Conflict of interest and an Economic Separation of Powers

Last post I explored the central problem of conflict of interest in both right and left wing economics, through a story about a group of shipwrecked people trying to establish a new economy and democracy on an island. This post draws on that previous post, so you may wish to take a look if you haven’t already. In summary, the island failed because neither left nor right wing solutions fully faced up to the problem of structural conflicts of interest. Perhaps the fate of the island is not so unlike our own, even here in the midst of civilisation. After all, the problems of power, and in particular conflicts of interest, remain central in any human culture.

Though they’ve both done much for democracy, both the Left and Right of politics have made only minor contributions to the separation of power in the economic sphere. The Right’s contribution has been to point to the flaws of command economies and central planning. They explain that by “socialising” economic activity into government enterprises, we actually concentrate power in the hands of a largely unaccountable government bureaucracy. The solution, says the Right of politics, is to establish a free-market economy, where many commercial players compete with one another, ensuring that if one company performs poorly, another has the power to offer an alternative. This, the Right claims, is the efficient and safe approach to economics.

The Left points out that in a free-market economy, companies often wield immense power and, in practice, are not directly accountable to anyone other than their major shareholders. There is a strong tendency, the Left says, for market economies to shift from pluralistic competition to the domination of a handful of monopolies and cartels. These giants abuse their position, not just by buying up or locking out small players that might serve to decentralise power, but also by dominating and hood-winking both consumers and citizens through marketing and public relations. They ignore or gloss over the problems creating in public health, the environment, and the community. The Left call for a response that forcibly breaks up monopolies, sometimes by structurally separating them, sometimes by legislating top-down procedural improvement, and sometimes by placing enterprise in the hands of government that the Left hopes can be managed and kept accountable through democracy.

Yet proponents for both sides generally spend most of their time selling their message by pointing to the flaws of those opposite. In a way, both the Left and the Right are in business together, using each-other as an excuse to sell their flawed and half-baked solutions. Neither addresses the fundamental problem – conflict of interest. Both approaches lack an economic separation of powers or a serious attempt to deal with conflict of interest. For example, in both cases citizens receive information about economic products and processes from the powerful organisations that produces them, whether that be the marketing department of a company trying to push their wares, or government propaganda telling people that their government-issue goods are good for them. In both cases, the citizen is getting their information from someone with a fundamental conflict of interest. These organisations don’t want to give you an impartial, accurate, well-rounded report of the product and it’s externalities. They want you to just like the product and ignore its flaws, including whatever social, environmental, efficiency and power-related problems that the production and its apparatus bring.

Many people, realising the fundamental failure of both central planning and laissez-faire markets, make modest attempts to limit the damage. One response is to call for a mixed economy with a moderate combination of market and government involvement. This centrist, moderate solution is probably better than the more extreme alternatives, because although we still suffer the failures of not one but two flawed systems, we receive vastly moderated versions of the failures. These are somewhat manageable and in rare cases can offset or balance each-other. Still its an inadequate response and a failure to fully confront the challenge.

Other reach for less sensible answers of anarchy, or primitivism, or succession from society. This is a fundamental failure to even engage with the problem, because in the modern world, with modern technology we have unleashed, we will have institutions and industry regardless of whether we aim to or not. Even if it was possible for such entities to be removed, the loss of production would result in countless deaths. This chaos is less like a solution, and more like fixing your house’s structural problems by setting it on fire.

Still others throw themselves into advocacy for the Left or the Right, claiming that while their proposed solution may be flawed, but at least its better than its opposite.

Democracy has a significant separation of powers

Humanity’s failure to address this problem needs to end. We have the solution. It’s a separation of powers that we use to address conflict of interest. We’ve already been using it through the rule of law, the independence of our democratic institutions, that, when we choose to uphold them, have successfully served to abolish the violent conflict and crushing oppression that trouble all undemocratic social groups of any signficant size. All we need is to have the vision and determination to let go of our conflicts of interest, so poorly addressed by the Left and Right, and apply the separation of powers to the realm of economics. If the model is clear before us, there’s no need for upheaval and chaos, simply sensible and determined reform.

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The Standard Economy

The standard economy – both market economies and command economies have a poor structural separation of powers

The Advanced Economy – An Economic Separation of Powers

Economics needs a sophisticated separation of powers in order to navigate the twenty first century

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If our goal is to apply a separation of powers to the field of economics, we should begin by noting the essential functional components of economic activity. There are six central functions that then can serve as the foundation of our separation:

• Entrepreneurship
• Labour
• Labour assessment
• Economic information
• Contract
• Investment

Combining these functions together creates conflicts of interest. This is the case in both the corporations of market economies and government controlled industry in command economies. This is undesirable. So, rather than surrendering to the blunt instrument of a debate about public versus private, we should strive to establish six new entities that correspond with the functions we have identified. According to our earlier principles, these should not just be divided, but also have limited well-defined powers, and be independent from each-other’s official or unofficial control. This helps us avoid at least nine fundamental, institutional conflicts of interest that could potentially arise without a separation.

• Entrepreneurs/investors wish to maximise profit, labour wishes to maximise salary (industrial disputes – pay)
• Labour wishes to work less, entreprenueurs wish labour to work more (industrial disputes – conditions)
• Labour wishes to have a secure job, investors and consumers want unproductive busineses wound up (anti-protectionism vs job stability)
• Entrepreneurs/investors psychologically or socially minimise/rationalise the harms their business does, the public wants accurate assessment of externalities and punishment of negatives (public relations deceptions, government capture, central-planning and authoritarianism)
• Entrepreneurs/investors wish to overstate product quality to improve sales, consumers require accurate and unbiased information about products for market forces to work correctly (marketing vs production goals in industry) (flashy vs quality, product bias)
• Training/education providers and labour wish to overstate the skill and qualifications of job applicants, businesses require accurate information about worker skill to hire the best personel (education and assessment need to be structurally separated)
• Ideas may be seductively unrealistic, but implementation requires realism (entrepreneurs vs investors – central planning failures)
• Contracts between unequal parties not honoured (contractees, legal representation and enforcement need structural separation)
• Insurers wishes to understate coverage after an incident, while the policy holder (or investor/entrepreneur) wishes to overstate it. The opposite is true of risk before an incident. (eg. insurance fraud, insurance company cop-out on technicality)

Many of these kinds of problems are usually presented as zero-sum conflicts between people. If we understand them as conflicts of interest, we understand them as problems of efficiency and organisation, and so the solutions become positive-sum. Many are also subject to moral argumentation by the Left or Right, yet rarely is a significant structural solution proposed.

So how would these six institutions, based upon the six functions, work? To begin with, our aim should be for participants in these organisations to be immersed in a cultural and financial reward structure that aligns their self-interest, or rewards their altruism, in a way that matches the role of the organisation. For example, the entrepreneurial function should involve creative people with bold business ideas being given a financial reward based on the financial success of their business. We want this reward to always increase with improved performance of the individual, but we may wish it increase by gradually smaller increments to preserve a socially beneficial limit on the rich-poor gap (functioning the same way as a progressive taxation system). Thus we may wish to utilise a logarithmic formula or similar algorithm to calculate the appropriate financial reward, funnelling the difference into capital availability, community projects, start-up business assistance, or humanitarian resources as desired.

Where needed the institutions could have sub-institutions carrying out roles, but provided they do not have conflicts of interest with each-other, these sub-institutions can be under the direction of the main six institutions. We should be careful to apply rigorous criteria when considering institutional conflict of interest.

We also want to preserve the power of the free-market and price signals to harmonise and optimise our economy. This means several of the institutions or functions are optimally organised as marketplaces, such as marketplaces for investment or marketplaces for labour, though we would require participants to subscribe to the overall separation of powers to engage in any marketplace. We should also retain a generally free consumer marketplace (limited in extreme cases of safety), provided we can correct for errors in the price signal arising from poor handling of externalities, or misleading product information damaging the consumer ability to make informed choices on the demand side of the market.

Now, to describe each of the functions briefly:

Marketplace of entrepreneurship:

• Marketplace of ideas – Creative individuals or groups with great ideas for business post their business ideas in the marketplace. This could be anything from a local paper delivery route to a billion dollar mining venture.
• Marketplace of business development – Professional Business Developers (teams or individuals) with abilities to statistically assess and plan a successful business bid for the right to take an idea from the marketplace of ideas and develop it. They are responsible for projecting business revenue and costs and ensuring the venture will be profitable, as well as planning the business structure, its human resources, and equipment.

Marketplace of labour:

• Marketplace of leadership – Charismatic leaders able to inspire workers, motivate teams and resolve conflict offer their labour as the everyday leaders for fully developed business plans from the marketplce of business development.
• Marketplace of work – Workers offer their labour to the business, and are hired and paid based on merit. Position pay is set by an assessor from labour assessment (basically acting as HR department in the unseparated version), priced to attract an appropriate number of applicants in the current market conditions. Labour performance is also assessed by labour assessment, and the final financial reward adjusted from the base pay for each individual based on performance.

Institute of labour assessment:

• Performance assessment – Professional assessors acting without bias assess the performance of each worker or leader and apply a adjustment rating accordingly.
• Skill assessment department – Rather than workers misrepresenting their own skills, making the hiring process fraught with difficulty, the skill assessment department attempts to assess worker skill.

Institute of economic information:

• Product assessment – Acting as a neutral party with no financial interest, product assessment rates all products and services on KPIs that reflect consumer demand, providing comparisons between products that allow the “perfect information” requirement for effective market forces to come to bear on product pricing.
• Risk assessment – In order to inform insurance decisions and risk flattening mechanisms, this independent assessor. They also determine the validity of insurance claims in a way that is structurally separate from the insurers. Insurers are forbidden from interacting with risk assessors in any unofficial capacity.
• Externality assessment – Professionals with the appropriate scientific backgrounds assess business impacts on external entities and prices them as accurately as possible, with the result being factored into the effective bottom line of the business. This includes things such as environmental and social externalities. Revenue raised this way does not go into “government coffers”, which may perversely incentivise regulation, but instead is applied as a revenue neutral redistributive “negative tax rate” to all business profits, rewarding those who are neutral or doing the right thing.

Investment consortium

• Fund and asset management – Independent fund managers offer loans of financial capital to businesses being developed by Business Developers. Fund managers attempt to maximise their return on investment just as normal investors do. The fund managers receive a financial reward/incentive based on the return of the business. They exercise no control over the specifics of the business, and are forbidden from issuing instructions beyond the interest rates of the loans. The investment capital is allocated by the Business Developers, but is legally owned by the community, nation, member-controlled fund, or other citizen-orientated entity. All participants in the system qualify as equal shareholders.
• Insurance / Risk management – While this is not necessarily structurally separate from regular asset management, the investment consortium may also have funds specialising in taking on risk for a fee.

Department of contracts

• Contract negotiation and enforcement – Acts as a neutral judge and enforcer in contract negotiations and disputes.

 

Provided we can protect the separation of powers from being undermined through unofficial channels, we can receive the immense benefits of removing conflict of interest by implementing this economic structure.

Let’s take a brief example of the benefit. Normally companies waste significant amounts of resources on marketing. This is a individually necessary, zero-sum activity that produces nothing and does not boost the national economy. However with a good economic separation of powers, the business entity under the management of the Business Developer does not have the power to engage in marketing. Instead, the only function able to provide product information is the Institute of Economic Information. This does not mean it has to be a monolithic organisation. We can also organise this as a marketplace if necessary, with consumers selecting a source of information that addresses their needs or niche.

Or, as a second example, a separation of powers makes regulation is simpler, less burdensome, more efficient and less prone to perverse outcomes that undermine democracy. On the one side, the independent nature of the externality assessment means that an accurate figure that reflects benefits or costs not captured by the basic consumer price mechanism is made by an independent organisation that’s difficult to bribe or influence because it’s revenue source is independent of its pricing decisions. In other words, in cannot increase its budget by overpricing externalities, nor can it increase its budget by accepting compromising payments from businesses.

There are other benefits you may wish to consider by examining our earlier list of institutional conflicts of interest.

However, in each case we need to vigilantly protect the independence of this function, because if either business or government departments with a conflict of interest are able exercise control over it, then all the benefits of the system will be lost. This is particularly the case if the function is compromised secretly. For this reason we must require a significant level of transparency, particularly in the leadership and administrative roles of these institutions. No system can work without vigilance.

So, in summary, by separating out the six fundamental functions of the economy, ensuring they are both officially and unofficially independent, and then articulating discrete, well-defined roles to each, we can create an economic separation of powers with numerous benefits. In this unique way, we allow ourselves to gain the best of both worlds. We gain the market efficiency of market economics, but at the same time make the economy a little more human, and a little more driven by morally acceptable goals. Yet at the same time it’s a system that doesn’t require an unrealistic extreme conception of human behaviour. We can accept widespread pursuit of self-interest by turning into a force for good, and at the same time we can reward, instead of punish, altruism in a way that prevents our aspirations becoming perverted into something oppressive.

Of course at the heart of economics lies capital (in our model, the investment role in the separation). On this both the Left and the Right agree. So where could reformers concerned with an authentic separation of economic powers hope to find the capital to achieve such a separation? A community or nation utilising funds under this model have the possibility of making excellent returns, because this style of economic activity can adopt the power of prices signals and market forces without its usual drawbacks. There is also a powerful argument in this being an efficient but far more ethical alternative to existing methods. But there must be an agreement of minds, given that by contributing to this system, one preserves the capital but is swearing off meddling that compromises the separation.

There are several possible places where this is a serious possibility. The first is as a use for a nation’s sovereign wealth fund, such as those that exist in Singapore and Norway. These funds generally seek to maximise not only profits, but also to achieve social and environmental outcomes that influence the long term well-being of their nation. The second is the enlightened philanthropy of those entrepreneurs and captains of industry who see the flaws of central planning, but also understand the problems that pure self-interest is causing humanity. The third is member-controlled superannuation and ethical investment funds, who have a duty not only to their bottom line, but to the moral principles that guide both their management and their members. Finally there is crowd-sourcing, harnessing the power of the everyday citizen to achieve the remarkable.

Why would an economic separation be so remarkable? Why is it so vital to achieve? It’s the simple fact the where economics fails, so does humanity. It’s simply too vital to public health, to living standards, to our species future, for us to keep getting it wrong. It’s our duty, to ourselves, and to every person on this planet, to do everything we can to get it right.