unheard of for a Board to contradict a decision made by the top management of a corporation. Galbraith notes that even when a corporation’s profits, and/or its stock values, have recently dropped dramatically, management pay and favourable stock options have continued rising to extremes without so much as a pause.

      Galbraith concludes by saying “No one should be in doubt: Shareholders—owners—and their alleged directors in any sizeable enterprise are fully subordinate to the management. Though the impression of [ultimate] owner authority is offered, it does not in fact exist.” [pg. 28] Because this fraud is accepted, it is used very effectively to excuse corporate governance from any responsibility for managerial policies that prove detrimental either to stockholder values or to the public interest. Management can be made accountable only with active and effective regulatory oversight. But this oversight is again rare in today’s world, with the intense and effective political lobbying efforts that are carefully designed to inhibit just such oversight.

      In chapter ten of his book, Galbraith returns to this same theme, this time to focus on certain major corporate scandals: at Enron, WorldCom, Tyco, etc. These show how management’s control over and misuse of corporate power for personal enrichment, coupled with corrupted or lax accounting and corporate auditing, has caused major harms to the national economy and to society. Galbraith shows how corporate influence now extends even to some corporate regulators, auditors, and accounting firms. He concludes that what is required is “independent, honest, professionally competent regulation…a difficult thing to achieve in a world of corporate dominance.” [pg. 51] He notes that prison time, if mandated for cases of corporate fraud, would help to deter such corruption, if only the legal system would facilitate its use.

      In the last chapter of his book, Galbraith returns to the theme of the private sector and its inappropriate control over public sector policy and decision making. Again he emphasizes examples of corporate encroachment by the military-industrial complex into decisions about defence spending. He reveals how a post-war study of the efficacy of strategic bombing in WWII, a study demonstrating that this campaign had no effect either in shortening the war or in reducing the enemy’s production of military aircraft, was vigorously and effectively suppressed by the Pentagon in Washington. And later, in Vietnam, a study by Galbraith found complete military dominance of U.S. foreign policy in that region. Similar corporate control of national energy policy, of pharmaceutical policies and pricing, of broadcast and media ownership, and of health policies, are all further examples of corporate encroachment into the affairs of the so-called “public sector” of government. The myths of corporate benevolence and of public control over government policy are not innocent at all. For Galbraith, they present an increasing danger that needs correcting.

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      How such corrections might be realized, Galbraith does not tell us. But he has emphasized that first we must recognize the myths and frauds for what they are. These frauds are not nearly as innocent as we are still being asked to believe they are, by many economists, by the media, and by corporations themselves. Each of the frauds that Galbraith describes in this book plays a supporting role in amplifying the increasingly rapid growth of inequality throughout the world. There can be no limitations placed on excessive social and economic inequality without recognition of, and effective rejection of, the existing myths that Galbraith has described in The Economics of Innocent Fraud.

© J. Barnard Gilmore   Kaslo, British Columbia   March 2016

 

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