The Decadence of the People’s Car
PRINCETON
– So far, the Volkswagen scandal has played out according to a
well-worn script. Revelations of disgraceful corporate behavior emerge
(in this case, the German automaker’s programming of 11 million diesel
vehicles to turn on their engines’ pollution-control systems only when
undergoing emissions testing). Executives apologize. Some lose their
jobs. Their successors promise to change the corporate culture.
Governments prepare to levy enormous fines. Life goes on.
This scenario has
become a familiar one, particularly since the 2008 financial crisis.
Banks and other financial institutions have enacted it repeatedly, even
as successive scandals continued to erode confidence in the entire
industry. Those cases, together with Volkswagen’s “clean diesel” scam, should give us cause to rethink our approach to corporate malfeasance.
Promises of better
behavior are clearly not enough, as the seemingly endless number of
scandals in the financial industry has shown. As soon as regulators had
dealt with one case of market manipulation, another emerged.
The trouble with the
banking industry is that it is built on a principle that creates
incentives for bad behavior. Banks know more about market conditions
(and the likelihood of their loans being repaid) than their depositors
do. This secrecy lies at the heart of financial activity. Polite
analysts call it “management of information.” Critics consider it a form
of insider dealing.
Banks are also
uniquely vulnerable to scandal because many of their employees are
simultaneously behaving in ways that could influence the reputation, and
even the balance sheet, of the entire firm. In the 1990s, a single
Singapore-based trader brought down the venerable Barings Bank. In 2004,
Citigroup’s Japanese private bank was shut down after a trader rigged
the government bond market. At JPMorgan Chase, a single trader – known
as “the London Whale” – cost the company $6.2 billion.
What these repeated
scandals show is that apologies are little more than words, and that
talk about changing the corporate culture is usually meaningless. As
long as the incentives remain the same, so will the culture.
The Volkswagen case
is a useful reminder that corporate wrongdoing is not confined to the
banking industry, and that merely levying fines or ramping up regulation
is unlikely to solve the problem. Indeed, it is one of the iron laws of
corporate physics: For every regulation, there is a proportionate
proliferation of innovations to circumvent it.
It should come as no
surprise that there were incentives in the automobile industry to game
the system. Everyone knows that actual fuel economy does not correspond
to the numbers on the showroom sticker, which are generated by tests
carried out with the wind blowing from behind or on a particularly
smooth road surface. Similarly, anyone who has stood next to a diesel
vehicle, even one proclaiming the virtues of “clean diesel,” could tell
that it was smellier than cars powered by gasoline.
There are two
important similarities between the scandals in the finance industry and
at Volkswagen. The first is that large corporations, whether banks or
manufacturers, are deeply embedded in national politics, with elected
officials dependent on such firms for job creation and tax revenues.
Volkswagen in particular is an icon of German manufacturing. Chancellor
Angela Merkel has gone out of her way to support the company, as did her
predecessor, Gerhard Schröder, who came to its defense in 2003, when
the European Commission challenged the legality of its holding
structure.
The second similarity
is that both industries are subject to multiple regulatory objectives.
Regulators may want banks to be safer, but they also want them to lend
more to the real economy, which often means taking more risks. As a
consequence, they impose rules that do not clearly push banks in one
direction or the other.
The regulation of
automobile emissions faces a similar problem. As regulators’ focus
turned toward limiting global warming, there were tremendous incentives
to manufacture vehicles that produced fewer greenhouse-gas emissions,
even if that meant, as with diesel engines, emitting other gases and
micro-particles that are much more harmful to humans in their vicinity.
There was never a discussion of the tradeoff between limiting local
pollution and fighting climate change.
As
the Volkswagen crisis so vividly illustrates, we need more than
corporate apology and regulatory wrist slapping. It is time for a
sustained discussion about how to craft regulations that provide the
proper incentives to achieve the objectives we truly desire: economic
and social wellbeing. It is only when that discussion takes place that
we will get the banks, cars, and other goods and services that we want.
Harold James is Professor of History and
International Affairs at Princeton University, Professor of History at
the European University Institute in Florence, and a senior fellow at
the Center for International Governance Innovation. A specialist on
German economic history and on globalization
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