Business Ethics

EXEC 870-3 e
Prof. Dr. Harald Müllich

READER
Course Objectives

The course is designed to sharpen the students’ awareness of problems, controversies and
implications, provide them with an overview of topical key issues as a basis for the
development of students' own standpoints and solutions, being able to resort to recognition,
knowledge and understanding of philosophical principles and historical bases (presented and
discussed in class); students are to be sensitized for the social discussion of changing values;
they are to gain profound insights into the power shift between (national) politics and
(international) corporations; thanks to a strengthened sense of responsibility and
understanding - both from a humane and a global perspective - they will be able, after the
module, to successfully cope with cross-cultural interacting of different regions and
mentalities in the minefield of converging globalization and diverging regionalization as well
as with value systems of different societies and of Corporate Social Responsibility (CSR)
within multinational corporations.

Course Outline
Contents:

Topical and controversial business ethics issues; bases of business ethics; basic ethical
considerations; philosophical sources and origins; historical socio-political processes such as
labour laws, working hours, morale, performance, pay, relationship employer - employee;
company structure, philosophy, leadership, political correctness, sustainability, personal
responsibility, corruption; etc.

1 Social Contract revisited - nationally & globally

1.1 political, economic & value systems
1.2 Democracy, division of powers, lobbies, distribution of power; media
1.3 Justice, fairness; jurisdiction & moral feeling
1.4 Legislation - ethical foundations
1.5 Civil Service, state employees; state functions
1.6 Poor and rich
1.7 Technology and society
1.8 Global society?
2 Business ethical bases and developments
2.1 Milestones: Club of Rome, Brundtland Report etc.
2.2 Sustainability
2.3 UN Global Compact
2.4 Corporate Social Responsibility (CSR) & Corporate Citizenship (CC)
2.5 Philanthropy
2.6 Corruption
2.7 Whistleblowing

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3 Corporate Ethics
3.1 Implementation and Securing of Business Ethics in a Company
3.2 Company Philosophy and Value System
3.3 Change Management
3.4 Reward and Punishment
3.5 Monitoring and Quality Control
4 Specific aspects (e.g.: CEO compensation, child labour, labour conditions, product quality,
marketing, customer relations, intellectual property, data & privacy etc.)
5 Cases (presentations)

Teaching and Learning Methods

Input is given through a handout and a selection of files in intranet, with different functions:
basic information, in-depth analyses, overviews, provocative commentaries, different
perspectives, examples and cases etc.; video and audio sequences are used in preparation of
topics and on certain (hidden) aspects; the lecturer gives input, serves, above all, as a catalyst
in class discussions and a facilitator in the recognition process; he reactivates and pulls in
participants’ own knowledge and experience and builds it into the course contents; he keeps
the module on course, aiming at context-building, at the development of a coherent matrix of
knowledge, insight and understanding as an operational basis for the assumption of an
accountable role in business life; students give input on specific cases through presentations,
which trigger classroom debates; they work in pairs and in small groups in certain phases; the
bulk of the module is reserved for an interactive exchange of knowledge and insights,
classroom discussions, for putting details together to overall pictures, for finding answers and
solutions together; every participant is invited to actively shape his/her own viewpoints.

Reading
mandatory:

• Reader; handouts; course material & videos (selected excerpts from texts, audio & video
recordings & documents)
• Ferrell, O.C.; Fraedrich, John; Ferrell, Linda (2005): Business Ethics. Ethical Decision
Making and Cases. Sixth Ed., Bosten, New York. [course book]

optional:

• Korff, Wilhelm et al. (1999; 2009): Handbuch der Wirtschaftsethik Band 1-4, Berlin.
• Sloterdijk, Peter (2005): Im Weltinnenraum des Kapitals, Frankfurt am Main.
• Smith, Adam: The Wealth of Nations.
• Nasher, Jack (2009): Die Moral des Glücks. Eine Einführung in den Utilitarismus. Berlin.

Assessment Methods
- 40 % Coursework (presentions - weighting: 2 x; contributions to class discussions –
weighting 1 x each, if better than presentation grade)
- 60 % Final Exam (oral)

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Key Questions:
1. What are Corporate Social Responsibility, Corporate Responsibility
Management and Corporate Citizenship?
2. How can and how should Corporate Citizenship be exercised?
3. What methods can be used to measure companies’ level of well-doing?
4. What is sustainability? What area does the term come from originally?
5. What contributions can, should or must companies make to society?
6. How can a balance be struck between profit-seeking and corporate
(social) responsibility? What are the benefits, where are the limits of
philanthropy?
7. What is the Janus face of whistle-blowing?
8. What are opportunities for and limits to the implementation of ethical
codes in companies?
9. What are mechanisms and effects of corruption? Who wins? Who loses?
10. How should CEO’s be compensated?
11. What was the historical environment of Rousseau’s Social Contract?
12. What has changed in the meantime? With what effect(s)?
13. What are and what should be benchmarks for a New Social Contract today?
14. What values/guidelines should Germany/Europe/the World be based on?
15. What are crucial criteria for a genuine democracy?
How democratic are current democratic states if this yardstick is used?
(USA, Italy, Germany, Russia, China, Latin American States,…)
16. What should be the relationship between society, politics and business?
17. What are risks and chances of technology for the state and its citizens?
18. What is and what should be the role of the media (press/TV/Internet…)?
19. Should the Civil Service abolished, redefined or left unchanged?
20. What should be the right balance in the protection of intellectual property
rights to boost innovation and not to stifle it?

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The UN Global Compact

The Ten Principles

The Global Compact's ten principles in the areas of human rights, labour, the environment and
anti-corruption enjoy universal consensus and are derived from:

 The Universal Declaration of Human Rights

 The International Labour Organization's Declaration on Fundamental Principles and
Rights at Work
 The Rio Declaration on Environment and Development
 The United Nations Convention Against Corruption

The Global Compact asks companies to embrace, support and enact, within their sphere of
influence, a set of core values in the areas of human rights, labour standards, the environment,
and anti-corruption:

Human Rights

 Principle 1: Businesses should support and respect the protection of internationally

proclaimed human rights; and
 Principle 2: make sure that they are not complicit in human rights abuses.

Labour Standards

 Principle 3: Businesses should uphold the freedom of association and the effective
recognition of the right to collective bargaining;
 Principle 4: the elimination of all forms of forced and compulsory labour;
 Principle 5: the effective abolition of child labour; and
 Principle 6: the elimination of discrimination in respect of employment and
occupation.

Environment

 Principle 7: Businesses should support a precautionary approach to environmental

challenges;
 Principle 8: undertake initiatives to promote greater environmental responsibility; and
 Principle 9: encourage the development and diffusion of environmentally friendly
technologies

Anti-Corruption

 Principle 10: Businesses should work against corruption in all its forms, including
extortion and bribery.

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Integrity Measures
Available in: Arabic - Chinese - English - French - Russian - Spanish

1. Background

The UN Global Compact is a voluntary initiative that seeks to advance universal principles on
human rights, labour, environment and anti-corruption through the active engagement of the
corporate community, in cooperation with civil society and representatives of organized
labour. The initiative is not designed, nor does it have the mandate or resources, to monitor or
measure participants’ performance. Nevertheless, with the aim of assuring that the integrity of
the Global Compact is safeguarded at all times, the Secretary-General has adopted the
following measures.

2. Misuse of Association with the UN and/or Global Compact

The use of the United Nations’ name and emblem and any abbreviation thereof is reserved for
official purposes of the Organization in accordance with General Assembly resolution 92(I) of
7 December 1946. That resolution expressly prohibits the use of the United Nations’ name
and emblem for commercial purposes or in any other manner without the prior authorization
of the Secretary-General, and recommends that Member States take the necessary measures to
prevent the unauthorized use thereof.

The United Nations emblem may be authorized for use by non-UN entities in exceptional
circumstances, such as for illustrative and educational purposes. All uses of the UN emblem
by non-UN entities require the prior written authorization of the Secretary-General. Requests
for such authorization should be submitted to the Office of Legal Affairs, United Nations,
New York, NY 10017 or Fax: +1-212-963-3155. Any suspected misuse of the UN name or
emblem similarly should be referred to the Office of Legal Affairs.

The use of the Global Compact’s name and logos are limited to certain authorized users and
instances only. The full policy statement is available on the Global Compact website
(www.unglobalcompact.org) and should be consulted; questions should be addressed to the
Global Compact Office. The Global Compact Office reserves the right to take appropriate
action in the event of a breach of this policy. Possible actions may include, but are not limited
to, revoking participant status, requesting the assistance of the relevant Global Compact
governmental authorities and/or instituting legal proceedings. Any suspected misuse of the
Global Compact name or logos should be referred to the Global Compact Office.

3. Failure to Communicate Progress

The Global Compact’s policy on communicating progress asks participants to communicate

annually to all stakeholders their progress in implementing the ten principles ( download COP
policy here ) . Participants are also expected to submit a link to or description of their
communication on progress to the Global Compact website and/or, Global Compact local
network website.

If a participant fails to communicate its progress by the deadline, it will be listed as "non-
communicating" on the Global Compact website. If a further year passes without the
submission of a COP, the company will be de-listed. The Global Compact reserves the right

Business Ethics 6
 to publish the names of companies that have been de-listed for failure to communicate their
progress.

Non-communicating companies can become active participants by posting their COP.

Companies that have been de-listed would need to reapply to join the Global Compact. Their
application must be accompanied by their COP.

4. Allegations of Systematic or Egregious Abuses

The Global Compact welcomes any participant that pledges to work towards implementation
of the Global Compact principles through learning, dialogue, projects, process improvements
or other such measures. Moreover, it is not now and does not aspire to become a compliance
based initiative. Nevertheless, safeguarding the reputation, integrity and good efforts of the
Global Compact and its participants requires transparent means to handle credible allegations
of systematic or egregious abuse of the Global Compact’s overall aims and principles. The
Global Compact Office can assist or provide guidance in this regard, by means of the
measures described below. The purpose of these measures in the first instance always will be
to promote continuous quality improvement and assist participants in aligning their actions
with the commitments they have undertaken with regard to the Global Compact principles. It
should be noted that the Global Compact Office will not involve itself in any way in any
claims of a legal nature that a party may have against a participating company or vice versa.
Similarly, the measures set out below are not intended to affect, pre-empt or substitute for
other regulatory or legal procedures or proceedings in any jurisdiction.

Thus, when a matter is presented in writing to the Global Compact Office, the Office will:

a. use its judgement to filter out prima facie frivolous allegations. If a matter is found to
be prima facie frivolous, the party raising the matter will be so informed and no further action
will be taken on the matter by the Global Compact Office.
b. If an allegation of systematic or egregious abuse is found not to be prima facie
frivolous, the Global Compact Office will forward the matter to the participating
company concerned, requesting
i. written comments, which should be submitted directly to the party raising the matter,
with a copy to the Global Compact Office, and
ii. that the Global Compact Office be kept informed of any actions taken by the
participating company to address the situation which is the subject matter of
the allegation. The Global Compact Office will inform the party raising the
matter of the above-described actions taken by the Global Compact Office.
c. The Global Compact Office would be available to provide guidance and
assistance, as necessary and appropriate, to the participating company
concerned, in taking actions to remedy the situation that is the subject matter of
the allegation in order to align the actions of the company with its
commitments to the Global Compact principles.

The Global Compact Office may, in its sole discretion, take one or more of the following
steps, as appropriate:

i. Use its own good offices to encourage resolution of the matter;

ii. Ask the relevant country/regional Global Compact network, or other Global Compact
participant organisation, to assist with the resolution of the matter;

Business Ethics 7
 iii. Refer the matter to one or more of the UN entities that are the guardians of the Global
Compact principles for advice, assistance or action;
iv. Share with the parties information about the specific instance procedures of the OECD
Guidelines for Multinational Enterprises and, in the case of matters relating to the
labour principles, the interpretation procedure under the ILO Tripartite Declaration of
Principles concerning Multinational Enterprises and Social Policy.
v. Refer the matter to the Global Compact Board, drawing in particular on the expertise
and recommendations of its business members.

If the participating company concerned refuses to engage in dialogue on the matter within two
months of first being contacted by the Global Compact Office under sub-paragraph (b) above,
it may be regarded as “non-communicating”, and would be identified as such on the Global
Compact website until such time as a dialogue commences. If, as a result of the process
outlined above and based on the review of the nature of the matter submitted and the
responses by the participating company, the continued listing of the participating company on
the Global Compact website is considered to be detrimental to the reputation and integrity of
the Global Compact, the Global Compact Office reserves the right to remove that company
from the list of participants and to so indicate on the Global Compact website.

A participating company that is designated “non-communicating” or is removed from the list

of participants will not be allowed to use the Global Compact name or logo if such permission
had been granted.

If the participating company concerned has subsequently taken appropriate actions to remedy
the situation that is the subject matter of the allegation, and has aligned its actions with the
commitments it has undertaken with regard to the Global Compact principles, the company
may seek reinstatement as an “active” participant to the Global Compact and to the list of
participants on the Global Compact website. If there is a local network in the country where
the company is based, the company should first approach the local network; in all other cases
the Global Compact Office should be contacted directly. Only the Global Compact Office can
make a final determination of reinstatement.

The Global Compact Office is committed to ensuring a fair process for the parties involved.
In order to promote the productive resolution of matters raised, no entity involved in the
process should make any public statements regarding the matter until it is resolved.

These Integrity Measures will be reviewed periodically by the Global Compact Board, the
Annual Local Networks Forum and the Global Compact Leaders Summit.
(Last update 12 January 2010)

Source: http://www.unglobalcompact.org/AboutTheGC/IntegrityMeasures/index.html ;
Feb. 2010

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Overview of the UN Global Compact
The UN Global Compact is a strategic policy initiative for businesses that are
committed to aligning their operations and strategies with ten universally accepted
principles in the areas of human rights, labour, environment and anti-corruption. By
doing so, business, as a primary agent driving globalization, can help ensure that
markets, commerce, technology and finance advance in ways that benefit economies
and societies everywhere.

Never before have the objectives of the international community and the business
world been so aligned. Common goals, such as building markets, combating
corruption, safeguarding the environment and ensuring social inclusion, have
resulted in unprecedented partnerships and openness among business, government,
civil society, labour and the United Nations. Many businesses recognize the need to
collaborate with international actors in the current global context where social,
political and economic challenges (and opportunities) – whether occurring at home or
in other regions – affect companies as never before.

This ever-increasing understanding is reflected in the growth of the Global Compact,

which today stands as the largest corporate citizenship and sustainability initiative in
the world -- with over 7700 corporate participants and stakeholders from over 130
countries.

The Global Compact is a leadership platform, endorsed by Chief Executive Officers,

and offering a unique strategic platform for participants to advance their commitments
to sustainability and corporate citizenship. Structured as a public-private initiative, the
Global Compact is policy framework for the development, implementation, and
disclosure of sustainability principles and practices and offering participants a wide
spectrum of specialized workstreams, management tools and resources, and topical
programs and projects -- all designed to help advance sustainable business models
and markets in order to contribute to the initiative's overarching mission of helping to
build a more sustainable and inclusive global economy. (See How to Participate.)

The UN Global Compact has two objectives:

1. Mainstream the ten principles in business activities around the world

2. Catalyze actions in support of broader UN goals, including the Millennium
Development Goals (MDGs)

With these twin and complementary objectives in mind, the Global Compact has
shaped an initiative that provides collaborative solutions to the most fundamental
challenges facing both business and society. The Global Compact seeks to combine
the best properties of the UN, such as moral authority and convening power, with the
private sector’s solution-finding strengths, and the expertise and capacities of a range
of key stakeholders. The initiative is global and local; private and public; voluntary yet
accountable. The Global Compact’s has a unique constellation of participants and
stakeholders -- bringing companies together with governments, civil society, labour,
the United Nations, and other key interests.

The benefits of engagement include the following:

Business Ethics 9
  Adopting an established and globally recognized policy framework for the
development, implementation, and disclosure of environmental, social, and
governance policies and practices.
 Sharing best and emerging practices to advance practical solutions and
strategies to common challenges.
 Advancing sustainability solutions in partnership with a range of stakeholders,
including UN agencies, governments, civil society, labour, and other non-
business interests.
 Linking business units and subsidiaries across the value chain with the Global
Compact's Local Networks around the world -- many of these in developing
and emerging markets.
 Accessing the United Nations' extensive knowledge of and experience with
sustainability and development issues.
 Utilizing UN Global Compact management tools and resources, and the
opportunity to engage in specialized workstreams in the environmental, social
and governance realms.

Finally, the Global Compact incorporates a transparency and accountability policy

known as the Communication on Progress (COP). The annual posting of a COP is an
important demonstration of a participant's commitment to the UN Global Compact
and its principles. Participating companies are required to follow this policy, as a
commitment to transparency and disclosure is critical to the success of the initiative.
Failure to communicate will result in a change in participant status and possible
delisting.

In summary, the Global Compact exists to assist the private sector in the
management of increasingly complex risks and opportunities in the environmental,
social and governance realms. By partnering with companies in this way, and
leveraging the expertise and capacities of a range of other stakeholders, the Global
Compact seeks to embed markets and societies with universal principles and values
for the benefit of all.

Source: http://www.unglobalcompact.org/AboutTheGC/index.html ; 27 Feb. 2010

Business Ethics 10
The BPI 2011 Results
90 % Confidence
Number of Standard
Rank Country/territory Score Interval (Lower Bound
observations Deviation
- Upper Bound)
1 Netherlands 8.8 273 2.0 8.6 - 9.0
1 Switzerland 8.8 244 2.2 8.5 - 9.0
3 Belgium 8.7 221 2.0 8.5 - 9.0
4 Germany 8.6 576 2.2 8.5 - 8.8
4 Japan 8.6 319 2.4 8.4 - 8.9
6 Australia 8.5 168 2.2 8.2 - 8.8
6 Canada 8.5 209 2.3 8.2 - 8.8
8 Singapore 8.3 256 2.3 8.1 - 8.6
8 United Kingdom 8.3 414 2.5 8.1 - 8.5
10 United States 8.1 651 2.7 7.9 - 8.3
11 France 8.0 435 2.6 7.8 - 8.2
11 Spain 8.0 326 2.6 7.7 - 8.2
13 South Korea 7.9 152 2.8 7.5 - 8.2
14 Brazil 7.7 163 3.0 7.3 - 8.1
15 Hong Kong 7.6 208 2.9 7.3 - 7.9
15 Italy 7.6 397 2.8 7.4 - 7.8
15 Malaysia 7.6 148 2.9 7.2 - 8.0
15 South Africa 7.6 191 2.8 7.2 - 7.9
19 Taiwan 7.5 193 3.0 7.2 - 7.9
19 India 7.5 168 3.0 7.1 - 7.9
19 Turkey 7.5 139 2.7 7.2 - 7.9
22 Saudi Arabia 7.4 138 3.0 7.0 - 7.8
23 Argentina 7.3 115 3.0 6.8 - 7.7
United Arab
23 7.3 156 2.9 6.9 - 7.7
Emirates
25 Indonesia 7.1 153 3.4 6.6 - 7.5
26 Mexico 7.0 121 3.2 6.6 - 7.5
27 China 6.5 608 3.5 6.3 - 6.7
28 Russia 6.1 172 3.6 5.7 - 6.6
Average 7.8
Source: http://www.transparency.de/BPI-2011-Results.1988.0.html; 29th July 2014.

Business Ethics 11
Milton Friedman goes on tour

A survey of attitudes to business turns up some intriguing

national differences
Attitudes to business
Jan 27th 2011 | from PRINT EDITION

PUBLIC-RELATIONS folk are not noted for

burning the midnight oil over the works of great
economists. But Edelman, an American firm, has
come up with a clever idea. It asked members of
the “informed public”—broadly, people with
university degrees who are in the top quarter of
wage-earners in their particular age groups and
countries—what they think of Milton Friedman’s
famous assertion that “the social responsibility of
business is to increase its profits.”

The issue of whether businesses should promote

corporate social responsibility (CSR) is hotly
debated. Many of the world’s biggest companies
(including BP and the now defunct Enron) have
embraced the notion. So have politicians. Britain’s
2006 Companies Act requires businesses to report
on their CSR records. The United Nations has a
“global compact” for CSR. But the world’s
Friedmanites have waged a relentless guerrilla war
against the idea, denouncing it as a farrago of
value-destroying nonsense.

Edelman’s research gives a good overview of the

state of the global battle. The world’s most
Friedman-friendly country is the United Arab
Emirates, with 84% agreeing with his dictum:
perhaps not surprising for a small, business-
oriented country. Second prize goes to Japan, a
country normally associated with stakeholder
capitalism, but which may have tired of its model
after two decades of stagnation. Sweden also scored remarkably highly, with 60% of people
agreeing with Friedman. Perhaps people feel little need for CSR when the government cares
for them from cradle to grave. Yet some supposedly Friedmanite bastions went wobbly, with
Britain scoring 43% and Friedman’s own homeland, the United States, 56%.

The world’s striving nations tend to disdain CSR. The top ten Friedmanite countries include
four emerging markets (India, Indonesia, Mexico and Poland) and two recently emerged ones
(Singapore and South Korea). But there are important exceptions to the rule. Well-informed
folk in China and Brazil almost match their peers in Germany and Italy in their enthusiasm for
corporate do-gooding.

Business Ethics 12
HBR Blog Network

How Unethical Behavior Becomes Habit

by Francesca Gino, Lisa D. Ordóñez and David Welsh | 11:00 AM September 4, 2014

When a former client’s secretary was arrested for embezzlement years before his own crimes
were uncovered, Bernie Madoff commented to his own secretary, “Well, you know what
happens is, it starts out with you taking a little bit, maybe a few hundred, a few thousand. You
get comfortable with that, and before you know it, it snowballs into something big.”

We now know that Madoff’s Ponzi scheme started when he engaged in misreporting to cover
relatively small financial losses. Over a 15-year period, the scam grew steadily, eventually
ballooning to $65 billion, even as regulators and investors failed to notice the warning signs.

Many of the biggest business scandals of recent years — including the News of the World
phone hacking scandal, billions in rogue trading losses at UBS, and the collapse of Enron —
have followed a similar pattern: The ethical behavior of those involved eroded over time.

Few of us will ever descend as deeply into crime as Bernard Madoff, yet we all are vulnerable
to the same slippery slope. We are likely to begin with small indiscretions such as taking
home office supplies, exaggerating mileage statements, or miscategorizing a personal meal in
a restaurant as business-related. Nearly three-quarter of the employees who responded to one
survey reported that they had observed unethical or illegal behavior by coworkers in the past
year.

“The safest road to Hell is the gradual one — the gentle slope, soft underfoot, without sudden
turnings, without milestones, without signposts,” wrote C. S. Lewis. Our research backs up
both Lewis’s intuition and the anecdotal evidence: People often start their misconduct with
small transgressions and then slide down a slippery slope.

Two of us (Dave, Lisa, and our team) found that people who are faced with growing
opportunities to behave unethically are much more likely to rationalize this conduct than those
who are presented with an abrupt change. We predicted that if we could get people to cheat a
little in one round, they might be willing to cheat a bit more in another round, and finally
cheat “big” in a third round.

Business Ethics 13
This is precisely what we found: When given a series of problem-solving tasks, 50% of our
subjects cheated to earn $.25 per problem in the first round, and 60% cheated to earn $2.50
per problem in the final round. However, the people in the abrupt change group who could not
cheat during the first two rounds were much less willing to cheat big for $2.50 per problem
during the final round (only about 30% did).

This suggests that employees might look at their slightly exaggerated mileage statements as
“rounding up.” But rationalizing minor indiscretions inevitably influences how they view
progressively worse behaviors and may lead them to commit bigger offenses (e.g., billing
their employers for personal travel expenses) that they initially would not have considered.

To make matters worse, people are more likely to overlook the unethical behavior of others
when it deteriorates gradually over time. For example, one of us (Francesca) found,
with colleague Max Bazerman, that people who played the role of auditors in a simulated
auditing task were much less likely to report those who gradually inflated their numbers over
time than those who made more abrupt changes all at once, even though the level of inflation
was eventually the same.

Unfortunately, the assumption that unethical workplace behavior is the product of a few bad
apples has blinded many organizations to the fact that we all can be negatively influenced by
situational forces, even when we care a great deal about honesty. Yet approaches to warding
off the slippery-slope problem need not to be drastic. In their book Nudge: Improving
Decisions about Health, Wealth, and Happiness, Richard Thaler and Cass Sunstein illustrate
how a small and unobtrusive nudge in the right direction can lead people to eat better, save
more for retirement, and conserve energy.

Our research similarly indicates that ethical nudges can help people avoid the types of
indiscretions that might start them down the slippery slope. For example, in a study conducted
with a major U.S. insurance company, Francesca and colleagues found that customers who
signed the statement “I promise that the information I am providing is true” prior to reporting
their annual mileage — that is, at the top of the page — were significantly more honest in
their reporting compared to those who reported first and signed at the bottom of the page.

In a different study, Dave and Lisa found that even subconsciously exposing people to ethical
content increased their moral awareness and prompted more ethical decisions. Perhaps with
this in mind, some organizations have incorporated ethical nudges into images, symbols,
stories, and slogans. For example, the University of Arizona’s Eller College of Management
recently created posters featuring the image of a fire alarm to call attention to cheating. And at
International Paper, employees are given a wallet card with a set of ethics-related questions to
consider when making business decisions.

When moral standards are unclear or unenforced, it’s easy for employees to feel emboldened
to engage in questionable behaviors that are readily rationalized. Environments that nudge
employees in the right direction, and managers who immediately identify and address
problems, can stop ethical breaches before they spiral out of control.

http://blogs.hbr.org/2014/09/how-unethical-behavior-becomes-
habit/?utm_medium=referral&utm_source=pulsenews; 21.09.2014.

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Business Ethics 17
Corporate transparency
The openness revolution

As multinationals are forced to reveal more

about themselves, where should the limits of
transparency lie?
Dec 13th 2014 | From the print edition, p. 59-60.

Business Ethics 18
HOWARD SCHULTZ, the head of Starbucks, said last year that “the currency of leadership
is transparency.” If so, bosses should be feeling ever more qualified to command their troops.
Business is being forced to open up in a host of reporting areas, from tax and government
contracts to anti-corruption and sustainability programmes. Campaigners are cock-a-hoop, but
continue to demand more. Executives are starting to ask whether the revolution is in danger of
going too far.

Three forces are driving change. First, governments are demanding greater corporate
accountability in the wake of the global financial crisis. No longer is ending corporate
secrecy—the sharp end of which is money-laundering shell companies—an agenda pushed
merely by Norway and a few others; it has become a priority for the G20. Second,
investigative journalists have piled in. A recent example is the exposure by the International
Consortium of Investigative Journalists of sweetheart tax deals for multinationals in
Luxembourg. The third factor is the growing sophistication of NGOs in this sphere, such as
Transparency International (TI) and Global Witness. “Twenty years ago our work seemed an
impossible dream. Now it’s coming true,” says Ben Elers of TI.

TI recently published its latest study on corporate reporting, which evaluated 124 big publicly
listed companies, based on the clarity of their anti-corruption programmes, their corporate
holdings and their financial reporting. Four-fifths of them scored less than five out of ten
overall, but there were big regional disparities: seven of the ten most open firms were
European; eight of the ten most clammed-up were Asian (see table).

One measure on which the firms were judged was country-by-country reporting of profits,
taxes paid and the like. Clearer reporting by jurisdiction would help outsiders spot offshore
tax shenanigans and graft. It is seen as the “holy grail” by NGOs, says Raymond Baker of
Global Financial Integrity, one of them. Currently most companies aggregate their accounts in
a way that makes it hard to see what assets and revenues they have in any given country. But
change is coming: country-by-country reporting is on the OECD’s “Base Erosion and Profit
Shifting” reform agenda, which is aimed at curbing tax avoidance.

The biggest push for greater openness has come in extractive industries. That is not surprising
as these (as well as defence) have historically been pits of corruption. Progress has come at
the regional level: EU states have begun to pass into law a new directive requiring country-
by-country, and in some cases project-by-project, reporting of extractive groups’ payments to
governments. America should have introduced similar regulations by now, but these,
mandated by the Dodd Frank act of 2010, are still on the drawing board.

Publish What You Pay, a campaigning group, reckons these rules would cover two-thirds of
the global extractives business by value—not only Western groups, but Chinese, Russian and
other firms that are caught in the net by virtue of having securities listed in the West. But
there would still be bumps in the playing field: some state-owned producers from the Middle
East, for instance, would not be covered.

Hence the push for global standards. One may be emerging from the Extractive Industries
Transparency Initiative, whose Oslo-based secretariat oversees the development of
multilateral standards shaped by a coalition of governments, companies and civil society. The
EITI is voluntary, but if a country signs up, all firms operating there must comply with its
reporting guidelines. Almost 50 countries (including Iraq and Nigeria) have joined.

Business Ethics 19
The EITI has backing from 90 firms, among them Norway’s Statoil. Its head of sustainability,
Hege Marie Norheim, argues that while not disclosing project payments might be better for
short-term competitiveness, disclosing them is “better for the company’s long-term stability”.

The costs of opacity

Commodity traders, usually a secretive bunch, are opening up to this way of thinking.
Trafigura, a Swiss trading giant, recently said it will disclose oil-related payments in all EITI
countries. Its reasons for doing so: change is coming anyway, and early movers will be better
placed to help shape the standards. There is a financial motivation, too: banks have reduced
funding for opaque trading firms after being hit with fines for sanctions violations.

Oil producers, meanwhile, are starting to publish more details of production-sharing contracts
with governments. This is “good for companies because it will show how [the contracts] are
weighted, which contrary to common perception is usually in the government’s favour,” says
George Cazenove of Tullow Oil. “That’s why it’s more often the governments than the
companies that want the terms kept quiet.”

Indeed, though campaigners make much noise about holding multinationals to account, most
admit the bigger impact could be on the states they deal with. Publication of what
governments receive will increase pressure on them to show how money is spent. They could
be held even more accountable if firms were forced to disclose which of their payments go to
central governments, which to regional ones and which to local administrations.

Another area of the NGOs’ focus is organisational structure. The more tangled a group’s web
of subsidiaries, the harder it is for outsiders to follow the money, including intra-group
transfers that might be used to funnel profits to tax havens.

Here, the picture is mixed. While some firms reveal more, others shuffle into the shadows.
Jeffrey Gramlich of the Hoops Institute at Washington State University and Janie Whiteaker-
Poe of Baylor University have identified a phenomenon they call “the disappearing
subsidiary”. Crunching data at The Economist’s request, they found a sharp increase since
2010 in the number of American
firms dramatically reducing the
number of tax-haven subsidiaries they
disclosed (see chart). In one extreme
case Google reported more than 100
divisions in 2009, but just two (both
in Ireland) in 2012. “Google wants to
know everything about you, but it
doesn’t want you to know everything
about it,” says Chris Taggart of
OpenCorporates, which collects and
crunches data on companies.

What’s going on? Use of tax havens

may have fallen a bit, but that doesn’t
explain such a sharp decline. What
does, says Mr Gramlich, is a mass
redefinition of subsidiaries as not
“significant”. Only material holdings

Business Ethics 20
have to be disclosed in America (whereas in, say, Germany all have to be reported). The firms
would never admit it, but the likely reason for this redefinition is increased scrutiny of their
tax affairs. Their move into the dark coincided with a surge in investigative articles about
profit-shifting by multinationals. Not all the redefining is likely to be legal, but the companies
are willing to take the risk: the most they can be fined for de-disclosing significant
subsidiaries is $100 a day.

Companies have wider gripes about the disclosure revolution. Some contend that transparency
has natural limits. The argument has three planks. The first is that it can be unfair on those
forced to disclose because it hands a competitive advantage to non-Western rivals that aren’t
held to the same standards. Simon Henry, Shell’s chief financial officer, argues that EU
transparency rules could undermine the EITI because they don’t cover unlisted foreign firms
or require governments to account for all payments received. Next, some firms complain that
new transparency rules wedge them between a rock and a hard place: abiding by an EU
requirement to be open, for instance, could mean breaking the law in a country of operation
that forbids disclosure. The first argument underlines the need for global standards. The
second is thin: when pressed, whingers struggle to identify countries that lock up executives
for complying with Western disclosure requirements.

The third argument is stronger: that those trying to make sense of it will be better informed
but none the wiser. Debra Valentine of Rio Tinto likens it to the long but unenlightening lists
of side-effects that come with medicines. Can country-by-country reporting capture what is
really going on in a group that produces in Australia and Canada, markets through Singapore
and sells in China, she asks? A firm’s tax payments might be unusually low, not because it is
dodging tax, but because of high upfront investments and all manner of reliefs and
allowances. Financial restructuring can render the numbers even harder to parse, says John
Connors of Vodafone (the only firm to score half-marks or better in all categories in the TI
report).

Some transparency campaigners acknowledge a risk of drowning in data or of comparing

apples with oranges. Britain, for instance, now requires its companies to disclose all foreign
payments to governments of more than £86,000 ($135,000)—the equivalent of an individual
spending pennies. “Ludicrously granular,” grumbles another oilman.

Michael Meehan of the Global Reporting Initiative, which sets standards for corporate
reporting on sustainability issues, says he can see why large companies have “data fatigue”.
Their being forced to report every single data point would lead to less transparency, not more,
he says. “Responsibility is coming back to civil society and the media to make good use of
information they already have, rather than calling for more,” says Jonas Moberg of the EITI.

Private transparency initiatives can help in this regard. OpenCorporates uses data-scraping
and other technologies to collate information from national corporate registers and other
sources, clean it up and join the dots, so that relationships within and between corporate
families become clearer. It now has 80m companies from 100 countries in its database. It
sometimes receives threats of violence from those who want their law-breaking firms to
remain hidden, says Mr Taggart.

Governments, too, have a role to play. The G20 has thrown its weight behind the idea of
central registers, with better policing of information on corporate owners. The most ambitious
countries, like Britain and Denmark, plan to make their registers publicly accessible. Some
are embracing open-data standards. Britain, already a world leader in accessibility of

Business Ethics 21
corporate-registration information, such as financial accounts and shareholder information,
will make all that data available free of charge next year.

Let it flow, or suffer a leak

As openness spreads, it would be easy to get carried away. Multinationals will continue to do
dodgy deals, and to bury inconvenient financial information in the footnotes of annual reports.
Some extractives giants pay lip service to the EITI while dragging their feet. The world is still
full of murky shell companies.

But the direction of travel is clear. In tax and contract transparency, there is general
acceptance that change is coming, like it or not. And many boards no longer fear that
openness is bad for business. In some areas, such as corporate social responsibility, there is
evidence that it boosts the share price by signalling that management is tackling hidden risks,
says George Serafeim of Harvard Business School. Investors increasingly appreciate the
reputational benefits of openness, and employees want to work for firms that are leaders in
disclosure—and, just as importantly, ever more of them appear to see it as their civic duty to
leak information if their employer is shady and secretive.

Business Ethics 22
Corporate anonymity
Light and wrong

Incorporation with limited liability is a

privilege. It should not include anonymity
Jan 21st 2012 | from the print edition

LIMITED liability—a commercial venture that protects its shareholders from personal
bankruptcy—is one of the greatest wealth-creating inventions of all time. The law allows
companies to borrow money, to take risks and to make contracts as if they were people, but
without the human beings who own it going bust if things go wrong, as they would in an
unlimited partnership. Limited liability allowed Elizabethan adventurers to finance voyages to
spice islands; it allows Silicon Valley technologists now to make similarly risky bets.

But limited liability is a concession—something granted by society because it has a clear

purpose. It is unclear why in parts of the world anonymity became part of the deal. Efforts to
withdraw that unjustified perk deserve to succeed.

In dozens of jurisdictions, from the British Virgin Islands to Delaware, it is possible to

register a company while hiding or disguising the ultimate beneficial owner. This is of great
use to wrongdoers, and a huge headache for those who pursue them (see article).
Anonymously owned companies can buy property, make deals (and renege on them), launch
intimidating lawsuits, manipulate tenders—and disappear when the going gets tough. Those
who seek redress run into baffling bureaucracy and a legal morass. Seeking real names and
addresses means dealing with lawyers and accountants who see it as their job to shield their
clients from nosy outsiders.

Attempts to change this have bogged down. The campaigners for reform are hardly anti-
corporate zealots: they include the World Bank, the OECD (a rich-country think-tank), and an
American senator, Carl Levin, who with the support of the administration has introduced a
bill to rein in the antics of states like Delaware (and a bunch of others including Wyoming and
Nevada). But progress is slow, with reformers stuck in an argument about who should pay the
costs of clarity.

If you strip out the obvious self-interests of the jurisdictions that make money from hiding
people’s identity, the main excuse offered is privacy. Hiding your identity can have honest
commercial reasons: if everyone knows that Exxon Mobil, BP or another oil major is bidding
for a patch of Texas, the price will go up. In some countries and industries revealing
ownership is dangerous. Besides, many libertarians would add, private shareholders have the
right to be just that.

Owning up

Except that the rest of us are giving a limited company’s owners a perk. It does not seem
unreasonable to ask who are the main recipients of this benefit (with, say, stakes above 5%).
Legitimate concerns for owners’ safety, such as biotech firms hunted by animal-rights

Business Ethics 23
activists, are rare. In many more cases, such as Caribbean holding companies controlled by
well-connected Russians, greater transparency is
on the side of democracy and freedom. If the
owners of an enterprise really want to preserve
their anonymity, they can still opt for an unlimited
option—but that will be their risk.

Reform ought to be simple. Anyone registering a

limited company should have to declare the names
of the real people who ultimately own it, wherever
they are, and report any changes. Lying about this
should be a crime. Some dodgy places will try to
hold out. But anti-money-laundering rules show
international co-operation can work. You can no
longer open an account at a respectable bank
merely with a suitcase of cash. Let the same apply
to starting a limited company.

Schumpeter
Peculiar people

How far should one push the idea that

companies have the same rights as ordinary
people?
Mar 24th 2011 | from the print edition

OVER the past year and a bit the

United States Supreme Court has
produced two landmark rulings on the
metaphor at the heart of corporate law:
the idea that companies are legal
persons. Unfortunately, the rulings
point in opposite directions. In Citizens
United (2010) the court ruled that the constitution’s first amendment guarantees companies
the same right to free speech as flesh-and-blood people. This means they have the same right
as individuals to try to influence political campaigns through advertisements. But in a case
involving AT&T the court ruled this month that the company has no right to personal privacy.

The legal conceit that companies are natural persons is vital to capitalism. It simplifies
litigation greatly: companies can act like individuals when it comes to owning property or
making contracts. Timur Kuran of Duke University argues that the idea of corporate
personhood goes a long way to explaining why the West pulled ahead of the Muslim world
from the 16th century onwards. Muslim business groups were nothing more than temporary

Business Ethics 24
agglomerations which dissolved when any partner died or withdrew. Legal personhood gave
Western firms longevity.

The concept of companies as people became ever more vital as capitalism developed. Until
the mid-19th century companies (as opposed to partnerships) were regulated by corporate
charters which laid down tight rules about what they could do. But reformers used the idea
that companies, like people, should be captains of their own souls, to free them from these
restrictions. The result of this liberation was an explosion of energy: Western companies
turbocharged the industrial revolution and laid the foundations for mass prosperity.

America’s legal system has been forced to grapple with the meaning of corporate personhood
more thoroughly than other countries’ courts have done, because the constitution is so specific
about the rights it bestows on people. And for the most part the Supreme Court has been
generous in extending the rights of flesh-and-blood people to artificial persons (which include
trade unions and other collectives as well as corporations). In Santa Clara County v Southern
Pacific Railroad in 1886, for example, it ruled that companies enjoy the protections of the
14th amendment (including due process and equal protection under the law).

Yet these artificial persons have always provoked worries, too. Aren’t they likely to use their
collective muscle to trample over the little people? And won’t they invoke the rights of
ordinary people without burdening themselves with the responsibilities? These worries started
in Britain in the age of chartered corporations. In the 17th century Sir Edward Coke, a jurist,
complained that “they cannot commit treason, nor be outlawed, nor excommunicated, for they
have no souls.” But the complaints have grown louder as companies have been freed from
their charters and the Supreme Court has reinforced their rights.

Some critics of corporations have also put the idea of corporate personhood to their own uses.
Joel Bakan, a legal academic, has produced a book and a film—both called “The
Corporation”—which argue that, if companies are people, they are particularly dysfunctional
and irresponsible ones. In the film, he even consults a psychiatrist who argues that companies
display all the characteristics of a psychopath: callous disregard for others’ feelings, inability
to maintain relationships, a willingness to bend any rule and break any law if it advances their
interests, and an obsession with amassing power and money.

This is overheated rhetoric, to be sure. But you do not have to be a radical to worry about the
might of organisations that can live for ever and take up residence in dozens of countries at
once. Nor is it unreasonable to wonder why the idea of corporate personhood should only cut
one way: if companies enjoy the same rights as flesh-and-blood humans then shouldn’t they
be under the same obligations? The conservative majority on the Supreme Court is in danger
of digging a trap for itself: strengthening the arguments of people who insist that companies
have a moral duty to pursue social rather than merely business ends.

Don’t take it personally

The court knows it can take the analogy too far. It has ruled against companies being allowed
to take the fifth amendment (against self-incrimination). It has restricted companies’ rights to
make political contributions: for example, they cannot give donations directly to individual
candidates. In the AT&T decision John Roberts, the chief justice, devoted a lot of effort to
demonstrating that “personal” is more than an adjectival offshoot of “person”: when a
company’s boss asks his finance director a “personal” question he is not likely to be asking
about the company’s balance-sheet. Indeed, the term “personal” is frequently used to mean

Business Ethics 25
the very opposite of “corporate”. But all this umming and erring confuses more than it
clarifies.

What would help is if the Supreme Court (and indeed corporate law in general) adopted a
clear principle when it comes to the analogy between artificial persons and real ones: that
companies should be treated as people only in so far as it is expedient. They clearly need to be
able to enter into contracts just like individuals. But they should not be treated as if they
experience such essentially human emotions as embarrassment and a desire for self-
expression. Thus they should not have the same rights to privacy and political freedom as a
citizen, but should have only as much of a right to confidentiality and political participation as
is helpful for the efficient functioning of business (including letting firms contribute to the
public debate on the regulation of business). Companies—or rather their bosses and owners—
should welcome such constraints: any further “rights” would, sooner or later, be matched by
onerous responsibilities.

Credit Suisse in court

Not too big to jail

A big financial firm pleads guilty to a

criminal charge and lives to tell the tale
May 24th 2014 | New York | From the print edition, p. 63-64.

SINCE Arthur Andersen, a giant accountancy firm, collapsed after being found guilty of
obstruction of justice in 2002, the prevailing wisdom has been that no financial firm could
survive a criminal conviction. Various financial licences and permissions, after all, depend on
the regulators’ agreement that a firm is fit for the task; clients also make similar, if less
formal, judgments. Yet on May 19th Credit Suisse, a multinational bank based in Switzerland,
pleaded guilty to a criminal charge of having helped its customers elude America’s tax
authorities.

The plea came with an enormous fine: $2.8 billion, much more than the $780m paid in 2009
by UBS, another big Swiss bank, for much the same offence. Although Credit Suisse seems to
have been quite brazen in its attempts to fox the Internal Revenue Service—sending private
bankers to visit American clients using tourist visas, for example—it appears to have catered
to far fewer tax-dodging customers than UBS. As has been the case in many recent legal
encounters between American regulators and the banks they supervise, there was no clear
formula to explain the size of the fine. Shrugging bankers refer simply to “regulatory
inflation”.

The potential consequences of the criminal conviction are far bigger. Clients scattered from
Andersen after its conviction, precipitating the firm’s collapse and the loss of thousands of
jobs. Mindful of this example, banks have fiercely resisted admissions of guilt in all their
dealings with America’s regulators.

Business Ethics 26
Prosecutors, also worried about unintended consequences, have been hesitant to insist—
especially since Andersen’s conviction was overturned on appeal. UBS, for instance, did not
admit guilt, instead entering a deferred-prosecution agreement, whereby the Department of
Justice has suspended legal action against it in exchange for a series of reforms, in addition to
the fine. Indeed, in spite of the popular belief that wayward bankers precipitated the financial
crisis, no bank in America has admitted to, or been convicted of, any crime related to it.

Justice is blind, not deaf

Over the past year, however, Eric Holder, America’s attorney-general, has faced widespread
criticism for suggesting that the broader costs of holding financial firms criminally liable
could, in effect, make them “too big to jail”. Pressure to secure a conviction grew in February
after a Senate committee released a damning report on Credit Suisse’s activity.

“This case shows that no financial institution, no matter its size or global reach, is above the
law,” said Mr Holder at a press conference announcing the criminal plea by Credit Suisse. But
what, in this case, does the law require as a consequence? In principle, the firm might have
lost all-important licences to operate in the state of New York and America in general.
Instead, as part of the intricately negotiated deal, regulators agreed not to withdraw any of its
licences or restrict its operations.

Moreover, Credit Suisse says that not a single client has announced it would need to move on.
Speaking to analysts in the wee hours of the night, Brady Dougan, its chief executive, insisted
that after “detailed legal work” the bank had found “no instances” of legal barriers or other
impediments that would prevent clients and counterparties from continuing to do business
with Credit Suisse as a result of its guilty plea. Investors appear to believe him: the bank’s
shares, alone among big financial institutions, rose the day the plea was announced.

Credit Suisse’s apparent resilience to the stain of criminality is something of a mystery. One
explanation for Andersen’s grimmer fate is that auditors need to have an especially pristine
reputation, because their business involves renting out that reputation, in effect, when they
certify a financial report. But the success of investment banks, particularly in their
underwriting business, also rests on a reputation for probity.

Another explanation is that, in Credit Suisse’s case, regulators have tacitly encouraged other
financial institutions to carry on business with the bank as normal in spite of its admission of
guilt. If so, such an understanding is likely to be tested in the months ahead, as a number of
other financial institutions strike deals with the Department of Justice over investigations of
potentially criminal conduct. BNP Paribas, France’s biggest bank, is said to be haggling with
prosecutors over whether it violated a law barring banks operating in America from doing
business in certain countries subject to American sanctions.

The agreement between Credit Suisse and New York state’s Department of Financial Services
(DFS) calls for the dismissal of three employees, who had already been indicted for abetting
tax avoidance but were still being paid. The bank’s most senior executives will keep their
jobs, even though various Swiss politicians have called on them to resign and Benjamin
Lawsky, the head of the DFS, says its crime was “decidedly not the result of the conduct of
just a few bad apples”.

The top brass has argued that it had no part in the actions for which the bank was prosecuted.
One of the “sham” entities involved, according to the government’s statement of facts, dated

Business Ethics 27
back a century, making it almost as old as federal income tax in America. Credit Suisse’s
board reportedly considered its own purge, but also concluded that responsibility lay
elsewhere and that any benefit would not be worth the additional upheaval.

Another group to have been spared the worst of the investigation are the clients who dodged
taxes: Credit Suisse has not handed over their names. “It is a mystery to me that the US
government didn’t require as part of the
agreement that the bank cough up some of the
names,” said Carl Levin, the senator who
heads the committee that published the
damning report in February. In theory, the
impediment was Swiss bank-secrecy laws, but
they were waived for UBS, which revealed
the owners of 4,700 accounts. That is not the
only way in which America’s legal reckoning
with banks since the financial crisis has been
opaque and inconsistent.

Trade and money laundering

Uncontained

Trade is the weakest link in the fight against

dirty money
May 3rd 2014 | NEW YORK | From the print edition, p. 53-54.

CUDDLY toys don’t have to be stuffed with cocaine or cash to be useful to traffickers. A few
years ago American customs investigators uncovered a scheme in which a Colombian cartel
used proceeds from drug sales to buy stuffed animals in Los Angeles. By exporting them to

Business Ethics 28
Colombia, it was able to bring its ill-gotten gains home, convert them to pesos and get them
into the banking system.

This is an example of “trade-based money laundering”, the misuse of commerce to get money
across borders. Sometimes the aim is to evade taxes, duties or capital controls; often it is to
get dirty money into the banking system. International efforts to stamp out money laundering
have targeted banks and money-transmitters, and the smuggling of bulk cash. But as the front
door closes, the back door has been left open. Trade is “the next frontier in international
money-laundering enforcement,” says John Cassara, who used to work for America’s
Treasury department.

Adepts include traffickers, terrorists and the tax-evading rich. Some “transfer pricing”—
multinationals’ shuffling of revenues to cut their tax bills—probably counts, too. Firms insist
that tax arbitrage is legal, and that the fault, if any, lies with disjointed international tax rules.
Campaigners counter that many ruses would be banned if governments were less afraid of
scaring off mobile capital.

Trade is “a ready-made vehicle” for dirty money, says Balesh Kumar of the Enforcement
Directorate, an Indian agency that fights economic crime. A 2012 report he helped write for
the Asia/Pacific Group on Money Laundering, a regional crime-fighting body, is packed with
examples of criminals combining the mispricing of goods with the misuse of trade-finance
techniques. Using trade data, Global Financial Integrity (GFI), an NGO, estimates that $950
billion flowed illicitly out of poor countries in 2011, excluding trade in services and
fraudulent transfer pricing. Four-fifths was trade-based laundering linked to arms smuggling,
drug trafficking, terrorism or public corruption.

The basic technique is misinvoicing. To slip money into a country, undervalue imports or
overvalue exports; do the reverse to get it out. A front company for a Mexican cartel might
sell $1m-worth of oranges to an American importer while creating paperwork for $3m-worth,
giving it cover to send a dirty $2m back home. One group of launderers was reportedly caught
exporting plastic buckets that cost $970 each from the Czech Republic to America.

To lessen the risk of discovery the deal may be

sent via a shell company in a tax haven with strict
secrecy rules. This may mean using a specialist
“re-invoicing” firm to “buy” the oranges at an
inflated price with an invoice to match and charge
the importer the true price. The point is to get
paperwork to justify an inflated transfer to the
seller. Re-invoicers are used by multinationals to
shift profits around, which gives them a veneer of
respectability, says Brian LeBlanc of GFI—but
they also “feed a giant black market in the
offshore manipulation of paperwork”.

According to American customs investigators,

Mexican drug gangs copied trade-based money-
laundering techniques from Colombian ones. They have since become experts. Before going
on the run in 2007, Blanca Cazares (aka “The Empress”) repatriated profits for the Sinaloa
cartel by trading toys, food and, in a touch of class, silk. Official figures for the past 20 years
put Mexican exports to America well above American imports from Mexico (see chart). The

Business Ethics 29
discrepancy is more than accounting or data errors can plausibly account for. One reason to
over-report exports would be fraudulently to collect export subsidies but these have been cut
in Mexico. The logical explanation, says Mr LeBlanc, is that Mexican groups are using trade-
based laundering to bring dollars into Mexico.

American authorities have ratcheted up penalties for banks that assist money-launderers,
knowingly or not. In 2012 they reached a $1.9 billion settlement with HSBC after concluding
that Latin American drug gangs had taken advantage of lax controls at its Mexican subsidiary.
And last year they imposed a $102m forfeiture order on a Lebanese bank implicated in a
complex scheme involving the export of used cars to West Africa with the proceeds funnelled
to Hizbullah, an Islamist group.

Alternative remittance systems and currency exchanges, such as the trust-based hawala
networks in Asia and the Middle East, and Latin America’s Black Market Peso Exchange
(BMPE), offer another route to launder money through trade. Organised crime funnels
billions a year through the BMPE, much of it to legitimate importers who cannot get enough
dollars through official channels because of currency restrictions, for instance in Argentina
and Venezuela. Some schemes combine formal and informal finance. A recently leaked
Turkish prosecutor’s report describes an alleged conspiracy involving Turkish front
companies and banks, an Iranian bank and money-exchangers in Dubai. By marking up
invoices for food and medicine allowed into Iran—to as much as $240 for a pound of sugar—
the scheme gave Iranian banks access to hard currency from Iran’s oil sales that was locked in
escrow accounts overseas, to be transferred only for approved transactions.

Trade-based techniques are also used to evade taxes and capital controls. Underinvoicing of
imports, particularly of construction materials, by Philippine firms dodging customs duties
and value-added tax means an estimated quarter of the country’s imports do not show up in
national statistics. India’s official exports to the Bahamas shot up one-thousand-fold between
2008 and 2011, probably because of a surge in over-invoicing by Indians taking home money
held in undeclared accounts, before a tax-transparency agreement between the two countries
came into force. Because Chinese firms and individuals sought to evade capital controls and
repatriate money parked in Hong Kong, exports from the Chinese mainland to Hong Kong
were over-reported by $101m in 2012—nearly as much as total foreign direct investment into
China that year.

Anything but transparent

Urged on by the Financial Action Task Force, an inter-governmental body that sets global
anti-money-laundering standards, governments have begun to focus on the relation between
trade and black-market money. American customs officials are arguing for the creation of a
global network of “trade transparency units” which would share trade paperwork and set
international standards for trade data. (So far they are mostly active in the Americas.) A more
radical approach would be to set banklike compliance requirements for firms that trade across
borders. But the extra red tape would be costly—and hard to justify in the face of a problem
that, though clearly big, is unquantifiable.

In the meantime, launderers who curb their greed and invoice goods worth $10 for $9, or $11,
will probably continue to get away with it. A dodgy deal is almost impossible to spot if the
pricing is only slightly out and you see just one end, says one American investigator. “You
can study the slips all day long, and all you see is stuff being imported and exported.”

Business Ethics 30
Offshore finance
Trouble in paradise

An international fraud investigation raises

vexing questions
Apr 18th 2015 | From the print edition, p. 64.

Better for a holiday than an investment

IT IS not certain if or to what extent investors have been bilked, or who has done the bilking.
Indeed, it is hard to establish very much at all, given the complexity of the case: authorities in
the Cayman Islands, Guernsey and Mauritius are all looking into it and a South African
financial regulator is following it closely. Investigations are focused on various entities
connected to Belvedere Management, a Mauritius-based group that claims to administer
around 100 hedge funds and run several finance-related companies. David Marchant, editor of
OffshoreAlert, a newsletter on financial crime, has identified numerous red flags in some of
these funds, including several years of consistent, positive monthly returns, which can be a
sign of a Ponzi scheme.

Belvedere’s bosses, Cobus Kellerman and David Cosgrove, deny all of the allegations of
wrongdoing and criminal activity. Instead, Belvedere has told worried investors that Grant
Thornton, an accounting firm, has been called in to wade through the complexities of the
funds and “review your assets and to advise us and assist the relevant authorities”.

Business Ethics 31
In the past, Belvedere has claimed to manage or advise on $16 billion in investments, for both
institutional and retail customers. One of its clients, an international financial-consulting
group in South Africa called deVere, claims to be a victim of wrongdoing and says it has
provided evidence of it to local authorities. (Many of Belvedere’s retail investors are also
believed to be South African.)

Regulators are turning up the heat. The Mauritian financial-services commission, which says
it warned two of the group’s funds last year to take remedial action for several breaches and
barred them from accepting new investors, last month revoked the licences of two of
Belvedere’s funds and placed them under the care of PricewaterhouseCoopers, another
accounting firm. Guernsey’s financial regulator is looking into a related fund. South Africa’s
regulator says it questioned Mr Kellerman late last year on investments coming out of
offshore funds into South Africa.

Last month the offices of Capital World Markets (CWM), a financial-services provider, were
raided by the City of London police, with 13 arrests made on suspicion of fraud by false
representation, conspiracy to defraud and money-laundering. Maria Woodall, the lead
detective, said the arrests were meant to “stop what we believe was ongoing criminality” and
asked investors, apparently lured by the promise of monthly returns of 5%, to come forward.

CWM strongly denies the police’s allegation that it is connected to fraud. Yet some claim the
raid is tied to events at Belvedere because the two groups are linked. On a now-deleted part of
its website, CWM stated it is part of the same group as Belvedere. Belvedere, however, says it
merely provided services to CWM and that whatever allegations there may be against CWM
have no bearing on Belvedere.

Whatever the outcome of the investigations into Belvedere and CWM, the affair raises
awkward questions over the role of professional-services firms that advise and check the
books of offshore financial groups. The long list of lawyers, auditors and fund administrators
that have worked with or been engaged by Belvedere’s funds includes blue-chip names such
as BDO and EY. In a statement deVere says it is deeply concerned that alarm bells were not
rung until now and that worrying signs appear to have been “ignored by professional service
providers trusted by deVere and other brokerages”. Auditors will certainly be in an awkward
position (and could be open to lawsuits) if it turns out they signed off on a Ponzi scheme, says
Jason Sharman of Griffith University in Australia.

In the coming months, as the shape of the affair becomes clearer, questions will also arise
about how good a grip regulators have on money channelled through tax havens. Earlier this
year Mauritius suffered another possible scandal involving Bramer Banking Corporation Ltd
(BBCL), whose licence was revoked earlier this month “following strong evidence that BBCL
is engaged in a Ponzi scheme which exceeds 25 billion rupees [$690m]”, according to the
country’s prime minister. Partly under commercial pressure due to increased regulation and
competition, offshore financial centres have begun to offer more complex funds and
collective-investment schemes. These require more skill to regulate than the simpler trusts
that have been their bread and butter. Mr Sharman, who studies offshore centres, says it is
inevitable that, as they venture into more complex finance, they will become more vulnerable
to scams.

Business Ethics 32
Tax evasion
The mega-haven

An index of financial secrecy highlights

American hypocrisy
Nov 7th 2015 | From the print edition, p. 67.

THE world is becoming less welcoming to tax dodgers. That is the conclusion of the latest
Financial Secrecy Index, published every two years by the Tax Justice Network (TJN), an
NGO. It looks at various measures of financial transparency and information-sharing in more
than 90 countries, then weights them according to the level of financial services each country
provides to non-residents. Most countries’ scores have fallen since 2013, indicating greater
transparency. Among the biggest improvers are the Cayman Islands, once a notorious tax
haven, and Luxembourg, which tax campaigners used to call Europe’s “death star” of
financial secrecy.

The reason for the shift is the global, austerity-era push for countries to share more
information on tax arrangements. Under the fast-spreading, OECD-sponsored Common
Reporting Standard, countries will routinely exchange data on each other’s citizens so they
can be taxed appropriately in their home countries. Rules on the registration of corporate
ownership are being tightened, too, in order to reduce opportunities to hide dirty money in
anonymous shell companies.

But America, the country that has arm-twisted so many others to join the transparency
revolution, is dragging its feet. It is now the third most secretive jurisdiction, behind Hong
Kong and, inevitably, Switzerland (where rumours of the death of bank secrecy have been
exaggerated).

America was in the vanguard in the fight against tax havens, first targeting the Swiss, then
passing the Foreign Account Tax Compliance Act, or FATCA, which forces financial firms
all over the world to spill the beans on their American clients. While demanding concessions
from others, however, Washington has made few itself. It has, for instance, failed to engage
with the OECD’s data-sharing scheme. Worse, anonymity-friendly incorporation regimes at
the state level mean America is unmatched in corporate secrecy.

This matters, because America hosts a lot of offshore business—just ask a billionaire from
Caracas or Cairo where he buys property or sets up the shell companies that hold it. The TJN
offers a solution: it reckons Europe should mimic FATCA by imposing a stiff withholding tax
(it suggests 35%) on payments from Europe to American financial institutions, until America
gives as much data as it takes. That would induce wry smiles in Zurich.

Business Ethics 33
Tax blacklists
EU hypocrites!

The naming and shaming of tax havens is

fraught with folly
Aug 22nd 2015 | From the print edition, p. 56-57.

Business Ethics 34
BLACKLISTS have been a feature of tax diplomacy ever since an internationally co-
ordinated assault on tax havens began in the late 1990s. One of the first lists, produced by a
global anti-money-laundering body, included, among others, Panama. The Central American
country rattled the only sabre it had—its canal—and was promptly taken off the list after
some Western governments squealed that their companies might lose engineering contracts.

Politicised though blacklisting may be, it is no less popular today. Pressure to name and
shame is high in a time of post-crisis austerity. The latest such list, published in June by the
European Union (EU), points the finger at 30 countries it views as “non-co-operative” on tax.

The targets (see table) have cried foul. Far from being exhaustively researched, the list is an
aggregation of national lists: it includes any country blacklisted by ten or more EU members.
Not only does that strike many as arbitrary, but the criteria for inclusion differ from EU state
to state: some consider a low tax rate alone sufficient grounds, others require secrecy and
opacity too. The most avid blacklisters are financial minnows such as the Baltic states and
Bulgaria; Germany and Britain are among those with no entries.

Worse, mistakes appear to have been made in the totting-up—and left unrectified even when
pointed out. Guernsey is on the list by virtue of being blacklisted by precisely ten EU
countries—but one of those, Poland, has a beef not with Guernsey but nearby Sark.
Guernsey’s government says that it made clear before the list was published that it has no
legal authority for Sark in tax matters, but that this fell on deaf ears.

The list is at odds with reality in other ways, too. On it are Nauru and Niue, two Pacific
microstates. Both have had problems with dodgy shell banks in the past, to be sure, but these
were shut down a decade ago under international pressure. Today Nauru’s only formal
financial institution, according to an anti-money-laundering group, is a branch of Western
Union, a money transmitter, in a hardware store. Niue’s financial sector is by this measure at
least twice as big—it boasts no fewer than two Western Union branches, plus a commercial
bank. “It is hard to imagine complex tax-evasion schemes being run from such places,” says
Jason Sharman, an expert in offshore finance at Griffith University in Australia.

Though blacklists lack credibility among tax cognoscenti, they do matter. They affect public
perceptions and give NGOs a rod with which to beat perceived offenders. Moreover, inclusion
on a list damages more than just reputation. The information is fed into commercial risk
software, making banks that use it less willing to deal with blacklisted countries. Few will
want to open local outposts in places regularly denounced as financial rogues.

A list compiled by one country or region is often used as an input for those of others,
compounding the problem. That can overlook the progress made by some places to shed their
pariah status by, for example, agreeing to exchange tax information systematically. The
OECD, a rich-country club which oversees that process, has called the EU list “unfortunate”.

The more advanced jurisdictions on the list, such as Guernsey and Bermuda, are particularly
annoyed. Though no angels, they have made progress and now meet more global tax and anti-
money-laundering standards than many OECD countries do. Bermuda points out that at least
5 of its 11 EU blacklisters have themselves failed to meet international tax obligations.
Indeed, if the EU had assessed its own members honestly, it is hard to imagine the
Netherlands, Luxembourg and Ireland—home to particularly rococo tax schemes attractive to
American tech groups—not being on it. Some might add Britain, too.

Business Ethics 35
The European Commission has responded to the criticism by arguing that the list should not
be viewed as a central blacklist, since the batching of the 30 names is merely a
“consolidation” of national lists. That is disingenuous, given that officials themselves refer to
it as “the pan-EU list”. They insist the removal or addition of countries is down to individual
member states, not Eurocrats. One official says the list is already having a positive effect, by
making offshore centres more willing to engage with small EU countries that have blacklisted
them. After all, who knows where closer co-operation between Guernsey and Estonia could
lead?

As pressure has mounted, however, Brussels has backtracked. At a meeting with the 30
ostracised states last month, it agreed to make clearer reference to efforts that some of them
have made to adhere to new tax-transparency standards—though it is not clear if it will ditch
the “non-co-operative” label. Officials have assured Guernsey that it is not considered a tax
reprobate, but the island remains on the list—at least until it is formally updated later this
year. “This sort of thing can make you feel like your efforts are never rewarded,” sighs Steve
Wakelin, who handles Guernsey’s international relations.

Financial crimes
Unfair cop

America’s approach to punishing financial

crime is muddled, lenient and self-defeating
May 23rd 2015 | From the print edition, p. 13.

“THE message to every Wall Street banker is loud and clear,” cried Elizabeth Warren, a
senator from Massachusetts, last year. “If you break the law, you are not going to jail.” After
the savings-and-loan crisis of the early 1990s, Ms Warren pointed out, over 1,000 people were
prosecuted, and more than 800 convicted. Yet since the financial crisis of 2007-08, which did
far more damage to the economy, no senior banker has been convicted of any crime related to
it. America’s regulators and prosecutors, Ms Warren complained, were not only failing to
pursue those responsible; they were also declining to take the banks themselves to court.
Instead, they were negotiating murky settlements, in which financial firms agree to pay big
fines if prosecutors promise not to press charges.

Events this week have only made the senator more apoplectic. Regulators and prosecutors
announced settlements with six international banks for alleged manipulation of currency
markets (see article). The six agreed to pay some $5 billion in fines. Two did not admit to any
crimes related to this abuse; the other four did, but received waivers shielding them from the
consequence that would normally follow—the loss of an all-important banking licence. This
week also marked the end of a 90-day period the Department of Justice (DoJ) had given itself
to decide once and for all whether it could launch any prosecutions related to the financial
crisis. The DoJ says only that it is reviewing the results of the review.

Ms Warren is wrong on many things; on this, she is spot on. (Well almost: one senior banker
has been convicted of fraud linked to the financial crisis.) If banks have been involved in acts
Business Ethics 36
serious enough to qualify for billions of dollars in penalties, then a few more executives must
surely have committed a crime. Negotiated settlements are no substitute for criminal
proceedings. For one thing, the punishment falls on shareholders, since the bumper fines
come straight out of profits. For another, the lack of trials means there is no proper public
examination of the merits of the cases or the calculus behind the penalties; no firm precedents
are set indicating how banks should behave in future and what penalties they can expect if
they transgress.

Yet this is the way the Obama administration has handled all manner of alleged misdeeds at
banks, from turning a blind eye to money-laundering to helping customers get round
American sanctions. Even its campaign against banks that abet tax evasion, the one financial
crime it is widely reckoned to have tackled with firmness and consistency, looks muddled on
close scrutiny (see article).

The wooliness of the government’s approach has sparked a political backlash. Ms Warren, a
former academic, secured her seat in the Senate and became a hero of left-wing Democrats by
harrumphing about it (see article). It is not just the left that is outraged, however: anger at the
lenient treatment of big banks has been one of the main factors animating the right-wing Tea
Party movement.

No one’s happy—they’re doing something wrong

Even bankers balk at today’s arrangements. They say they can never contest criminal charges,
because they will lose their licences if found guilty. A few small banks that have incurred
their prosecutors’ ire have indeed gone out of business. That gives the big ones a strong
incentive to agree to whatever settlement the DoJ proposes. Since banks remain unsure which
activities will lead to which punishment, they are responding less by altering their behaviour
than by hiring former prosecutors and regulators and lobbying for leniency. Smaller foreign
banks are trying to limit their activities in America in the hope of escaping this capricious
system.

It need not be this way. There is nothing to stop prosecutors pursuing individuals, and being
more open and consistent about how they strike deals. At least some cases should go to trial.
In the longer term, Congress should make the consequences for banks of a criminal conviction
commensurate with the gravity of the crime. That would both serve justice and make America
a more attractive financial centre.

Business Ethics 37
Digital money
Taking a liberty

Life for virtual money-launderers is getting

harder
Jun 1st 2013 | NEW YORK |From the print edition, p. 68-69.

A CRIMINAL indictment, filed in New York against Liberty Reserve (LR) and seven current
and former employees, has shaken the world of digital currencies. The defendants are charged
with running a money-laundering operation that allegedly acted as “a financial hub of the
cybercrime world”, serving credit-card fraudsters, identity thieves, hackers and drug
traffickers. Authorities estimate that LR processed 55m transactions and laundered $6 billion
between 2006 and May 2013. That makes it the largest case in the history of cross-border
money-laundering.

With LR’s website shut down—and regulators warning that virtual currencies should follow
anti-money-laundering rules more assiduously—cyber-enthusiasts have been left wondering
which digital-money business will be next in the prosecutors’ sights. Attention has inevitably
turned to Bitcoin, the darling of virtual currencies, which is widely used on Silk Road, an
online marketplace for illegal drugs.

But the two are not the same. LR was essentially no more than a digital Western Union or
PayPal, albeit one designed to break the rules. Users had to provide a name, address and date
of birth, but the firm did not verify the information. It charged a 1% fee per transfer, plus a
75-cent “privacy fee” to ensure untraceability (even within LR’s system). To dodge
regulations and avoid creating a paper trail, LR made users deposit and withdraw funds
through third-party “exchangers”.

Bitcoin is more of a proper currency, because it can be transferred without recourse to a

central clearing house—rather like bundles of dollar bills. But businesses which trade Bitcoins
for central bank-issued money, such as Mt.Gox, an exchange based in Japan, resemble Liberty
Reserve. They could find themselves chased down by prosecutors if too much dirty money
starts flowing through Bitcoin. On May 14th federal agents seized some funds from an
account held by Mt.Gox at Dwolla, another online transfer service, on the basis that laws
governing money transfers were not being followed.

If prosecutors look for more cases, the most likely targets are online payment services that
allow cash to be moved without verifying users’ identities. The number that merely pretend to
apply “know your customer” and other anti-laundering rules is thought to be in the dozens.
The LR case will make regulators warier of digital-money innovations such as Bitcoin.

The case highlights how hard it is to track such operations. LR’s founder, Arthur Budovsky
(pictured on previous page, after his arrest), had been known to the authorities for years. After
being prosecuted in America for running an unlicensed money-transmission firm (the home of
E-Gold, a now-defunct digital currency), he moved the business to Costa Rica. When local
regulators grew concerned, he allegedly designed a fake compliance portal, then pretended to
shut the firm down while in fact taking it underground.
Business Ethics 38
But crimefighters’ techniques have evolved too. As well as creating undercover LR accounts,
they wiretapped internet connections and executed search warrants for e-mail accounts and
internet service providers. Prosecutors’ offices are investing heavily in their cybercrime labs.
Money-moving businesses that facilitate digital dodginess will find it increasingly hard to stay
a step ahead.

Philanthropy
Doing good by doing well

Lessons from business for charities

May 23rd 2015 | From the print edition, p. 52.

“WHAT charity will give me the biggest bang for my buck?” asks Elie Hassenfeld. In 2007
the former hedge-fund manager co-founded GiveWell, a non-profit organisation set up to
answer that question for the growing number of donors who want
to know how much good their cash will do before deciding which
charity to entrust it to. GiveWell researches charities active in
fields where there is strong evidence that great good can be done
for a modest cost, such as cutting the incidence of malaria and
treating children for parasites. The most effective are published in
a list of “best buys”.

According to Alana Petraske, who advises charities and donors for

Withers, a law firm, much of the new interest in such “impact-
driven” philanthropy is from donors with business backgrounds
who aim for the same efficiency in their giving as in their work.

Business Ethics 39
Bill Gross is a recent example. The billionaire bond investor has said that he will give his
entire fortune away, and lauded GiveDirectly, a GiveWell top pick that makes no-strings cash
grants to poor people in developing countries that he describes as “outperforming the market”.

Venture philanthropy, modelled on venture capitalism, offers a way to invest in charities that
are testing new approaches to solving old problems. Some big donors, including the Gates
Foundation and USAID, the American government’s aid agency, run competitions for
innovative approaches, which are extended if they prove to be effective and efficient. They
look for rigorous evaluation: almost half the projects USAID funds include “gold-standard”
randomised controlled trials.

Small donors, too, are becoming more discerning in their giving. Together, their contributions
vastly outweigh those of billionaire philanthropists and their foundations: a 2007 study
estimated that American households gave at least $60 billion annually to charities focused on
the needs of the poor. By comparison, the Gates Foundation made grants totalling $3.9 billion
last year.

Members of Giving What We Can, an Oxford-based society, pledge to make regular

donations right through their working lives to charities that alleviate poverty as efficiently as
possible. Many are recent graduates on modest incomes. Using information provided by
charities themselves, it calculates that the most effective health-focused charities do more than
a thousand times as much good as the least effective, as measured in “quality-adjusted life-
years”, a standard unit that combines survival and quality of life. Choosing the right charity
thus matters at least as much as deciding how much to give to it.

That donors are paying more attention to the uses their money is being put to may seem an
unalloyed good. But demanding proof of impact may push charities to focus on short-term
outcomes, rather than more meaningful long-term measures of success. Worthy but risky
projects such as pioneering medical research may be squeezed out. Others that do good work
with particularly difficult groups, such as persistent young offenders, could go the same way.
“What you don’t want is all charities gravitating towards the easier projects that guarantee
high levels of success,” says Iona Joy of New Philanthropy Capital, a think-tank that advises
charities.

Another potential pitfall, says Ms Joy, is that impact-minded donors may withdraw their
support if charities admit to mistakes. That can push charities to seek to justify failures rather
than learn from them. Though nearly three-quarters of British charities with an annual income
of more than £10,000 ($15,500) say they have been trying harder than before to measure
impact, just 5% say that they do so mainly to improve their service. More than half are trying
to satisfy funders.

This is a missed opportunity. SolarAid, which won Google’s Global Impact Challenge in
2013, sells solar lamps that cost $10 and save families on average $70 on paraffin (kerosene)
a year. In 2012 sales failed to grow as much in Malawi as elsewhere. Most potential
customers, its research and impact unit found, could only afford a solar light straight after
tobacco harvest, in May. Scheduling its sales visits to coincide with this period made the
charity more cost-effective, says Kat Harrison, its director of research and impact, and helped
it to reach more very poor people.

Donors often look for low overheads in the mistaken belief that this is a proxy for cost-
effectiveness. But to solve new problems charities need discretionary cash for staff, research

Business Ethics 40
and infrastructure. Dasra, an Indian foundation, specifically encourages affluent donors to
give charities money to be spent on administration. In 2010 it set up its first “giving circle” of
three donors who collectively committed $600,000 over three years, to be used by a small
charity to get better at managing its work and measuring its impact.

Educate Girls, the first charity supported by a giving circle, covers 10,000 schools in
Rajasthan, India’s largest state. A preliminary evaluation by researchers at Michigan
University suggests that it cuts girls’ drop-out rate by 5%. Smarinita Shetty, one of Dasra’s
senior managers, compares the approach to that of private equity, which seeks to make
businesses more valuable by improving their management. As charities are learning, if you
want to do good, you have to do well.

Philanthropy
Panda power

Scepticism about charity starts to give way

to generosity
Dec 19th 2015 | SHANGHAI | From the print edition, p. 82.

THE feeding frenzy for the pandas comes at nightfall. People furtively approach them,
pouring bags of old clothes down their gullets. By day, the trucks arrive to clean the bears out,
leaving them empty for the next big meal. The pandas are plastic. They are large, bear-shaped
receptacles, designed to entice people to donate their unwanted garments to those in need.
First deployed in 2012, there are now hundreds around Shanghai, often placed by entrances to
apartment buildings. They swallowed about a million items of clothing last year.

The procession of donors feeding trousers to pandas is impressive. But they usually do so
under cover of darkness. Charitable giving is not yet a middle-class habit. Many people still
feel awkward about it, despite their growing prosperity. China’s GDP per person is about one-
seventh of America’s. But in 2014 Chinese gave
104 billion yuan ($16 billion) to charity, about one-
hundredth of what Americans donated per person
(see chart).

This is partly a legacy of attitudes formed during

Mao’s rule, when the party liked to present itself as
the source of all succour for the poor (to suggest
otherwise was deemed counter-revolutionary).
Even until more recent years the party was
reluctant to encourage charities, worried that they
might show up its failings.

The middle classes have worries too—that giving

large amounts to charity may draw unwanted

Business Ethics 41
attention to their wealth. They do not want to fuel the envy of the have-nots or encourage tax
collectors to pay them closer attention. The top 100 philanthropists in China gave $3.2 billion
last year, according to Hurun Report, a wealth-research firm based in Shanghai. That was less
than the amount given by the top three in America.

In 2008 when a powerful earthquake hit the south-western province of Sichuan—the deadliest
in China in more than 30 years—it seemed that one positive outcome would be a boom in
charitable giving. Volunteers poured into the devastated region and donations filled the
coffers of aid organisations. Problems soon arose, however. Embarrassed that private relief
efforts were proving more effective than official ones, the government reined in citizen-led
organisations.

A subsequent succession of scandals about mismanaged funds has not helped the growth of
charities either. Even though most of them are well run, caution is sometimes warranted.
Swindlers have even spied opportunity in the panda receptacles. Yuan Yuan, the organisation
behind the pandas, noticed copycat ones popping up in Shanghai over the past year. Someone
devised a scheme for using these as a way of conning people into donating clothes, and into
investing in a business which would supposedly make money by reselling them. Returns of
more than 10% were promised—much higher than on deposits in banks. Dozens of people fell
for the scam, handing over a total of at least 3m yuan to the crook. They got nothing back.

For Yang Yinghong, general manager of Yuan Yuan, this con was just the latest in a series of
challenges. Lest people be tempted to put their refuse in the donation boxes, he came up with
the panda design and made the animals translucent so that passers-by could see that clothes
were piling up inside them. The pandas’ eye-catching visibility has had an unfortunate side-
effect, however. Mr Yang says people prefer to drop off their donations at night because
others may think badly of them for giving away perfectly wearable clothes.

Despite such middle-class diffidence, the proliferation of the pandas on Shanghai’s streets
may reflect a growing acceptance of public displays of charity. The pandas are migrating
around the country, popping up in cities along the coast and deep in the interior.

Big-ticket donations by rich businesspeople are also becoming more common. When Bill
Gates and Warren Buffett hosted a dinner in Beijing for China’s richest people in 2010,
hoping to encourage them to give to charity, many billionaires chose to stay away (Zong
Qinghou, a drinks magnate, said that philanthropy was just a way to dodge taxes). Some of
them now seem less inhibited. In 2014 Jack Ma, co-founder of Alibaba, an e-commerce
company, created a philanthropic trust (the firm’s diverse interests expanded further this week
with the purchase of Hong Kong’s leading English-language newspaper, the South China
Morning Post—see article). Zhang Xin and Pan Shiyi, who are property developers, launched
a fund to help poor Chinese students go to universities abroad.

The China Philanthropy Research Institute estimates that fully 80% of donations by the
wealthiest Chinese go to overseas charities. Many may well prefer to give to local causes, but
regulations have hindered the development of philanthropy at home. To function as a not-for-
profit organisation, charities must have a government partner, which entails the loss of their
autonomy. It is also difficult for them to obtain tax breaks for their donors.

But this will soon change. The government published a draft law on charities in late October.
Under discussion for a decade, it defines charities broadly, and acknowledges that they can
help improve everyone’s quality of life. The law promises to allow charities to register

Business Ethics 42
directly, rather than work through an official partner. They may also enjoy tax exemptions.
Zhu Jiangang of Sun Yat-sen University in Guangzhou says the law should help reduce the
influence of government, and thus encourage charities to flourish. It is expected to be
approved soon.

How far the government is really willing to go remains in doubt, though. At the same time as
giving charities more space to operate, it is cracking down on non-governmental
organisations, wary of foreign influence. Until charities are allowed to develop independently,
the wealthy who aspire to be more generous will have few options. Some quip that it is easier
to make money in China than to give it away.

Corporate social responsibility

The halo effect

Do-gooding policies help firms when they

get prosecuted
Jun 27th 2015 | From the print edition, p. 60.

“THERE is one and only one social responsibility of business,” wrote Milton Friedman, a
Nobel prize-winning economist. “To use its resources and engage in activities designed to
increase its profits.” Plenty of climate-change campaigners would argue with that (see article).
But even if you accept Friedman’s premise and regard corporate social responsibility (CSR)
policies as a waste of shareholders’ money, things may not be absolutely clear-cut. New
research suggests that CSR may create monetary value for companies—at least when they are
prosecuted for corruption.

Business Ethics 43
The largest firms in America and Britain together spend more than $15 billion a year on CSR,
according to an estimate last year by EPG, a consulting firm. This could add value to their
businesses in three ways. First, consumers may take CSR spending as a “signal” that a
company’s products are of high quality. Second, customers may be willing to buy a
company’s products as an indirect way to donate to the good causes it helps. And third,
through a more diffuse “halo effect”, whereby its good deeds earn it greater consideration
from consumers and others.

Previous studies on CSR have had trouble disentangling these effects because consumers can
be affected by all three. A recent paper by Harrison Hong of Princeton University and Inessa
Liskovich of the University of Texas attempts to separate them by looking at bribery
prosecutions under America’s Foreign Corrupt Practices Act (FCPA). The authors argue that
since prosecutors do not consume a company’s products as part of their investigations, they
could be influenced only by the halo effect.

The study found that, among prosecuted firms, those with the most comprehensive CSR
programmes (as measured by MSCI ESG, a provider of corporate indices) tended to get more
lenient penalties. Their analysis ruled out the possibility that it was firms’ political influence,
rather than their CSR stance, that accounted for the leniency: companies that contributed more
to political campaigns did not receive lower fines.

In all, the authors conclude that whereas prosecutors should only evaluate a case based on its
merits, they do seem to be influenced by a company’s record in CSR. “We estimate that either
eliminating a substantial labour-rights concern, such as child labour, or increasing corporate
giving by about 20% results in fines that generally are 40% lower than the typical punishment
for bribing foreign officials,” says Mr Hong.

The authors also found that all forms of CSR are not created equal. Spending on employee
and community relations had a much bigger impact on the prosecutors than did promoting
diversity or being environmentally friendly.

Mr Hong and Ms Liskovich admit that their study does not answer the question of how much
businesses ought to spend on CSR. Nor does it reveal how much companies are banking on
the halo effect, rather than the other possible benefits, when they decide their do-gooding
policies. But at least they have demonstrated that when companies get into trouble with the
law, evidence of good character can win them a less costly punishment.

Business Ethics 44
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Business ethics
Going bananas

Chiquita has tried hard to be good—and got no credit for it

Mar 31st 2012 | from the print edition, p. 64.

SOMETIMES you bend over backwards to please, but still get nowhere. That is what appears
to have happened to Chiquita Brands, an American firm which is one of the world’s biggest
suppliers of bananas and other fruit. Despite accommodating eco-warriors, social activists and
unions, it has found little reward.

After a campaign by a green group called ForestEthics, Chiquita agreed in November to avoid
fuel from Canadian tar sands. Extracting this oil is a dirty process. Environmentalists have
worked furiously to block a pipeline, called Keystone XL, which would carry it from Canada
to America. Chiquita told ForestEthics that it does not use such fuel in its ships and agreed to
avoid its use in lorries.

This may have pleased environmentalists, but it infuriated Canadians who depend on the oil
industry. A pro-business lobby called EthicalOil.org is urging a boycott of Chiquita’s
products that is said to be costing the company a fortune. Chiquita would not quantify its
losses.

Chiquita traces its origins to the late 1890s and the United Fruit Company, which treated
some of the Central American countries it operated in as banana republics. In recent years,
however, the firm has made huge efforts to promote social responsibility and sustainability,
working with activist groups such as the Rainforest Alliance. “We can do good and do well at
the same time,” Fernando Aguirre, the firm’s chief executive, wrote in the company’s latest
social responsibility report, issued in 2008.

Chiquita has signed and largely upheld a global agreement with local and international food
unions. It has embraced sustainable farming techniques and allows products to be certified for
environmental and other standards. Last year it promised to promote more women and to
ensure there is no sexual harassment on the plantations it owns and buys from. But that has
not provided protection from big retailers buying bananas direct from plantations and
bypassing Chiquita and its main rivals, Dole and Fresh Del Monte Produce.

Many firms in conflict zones face extortion. In 2003 Chiquita became the only American
company voluntarily to admit to the Department of Justice that it had paid protection money
to Colombian paramilitary forces surrounding its plantations. Now it is facing a raft of
American and Colombian lawsuits.

Chiquita’s conspicuous lack of reward is beginning to worry some veteran campaigners.

Neither Dole nor Del Monte has been interested in following Chiquita in signing a global
union agreement, says Ron Oswald, head of IUF, the international foodworkers’ union.“It’s
not sustainable for any company in a competitive sector to make progress and gain no
recognition for it,” he grumbles.

Business Ethics 47
Schumpeter
The corporate closet

One of Britain’s leading businessmen urges firms to

become more gay-friendly
May 31st 2014 | From the print edition, p. 59.

ON MAY 1st 2007 John Browne resigned as boss of BP, a British oil giant, his career
apparently in ruins. A tabloid newspaper had exposed his affair with a male ex-prostitute. For
the next few weeks Lord Browne was subjected to one of those trials by media at which the
British excel. Three years later the Deepwater Horizon disaster, an explosion that led to the
leakage of millions of gallons of oil off America’s Gulf coast, suggested that there might have
been more serious reasons than his private sexual preferences to question Lord Browne’s
tenure at BP. The disaster seemed to confirm both the worries of some analysts that he had
sacrificed investment in a dash for growth, and environmentalists’ accusations that his
rebranding of BP as Beyond Petroleum was just superficial “greenwashing”.

Despite all the blows to his reputation, Lord Browne has done a remarkable job of reviving
his career. He has built Riverstone Holdings, a private-equity company, into a powerful force
in European fracking. He has also turned himself into a leading spokesman for gay rights in
the corporate world. His new book, “The Glass Closet”, is his most comprehensive statement
of his position: part memoir of what it was like to live a lie while running one of the world’s
biggest companies and part corporate manifesto on why “coming out is good business”.

On the face of it, the corporate world has embraced gay rights with enthusiasm. More than
90% of Fortune 500 companies have policies to prevent homophobic discrimination. Both
Lloyd Blankfein, the boss of Goldman Sachs, and Jamie Dimon, the boss of JPMorgan Chase,
have spoken out in favour of same-sex marriage. In-house networks for homosexual staff,
such as Glam (Gays and Lesbians at McKinsey) and Google’s Gayglers, have become part of
the corporate furniture. Lord Browne says he has even heard of business students pretending
to be gay in order to increase their chances of landing jobs at elite companies.

Look beyond the welcome signs, however, and the picture is not so good. Neither the Fortune
500 nor the FTSE 100 has a single openly gay CEO. Christopher Bailey will become the
FTSE’s first when he takes over as boss of Burberry later this year. An estimated 41% of gay
employees in the United States and 34% in Britain remain in the closet, the book notes.

Lord Browne argues that the upper echelons of business are bound to be slow in adjusting to
changing mores: the executive suite is the product of a race that began decades ago. But he
also notes that many younger employees are still choosing to remain in the closet. They fear
that being “out” will lead to them being pigeonholed as suitable for some jobs but not others,
or will otherwise hurt their chances in a fiercely competitive labour market. And they prefer
to keep their private lives to themselves.

The last point is surely understandable: work is a place where people go to earn a living rather
than to bare their souls. But Lord Browne raises powerful objections to this position. The
barrier between “work” and “life” is a thin one, particularly in today’s high-pressure work
environment. Companies are constantly inviting people’s partners to social functions. Above a
Business Ethics 48
certain level of seniority businesspeople have little choice but to operate in the limelight:
those who disguise their sexual identity to reach the top risk suffering Lord Browne’s fate
when they get there.

Lord Browne is reasonably convincing that coming out is good for business. Embracing gay
rights helps firms win the war for educated talent—not just because they stand a better chance
of recruiting gay employees (who constitute perhaps 5-10% of the workforce) but also
because it sends a positive signal to gay-friendly straights. Coming out probably improves the
productivity of gay employees: he cites a raft of statistics, together with his own biography, to
show that people are more creative if they are not using a quarter of their brains to hide who
they are. He is even more convincing in arguing that a combination of business logic and
changing social attitudes will radically reduce the number of corporate employees who feel
obliged to hide in the closet.

Pride and pitfalls

However, Lord Browne’s enthusiastic advocacy leads him to gloss over some of the difficult
issues raised by the move towards more gay-friendly workplaces. He never has a bad word to
say about the “diversity consultants” who provide him with most of the book’s statistics. He
seems to have overlooked that these consultants are members of a self-serving industry that
constantly redefines discrimination so as to keep itself in work. He praises bosses who speak
out in favour of gay marriage, but says nothing about those with sincere reasons to oppose it,
and their right to express their opinions—such as Brendan Eich, who was forced to quit as
boss of Mozilla, a software firm, for this reason.

In particular, he should have more to say about the way that gay rights will complicate
globalisation. The world is dividing into two sharply opposed camps: an ever more gay-
friendly West; and the 77 countries that still outlaw homosexual acts between consenting
adults. Uganda, Nigeria and Russia have strengthened their homophobic laws in reaction to
gay liberation in the West. Lord Browne lauds companies like IBM, which prides itself on
pursuing the same anti-discrimination policies in all the 170 countries where it operates. But
in practice many multinationals and their homosexual employees will have to make difficult
choices. In Mr Browne’s own industry, it will be hard for firms to send openly gay staff to
many of the world’s biggest oil-producing countries, perhaps limiting their career prospects.
In rich countries the old culture of “don’t ask, don’t tell” is rapidly coming to an end, thanks
in part to stories like Lord Browne’s. The new culture, though more admirable than the old
one, will confront firms with some tricky managerial tests.

Business Ethics 49
Schumpeter
The enemy within

Rogue employees can wreak more damage

on a company than competitors
Jul 25th 2015 | From the print edition, p. 54.
EMPLOYEES are often said to be
a company’s biggest resource. It is
equally true that they are its
biggest liability. Scarcely a week
goes by without a company falling
victim to employees-turned-
enemies-or-embarrassments. On
July 20th Ashley Madison, a
website for married people looking
to have an affair, announced that it
had been hacked. Noel Biderman,
the company’s chief executive,
says that he thinks the attack was “an inside job”. On July 6th HSBC fired a group of
employees when it emerged that they had filmed themselves engaged in an “ISIS-style mock
beheading” of an Asian colleague dressed in an orange jumpsuit.

The most familiar type of enemy within is the fraudster. The Economist Intelligence Unit, a
sister organisation of The Economist, conducts a regular poll of senior executives on the
subject of fraud committed by insiders. In 2013 the poll discovered that about 70% of
companies had suffered from at least one instance of fraud, up from 61% in the previous
survey. Fraud is often petty: a survey of British employees for YouGov in 2010 found that a
quarter of staff eligible for expenses admitted to inflating claims. But fraud can also be more
audacious and more harmful: think of former employees setting up rivals using stolen
technology and purloined client lists.

Even more dangerous than the fraudster is the vandal. Thieves at least have a rational motive.
Vandals are driven by a desire for revenge that can know no limits. David Robertson of K2
Intelligence, a company that specialises in corporate investigation, recounts the story of a
British manufacturing company that was undergoing restructuring. A member of the
information-technology department discovered that his name was on the list of people whose
services would no longer be required. He built a “backdoor” into the company’s IT system
from his home computer and set about wreaking damage—deleting files, publishing the chief
executive’s e-mails and distributing pornographic pictures.

Some enemies-within start out as star employees. A striking number of the worst corporate
scandals in recent years have been the work of high-flyers who bend and then break the rules
in order to please their bosses. Barings, a collapsed British investment bank, showered Nick
Leeson with rewards before it discovered that he had produced his outsized results because he
took outsized (and unauthorised) risks.

Business Ethics 50
Other enemies-within are the very opposite of high-flyers. The HSBC execution squad are
only the latest example of low-level employees who have either wittingly or unwittingly used
the power of the internet to blacken their employer’s reputation. In April 2009 two employees
of Domino’s, a fast-food chain, posted videos of themselves “abusing takeaway food”. And in
July 2012 a Burger King employee posted photos of himself online which showed him
standing in a tub of lettuce in filthy shoes along with the caption “This is the lettuce you eat at
Burger King”.

One of the most effective ways for outsiders to damage a company is to strike up a
relationship with an insider. This can sometimes be fairly crude: bribing a cleaner to replace a
keyboard with a carefully-modified lookalike or swapping a USB stick for a virus-laden
doppelganger. But it is often more sophisticated. Many of the biggest corporate disasters in
recent years are likely to have involved collaborators. Security experts suspect that the
hackers who stole the personal information of about 40m customers from Target, an
American retail chain, in 2013 may have had help from insiders (the store refuses to
comment).

What can companies do to reduce the threat from these wolves in sheep’s clothing? A lot
depends on which particular sorts of wolves you are dealing with: traps that work for vandals
may not work for fraudsters, for example. And even the best-managed companies are fighting
an uphill battle. Information is getting harder to control. A single USB stick can contain more
data than 500m typewritten pages. A mobile phone can be hijacked and turned into a listening
device. People regularly log in with their electronic devices in crowded places where they can
be watched, filmed or hacked.

Fifth column, three principles

Yet three precepts are always worth bearing in mind. The first is that firms need to focus on
the people who have the greatest capacity to do harm—those who control the money and
information. The more complicated companies become, the harder it is to identify where
power really lies. But one thing is clear. The more dependent on information firms get, the
more IT specialists can compromise the whole business. The least companies can do is to
keep a careful watch on the IT department—and, if you’re going to sack somebody from that
team, do so immediately.

The second is that the human touch is still invaluable. Companies can certainly strengthen
their hand by installing software that can identify anomalous behaviour or monitor e-mail, or
by employing forensic accountants to double-check the accounts. But rogue employees are
usually a step ahead of their employers: they will simply shift to text messaging if they think
that their e-mails are being watched. Companies can probably do more by listening to
company gossip. Corporate-security firms get some of their best results by using “spies” to
hang around in the smoking room or go out for drinks after work.

The best way to fight the enemy within is to treat your employees with respect. And this third
principle is where many firms fail. They may embrace the rhetoric that nothing matters more
than their people, but too many workers feel that nothing matters less. According to a recent
survey by Accenture, a consultancy, 31% of employees don’t like their boss, 32% were
actively looking for a new job, and 43% felt that they received no recognition for their work.
The biggest problem with trying to do more with less is that you can end up turning your
sheep into wolves—and your biggest resources into your biggest liabilities.

Business Ethics 51
Schumpeter
When workers are owners

The received wisdom that employee

ownership is a good thing comes with
caveats
Aug 22nd 2015 | From the print edition, p. 53.
IT IS popular to lament the
growing gap between
capitalists and workers. In one
respect, however, the gap is
shrinking: the number of
workers who own shares in the
business that employs them has
never been higher. America
leads the way: 32m Americans
own stock in their companies
through pension and profit-
sharing plans, and share-
ownership and share-option
schemes. The idea continues to gain momentum. Hillary Clinton’s recent speeches suggest
that she may make it an important plank in her plans to reform capitalism. And worker-
capitalists are also on the march in Europe and Asia.

Conservatives like employee ownership because it gives workers a stake in the capitalist
system. Left-wingers like it because it gives them a piece of the capitalist pie. And middle-of-
the-roaders like it because it helps to close a potentially dangerous gap between capital and
labour. David Cameron, Britain’s Conservative prime minister, praises John Lewis, a retailer
entirely owned by its staff. Bernie Sanders, America’s only socialist senator and now a
candidate for the Democratic nomination (see Lexington), is a champion of employee share-
ownership.

The trend is also being driven by a long-term shift from “defined benefit” (DB) pension plans,
in which employers guarantee the retirement income of their workers, to “defined
contribution” (DC) schemes, in which workers and employers put money into an investment
pot, with no guarantees of how much it will eventually pay out. Including current workers and
pensioners there are more than 88m DC plans in existence. A 2013 survey by Aon Hewitt, a
consulting firm, found that 14% of such plans’ assets were invested in the shares of the
employer in question.

A number of studies have found that workers at firms where employees have a significant
stake tend to be more productive and innovative, and to have less staff turnover. Employee
ownership has its drawbacks, however. One is the risk that workers have too many eggs in
one basket: if their employer goes bust they can lose their pensions as well as their jobs.
Enron employees were encouraged to stuff their “401(k)” plans (the most popular type of
pension scheme) with company stock. Just before the firm went bankrupt in 2001 the average
Business Ethics 52
employee held 62% of his or her 401(k) assets in Enron shares. Likewise when Global
Crossing went bust a few months later, the collapse in its shares wiped out a large chunk of its
workers’ pension savings. Despite various initiatives by Congress to stop firms touting their
shares to employees, cases are still arising: some former workers at Radio Shack, a retailer
that filed for bankruptcy in February, are taking the firm to court, arguing that it kept offering
to make its pension contributions in the form of company shares, when it should have known
they were going to lose value.

A second problem is entrenchment. Supporters of worker ownership argue that it helps

companies take a more long-term perspective. Critics argue that it can entrench bad
management and undermine a company’s long-term competitiveness: underperforming bosses
are much more likely to be able to stay in place, and resist hostile takeovers, if some of the
company’s shares are in friendly hands. In 1994 United Airlines handed many of its workers a
55% stake, and representation on the board, in return for pay cuts. But its performance
remained poor, and it filed for bankruptcy in 2002.

A third risk is entitlement. The strongest argument in favour of employee ownership is that
workers will not only toil harder if they get a slice of the profits, but will make sure that their
colleagues do so too. A new paper by Benjamin Dunford and others, presented at the
Academy of Management’s annual meeting in Vancouver, argues that commitment can
transmute into entitlement. The academics studied a sample of 409 employees at a
commercial-property firm in the Midwest and found that those who invested a higher
proportion of their 401(k) accounts in company stock expected better benefits—in the form of
promotions and pay rises—than the rest, and took more discretionary leave. (However, the
study did not consider whether, nevertheless, employee ownership boosted the firm’s overall
performance.)

ESOP fables

Arguments about employee ownership can easily become too sweeping: grand claims from
supporters invite vigorous rebuttals by critics. A great deal depends on how schemes are
structured, and the motives for introducing them. Another recent paper, by Han Kim and
Paige Ouimet, of the University of Michigan and University of North Carolina respectively,
considers the sizes of ESOPs and of the firms that offer them. They find that small ESOPs
(which control a stake of less than 5% in the company in question) are far more likely to boost
productivity than large ones, because firms that introduce large ESOPs are often troubled ones
trying to conserve cash by substituting shares for pay, or seeking to fend off hostile takeovers
by giving shares to friendly insiders. They also argue that ESOPs are much more likely to
work in smaller firms than larger ones because employee-owners can more easily monitor
each other and thereby boost overall productivity.

There is plenty to be said for employee ownership. It can sharpen workers’ motivation and go
some way to healing a potentially dangerous divide between the working class and the boss
class. But if politicians are serious about the idea, they need to think harder about how to
make it work in practice. They should pay closer attention to how schemes are designed, and
look for ways to tailor regulations and tax incentives so as to encourage well-designed
schemes. They also need to deal with the problem of concentrating risk in a single company’s
shares. Given that the average life expectancy of Fortune 500 companies has fallen from 75
years in the 1930s to perhaps just 15 years today, encouraging employees to invest their
savings with the companies that employ them is a recipe for miserable retirements.

Business Ethics 53
Schumpeter
Digital Taylorism

A modern version of “scientific

management” threatens to dehumanise the
workplace
Sep 12th 2015 | From the print edition, p. 63.

FREDERICK TAYLOR was the most influential management guru of the early 20th century.
His “Principles of Scientific Management” was the first management blockbuster. His fans
included Henry Ford, who applied many of his ideas in his giant River Rouge car plant, and
Vladimir Lenin, who regarded scientific management as one of the building blocks of
socialism. Taylor’s appeal lay in his promise that management could be made into a science,
and workers into cogs in an industrial machine. The best way to boost productivity, he argued,
was to embrace three rules: break complex jobs down into simple ones; measure everything
that workers do; and link pay to performance, giving bonuses to high-achievers and sacking
sluggards.

Scientific management provoked a backlash. Aldous Huxley satirised it in “Brave New

World” (1932), as did Charlie Chaplin in “Modern Times” (1936). A rival school of managers
argued that workers are more productive if you treat them as human beings. But a recent
article about Amazon in the New York Times suggests that Taylorism is thriving. The article
claimed that the internet retailer uses classic Taylorist techniques to achieve efficiency:
workers are constantly measured and those who fail to hit the numbers are ruthlessly
eliminated, personal tragedies notwithstanding. Amazon’s boss, Jeff Bezos, insisted that he
did not recognise the company portrayed in the piece. Nevertheless, it provoked quite a
reaction: the article attracted more than 5,800 online comments, a record for a Times article,

Business Ethics 54
and a remarkable number of commenters claimed that their employers had adopted similar
policies. Far from being an outlier, it would seem that Amazon is the embodiment of a new
trend, digital Taylorism.

This new version of Taylor’s theory starts with his three basic principles of good management
but supercharges them with digital technology and applies them to a much wider range of
employees—not just Taylor’s industrial workers but also service workers, knowledge workers
and managers themselves. In Taylor’s world, managers were the lords of creation. In the
digital world they are mere widgets in the giant corporate computer.

Technology allows the division of labour to be applied to a much wider range of jobs:
companies such as Upwork (formerly oDesk) are making a business out of slicing clerical
work into routine tasks and then outsourcing them to freelances. Technology also allows time-
and-motion studies to be carried to new levels. Several firms, including Workday and
Salesforce, produce peer-review software that turns performance assessments from an annual
ritual into a never-ending trial. Alex Pentland of the Massachusetts Institute of Technology
has invented a “sociometric” badge, worn around the neck, that measures such things as your
tone of voice, gestures and propensity to talk or listen. Turner Construction is using drones to
monitor progress on a sports stadium it is building in California. Motorola makes terminals
that strap to warehouse workers’ arms to help them do their jobs more efficiently—but could
also be used to keep tabs on them.

As stopwatch management continues to conquer new territory, so too does pay for
performance. The more firms depend on the brainpower of their employees, the more they are
seeking to reward their finest minds with high salaries and stock options. “A great lathe
operator commands several times the wage of an average lathe operator,” Bill Gates points
out, “but a great writer of software code is worth 10,000 times the price of an average
software writer.” Many firms, including Amazon, apply the same Darwinian logic to their
worst performers as well, in a process known as “rank and yank”: workers are regularly
ranked by productivity and the weakest are culled.

The reaction to the Times piece shows that digital Taylorism is just as unpopular as its
stopwatch-based predecessor. Critics make some powerful points. “Gobbetising” knowledge
jobs limits a worker’s ability to use his expertise creatively, they argue. Measuring everything
robs jobs of their pleasure. Pushing people to their limits institutionalises “burn and churn”.
Constant peer-reviews encourage back-stabbing. Indeed, some firms that graded their staff,
including Microsoft, General Electric and Accenture, concluded that it is counter-productive,
and dropped it.

The meatware fights back

The march of technology can cut both ways. The rise of smart machines may make Taylorism
irrelevant in the long term: why turn workers into machines when machines can do ever
more? The proliferation of websites such as Glassdoor, which let employees review their
workplaces, may mean that firms which treat their workers as mere “meatware” lose the war
for the sort of talent that cannot be mechanised. And Mr Pentland’s sociometric badges have
produced some counter-intuitive results: for example, in a study of 80 employees in a Bank of
America call centre, he found that the most successful teams were the ones that spent more
time doing what their managers presumably didn’t want them to do: chatting with each other.

Business Ethics 55
Even so, digital Taylorism looks set to be a more powerful force than its analogue
predecessor. The prominent technology firms that set the tone for much of the business world
are embracing it. Google, which hires a few thousand people a year from up to 3m applicants,
constantly ranks its employees on a five-point scale. Investors seem to like Taylorism:
Amazon’s share price ticked upwards after the Times’s exposé. The onward march of
technology is producing ever more sophisticated ways of measuring and monitoring human
resources. And Taylorist managers are mixing the sweet with the bitter: Amazon’s
“Amabots”, as they call themselves, seem happy to put up with micromanagement if they get
a nice bonus at the end of the year. The most basic axiom of management is “what gets
measured gets managed”. So the more the technology of measurement advances, the more we
hand power to Frederick Taylor’s successors.

Schumpeter
McJobs and UberJobs

Lawsuits about what it means to be an

employee could shape the future of big
industries
Jul 4th 2015 | From the print edition, p. 58.

THE French enjoy nothing more than resisting the forces of Anglo-Saxon capitalism. On June
25th French taxi drivers paralysed Paris in protest against Uber, a ride-sharing service, and
attacked a few Uber cars for good measure. On June 29th police arrested two of Uber’s
managers in France for “illicit activity”. But from Uber’s point of view, all this is but a minor

Business Ethics 56
inconvenience: Paris is just one of 300 cities it serves. Far more worrying is what is
happening in the company’s own backyard in San Francisco.

On June 3rd the California Labour Commissioner ruled that Uber owes a former driver,
Barbara Ann Berwick, $4,152, mostly in expenses, on the ground that she was an employee
rather than, as Uber claims, an independent contractor. Uber is appealing against the ruling.
But it is a harbinger of things to come: San Francisco courts are also hearing two more cases
that hinge on the same question. If the rulings go against the company, its labour costs may
rise significantly, as it is forced to pay drivers’ social security and other benefits as well as
their expenses. Its valuation, which is currently above $40 billion, may suffer.

Uber is not the only big American company whose business model may be upended by
employment law. Last year the National Labour Relations Board’s general counsel said he
would treat McDonald’s as a joint employer, together with franchisees, of staff in the chain’s
franchised restaurants. This opinion will soon be tested in a case brought by ten employees
who claim that they were sacked by a franchisee in Virginia on racial grounds.

Both Uber and McDonald’s are up against powerful interest groups that are capable of both
fighting prolonged legal battles and playing on the public’s heartstrings. Uber has to confront
state governments which stand to gain sizeable tax revenues if on-demand workers are
classified as employees. McDonald’s has to wrestle with the Service Employees International
Union, which has been trying for years to unionise fast-food restaurants.

The legal situation seems to be murky in both cases. A pro-Uber lawyer could argue that the
firm is essentially little more than a marketmaker that provides a forum for buyers and sellers
of rides to come together. Its drivers own their vehicles and choose their working hours. They
are free to work for rivals, such as Lyft. An anti-Uber lawyer could retort that the company
exercises considerable control over its workers. It screens them for criminal records, and
weeds out those who get poor reviews from passengers. Likewise, a pro-McDonald’s lawyer
could argue that it is the franchisees who hire and fire workers, and who run the business from
day to day. An anti-McDonald’s lawyer could point to the detailed rules that the company
lays down on how workers in franchised restaurants are trained and how they should serve
customers.

The fundamental problem is that in America, as in many other rich countries, employment
law has failed to keep up with the changing realities of modern work. Its labour rules are
rooted in a landmark piece of legislation, the Fair Labour Standards Act, passed in 1938
during Franklin Roosevelt’s presidency. In those days a far larger proportion of American
men worked in manufacturing; most women did not work; and the difference between
employees, who worked full-time for a company, and contractors, who were typically
tradesmen such as plumbers, seemed much clearer. The post-war growth of franchising, and
the expansion of companies like Amway and Avon that used freelance door-to-door sellers,
began to blur the distinction. Now, the “on-demand” economy is all but obliterating it, by
letting people sell their labour and rent out their assets—from cars to apartments—in a series
of short-term assignments arranged by smartphone app.

That the law is so dated suggests that judges should exercise as light a touch as possible. The
franchise model has thrived because it allows local entrepreneurs to join forces with a global
goliath to scale up their businesses quickly while operating them according to local labour-
market conditions. Forcing McDonald’s to become a co-employer would expose those

Business Ethics 57
franchisees to co-ordinated union action and make it much more difficult for them to respond
to local circumstances.

The benefits of flexibility

The case for a light touch is even more compelling when it comes to Uber and its peers. The
most important thing to remember about the on-demand economy is that it has been a
dramatic success not just for consumers but also for workers seeking flexibility. That is why
Uber’s number of drivers has been doubling every six months for the past couple of years.
Some on-demand companies will choose to classify their workers as employees: for instance,
Instacart, a grocery-delivery service, has invited some of its freelancers to become part-time
employees, in the belief that this will make it easier to train and supervise them. But other
firms should be free to decide otherwise. Uber’s drivers, and their peers at on-demand firms,
would get expenses and other benefits if they were declared employees—but they would have
less flexibility over working hours and, more important, the increased cost of employing them
might mean fewer jobs.

America needs to update its employment law to take into account the fact that FDR is no
longer president. This will involve some careful balancing. Policymakers need to recognise
that people want to work more flexible hours and that technology has made it possible to
create spot markets in surplus labour and idle assets. But they must also recognise the state’s
need to raise taxes to pay for public services and benefits. Given the dysfunctional nature of
America’s politics, such updating will take a good deal of time and will probably involve
many false starts. Until then judges should leave open as many options as possible. The last
thing the country needs is for over-strict interpretations of outdated laws to kill exciting new
businesses and sabotage jobs. Do that and you end up like France.

Business Ethics 58
Schumpeter
Manage like a spymaster

Counter-intelligence techniques may help

firms protect themselves against cyber-
attacks
Aug 29th 2015 | From the print edition, p. 54.

UNTIL recently, for most businesses security was a question of buying decent locks, doors
and windows, installing CCTV, making sure that reception staff sign visitors in and out, and
trying not to leave confidential papers in the photocopier. But attacks on their computer
systems, be they by business rivals, political activists, criminals or foreign governments, are
much harder to defend against—and can have far worse consequences than a physical break-
in. A company can suffer a devastating blow to its reputation, its intellectual property, or its
ability to serve customers—not to mention its bank balances. It may never learn who has
attacked it or why, or how much information has been taken; so it may never be sure if it has
done enough to plug the leak.

Cyber-security is now burning a hole in boardroom tables. Before the recent hacking of
Ashley Madison, an online broker of adulterous trysts, the most notorious example in the past
year was that of Sony Pictures Entertainment, in which a torrent of embarrassing e-mails,
personal information about employees and copies of unreleased films was released on the
internet by unknown infiltrators. But there is a steady stream of less prominent cases in which
businesses suffer serious damage. Earlier this month the FBI said it had uncovered a scheme
in which hackers had got into the computers of three firms that distribute corporate press
releases, and made a fortune by trading on market-sensitive information before it had been
officially released. Ubiquiti Networks, an American maker of wireless-networking equipment,
admitted this month that it had been diddled out of $46.7m by fraudsters who falsified e-mails
from an executive, instructing the finance department to wire money to the criminals’ bank
accounts. Customers of Carphone Warehouse, a British mobile-phone retailer, are venting
their fury after large numbers of them had their financial details stolen from the company by
hackers.

Many companies now hire “penetration testers” to see how strong their defences are, both
online and in the real world. This can help them to identify unexpected weaknesses before
someone with malign intent takes advantage of them. But as soon as one gap is plugged, the
hackers will start looking for others. So, it is important for managers to adopt some of the
wiles of the spy world. Counter-intelligence officers assume that their adversaries are
constantly probing for weaknesses and trying to exploit them. Instead of attempting to
identify every potential line of attack, their aim is to minimise the damage when someone
does break in, and if possible, to turn the situation to their advantage.

The first lesson from the spymasters is that sometimes the convenience of having everything
easily accessible on an internal network has to be sacrificed. Intelligence agencies’ most
important stuff may not be kept on computers at all—manual typewriters and carbon paper
Business Ethics 59
still have their uses. Sensitive information may be kept in separate chunks, with no one person
in possession of, or aware of, them all. A great deal of thought goes into who needs to know
what, how the rules for information-sharing are set and who enforces them. Companies can
adopt the same “defence in depth” approach, to make it hard for an electronic intruder to
gather enough information to do serious damage.

More often than not, hacking attacks are facilitated by carelessness. But with the right
incentives and punishments, good computer-security habits can be acquired, and bad ones
shed. However, it has to start at the top—which is why spies fume about the way Hillary
Clinton casually kept official e-mails on a private computer when she was America’s
secretary of state. If the boss does not take cyber-security seriously, nor will her underlings.

Another lesson from counter-intelligence is the use of deception. The best way to find out if
you are being attacked is to offer a tempting target. “Honeypots” are bogus but convincing
computers, networks and files which will attract an attacker’s attention, while revealing his
presence to the silent watchers. For example, one American bank placed a series of fake
profiles of non-existent staff on its internal computer network, including e-mail addresses.
Whenever a transfer request arrived, addressed to one of these aliases, it knew that the sender
was likely to be a fraudster.

If you find out who is attacking you, and what they want, you have some options. You can
bring in law-enforcement: breaching someone else’s network is a crime in most jurisdictions.
But that may not help much if the attacker is from a lawless country. You may simply gather
more information about the attacker, building a picture of his aims and capabilities. If he is
trying to steal blueprints of your products, say, then make sure he gets fictitious documents
that will mislead him. In 2012 spies in Georgia put a file labelled “Georgian-NATO
Agreement” on a computer network that they knew a Russian hacker had breached. The
document was, of course, bogus—it also contained a virus that let the Georgians spy back at
the hacker, although this would be a step too far for most companies.

In paranoia we trust

Managers could also do with practising a little of the constructive paranoia that spymasters
adopt when dealing with technology. For instance, when on a business trip abroad, take a
disposable laptop containing no sensitive information; and assume there will be attempts to
slip spyware onto it. Spooks know that people’s private and family lives are a vulnerability to
be exploited: an executive at a corporate-security firm says he knows of cases in which
criminals stole the smartphones of the spouse or children of the boss of a family firm, to look
for bank-account details or other exploitable information. And an unexpected message from
an old friend or business associate should always be treated with suspicion: it may be a spoof
e-mail from someone who has scoured your LinkedIn or Twitter account to find out who your
contacts are. You don’t have to be paranoid to run a business in the age of cybercrime, but it
helps.

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Sports extravaganzas
Games that must stop

Major international sporting events must

not become the preserve of autocrats
Feb 28th 2015 | From the print edition, p. 12.

BAKU is humming with the customary accompaniments to showcase events: lavish new
facilities are being finished, sponsors schmoozed, and human-rights activists and awkward
journalists locked up. For June’s European Games—an unconvincing new tournament that
Azerbaijan is hosting—the brutal regime is using the formula it honed at the Eurovision Song
Contest of 2012, and hopes to deploy for the Olympic games of 2024. Smile, spend big and
suppress dissent.

Sport is separate from politics, and can even be therapy for it; or so its organisers often
maintain. What does it matter if some faraway goon blows his petrodollars on a summer
jamboree—or a winter one, as will now be the case for the 2022 World Cup in Qatar, which
FIFA, football’s disgraced governing body, this week farcically moved to December to avoid
the intolerable heat? It matters. Frivolous as they seem, staging these events in ghastly places
not only tarnishes FIFA, the International Olympic Committee (IOC) and other overseers. It
renders all involved complicit in corruption, and worse.

As a new study (reviewed on page 82) makes clear, democratic governments and their
pinched voters are realising that although the public benefits of hosting these events are
vague, the outlays—and losses—are high and rising. London’s Olympics were sublime, but
the costs more than tripled from initial estimates. Brazil’s World Cup led to riots as well as
footballing disaster for the home side. The preference of FIFA and the IOC for glitzy new
stadiums, and an inflationary contest in spectacle, do not help. The risk is that the field is left

Business Ethics 61
to authoritarian countries. The Winter Olympics of 2022 now has only two bidders: China and
Kazakhstan. Last year’s winter games were held in Sochi, Russia, just as Vladimir Putin’s
meddling in Ukraine boiled over into bloodshed. Invasions notwithstanding, in 2018 Mr Putin
is due to preside over the next World Cup.

The trouble is that these shindigs are not merely symptomatic of authoritarianism: they are
themselves occasions for self-aggrandisement, larceny and abuse. The prestige and
propaganda fodder they confer is only their most obvious incidental perk. Costs are spiralling
not only because of white-elephant projects, but because such extravaganzas are a gold-medal
chance for autocrats to reward cronies through kickbacks and dodgy contracts. The well-
connected rich get richer (and the autocrats more safely ensconced) while, too often, the poor
get little or nothing. Human rights can suffer directly, too. Sometimes, as in Azerbaijan,
critics are incarcerated in advance or, if they cause embarrassment during the circus, are
banged up when it moves on. Too many of Qatar’s migrant construction workers are still
labouring in conditions akin to indentured servitude; alarming numbers are dying.

Synchronised skimming

All this means that awarding a tournament to a nasty regime, and even attending it, is neither
neutral nor blameless. Visiting teams in effect use their own countries’ public funds to shore
up repression abroad. And the ascendancy of authoritarians is killing sport’s claim to promote
dignity and fraternity.

Three kinds of change are needed. Sponsors and participants must force the organising bodies,
above all the egregious FIFA, to clean up their acts, by making public both their decision-
making on venues and their executives’ interests. The arms-race in razzmatazz and pointless
new construction must end, so that the costs for hosts become less prohibitive. Finally, the
human-rights records of applicants—not just their easy promises of improvements—must be
taken into account. The figleaf idea that sport can float free of mundane political reality must
go. It never could.

Cleaning up sport
Bigger than Blatter

The problem of corruption in sport

transcends FIFA and is too serious to ignore
Jun 6th 2015 | From the print edition, p. 12.

SO THE stubborn septuagenarian resigned from the tiddlywinks committee. Why all the fuss
and headlines, some eye-rolling observers have been wondering? What does it matter who
runs FIFA, football’s abstruse governing body, or where its tournaments are held? All these
shenanigans, like the furores that occasionally erupt in other sports, are absurdly overblown.
Football belongs on the back pages, not the front.

Business Ethics 62
That view, common among sports non-enthusiasts, rests on the mistaken notion that
corruption in sport is also a sort of game, in which rubicund rogues harmlessly siphon off gate
receipts. Even many fans, perturbed by the disruption of their hobby, miss its real gravity.
Because at bottom this is not a recreational issue but a criminal one. Neither harmless nor
victimless, sports corruption is perpetrated by crooked officials, abusive governments and
gangsters, sometimes in concert. It matters—and, welcome as Sepp Blatter’s demise is, the
problem goes well beyond him, FIFA and football (see article).

Sepp Blatter's exit is a necessary but insufficient condition for reform at FIFA

Corruption in sport has four main, related drivers. One is the needlessly pharaonic scale of
mega sporting events. For kleptocratic regimes such as that of Russia—venue of last year’s
ludicrously costly winter Olympics and, on current plans, of the football World Cup in
2018—these are superb opportunities to embezzle public funds. The victims are the host
country’s short-changed taxpayers, pensioners and public services.

Second, top-level sport is now a global commodity, eliciting vast sums from marketeers and
broadcasters (real-time sporting drama is one of the few remaining draws for live audiences).
As the American inquiry that helped topple Mr Blatter suggests, kickbacks sometimes
lubricate the fat contracts that arise. Thus sports corruption is inextricable from the wider
scourge of corporate graft. A third factor is the under-regulated globalisation of gambling, and
its exploitation by match-fixers and money-launderers. Dodgy betting is hardly new: the
rigging of baseball’s World Series of 1919 is immortalised in “The Great Gatsby”. But
worldwide fan bases and the internet have made it more rife and much more lucrative,
attracting serious mafiosi from Asia and eastern Europe.

Last, the governance of too many sports is opaque, juicily monopolistic, badly monitored—
and wholly unsuited to the big-money age. Some sports (such as professional tennis) and
places (such as Finland and South Korea, which have cracked down on match-fixing in
football) have caught up. Others have, like FIFA, proved ill-equipped to combat predation and
too hospitable to unscrupulous officials. Football is not the only vulnerable game; scandal has
struck pastimes as obscure as handball. Villainous politicians, such as some of the many
involved in Indian cricket (a swamp of fixes and backhanders), are often in on the act.

Jail time, not yellow cards

In many ways globalisation has been a boon to sport, and not just for well-paid players and
the car dealerships they patronise. It has produced higher standards, better stadiums and
slicker spectacles. But to cope with the concomitant risks, sports need to be run as transparent,
rigorous businesses. In some cases their rule-setting and game-nurturing functions should be
split off from their marketing and event-organising roles. Corporate sponsors should be
quicker than they have been in FIFA’s case to dissociate themselves from thievery.

Business Ethics 63
Yet because sports corruption is a reflection of wider problems—sport merely being an
organism to which criminal succubi attach themselves—it is too formidable for sporting
organisations to tackle alone, even if they are inclined to. Precisely because it is a nexus for
broader crime and malpractice, more governments and law-enforcement agencies should
emulate America’s Justice Department (and India’s Supreme Court, which is trying to clean
up cricket) by pursuing the embezzlers, bribe-payers and money-launderers, and dishing out
serious punishments to those they catch. Too often the authorities have shared the
misconception that corruption in sport is essentially benign. Worried about appearing killjoys,
they have let it be. FIFA’s shame should mark the end of such naivety.

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Workplace safety
Avoiding the fire next time

After the Dhaka factory collapse, foreign

clothing firms are under pressure to
improve working conditions at Bangladeshi
suppliers—or to go elsewhere
May 4th 2013 | DHAKA AND NEW YORK |From the print edition, p. 57.

THE fire that swept through the Triangle Shirtwaist factory in New York in 1911, killing 146
people, was the catalyst for big improvements in industrial working conditions in America.
The collapse on April 24th of Rana Plaza—an eight-storey complex of clothing factories, near
Dhaka, Bangladesh—was far deadlier, killing at least 400. Although the tragedy has led to
calls for safer factories in Bangladesh and other developing countries, it is far from certain
that this will happen.

After the New York fire, protests by trade unionists led to new laws being passed, and
enforced. Factory owners and their customers took the higher costs on the chin: in those less
globalised times there was nowhere else for them to go. In Bangladesh today, things are more
complicated. Its trade unions are suppressed more aggressively than they ever were in
America. It already has building regulations that should have prevented the collapse—but
they were not enforced. Some two dozen factory owners are members of parliament. The
factories’ foreign customers have plenty of other low-cost countries they could switch their
work to.

Some well-known American firms are said to be contemplating doing just that—not because
they fear that higher standards in Bangladeshi factories will raise costs, but because they fear
that another tragedy would damage their reputations. The Dhaka factory collapse came less
than six months after a fire at another clothing factory near the city killed at least 117 people.

So far, however, most of the big global clothing brands and retailers seem minded to stay in
Bangladesh, try harder to improve safety in their contractors’ factories and build goodwill
among locals. Primark, a low-cost British retailer, and Loblaw, the Canadian owner of the Joe
Fresh brand, whose wares had been found in the rubble, have both agreed to pay
compensation to victims and their families.

Even before the latest disaster, some foreign retailers had taken steps to raise standards. Last
October Gap announced a fire-safety action plan, which would include helping factory owners
to pay for improvements. On April 9th Walmart, some of whose products were found in the
ashes of last year’s factory fire, gave $1.6m to the Institute of Sustainable Communities, a
non-governmental organisation (NGO), to help it set up a health-and-safety academy in
Bangladesh. Walmart also recently introduced stricter fire-safety audits, and a “zero
tolerance” policy towards contractors caught using unauthorised factories to make Walmart
products.

Business Ethics 70
Safety, eventually

For the past couple of months the main international firms buying clothes from Bangladesh
have been meeting government representatives to try to agree on a broader strategy to
improve factory safety. The latest meeting took place on April 29th in Germany, with a
couple of dozen firms and some NGOs, hosted by GIZ, a German government agency.

Critics gripe that the existing system for auditing the complex and constantly changing supply
chain is little more than a box-ticking exercise. Some global firms’ audits are more
transparent than others’. Some auditors are paid by the factories they inspect—a clear conflict
of interest. Scott Nova of the Worker Rights Consortium, a pressure group, says that many
audits covered other important issues such as working hours and child labour but, at least until
recently, lacked even cursory inspections of factories’ structural soundness or fire exits.

Walmart, Gap, Nike and some other big firms acknowledge that audits alone are not doing
enough to improve safety. They have started to work more closely with factory owners to
make good any shortcomings the audits show up. But progress has been slow, prompting
some NGOs to wonder if they should call for global firms to quit Bangladesh. “I’m not
normally one to call for disinvestment in a country, but you have to ask if it is the right thing
to do given the massive across-the-board failure in Bangladesh,” says Aron Cramer of
Business for Social Responsibility (BSR).

America and the European Union should do more to press developing countries to improve
working conditions, says Mr Cramer. Besides offering technical help, they could threaten to
restrict imports from places that fail to enforce proper standards, he says. This week the EU
said it would indeed look at how it might use its rules on preferential trade treatment to arm-
twist Bangladesh into doing better.

Whatever rich countries’ governments do, the pressure is on the global clothing brands to
come up with a credible strategy. The meeting in Germany discussed how foreign firms could
share information on rogue contractors running dangerous factories, and how to get more
companies to back the new health-and-safety academy. Worker Rights Consortium sought to
rally support for its proposal that foreign clothing giants sign a binding agreement to finance
the upgrading of factories in Bangladesh. So far only two firms have signed up: Tchibo, a
German retailer, and PVH, an American firm whose brands include Calvin Klein and Tommy
Hilfiger.

Mr Nova reckons it would cost around $3 billion to make safe all 5,000 clothing factories in
Bangladesh. Spread over a few years, that would amount to only a few cents on the cost of
each garment produced, he calculates. Many of the clothing firms felt that the proposal was
too bureaucratic and binding, however.
Some were keener on the sort of
voluntary incentives that Gap is
offering its contractors. However it is
done, an effort to force Bangladeshi
factory bosses to improve safety, and to
help them pay for this, would mean that
death was not the only result of the
disaster at Rana Plaza.

Business Ethics 71
Working conditions in factories
When the jobs inspector calls

Do campaigns for “ethical supply chains”

help workers?
Mar 31st 2012 | NEW YORK | from the print edition, p. 63-65.

“DEATH to Apple executives,” a protester shouted after a recent performance of “The

Agony and Ecstasy of Steve Jobs”, a popular off-Broadway play. Apple executives must have
been delighted when Mike Daisey, the playwright and star, recently retracted his nastiest
allegations about the mistreatment of workers making Apple’s products in China. Apparently,
he did not meet a worker poisoned by exposure to chemicals, or child workers at the factory
gate. With its share price soaring as the latest iPad storms the market, Apple might be tempted
to forget about the fuss over its labour practices. But that would be a mistake.

Any big company that makes things in poor countries faces scrutiny of its supply chain.
Campaigners against harsh working conditions (and unions back home that hate competition
from low-wage countries) will pounce on any hint of scandal. Horrified headlines can tarnish
a brand. Companies need to pay heed.

Wages for factory workers in China have been soaring at double-digit rates for years, for
reasons that have little if anything to do with Western activists and a lot to do with
productivity improvements. But some workers are abused, as even Apple admits. In February
it invited the Fair Labour Association (FLA), a prominent non-governmental organisation
(NGO), to look at the factories it uses in China, including those of Foxconn, which assembles
iPhones and iPads for Apple and is owned by Hon Hai, a Taiwanese firm (see article). The
FLA report, expected soon, is unlikely to give Apple a clean bill of health. Auret van
Heerden, the organisation’s boss, gripes that although conditions in the factories are better
than he expected, there are “tons of issues”.

In the past 20 years what has become known as the “ethical supply chain” movement has
targeted brands such as Nike, Gap and Coca-Cola. But its army of activists, some in business
themselves, are grappling with growing evidence that appointing an outside body to audit and
set standards, as Apple has done, is not going as well as it should. Apple could turn into a test
case of how to improve things.

Not a bad Apple

Tim Cook, Apple’s boss, this week visited a new Foxconn factory in central China which
employs 120,000 people. He has insisted that Apple is doing a lot to improve working
conditions. But he also echoes the concerns of critics. “We think the use of underage labour is
abhorrent. It’s extremely rare in our supply chain, but our top priority is to eliminate it
totally,” he declared.

After a bad press in the early 1990s, Nike is now one of the loudest advocates of improving
working conditions. In 1992 it established a code of conduct for suppliers. (Apple did not get

Business Ethics 72
around to that until 2005.) In 1996 Nike helped create the Apparel Industry Partnership,
which drew up a code of conduct for factories, and in 1999 evolved into the FLA.

Having a code of conduct and being part of an industry initiative on workers’ rights has
become standard practice for multinationals. But there are big differences in the toughness of
codes, how rigorously compliance is monitored and how remedial action is taken.

Factory audits also vary. Nike first published the overall results of its monitoring in 2000, but
did not list details of all the factories in its supply chain until 2006. (Apple did not publish
details of its supply chain until this year.)

When Nike opened up it was a conscious effort to challenge industry norms. Clothing and
shoe firms took it for granted that revealing which factories they used would put them at a
competitive disadvantage. But Nike reckoned the downside was negligible and the lack of
transparency hindered the monitoring process, says Hannah Jones, the firm’s head of
corporate social responsibility. Secrecy led to some factories that worked for a variety of
companies undergoing multiple audits. Other factories escaped entirely.

Another challenge is preventing corruption, says Alan Hassenfeld, a former boss of Hasbro
who is now the driving force behind the International Council of Toy Industries’ code, called
ICTI Care. Factory managers sometimes bribe auditors. Some firms use fake books showing
shorter hours and higher pay. Some workers collaborate in these violations more willingly
than is assumed. Many migrants, for example, want to work long hours to save as much
money as possible in a short time—and then go home.

NGOs can be both a help and a hindrance, reckons Mr Hassenfeld. Some only campaign.
Others work with firms to help put things right. Some do both. Campaigning NGOs can put
pressure on a firm to do better, but they rarely support it when expelling a factory from its
supply chain, which also hurts workers, says Mr Hassenfeld. “One of the things we need to do
is be tougher with repeat offenders, to make an example of them,” he adds.

“Governments are not pulling their weight,” complains Aron Cramer of BSR, an NGO. He
thinks there has been “too much outsourcing of enforcement to the private sector”. Individual
firms may find enforcement difficult. Governments may do better, but few governments of
emerging markets like to be bossed around.

“Nobody thinks this process is perfect, but we have made progress,” says Mr Hassenfeld. Mr
Cramer agrees. At least for firms at the top of the supply chain, “the old problems of forced
labour and child labour are largely gone,” he says. The worst abuses tend to be further down
the supply chain, and in particular sectors, such as agriculture and mining. Nonetheless, there
remains much to do even among first-tier suppliers on things like excessive hours and
inadequate pay, says Mr Cramer.

Richard Locke of the Massachusetts Institute of Technology has taken a detailed look at how
things really work. He persuaded four global firms regarded as leaders in ethical supply
chains (Nike, Coca-Cola, HP and PVH, a big American producer of clothing) to let him
analyse six years of data from their factory audits, starting in 2005. His research, to be
published this year in a book, “Promoting Labour Rights in a Global Economy”, drew four
conclusions.

Business Ethics 73
First, codes of conduct, compliance programmes and audits “[do] not deliver sustained
improvements in labour conditions over time,” he says. Rather, these things help gather
information that highlights the problem without remedying it. At HP, for example, only seven
of the 276 factories in its supply chain fully complied with its code of conduct at the last
audit. At the factories he visited, Mr Locke typically found that many suppliers serving global
brands drift in and out of compliance.

Down the chain

Second, investing time and money in helping factories improve their managerial and technical
capabilities did produce some benefit in improved working conditions. But his third
conclusion found that for significant and sustained improvement to take place, the relationship
between a company and its suppliers needed to change too. The relationship had to become
more collaborative. In particular, gains from changes in the production process needed to be
shared.

Mr Locke’s fourth conclusion poses the toughest challenge. For firms trying to improve
working conditions the fault may well be in their own business model. Just-in-time
manufacturing has made supply chains leaner. Slimmer inventory cuts costs and allows firms
to move more quickly. As products’ life-cycles shorten, this is a crucial competitive edge. But
a last-minute design change or the launch of a new product can mean suppliers having to pull
out all the stops to keep up—or face a stiff financial penalty.

Timberland, a bootmaker and vocal supporter of ethical working practices, admitted as much
in 2007 in a company report, noting that “some of our procedures were making it difficult for
factories to control working hours”, including developing a huge number of new styles and
the simultaneous launch of many new products. Nike has since said much the same.

As part of his research, Mr Locke visited an inkjet-printer factory in Malaysia which, at its
historic peak in 2007, produced 1m products a month for HP. The factory, which made six to
eight models a year with an average lifespan of less than nine months, experienced extreme
demand volatility—with the result that it sometimes had to increase monthly output by 250%,
then cut it again. This forces suppliers to ask their workers to put in vast amounts of overtime.
Apple’s product launches presumably produce similar surges.

Nike’s Ms Jones says her company has taken this to heart by trying to incorporate the need to
protect workers into the design of its production process. She is now jointly accountable for
enforcing the code of conduct with the head of the supply chain, a change which she says has
removed an “us-versus-them problem”. Members of Nike’s 140-strong corporate social
responsibility team are now involved in all branches of the supply chain. The firm is thinking
harder about how it schedules product launches. And it espouses a philosophy of continuous
improvement by delegating more responsibility to workers. This will only work if they are
treated well, says Ms Jones.

Apple’s sales continue to boom despite all the stories about the working conditions of the
people who make iPads and iPhones. So how seriously should firms take these issues? Nike
claims its approach means that good labour and environmental practices boost profits—even
without taking into account any reputational benefits they may deliver. Productivity is rising
and the turnover of workers is down, which saves money recruiting and training replacements.
With hindsight, the criticism seems to have been good for Nike. Could the same be true for
Apple?

Business Ethics 74
Workers’ share of national income
Labour pains

All around the world, labour is losing out to capital

Nov 2nd 2013 | From the print edition, p. 65-66.

ON AN enormous campus in Shenzhen, in the

middle of China’s manufacturing heartland,
nearly a quarter of a million workers assemble
electronic devices destined for Western markets.
The installation is just one of many run by
Foxconn, which churns out products for Apple
among other brands, and employs almost 1.5m
people across China. In America Foxconn has
become a symbol of the economic threat posed
by cheap foreign labour. Yet workers in China
and America alike, it turns out, face a shared
threat: they have captured ever less of the gains
from economic growth in recent decades.

The “labour share” of national income has been

falling across much of the world since the 1980s (see chart). The Organisation for Economic
Co-operation and Development (OECD), a club of mostly rich countries, reckons that labour
captured just 62% of all income in the 2000s, down from over 66% in the early 1990s. That
sort of decline is not supposed to happen. For decades economists treated the shares of
income flowing to labour and capital as fixed (apart from short-run wiggles due to business
cycles). When Nicholas Kaldor set out six “stylised facts” about economic growth in 1957,
the roughly constant share of income flowing to labour made the list. Many in the profession
now wonder whether it still belongs there.

A falling labour share implies that productivity gains no longer translate into broad rises in
pay. Instead, an ever larger share of the benefits of growth accrues to owners of capital. Even
among wage-earners the rich have done vastly better than the rest: the share of income earned
by the top 1% of workers has increased since the 1990s even as the overall labour share has
fallen. In America the decline from the early 1990s to the mid-2000s is roughly twice as large,
at about 4.5 percentage points, if the top 1% are excluded.

Workers in America tend to blame cheap labour in poorer places for this trend. They are
broadly right to do so, according to new research by Michael Elsby of the University of
Edinburgh, Bart Hobijn of the Federal Reserve Bank of San Francisco and Aysegul Sahin of
the Federal Reserve Bank of New York. They calculated how much different industries in
America are exposed to competition from imports, and compared the results with the decline
in the labour share in each industry. A greater reliance on imports, they found, is associated
with a bigger decline in labour’s take. Of the 3.9 percentage-point fall in the labour share in
America over the past 25 years, 3.3 percentage points can be pinned on the likes of Foxconn.

Business Ethics 75
Yet trade cannot account for all labour’s woes in America or elsewhere. Workers in many
developing countries, from China to Mexico, have also struggled to seize the benefits of
growth over the past two decades. The likeliest culprit is technology, which, the OECD
estimates, accounts for roughly 80% of the drop in the labour share among its members.
Foxconn, for example, is looking for something different in its new employees: circuitry. The
firm says it will add 1m robots to its factories next year.

Cheaper and more powerful equipment, in robotics and computing, has allowed firms to
automate an ever larger array of tasks. New research by Loukas Karabarbounis and Brent
Neiman of the University of Chicago illustrates the point. They reckon that the cost of
investment goods, relative to consumption goods, has dropped 25% over the past 35 years.
That made it attractive for firms to swap labour for software whenever possible, which has
contributed to a decline in the labour share of five percentage points. In places and industries
where the cost of investment goods fell by more, the drop in the labour share was
correspondingly larger.

Other work reinforces their conclusion. Despite their emphasis on trade, Messrs Elsby and
Hobijn and Ms Sahin note that American labour productivity grew faster than worker
compensation in the 1980s and 1990s, before the period of the most rapid growth in imports.
Studies looking at the increasing inequality among workers tell a similar story. In recent
decades jobs requiring middling skills have declined sharply as a share of total employment,
while employment in high- and low-skill occupations has increased. Work by David Autor of
MIT, David Dorn of the Centre for Monetary and Financial Studies and Gordon Hanson of
the University of California, San Diego, shows that computerisation and automation laid
waste mid-level jobs in the 1990s. Trade, by contrast, only became an important cause of the
growing disparity in wages in the 2000s.

Trade and technology’s toll on wages has in some cases been abetted by changes in
employment laws. In the late 1970s European workers enjoyed high labour shares thanks to
stiff labour-market regulation. The labour share topped 75% in Spain and 80% in France.
When labour- and product-market liberalisation swept Europe in the early 1980s—motivated
in part by stubbornly high unemployment—labour shares tumbled. Privatisation has further
weakened labour’s hold.

Such trends may tempt governments to adopt new protections for workers as a means to
support the labour share. Yet regulation might instead lead to more unemployment, or to an
even faster shift to automation. Trade’s impact could become more benign in future as
emerging-market wages rise, but that too could simply hasten automation, as at Foxconn.

Accelerating technological
change and rising
productivity create the
potential for rapid
improvements in living
standards. Yet if the
resulting income gains
prove elusive to wage and
salary workers, that
promise may not be
realised.

Business Ethics 76
Social policies
Time to scrap affirmative action

Governments should be colour-blind

Apr 27th 2013 |From the print edition, p.10.

ABOVE the entrance to

America’s Supreme Court four
words are carved: “Equal justice
under law”. The court is
pondering whether affirmative
action breaks that promise. The
justices recently accepted a case
concerning a vote in Michigan
that banned it, and will soon rule
on whether the University of
Texas’s race-conscious
admissions policies are lawful.
The question in both cases is as simple as it is divisive: should government be colour-blind?

America is one of many countries where the state gives a leg-up to members of certain racial,
ethnic, or other groups by holding them to different standards. The details vary. In some
countries, the policy applies only to areas under direct state control, such as public-works
contracts or admission to public universities. In others, private firms are also obliged to take
account of the race of their employees, contractors and even owners. But the effects are
strikingly similar around the world (see article).

The burden of history

Many of these policies were put in place with the best of intentions: to atone for past
injustices and ameliorate their legacy. No one can deny that, for example, blacks in America
or dalits in India (members of the caste once branded “untouchable”) have suffered grievous
wrongs, and continue to suffer discrimination. Favouring members of these groups seems like
a quick and effective way of making society fairer.

Most of these groups have made great progress. But establishing how much credit affirmative
action can take is hard, when growth also brings progress and some of the good—for example
the confidence-boosting effect of creating prominent role models for a benighted group—is
intangible. And it is impossible to know how a targeted group would have got on without this
special treatment. Malays are three times richer in Singapore, where they do not get
preferences, than in next-door Malaysia, where they do. At the same time, the downside of
affirmative action has become all too apparent.

Awarding university places to black students with lower test scores than whites sounds
reasonable, given the legacy of segregation. But a study found that at some American
universities, black applicants who scored 450 points (out of 1,600) worse than Asians on
entrance tests were equally likely to win a place. That is neither fair on Asians, nor an
incentive to blacks to study in high school. In their book “Mismatch”, Richard Sander and
Business Ethics 77
Stuart Taylor produce evidence that suggests affirmative action reduces the number of blacks
who qualify as lawyers by placing black students in law schools for which they are ill-
prepared, causing many to drop out. Had they attended less demanding schools, they might
have graduated.

Although the groups covered by affirmative action tend to be poorer than their neighbours, the
individuals who benefit are often not. One American federal-contracting programme favours
businesses owned by “socially and economically disadvantaged” people. Such people can be
87 times richer than the average American family and still be deemed “disadvantaged” if their
skin is the right colour. One beneficiary of South Africa’s programme of “Black Economic
Empowerment” is worth an estimated $675m; he is also the deputy president of the ruling
party. Letting members of certain groups charge more and still win public contracts is nice for
the few who own construction firms; less so for the many who rely on public services. The
same goes for civil-service quotas. When jobs are dished out for reasons other than
competence, the state grows less competent, as anyone who has wrestled with Indian or
Nigerian officialdom can attest. Moreover, rules favouring businesses owned by members of
particular groups are easy to game. Malaysians talk of “Ali-Baba” firms, where Ali (an ethnic
Malay) lends his name, for a fee, to Baba (a Chinese businessman) to win a government
contract.

Although these policies tend to start with the intention of favouring narrow groups, they
spread as others clamour to be included. That American federal programme began by
awarding no-bid contracts to firms owned by blacks, Hispanics and Native Americans; now it
covers people with ancestry from at least 33 countries. In India 60% of the population are
eligible for privileges as members of scheduled castes, tribes or “other backward classes”.
Such policies poison democracy by encouraging divisions along lines drawn by
discriminatory rules. The anger thus stoked has helped stir bloody conflicts in India, Rwanda
and Sri Lanka. And such rules, once in place, are almost impossible to get rid of. In 1949
India’s constitution said quotas should be phased out in ten years, but they are now more
widespread than ever. America’s policies have survived decades of legal pushback, though
not unscathed.

The content of their character

The University of Texas (UT) justifies discriminating in favour of black people not on the
ground that society owes it to them, but because, it claims, a diverse university offers a better
education to all its students. That is a reasonable argument—some companies benefit from
understanding a variety of customers, for instance, and the police probably keep order better if
enough of them share a culture with the neighbourhood they patrol—but it does not wash for
most institutions. In UT’s case, although colleges benefit from a diversity of ideas, to use skin
colour as a proxy for this implies that all black people and all Chinese people view the world
in a similar way. That suggests a bleak view of the human imagination.

Universities that want to improve their selection procedures by identifying talented people (of
any colour or creed) from disadvantaged backgrounds should be encouraged. But selection on
the basis of race is neither a fair nor an efficient way of doing so. Affirmative action replaced
old injustices with new ones: it divides society rather than unites it. Governments should
tackle disadvantage directly, without reference to race. If a school is bad, fix it. If there are
barriers to opportunity, remove them. And if Barack Obama’s daughters apply to a university,
judge them on their academic prowess, not the colour of their skin.

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South Africa
Fool’s gold

Black economic empowerment has not

worked well. Nor will it end soon
Apr 27th 2013 | JOHANNESBURG |From the print edition, p. 19-20.

FEW people are more aware of the horrors of apartheid than Mamphela Ramphele. Her
boyfriend, Steve Biko, the founder of the Black Consciousness movement, was beaten to
death in police custody in 1977. Like South Africa’s ruling party, the African National
Congress (ANC), Dr Ramphele, now an opposition politician, believes that the government
should try to heal the wounds of half a century of white supremacist rule. But she does not
like the way it is going about it.

In March Dr Ramphele claimed that the government had forced Gold Fields, a mining firm of
which she used to be chairwoman, to sell a stake in its business to a consortium with ties to
the ANC. The 73 people in the consortium included the chairperson of the ANC and a
member of the legal team that defended President Jacob Zuma during his rape trial in 2006.
Gold Fields denies the claim, but says it has instigated an independent investigation into the
2010 transaction.

The controversy is one of many to dog the ANC’s policy of “black economic empowerment”
(BEE). When apartheid ended in 1994, the ANC promised to make black South Africans
richer. To this end, it has promoted the transfer of stakes in white-owned businesses to a new
class of black investors. Change at the top, it was claimed, would foster change further down
by removing blockages to the hiring and promotion of blacks.

The first BEE transaction was in 1993, before the country’s first multiracial elections.
Metropolitan Life, an insurer, sold a 10% stake to Methold, a holding company owned by
well-connected blacks such as Nelson Mandela’s former personal doctor. In 1998, the year
that the BEE business really took off, there were 111 transactions worth a total of 21 billion
rand (then worth $3.8 billion).

Few blacks had been able to accumulate capital under apartheid, so stakes were typically sold
at a discount and financed by loans, often from the companies themselves, many of which
judged it wise to woo influential black shareholders. The transfers were originally voluntary,
but the ANC, impatient at the slow pace of change, now uses state power to speed them up.

One of the accelerators is the award of licences in mining, telecoms and other regulated
sectors. If a firm is not sufficiently “empowered”—ie, if too few of its shares and jobs are in
black hands—it will not win or retain an operating licence. This is the threat that Dr
Ramphele claimed brought Gold Fields to heel. State-backed lenders favour black-owned
businesses. State-owned enterprises in transport and energy favour black-owned suppliers.

Various laws add to the pressure. The Employment Equity Act of 1998 obliges biggish firms
to try to make their workforces racially “representative”. Those that employ more than 50

Business Ethics 79
people are required to report at least every other year on their progress towards making their
staff 75% black, 10% coloured (mixed race), 3% Indian, and so on, at every level from shop
floor to boardroom. Failure to show “reasonable” efforts at compliance can result in fines of
up to 900,000 rand ($97,000).

Businesses with an annual turnover above 35m rand are also expected to obey a 2003 act
which called for “broad-based BEE”. This set targets for black ownership as well as the
promotion and training of black workers. Private firms can bolster their empowerment
rankings by buying from black-owned suppliers or by helping to set them up.

The white elite at the top of South African business has been joined by a sliver of super-rich
blacks. Forbes estimates that Cyril Ramaphosa, a union-boss-turned-tycoon who is now the
ANC’s number two (and therefore perhaps the next president of South Africa), is worth
$675m. A black middle class with government jobs is emerging, too. At private companies,
educated blacks command higher wages than similarly qualified whites: 23% more, according
to Adcorp, a big employment agency. Inequality between blacks and whites has narrowed a
bit as a result.

Not going anywhere

The lot of poorer blacks, however, has not improved much. Many are frozen out of the
workplace altogether. The unemployment rate among blacks is 28.5%, compared with 5.6%
for whites. If those who want work but have given up looking for it are included, the jobless
rate is a whopping 41.6% for blacks compared with 7.5% for whites.

Some believe the policy has been essential, if flawed. “The reality is that without BEE there
would not have been the same level of black participation in the economy,” says Martin
Kingston of Rothschild, which advises companies on BEE. But the gains must be weighed
against the policy’s unintended consequences.

Pitifully few black South Africans have grown rich by creating entirely new businesses,
perhaps because it seems so much easier to make money by acquiring stakes in existing firms.
The collapse in stock prices in 2008 left many would-be tycoons with assets that were worth
less than the loans taken out to buy them.

The allegations surrounding Gold Fields fit a familiar pattern. In BEE deals, political
connections often matter more than business skills. A costly bureaucracy has grown up to
enforce racial targets, which even black-owned firms have to contend with. Posts are left
vacant for want of qualified black staff. Some businesses re-employ white professionals as
freelance consultants to plug skills shortages without falling foul of the law.

The binding constraint on greater black participation in the economy is education, says Lucy
Holborn from the South African Institute of Race Relations, a think-tank that has called for
BEE to be scrapped. The proportion of professionals who are black is 36%, fairly close to the
share of degrees held by blacks, which is around 40%. But that falls short of the 75% share of
the total workforce who are black. It is no good setting quotas if there are not the skilled
workers to fill them, says Ms Holborn.

Few businessfolk or politicians have echoed the call to junk BEE. The ANC is not about to
lose power and no sensible business wants to offend it. Far from scrapping BEE rules, the
government is seeking stiffer penalties for firms that flout them.

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Unilever
In search of the good business

For the second time in its 120-year history,

Unilever is trying to redefine what it means
to be a virtuous company
Aug 9th 2014 | PORT SUNLIGHT | Business, p. 51-52.

Unilever’s lifebelt

SLEEPING in the open on top of his mansion was a nightly routine for William Lever,
founder of what is now Unilever, an Anglo-Dutch consumer-goods giant. When Paul Polman
became chief executive of the soap-to-ice-cream-maker in 2009 (joining from a Swiss rival,
Nestlé), the Dutchman spent a night in Lever’s rooftop bed as part of a total immersion in the
history of his new firm. It helped persuade him, a year later, to launch a “Sustainable Living
Plan”, the name for his attempt to make Unilever the pre-eminent example of how to do
capitalism responsibly, just as it had once been under Lever.

Outdoing even the Cadburys of Birmingham and the Rowntrees of York, Lever had pioneered
the Victorian model of paternalistic business. At a time when disease and malnutrition were
widespread in Britain, his products were marketed for their health benefits. His employees
were decently housed in a purpose-built company town, Port Sunlight, on Merseyside. Lever
campaigned for state pensions for the elderly and even provided schooling, health care and
good wages at palm-oil plantations in the Congo.

Business Ethics 86
 “Today, he would do the same things we are doing,” says Mr Polman. Like Lever, he insists
that running the firm with close attention to its environmental and social impact is not an act
of charity but of self-interest, properly conceived. The Sustainable Living Plan aims not only
to reduce Unilever’s environmental footprint and increase its “positive social impact”, but
also to double sales and increase long-term profitability. Milton Friedman’s view that
business should focus on maximising shareholder value has been “interpreted way too
narrowly”, Mr Polman argues. Under him, Unilever has again become the exemplar of the
“good company”, the poster child of sustainability. If it cannot make the idea pay—with its
deep pockets, long corporate history and determined boss—then perhaps no other firm can.

So far, Mr Polman’s efforts have earned rave reviews. A recent survey of “sustainability
experts” by GlobeScan, a consultant, ranked Unilever first by a wide margin (see chart). The
company is generally reckoned to have the most comprehensive strategy of enlightened
capitalism of any global firm.

Unilever also stands out for the way it has tried to institutionalise its efforts, says Alice
Korngold, author of “A Better World, Inc”, a book on corporate do-gooding. The board

Business Ethics 87
scrutinises the plan and executive pay is linked to its targets. In March, Mr Polman got a
bonus of $722,000 for his efforts. Unilever says the plan has boosted employee satisfaction.

It may also have boosted the share price. Since the plan was unveiled in November 2010,
Unilever’s shares have risen by more than 40%. And this was during a period when its biggest
rival, Procter & Gamble of America, lost its way and ultimately its boss.

But Unilever seems to have reached a critical moment. Its recent annual results disappointed
the markets and the share price recently dropped below what it had been a year earlier.
Shareholders are cautious. “Unilever has built a strong niche position with investors who
focus on environmental [matters],” says Martin Deboo of Jefferies, an investment bank. “But
for mainstream investors it is a modest positive at most, and then only so long as it does not
cost much.” So the big questions are: can the company achieve the targets set out in its
sustainability plan? And if it can, will that help it in the long run (as the share-price rise of
2009-2013 suggests)? Or might it eventually cost Unilever dear in terms of market share and
investors’ backing, as the recent downturn could imply?

The Polman Plan

Unilever defines sustainability broadly. It includes not just environmental factors but
improving the lot of customers and workers—its own and those in its supply chain. It also
aims to contribute to society as a whole. These goals are seen as necessary to maintain the
firm’s “licence to operate” in an age when, Mr Polman believes, companies will be subject to
increasing public scrutiny.

Specifically, by 2020, Unilever aims to: “help a billion people to take steps to improve their
health and well-being”; halve the environmental impact of its products; and source all its
agricultural raw materials sustainably, meaning that they should meet requirements covering
everything from forest protection to pest control.

Progress on energy use and waste reduction—which the firm directly controls—has been
impressive. Through recycling and efficiency drives, three-quarters of Unilever’s
manufacturing sites now send no non-hazardous waste to landfills. Carbon emissions in its
manufacturing operations are one-third lower than in 2008, through a combination of cleaner
technologies and greater efficiency. Newly established best practices have spread faster than
expected through the company, thanks to the creation of a central corporate team dedicated to
spreading the word; previously this had been left to individual factories. The company also set
up a “small actions, big differences fund” to invest in cost-saving ideas proposed by its
business units.

Many firms do such things. But to meet its broader goals Unilever has to change what goes on
beyond its corporate walls. When it measured the greenhouse-gas emissions associated with
its products, it found that significant emissions came in the supply chain—ie, not from
Unilever itself. So it had to get the support of its suppliers, who range from food giants such
as Cargill to small farmers in India.

In 2010, 14% of its agricultural supplies were sourced sustainably by its own definition. Now
the share is 48%. Unilever has achieved this partly by backing its suppliers’ innovations. For
its soup brand, it created a €1m ($1.3m) Knorr Sustainable Partnership Fund, which invested
in schemes such as drip irrigation for tomatoes in Spain and California that have increased
yields and reduced water use.

Business Ethics 88
The company has signed up to certification schemes run by the Rainforest Alliance, a non-
governmental organisation, to improve farming practices in cocoa (used in its ice-cream
brands, such as Wall’s and Ben & Jerry’s) and tea (used by Lipton’s). Rainforest Alliance
schemes also have an educational component and Unilever has trained more than half the
small farmers of Kenya who grow tea, the country’s largest export crop. It has budgeted €4m
to expand the scheme to other parts of Africa and to Vietnam. Training small farmers is all the
rage with other consumer-goods firms, such as Coca-Cola, SABMiller and Walmart. It
improves incomes at the bottom of the pyramid and makes farm supplies more secure by
reducing environmental threats such as water scarcity.

Yet although Unilever may be able to buy its own raw materials from sustainable sources, it
alone is rarely big enough to make a difference to any given commodity worldwide. As a
result, Mr Polman spends a lot of time trying to persuade his peers and rivals to act more
sustainably, too. A big test of his effectiveness will come with palm oil, a crop which plays a
significant role in deforestation (tropical forests are often cleared illegally to make way for
palm-oil plantations).

Polman looks over his shoulder at Lever

Lever’s main concern had been working conditions in his plantations. Mr Polman wants to
change the entire industry. He and others have persuaded members of the Consumer Goods
Forum, an industry group, to sign an agreement to shift to sustainable palm-oil production
practices. In July Wilmar, the world’s biggest palm-oil trader, signed up—a step forward. But
the agreement has been criticised by environmental groups such as Greenpeace for allowing
too long a transition to sustainability. Worse, the big Western consumer-goods companies
account for only 20% of palm-oil sales (the rest are by local traders in emerging markets such
as China). So even if they all promise not to use palm oil from cleared forests, they may not
be able to stop the deforestation.
Business Ethics 89
There is a bigger challenge for the Sustainable Living Plan: it will not be possible to meet its
goals without changing customers’ behaviour. Three years ago the company measured the
carbon footprint of 2,000 products and found that on average 68% of greenhouse-gas
emissions in their life cycles occurred only after they got into the hands of consumers, mostly
through the energy-intensive process of heating water (eg, for tea bags or washing powder).

Changing people’s behaviour is hard. The firm has a target of getting 200m consumers by
2015 to take shorter showers (thus reducing greenhouse-gas emissions, saving water—and
using more Unilever products designed to work with less liquid). The goal will be missed so
badly that people in the company liken it to getting smokers to quit.

The firm has had some success designing products that use fewer resources. Two years ago,
for example, it launched “dry shampoo”, a powder that works by being combed through hair.
It has caught on fast.

But even altering the product does not necessarily lead consumers to change behaviour, so
Unilever has embarked on the hardest part of its new strategy—overhauling how it markets its
brands. Soon after Lever launched Lifebuoy soap in the 1890s, he started running linked
advertisements and educational campaigns. In America, millions of children took part in a
Clean Hands Health Campaign in the 1920s. In 2002 Unilever started pushing the same idea
in India, offering hand-washing classes in villages. Mr Polman has expanded this across the
developing world. “We have done more hand-washing work in the past four years than in the
previous 20,” he brags. The 21-day course, according to independent studies, reduces
diarrhoea cases by 25% and increases school attendance because children are sick less often.
The challenge now is to do the same with brands that do not have such obvious benefits as
Lifebuoy.

Saving the world one investor at a time

“Unilever is taking this approach [sustainability] further than other companies,” says Linda
Scott of Oxford University’s Said Business School. But refocusing 400 brands “on the good
the product can do”, she reckons, will take a long time and “require patient capital”. And that
raises the biggest question of all: will investors give Mr Polman the time he needs?

In the 1920s shareholder pressure eventually forced Lever to scale back his ambitions. Mr
Polman has been canny. One of the first things he did after taking over Unilever was to move
away from quarterly reporting and stop giving guidance to the markets about the firm’s next
results. He is trying instead to encourage investors to think about the fundamentals of the
business which, he claims, are improved by the sustainability plan.

Still, the share price has been edging lower, and a Unilever executive concedes privately that
it may require a crisis—such as a spike in food prices like the one in 2007-08—for investors
properly to value the new approach. Mr Polman’s experiment in enlightened capitalism is
nothing if not ambitious. And not the least ambitious part of it is the attempt to change the
short-term horizons of investors.

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Combating illegal fishing
Dragnet

A new satellite-based surveillance system

will keep a sharp eye on those plundering
the oceans
Jan 24th 2015 | From the print edition, p. 66-67.

THE Yongding is something of a ghost ship, disappearing and changing her name many times,
along with her flag of registration. The 62-metre vessel was last spotted on January 13th in a
marine conservation area in the Southern Ocean, blatantly hauling up outlawed gill nets laden
with toothfish, a catch so prized that it is known as “white gold”. Interpol is seeking
information about who operates the ship and profits from its activities, as well as those of two
accompanying vessels, Kunlun (pictured above, landing a toothfish) and Songhua. In the
vastness of the open ocean, policing vessels like Yongding, Kunlun and Songhua is hard. But
it is about to get easier—for with just a few mouse clicks a satellite-based monitoring system,
unveiled this week, will be able to compile a dossier of evidence about even the most
clandestine fishing operations.

The scale of illegal and unreported fishing is, for obvious reasons, difficult to estimate. The
Pew Charitable Trusts, an American research group, has nevertheless had a stab at it. It
reckons that around one fish in five sold in restaurants or shops has been caught outside the
law. That may amount to 26m tonnes of them every year, worth more than $23 billion. This
illegal trade, though not the only cause of overfishing, is an important one. Stamping it out
would help those countries whose resources are being stolen. It would also help to conserve
fish stocks, some of which are threatened with extinction. It might even (if the more

Business Ethics 92
apocalyptic claims of some ecologists are well founded) slow down the journey towards a
wider extinction crisis in the oceans.

A global game of hide and seek

The new monitoring system has been developed by the Satellite Applications Catapult, a
British government-backed innovation centre based at Harwell, near Oxford, in collaboration
with Pew. In essence, it is a big-data project, pulling together and cross-checking information
on tens of thousands of fishing boats operating around the world. At its heart is what its
developers call a virtual watch room, which resembles the control centre for a space mission.
A giant video wall displays a map of the world, showing clusters of lighted dots, each
representing a fishing boat.

The data used to draw this map come from various sources, the most important of which are
ships’ automatic identification systems (AIS). These are like the transponders carried by
aircraft. They broadcast a vessel’s identity, position and other information to nearby ships and
coastal stations, and also to satellites. An AIS is mandatory for all commercial vessels, fishing
boats included, with a gross tonnage of more than 300. Such boats are also required, in many
cases, to carry a second device, known as a VMS (vessel monitoring system). This transmits
similar data directly to the authorities who control the waters in which the vessel is fishing,
and carrying it is a condition of a boat’s licence to fish there. Enforcement of the AIS regime
is patchy, and captains do sometimes have what they feel is a legitimate reason for turning it
off, in order not to alert other boats in the area to profitable shoals. But the VMS transmits
only to officialdom, so there can be no excuse for disabling it. Switching off either system
will alert the watch room to potential shenanigans.

The watch room first filters vessels it believes are fishing from others that are not. It does this
by looking at, for example, which boats are in areas where fish congregate. It then tracks these
boats using a series of algorithms that trigger an alert if, say, a vessel enters a marine
conservation area and slows to fishing speed, or goes “dark” by turning off its identification
systems. Operators can then zoom in on the vessel and request further information to find out
what is going on. Satellites armed with synthetic-aperture radar can detect a vessel’s position
regardless of weather conditions. This means that even if a ship has gone dark, its fishing
pattern can be logged. Zigzagging, for example, suggests it is long-lining for tuna. When the
weather is set fair, this radar information can be supplemented by high-resolution satellite
photographs. Such images mean, for instance, that what purports to be a merchant ship can be
fingered as a transshipment vessel by watching fishing boats transfer their illicit catch to it.

As powerful as the watch room is, though, its success will depend on governments, fishing
authorities and industry adopting the technology and working together, says Commander
Tony Long, a 27-year veteran of the Royal Navy who is the director of Pew’s illegal-fishing
project. Those authorities need to make sure AIS and VMS systems are not just fitted, but are
used correctly and not tampered with. This should get easier as the cost of the technology
falls.

Enforcing the use of an identification number that stays with a ship throughout its life, even if
it changes hands or country of registration, is also necessary. An exemption for fishing boats
ended in 2013, but the numbering is still not universally applied. Signatories to a treaty agreed
in 2009, to make ports exert stricter controls on foreign-flagged fishing vessels, also need to
act. Fishermen seek out ports with lax regulations to land illegal catches.

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Preserving Nature’s bounty

One of the most promising ideas for using the watch room is that shops could employ its
findings to protect their supply chains, and thus their reputations for not handling what are, in
effect, stolen goods. Governments sometimes have reason to drag their feet about enforcing
fisheries rules. Supermarkets, though, will generally want to be seen as playing by them. The
watch room’s developers say they are already in discussions with a large European
supermarket group to do just this.

The watch room will also allow the effective monitoring of marine reserves around small
island states that do not have the resources to do it for themselves. The first test of this
approach could be to regulate a reserve of 836,000 square kilometres around the Pitcairn
Islands group, a British territory in the middle of the South Pacific with only a few dozen
inhabitants.

The Pitcairn reserve, which may be set up later this year, will be one of the world’s largest
marine sanctuaries. By proving that the watch room can keep an eye on such a remote site, its
developers hope other places with similar requirements will be encouraged to get involved.

The watch-room system is, moreover, capable of enlargement as new information sources are
developed. One such may be nanosats. These are satellites, a few centimetres across, that can
be launched in swarms to increase the number of electronic eyes in the sky while
simultaneously reducing costs. Closer to the surface, unmanned drones can do the same. The
watch room, then, is a work in progress. But in the game of cat and mouse that enforcing
fishing regulations has become, it will give the cat an important advantage.

Governing the oceans

The tragedy of the high seas

New management is needed for the planet’s

most important common resource
Feb 22nd 2014 | From the print edition, p. 10-11.

IN 1968 an American ecologist, Garrett Hardin, published an article entitled “The Tragedy of
the Commons”. He argued that when a resource is held jointly, it is in individuals’ self-
interest to deplete it, so people will tend to undermine their collective long-term interest by
over-exploiting rather than protecting that asset. Such a tragedy is now unfolding, causing
serious damage to a resource that covers almost half the surface of the Earth.

The high seas—the bit of the oceans that lies beyond coastal states’ 200-mile exclusive
economic zones—are a commons. Fishing there is open to all. Countries have declared
minerals on the seabed “the common heritage of mankind”. The high seas are of great
economic importance to everyone—fish is a more important source of protein than beef—and
getting more so. The number of patents using DNA from sea-creatures is rocketing, and one

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study suggests that marine life is a hundred times more likely to contain material useful for
anti-cancer drugs than is terrestrial life.

Yet the state of the high seas is deteriorating (see article). Arctic ice now melts away in
summer. Dead zones are spreading. Two-thirds of the fish stocks in the high seas are over-
exploited, even more than in the parts of the oceans under national control. And strange things
are happening at a microbiological level. The oceans produce half the planet’s supply of
oxygen, mostly thanks to chlorophyll in aquatic algae. Concentrations of that chlorophyll are
falling. That does not mean life will suffocate. But it could further damage the climate, since
less oxygen means more carbon dioxide.

For tragedies of the commons to be averted, rules and institutions are needed to balance the
short-term interests of individuals against the long-term interests of all users. That is why the
dysfunctional policies and institutions governing the high seas need radical reform.

Net loss

The first target should be fishing subsidies. Fishermen, who often occupy an important place
in a country’s self-image, have succeeded in persuading governments to spend other people’s
money subsidising an industry that loses billions and does huge environmental damage. Rich
nations hand the people who are depleting the high seas $35 billion a year in cheap fuel,
insurance and so on. The sum is over a third of the value of the catch. That should stop.

Second, there should be a global register of fishing vessels. These have long been exempt
from an international scheme that requires passenger and cargo ships to carry a unique ID
number. Last December maritime nations lifted the exemption—a good first step. But it is still
up to individual countries to require fishing boats flying their flag to sign up to the ID scheme.
Governments should make it mandatory, creating a global record of vessels to help crack
down on illegal high-seas fishing. Somalis are not the only pirates out there.

Third, there should be more marine reserves. An eighth of the Earth’s land mass enjoys a
measure of legal protection (such as national-park status). Less than 1% of the high seas does.
Over the past few years countries have started to set up protected marine areas in their own
economic zones. Bodies that regulate fishing in the high seas should copy the idea, giving
some space for fish stocks and the environment to recover.

But reforming specific policies will not be enough. Countries also need to improve the system
of governance. There is a basic law of the sea signed by most nations (though not America, to
its discredit). But it contains no mechanisms to enforce its provisions. Instead, dozens of
bodies have sprung up to regulate particular activities, such as shipping, fishing and mining,
or specific parts of the oceans. The mandates overlap and conflict. Non-members break the
rules with impunity. And no one looks after the oceans as a whole.

A World Oceans Organisation should be set up within the UN. After all, if the UN cannot
promote collective self-interest over the individual interests of its members, what is it good
for? Such an organisation would have the job of streamlining the impenetrable institutional
tangle. But it took 30 years to negotiate the law of the sea. A global oceans body would
probably take longer—and the oceans need help now.

So in the meantime the law of the sea should be beefed up. It is a fine achievement, without
which the oceans would be in an even worse state. But it was negotiated in the 1970s before

Business Ethics 95
the rise of environmental concerns, so contains little on biodiversity. And the regional fishing
bodies, currently dominated by fishing interests, should be opened up to scientists and
charities. As it is, the sharks are in charge of the fish farm.

This would not solve all the problems of the oceans. Two of the biggest—acidification and
pollution—emanate from the land. Much of the damage is done within the 200-mile limit. But
institutional reform for the high seas could cut overfishing and, crucially, change attitudes.
The high seas are so vast and distant that people behave as though they cannot be protected or
do not need protection. Neither is true. Humanity has harmed the high seas, but it can reverse
that damage. Unless it does so, there will be trouble brewing beneath the waves.

Deepwater Horizon
Double, double, oil and trouble

What America has learned from its largest-

ever spill
Apr 18th 2015 | NEW ORLEANS | From the print edition, p. 39.

ON APRIL 20th it will be five years since BP’s Deepwater Horizon oil rig exploded, killing
11 men and unleashing more than 100m gallons of oil into the Gulf of Mexico. BP has set
aside $42 billion to pay fines, compensate victims and clean up the sea and the coastline. That
is a staggering sum—enough to fund England’s National Health Service for three months.
And the final bill could be even higher.

In February a federal judge rejected BP’s plea that its fines under the Clean Water Act should
be limited to $9.57 billion, ruling that an upper limit of $13.7 billion would be more
appropriate. In addition, trustees from federal agencies, the affected states (Alabama,
Louisiana, Mississippi, Florida and Texas) and Indian tribes are overseeing a “Natural
Resource Damage Assessment” (NRDA) to determine how much damage has been done and
what BP must pay to clean it up. It would suit the government if those estimates turned out to
be high. Politically, BP is an easy target. It is an oil firm. It is foreign. And it has genuinely
messed up. Plus, the government gets to spend some of the moolah. Small wonder the early
official estimates of damage differ from BP’s.

A recent report from the oil giant finds that the available data do not indicate “a significant
long-term impact to [sic] the population of any Gulf species.” Shrimp harvests are up. Sea-
birds are breeding much as before. As early as August 2010, less than 2% of water samples
showed more oil-related chemicals than the Environmental Protection Agency deems safe for
marine life. “The few areas where there were potentially harmful exposures were limited in
space and time, mostly in the area very close to the wellhead during the spring and summer of
2010,” says BP.

Trustees compiling the NRDA retort that BP “misinterprets and misapplies data”. Ben
Sherman of the National Oceanic and Atmospheric Administration (NOAA), which advises

Business Ethics 96
the Coast Guard on scientific issues, says it is too soon to assess the damage. The effects of
oil remnants on the Gulf bottom, the shoreline and deepwater corals are disputed, as is the
extent to which the accident drove away tourists.

The firm has so far spent about $12 billion to settle some 300,000 private claims. Some of
these were fraudulent. BP says it has paid out more than $500m to people with bogus or
exaggerated claims, such as a phone shop that burned down before the spill. It is unlikely to
recover much of this.

Nonetheless, green groups say BP has got off lightly. The National Wildlife Federation
(NWF) asserts that dead Bottlenose dolphins were found on the Louisiana coast last year at
four times historic rates. They have been dying in unusually high numbers since 2010; some
studies blame the oil. Brown pelicans seem to be suffering too; models and carcass counts
suggests that 12% of the local population died in the spill’s aftermath. (Although estimates of
pelican deaths may have been high because more people than ever before were counting the
bodies.) Other research concludes that sperm whales, acrobat ants and bluefin tuna have
suffered.

A huge pot of money

Some practical lessons have been learned. The environmental effects of spraying 1.84m
gallons of dispersants are becoming clearer and leading to new regulation. They prevented the
formation of an oil slick after the explosion (by breaking down the oil into droplets on the
water’s surface). However, a new study suggests that one dispersant harms epithelial cells,
found in human lungs and fish gills. Responders who helped in the explosion’s aftermath may
have suffered burning lungs and coughing bouts as a result. Other scientists discovered
compounds from dispersants in the eggs of white pelicans at nesting sites in Minnesota and
Illinois.

The disaster spurred technological progress. After it, NOAA and the University of New
Hampshire developed a geospatial reference system. Accessible to all online, the
Environmental Response Management Application mapped the site of the rig in the Gulf,
ocean currents, ship positions and the movement of oil. This made dealing with the disaster
easier. Doug Helton of NOAA calls it “a huge success”—the site had more than 3m hits on
the day it went live in June 2010. Now it can also depict areas in the Arctic, the Caribbean and
the Great Lakes—just in case.

On April 13th the Obama administration unveiled tough new safety requirements for blowout
preventers. These are the valves that seal drill pipes to prevent explosions—a precaution that
conspicuously failed on the Deepwater Horizon. The federal government raised standards for
well-casings five years ago and on the cementing of wells two years after that. Bethany Kraft
of the Ocean Conservancy, a green group, worries that drilling technology develops more
quickly than people’s ability to respond. But Mr Helton argues that America is “much better
prepared” for another spill. More than 100,000 people helped out after Deepwater Horizon,
and their memories are still fresh.

The huge penalties inflicted on BP could deter future negligence. But they could also deter
investment in America. They feed the perception that its legal system poses as serious a
political risk to multinationals as anything they might encounter in emerging markets—
Deepwater Horizon cost BP far more than sanctions on Russia over the invasion of Ukraine,
for example. And lawyers note that the efforts BP made to take full responsibility and

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compensate victims quickly counted for nothing in court. In the future, oil firms may fight
harder.

Clarification: We've tweaked some potentially ambiguous wording in an earlier version of

this story to make clear that the $13.7 billion figure cited above is an upper limit, not a final
assessment of fines under the Clean Water Act.

A tragedy and its aftermath

Oil in Nigeria
Problems at the pump

A fuel crisis in Nigeria highlights the

desperate need for subsidy reform
May 30th 2015 | LAGOS | From the print edition, p. 34.
Have jerry can, will queue

HOW does a big oil producer end up with no fuel? The irony of that predicament is not lost
on citizens of the country with sub-Saharan Africa’s largest oil reserves. They endure hours-
long queues at petrol stations and buy on the black market. Yet few recall a scarcity as severe
as the one that peaked this month.

Drivers turned to greasy hawkers who demanded up to six times the official price for their
cans of contraband. Traffic petered out in Lagos, a clamouring city of some 20m people.
Local airlines cancelled flights and international carriers began diverting through other West
African capitals for fuel. Since diesel and petrol are also needed to generate electricity
(mainly using backyard generators, since government networks are pitiful), darkness
descended on homes. Shops and offices closed and radio stations went off the air. Banks shut

Business Ethics 98
early, and mobile-phone companies warned of network outages. Africa’s largest economy
ground almost to a halt.

For a country that churns out roughly 2m barrels of oil a day, this is a scandal. The chief cause
is Nigeria’s inability to process its crude. Corruption and mismanagement have left its four
state refineries to rot, forcing this fuel-guzzling country to import up to 80% of its needs.

At the heart of the rot is a controversial subsidy scheme under which the government pays
wholesalers the difference between the open-market cost of fuel and a fixed pump price of 87
naira ($0.43). It is billed as protecting the poor, who see cheap fuel as the sole perk of their
country’s oil riches. In practice the subsidy is a mechanism for corruption by complex
networks of retailers, workers at the Nigerian National Petroleum Corporation (NNPC) and
government officials. They embezzle billions of dollars by overstating their imports and
pocketing the difference. At its peak in 2011, it was reckoned to cost the government $14
billion annually.

The latest shortage began when importers slowed deliveries, saying the government owed
them $1 billion in backdated subsidy payments. Without those, they said they could no longer
afford to import fuel. Critics responded that they were trying to bleed the government dry
ahead of a transfer of power to the incoming administration of Muhammadu Buhari on May
29th, amid speculation that he may reduce or indeed terminate the subsidy.

Mr Buhari, who inherits the crisis, is ironically one of its fathers: he set up the NNPC during
his time as petroleum minister in the 1970s. In 2012 the outgoing government tried to
eliminate the subsidy but backtracked on reform in the face of violent protests. It had the
perfect opportunity to take a second shot earlier this year, when oil prices were at their lowest.
Yet President Goodluck Jonathan tried to curry voters’ favour by cutting prices even further.

Those getting fat off the scheme will fight—perhaps literally—to save it. An investigation
into subsidy payments launched by Ngozi Okonjo-Iweala, the finance minister, in 2011 “led
directly to the kidnap of her mother,” her spokesperson claims. Reforms are not popular with
the masses, either. Although subsidies disproportionately benefit the rich, who drive bigger
cars and buy more fuel, prices for petrol, transport and food would all rise.

Yet Nigeria’s popular new president has more political capital than his predecessor. Citizens
are better informed about the theft surrounding the scheme. A phased withdrawal that is
explained carefully to voters and balanced by social grants or
investment in infrastructure might work.

Abolishing the subsidy might also give local refining a boost.

Official prices are now so low that no refiner can compete.
Tight government finances may force the change. Roughly $5
billion was allocated to subsidies in 2014. This year’s budget
makes provision for a fraction of that amount. Low oil prices
left a dent in government revenues. Foreign reserves have
fallen; a crude-oil savings account is all but empty; and the
currency has tanked. A cash-strapped government can no
longer afford such a corrupt and costly racket.

Business Ethics 99
European business and climate change
Walking the walk

Firms increasingly believe that saving the planet is

good for business
Jun 6th 2015 | PARIS | From the print edition, p. 54-55.

Plugged in to climate concerns

SIX big European oil and gas firms called on June 1st for a globally co-ordinated price on
carbon-dioxide emissions, to restrain the impact on the climate of burning fossil fuels. It was a
bombshell, in its way. Five years ago no one would have expected the move: as producers of
much of the world’s dirty fuels, their industry was disinclined to join forces and advocate
accelerating the switch to cleaner ones. “It is a sort of revolution,” says Patrick Pouyanné, the
boss of one of the six, Total. And it is not just the energy firms. As world leaders prepare to
meet in Paris in December to produce an agreement on reducing greenhouse-gas emissions,
attitudes towards climate change have altered profoundly among businesses of all kinds.

In 2009, when a global conference in Copenhagen failed to come up with a new agreement to
replace the Kyoto protocol, many businessmen were not much worried about either the failure
or global warming itself. They saw Europe’s host of related regulations—along with a carbon-
trading system of limited impact—as little more than a burden on firms’ competitiveness.
Three things have changed.

First, the price of renewable sources of energy—especially solar—has dropped dramatically,

and their share in power generation is growing. Second, consumers care more about climate
change than before. And third, investors—especially long-term ones such as pension funds—
have woken up to the risks of owning firms with assets and business models likely to decrease
in value as the world “decarbonises”. Some are beginning to divest from the dirtiest fuels,
such as coal (see article), to invest in cleaner ones and to press for greener policies all round.
“The cost of not doing things is starting to be higher than the cost of doing them,” says Paul
Polman, chief executive of Unilever, an Anglo-Dutch consumer-products maker. “Our
motives are not exactly altruistic,” admits another European boss. “Our clients and
stakeholders demand such initiatives.”

All sorts of firms are changing their inputs and processes and designing products that spare
the environment, while helping suppliers do the same. L’Oréal, a French cosmetics-maker,
says its CO{-2} emissions fell by 50% between 2005 and 2014, even as its output rose by
22%. Its target for 2020 is a 60% reduction. To avoid contributing to deforestation, Unilever
already buys all its palm oil (of which it is one of the world’s biggest users) through an
audited sustainability scheme, and by 2020 it plans to buy it from certified and traceable
sources.

Business Ethics 100

IKEA, a Swedish retailer, will have invested or committed to invest €1.5 billion ($1.7 billion)
in wind and solar power by the end of 2015, and the firm and its charitable foundation have
just pledged a further €1 billion to developing renewable energy and to helping people in
places affected by climate change. In Italy 54% of medium-sized manufacturers interviewed
by Mediobanca, an investment bank, and local chambers of commerce, said they were
investing in green technologies in 2015, compared with 37% in 2010.

A big German energy utility, E.ON, is hiving off its renewables business from its old power-
generation business to focus on the former. Enel, Italy’s largest utility, has pledged to halt all
new investments in coal, decommission fossil-fuel-powered plants in Italy and work towards
carbon neutrality by 2050. Renault and BMW have been enthusiastic in promoting electric
cars.

Kering, a French luxury-goods group, has pioneered an environmental profit-and-loss account

to measure the impact of its business across its entire supply chain. Sodexo, a French catering
company, reckons that over half of the 34% of emissions the firm has pledged to cut by 2020
will come from its suppliers. Many businesses now use a shadow carbon price internally when
allocating capital, to judge whether an investment will still make sense if and when carbon is
dearer.

Firms say that besides savings from greater energy efficiency they gain less quantifiable
benefits from an enhanced reputation, a motivated workforce and the like. But big, disruptive
investments in new energy sources or industrial techniques may take years to justify their
costs, if they ever do. Is greenery paying off?

Yes, broadly, argues Paul Simpson, the boss of CDP, a research outfit that collects
environmental data on more than 5,000 firms worldwide. Those with published targets for
cutting their CO{-2} emissions are more profitable, delivering a return on invested capital of
9.9%, compared with 9.2% for those with no targets, according to research published by CDP
in May. The Low-Carbon 100 Europe index compiled by Euronext, a stock exchange, which
includes the European firms with the lowest CO{-2} emissions in their respective industries,
has risen by 60% since the end of 2010. This compares with a 45% rise in the broader
STOXX Europe 600 index, from which its components were selected.

Green because good, not vice versa

However, it could just as well be that green firms are more profitable not because they are
green, but because they happen to be better run; and that their shares perform better because
investors see greenness simply as a proxy for good management. The six European energy
firms calling for an effective carbon price acknowledge that if the Paris conference succeeds
in agreeing on one, it will add to their costs.

But at least, they said, it would provide a “clear road map” for their future investment. The six
are heavy on gas—it now accounts for around half of Total’s output, for example, up from
35% ten years ago. So they are hoping that carbon-pricing would lead to a switch from coal to
gas—which they say produces half as much CO{-2} as coal, for each unit of electricity
generated from burning it. The overall impact of all this on profits would not be known for
years, says Mr Pouyanné. But, like others in Europe’s boardrooms, he has concluded there is
no choice in the matter.

Business Ethics 101

Schumpeter
A new green wave

A few pioneering businesses are developing

“sustainability policies” worthy of the name
Aug 30th 2014 | From the print edition, p. 53.

BILL MCKIBBEN, an American environmentalist, once dismissed sustainability as “a

buzzless buzzword”. That seems about right. A survey of 2,000 companies by the MIT Sloan
Management Review and the Boston Consulting Group found that two-thirds of
businesspeople thought social and environmental matters were “significant” or “very
significant” but that only 10% thought they themselves were doing enough about it.

That sense of disappointment should be no surprise. Sustainability can refer to anything from
building wind farms to combating social inequality. The idea crops up everywhere from
Starbucks to the deliberations of the United Nations (whose governments are in the middle of
working out a set of so-called Sustainable Development Goals for 2015-30). An ill-defined,
controversial notion is no basis for coherent policy.

Many corporate “sustainability plans” are therefore modest. They focus on saving energy,
cutting waste and streamlining logistics. Nothing wrong with that: these things reduce
operating costs while benefiting the environment. They help explain why sustainability efforts
tend to increase profits, not reduce them. A study by Robert Eccles and George Serafeim of
the Harvard Business School (HBS) found that, between 1992 and 2010, companies which
adopted what they call high-sustainability policies were more profitable and improved their
stockmarket valuation more than those which did not (though this may just have been because
high-sustainability firms happened to be better managed).

However, there are drawbacks to such plans. For one thing, they are misnamed: these are
efficiency policies, not sustainability ones. Companies ought to want to save energy or cut
waste anyway, regardless of the impact on the environment. And it turns out that many of the
schemes do not in fact do that much for the environment or social equity. The majority of
greenhouse-gas emissions associated with consumer goods, for example, are produced either
in the supply chain or by shoppers. So there is only limited scope for such products’ makers to
lessen their environmental footprints through green measures of their own.

As a result, most corporate sustainability plans rarely amount to more than cost-saving
measures and compliance with government regulations, plus a few projects with a public-
relations punch (say, reforesting parts of a cleared jungle). They fall well short of putting
sustainability at the heart of what firms do.

For some companies, though, that is changing. Take SABMiller, the world’s second-largest
brewer. The firm has been a pioneer in the field. But until recently its sustainability efforts
consisted of a laundry list of targets (there used to be ten) aimed at reducing carbon emissions
or water usage in its brewing operations. This summer it unveiled new, broader targets—only
five this time—which apply to suppliers, sellers and customers, as well as to SABMiller itself.
It is promising to teach basic business skills to 500,000 small enterprises, mostly shops which
Business Ethics 102
sell its beer. It is helping farmers use water more efficiently: in Rajasthan, in northern India, it
is working with wheat farmers who have been depleting their aquifer to reduce water use by a
quarter, to ensure it still has water to brew beer. And it is sponsoring anti-drunkenness and
road-safety campaigns aimed at its own customers.

Jane Nelson, director of the Corporate Social Responsibility Initiative at the Harvard Kennedy
School, says SABMiller’s efforts are characteristic of a new wave of sustainability plans.
These set targets not only for the company but for the people it works with and sells to. The
targets are not only about the environment but society at large. (In a spectacular example,
Unilever, an Anglo-Dutch consumer-goods giant, says it aims to “help a billion people take
steps to improve their health and well-being”.) They are supervised by the board, not left to
specialists. Domtar, an American fibre company, created a sustainability committee but the
vice-president for sustainability does not chair it; the chair rotates among other managers so
as to involve the firm as a whole. In short, she argues, for some companies sustainability has
become a core part of their strategy, not just a green way to cut costs.

Little green men

But why should firms make sustainability central to what they do? Environmentalists might
reply that virtue is its own reward. But companies need more concrete returns—higher profits,
say, or increased sales, or higher stockmarket valuations.

The first wave of sustainability policies provided those. The new wave may not: sustainability
targets could raise costs, not cut them, making environmentally friendly consumer goods
more expensive than the eco-hostile variety. Efforts to combat social inequality could boost
wages. Training can be costly.

Paul Polman, the boss of Unilever, argues that good sustainability policies still improve the
fundamentals of businesses in the long run. They change customers’ behaviour in beneficial
ways—by, say, increasing demand for green products that the firm makes. They also please
investors concerned about environmental threats. The trouble is that consumer behaviour is
often slow to change and that, if green products are too expensive, the firm risks losing
market share. Environmental investors are still a minority among shareholders, most of whom
continue to be more concerned about quarterly earnings.

The first wave of sustainability rewarded itself. The new wave will not do that. It is more akin
to investing now to have a licence to operate in future, when consumers, lobbyists and
regulators will be ever more demanding about the way firms behave. That does not mean the
new wave will not reward
its adopters. But it will
boost their long-term
competitive position, rather
than their short-term profits.
Unlike the rewards of the
superficial first wave, those
of deeper sustainability
could take years to sink in.
Economist.com/blogs/schumpeter

Business Ethics 103

 A goldmine

Waste collection in Nigeria

Clean it up

A pile of plans to collect and use

rubbish more efficiently
Feb 22nd 2014 | ABUJA | From the print edition, p. 31.

THE roughly 170m Nigerians who inhabit Africa’s most

populous country are producing far more waste than their
creaking infrastructure can manage. Aminu Omar is one of
thousands of unofficial waste-pickers who see this as an
opportunity to make some cash. Half-immersed in a large bin outside a smart housing
compound in the capital, Abuja, he pulls out beer cans, water bottles and empty jam jars, and
stuffs them into his patchwork plastic sack. He then sells his haul for 700 naira ($4). “I take
the rubbish, give it to a middleman and he sells it for much more,” he says, leafing through a
discarded women’s magazine.

Nigeria’s sprawling megacity, Lagos, with a population of 21m or so, disgorges 10,000 metric
tonnes of waste a day. Overburdened municipal governments are reckoned to collect barely
40% of this rubbish. Only 13% of recyclable materials is salvaged from the city’s landfills,
according to Wecyclers, a young company keen to promote recycling and reduce waste.

Wecyclers uses a fleet of bicycles to collect recyclables from over 5,000 households in
densely populated, poor areas of Lagos neglected by waste-disposal lorries. The company
awards points to registered households for the amount of recyclable material they provide,
which can then be redeemed in cash or kind—a household item such as an iron, or a telephone
credit—at the end of each quarter. Wecyclers makes money by selling the recyclables to
bigger companies that melt or process and then sell them on, usually to Asia. “It reduces the
number of people on dangerous landfills searching for waste at the mercy of a broker,” says
Bilikiss Adebiyi of Wecyclers, who says her company is the first of its kind in Africa. “Some
[people] have given us tonnes of waste.”

The Lagos State Waste Management Authority is trying to turn rubbish into energy by
harnessing methane gas emitted from rotting waste at Olushosun, the largest landfill in Lagos.
When completed in five years’ time, the project is supposed to produce 25MW of electricity.
That is a help for a country that produces only 3-4GW per year, a tenth of South Africa’s
output for a population triple the size.

In the metropolis of Kaduna, 200km (124 miles) north of Abuja, waste collection is currently
free for the 1.5m inhabitants. But the state government is trying to get people to pay a
monthly levy to reduce the burden on the authorities and to tempt in the private sector. It
wants to award contracts to companies to collect waste from paying customers. Persuading
people to pay for rubbish collection will depend on the quality of the service—or on the
penalty for not co-operating. As with most Nigerian government contracts, politics and palm-
greasing will probably play a part. Still, if more rubbish is collected, people may not
complain.
Business Ethics 104
Nestlé in India
Instant karma

Supposedly contaminated noodles can be

sold abroad, but not eaten at home
Jul 4th 2015 | MUMBAI | From the print edition, p. 55.

Noodlegeddon

IT TAKES only minutes to prepare, but India’s most popular processed-food dish is at the
centre of a drawn-out dispute over its safety. On June 30th the Bombay High Court said that
Nestlé India was free to export its Maggi brand of instant noodles but a ban on local sales
remains in place. The Indian subsidiary of the Swiss food giant was making a second visit to
the court to try to overturn the ban, which was imposed by the Food Safety and Standards
Authority of India (FSSAI) on June 5th.

Nestlé’s troubles began when a local food-safety agency in Uttar Pradesh state said it had
found excessive levels of lead in the noodles. Nestle insisted they were safe to eat but recalled
them hours before the ban was imposed, saying the public’s trust had been compromised.
Nestlé has so far incinerated 17,000 tonnes of suspect noodles. Rivals such as Unilever have
also pulled their instant noodles from the market until the air clears.

The FSSAI told the court it did not object to Nestlé exporting its noodles, although it stood by
its earlier decision to ban them in India. This seems a curious decision given that Singapore
had lifted a temporary ban on imports of Maggi noodles after its food-standards agency found
they were safe to eat; and that Hong Kong had also given Nestlé’s Indian-made noodles the
all-clear. On July 1st Britain’s Food Standards Agency said it had tested a batch of Maggi
noodles imported from India and found them to be well within European Union limits on lead
content, and safe to eat.

Business Ethics 105

Such findings strongly suggest that the tests in India were faulty. But the court has still to
decide on that. The hearing was adjourned until July 14th to allow Nestlé to respond to
affidavits from the FSSAI and other parties including the Food and Drug Administration
(FDA) of Maharashtra, the state where the court sits.

Foreign companies may feel they are being singled out. In 2006 both Coca-Cola and PepsiCo
had to fend off claims by environmentalists that their colas contained pesticides. In June KFC,
a fast-food chain, dismissed “false allegations” by a children’s-rights group that there were
traces of poisonous bacteria in its fried chicken. But the usual beef about India’s industry
regulators is not that they are too active but rather that they are ill-equipped to monitor their
charges. Satya Prakash, a retired food-safety expert, has warned the government that some of
the food laboratories it uses are unable to carry out basic tests. In January 2014 America’s
aviation authority downgraded India’s air-safety ranking a notch because its regulator had too
few trained officials (the downgrade was reversed in April).

Nestlé might have limited the damage if it had dealt more readily and speedily with the
regulators. But it can take comfort from the fact that other foreign food companies have come
back from similar adversity. In 2003 the FDA in Maharashtra seized stocks of Cadbury’s
chocolates when worms were found in a few bars. Cadbury initially said the infestation could
only occur because of careless storage by retailers. The FDA countered that chocolate
wrappers should be worm-proof. Cadbury then revamped its packaging and relaunched its
products with a heavy advertising campaign. It is now, once again, the leading brand in India.

Investors seem to be betting that Nestlé can likewise restore its reputation. The share price of
its local subsidiary, which had slumped by a fifth at its worst point, had recovered about half
that loss following the court’s hearing this week. The most regrettable thing about the affair,
especially in a country where so many people go hungry, is that in all likelihood a lot of food
has been destroyed unnecessarily.

Business Ethics 106

Schumpeter
The butterfly effect

Charities are irritating but often help

companies do the right thing
Nov 2nd 2013 | From the print edition, p.63.

“WE NOW understand it’s about corporate partnerships…That’s the model…and it’s killing
us.” Thus did Naomi (“No Logo”) Klein, self-proclaimed champion of the anti-capitalist
Occupy movement, recently castigate carbon markets, green incentives and the close ties
between companies and charities that have sprung up to support them.

Ms Klein can be relied on to espouse any cause that annoys business. But on this occasion her
views coincide with a broader backlash against links between companies and non-
governmental organisations (NGOs). Partnerships between the two have become like off-site
team-building exercises: they were once slightly exotic, but now no self-respecting firm does
without them. A survey of European multinationals and British charities by C&E Advisory
Services found that over a third of the firms invest £10m or more in their charitable alliances
and almost two-thirds classify the partnerships as “strategic” (whatever that means).

But these are partnerships of opposites. Businesses tend to think they discharge their duty to
society by obeying the law. Charities want to do the right thing. Indeed, charities like rights in
general: the right to food, the right to clean water, and so on. Businesses think in terms of
markets, not rights.

The gap is widening. The share of firms that told C&E they are “very confident” that their
partnership with NGOs will meet its aims has fallen by nearly half over the past year. Only
40% of NGOs say partnerships have changed companies’ behaviour for the better—down ten
points in a year.

The recent past has dealt several hefty blows to the perceived merits of these links. Most
companies sign such deals to seek “the bubble reputation”, as Shakespeare put it: to look
good, whether or not the activity is worthwhile. But the millions that BP gave to American
environmental NGOs did nothing to stop the company’s good name being dragged through
the muck of the Gulf of Mexico. John Browne, BP’s former boss, was even on the board of
one of those NGOs—for all the good it did him.

On their side, charities—which are often reluctant partners, since they risk accusations of
selling out—feel burned by two occurrences in April this year. One was the failure of the
carbon-trading market in Europe. NGOs such as the Environmental Defence Fund are sticking

Business Ethics 107

their neck out when they campaign for market mechanisms, because rival greens like Ms
Klein think worldwide central planning is the only way to reduce global warming. The
debacle at the world’s largest carbon-trading scheme therefore embarrassed all its backers and
left responsible NGOs under attack for consorting with Mammon.

The other event was the collapse of the Rana Plaza textile building in Bangladesh. Some of
the world’s best-known NGOs have put great efforts into improving the supply chains of big
clothing-makers such as Benetton, El Corte Inglés, Primark and Walmart. Factories at Rana
Plaza made clothes for all of them. But if the suppliers condoned such deadly working
conditions, what was the point of those well-meaning efforts? For a charity, why take all the
trouble? Why not just go around to Primark’s flagship store in London—as did War on
Want—and shout that the company was to blame for the deaths?

Before concluding that partnerships are valueless, though, it is worth recalling the reasons
why they took off in the first place. NGOs help companies reach parts of the market they
cannot reach by themselves. In a new book, “Everybody’s Business”, by Jon Miller and Lucy
Parker, Duncan Learmouth of GSK, a pharmaceutical firm, argues that “what NGOs bring is
an insight into the base of the pyramid, the marginalised populations…That’s an
understanding we just don’t have in the business.” Environmental NGOs help companies
consolidate their efforts to cut pollution and waste. P&G, the world’s biggest packager of
consumer goods, says green groups have helped it save nearly $1 billion through its
“sustainability programme” in the past ten years.

NGOs are usually better than companies at attracting and retaining idealistic graduates:
partnerships allow a little of the magic to rub off on firms. (Indeed, they can be almost too
successful: some corporate-social-responsibility departments are stuffed with people
administering the policies they had advocated when they worked for NGOs.) Partnerships
cannot save companies from public-relations disasters like BP’s but they can improve
relations with regulators: WWF, an environmental charity, helped Coca-Cola defuse a
damaging conflict in India which at one point led to the Indian Supreme Court demanding that
the company hand over its exact (and still secret) formula.

Even evil capitalists have their uses

For NGOs, too, partnerships with firms have their uses. Companies provide money, which all
charities need. They also offer a way of influencing the behaviour of millions. About 1.5
billion people are cultivating and making food around the world. NGOs which want to
improve nutrition or reduce food waste cannot hope to affect the behaviour of so many. But
roughly 100 companies are involved in selling a quarter of the world’s food. Changing the
standards they apply could have a greater impact than the charities would ever achieve on
their own.

All that said, the benefits of partnerships will never be uniform, smooth or even very
satisfying. Some alliances are well designed; many are not. Some firms are committed to the
idea; some are not. And NGOs are like companies themselves: they seek market share; they
compete for contributions. Some, like WWF, want to engage with businesses. Others, like
Greenpeace, do not. And a few, like Oxfam, want both—slamming companies one minute,
advising them the next. Partnerships are messy and patchy. But on balance they are forces for
good.

Business Ethics 108

Schumpeter
The Washington wishing-well

The unstoppable rise in lobbying by

American business is bad for business itself
Jun 13th 2015 | From the print edition, p. 62.

IN 1971 Lewis Powell, an American lawyer who would go on to become a Supreme Court
judge, wrote a memorandum for the Chamber of Commerce. Business was the victim of a
“broadly based and consistently pursued” assault, he argued. There were few elements of
American society that had “as little influence in government as the American businessman,
the corporation, or even the millions of corporate stockholders.” It was time for companies to
change all this—and acquire political power. “Such power must be assiduously cultivated;
and that, when necessary, it must be used aggressively and with determination.”

Powell has been granted his wish. In 2012 corporate America accounted for more than three-
quarters of the $3.3 billion spent on lobbying in Washington, DC. General Electric was the
market leader, spending $21.4m, and Google came second, with $18.2m. And this is just
lobbying in the strict sense defined by American law—ie, the work of registered lobbyists,
employed to make direct contact with congressmen and officials. Businesses also employ
innumerable other people, in areas such as “government relations”, “public affairs” or
“corporate communications”, whose job, in plain English, involves lobbying for or against
changes in public policy. Then there are the countless business-funded outfits that say they are
simply providing information about a particular industry, and the army of friendly, corporate-
sponsored academics, who are all indulging in a subtler form of lobbying.

A big American firm may nowadays have a dozen or more full-time registered lobbyists on
Capitol Hill, while also employing the services of a couple of dozen lobbying firms from
among the 2,000 or so based around K Street. At a moment’s notice, Gucci-clad glad-handers
can flood the halls of Congress, and retired politicians on a retainer can be summoned up to
“make a call”. Overworked, underpaid officials find there is always a sympathetic lobbyist on
hand to help them draft new regulations.

In a new book, “The Business of America is Lobbying”, Lee Drutman of the New America
Foundation, a think-tank, demonstrates that in recent years companies have gone from using
lobbying simply to protect themselves from politics (by seeing off such things as tax increases
and regulations) to using politics to help them become more profitable. They set the terms of
the debate by funding Washington’s innumerable talking-shops; and then work on the
politicians and officials to ensure that the legislation locks in their advantage. Mr Drutman’s
book complements a 2013 one, “The Fracturing of the American Corporate Elite”, by Mark
Mizruchi of the University of Michigan. It argued that whereas companies once lobbied for
public goods such as better roads, they are now more inclined to press for company-specific,
or at best industry-specific, benefits.

A classic case of selfish lobbying wrapped in a cloak of selflessness was the Medicare
Modernisation Act of 2003. Thanks to the pharmaceutical industry’s lobbyists, this brought
new prescription-drug benefits to millions of older Americans, but without any attempt to
Business Ethics 109
control costs through means-testing or bulk-buying. John Friedman, an economist at Brown
University, estimated that as a result the drugmakers would gain benefits of $242 billion over
a ten-year period—a healthy return on the $130m the industry spent on lobbying in the year
the law passed.

There is plenty of other academic evidence to demonstrate that every dollar big business
drops into the Washington wishing-well repays handsomely. Mr Drutman’s book notes
studies showing, for instance, that the more companies lobby, the lower their effective tax
rate; and that firms which lobby are less likely to be detected for fraud than comparable non-
lobbying ones.

There is equally abundant evidence that corporate lobbying is bad for society as a whole. The
American Jobs Creation Act of 2004, which began as a measure to cut export subsidies, ended
up being stuffed with handouts to big business at the behest of lobbyists. This added to the
burden on other taxpayers and helped frustrate efforts to simplify America’s Byzantine tax
rules. The infestation of lobbyists special-pleading for their clients contributes to Congress’s
gridlock, which means that important business like fixing the tax code, and improving
America’s infrastructure, does not get done. Ironically, businesses are themselves among the
victims when government seizes up. The tax code is so complex that companies and citizens
spend 6.1 billion hours and $163 billion preparing their tax returns each year. Bad
infrastructure damages the competitiveness of American firms.

Pathological and permanent

Is there any chance that America might be able to cure its lobbying cancer? There are
occasional signs of hope. The number of registered lobbyists has fallen since Congress passed
the Honest Leadership and Open Government Act in 2007. During the 2013 government
shutdown, Paul Stebbins, the chairman of World Fuel Services, expressed the private worries
of many business leaders when he said that, “We are part of the pathology that got us here.”
But these signs are probably illusions. The decline in numbers is probably just due to
registered lobbyists being rechristened as “strategic advisers”, “issues managers” and the like.
After the financial crisis Barack Obama worked closely (and opaquely) with lobbyists and
other interest groups in crafting his stimulus package and his financial and health-care
reforms.

Mr Drutman dashes any hopes that the growth of lobbying can be reversed. He notes that it is
“sticky”: once companies have made an initial investment in lobbying they almost never give
up. They find that the more they do of it, and the better they get at it, the more they get out of
it. American companies
succeeded in recovering
from the slough of the
1970s by overcoming
enemies who were
outsiders—over-mighty
trade unions and anti-
business campaigners.
Today they have a much
trickier problem on their
hands: they have to wage
war on themselves.

Business Ethics 110

Crony capitalism
Friends in high places

How cronyism undermines growth, jobs

and competition
Oct 11th 2014 | From the print edition, p. 68.

THE Arab Spring has not delivered all that was hoped for it, but it did call time on two
egregious examples of crony capitalism. After the revolution in Tunisia in 2011, 214
businesses, and assets worth $13 billion, including 550 properties and 48 boats and yachts,
were confiscated from Zine el-Abidine Ben Ali, the deposed president, and his relatives and
associates. In Egypt at least 469 businesses were linked to Hosni Mubarak, ousted as its
president soon after Mr Ben Ali, some of which were seized.

Using data that have only come to light since the Arab Spring, World Bank economists have
conducted a uniquely detailed study of the damage that crony capitalism does to an economy.
Its findings suggest that, among Egypt's medium-sized and large firms, the politically
connected ones made 60% of all the profits in 2010. Yet their share of the economy was far
smaller and they provided only 11% of private-sector employment.

Politically connected firms seemed remarkably lucky in having non-tariff trade barriers to
protect them. Some 71% of politically connected firms operated in markets protected by at
least three such import barriers; only 4% of unconnected firms were as well cushioned.
Generous energy subsidies were a favourite way for the government to help its friends: 45%
of politically connected firms operated in energy-intensive industries, compared with only 8%
of firms as a whole.

In Tunisia the Ben Ali empire dominated the telecoms and air-transport industries, to which
entry was highly regulated. They accounted for 21% of total profits in Tunisia in 2010 but
only 3% of private-sector output and 1% of jobs. They had far higher profits and market share
than non-crony firms in industries in which operating rights and foreign direct investment
were heavily regulated. But in lightly regulated sectors they were far less profitable than non-
crony rivals.

Although Messrs Mubarak and Ben Ali were swept away along with many of their cronies,
the study warns that there is a risk of old habits returning. Egypt’s powerful army, in
particular, has cronyish tendencies. Moreover, many of the policies that were conduits of
favours to firms with powerful friends, such as energy subsidies and heavy, discretionary
regulation of competition and foreign direct investment, remain in place.

Business Ethics 111

Shell companies
Launderers Anonymous

A study highlights how easy it is to set up

untraceable companies
Sep 22nd 2012 | NEW YORK | from the print edition, p. 62.

SHELL companies—which exist on paper only, with no real employees or offices—have

legitimate uses. But the untraceable shell also happens to be the vehicle of choice for money
launderers, bribe givers and takers, sanctions busters, tax evaders and financiers of terrorism.
The trail has gone cold in many a criminal probe because law enforcers were unable to pierce
a shell’s corporate veil.

The international standard governing shells, set by the inter-governmental Financial Action
Task Force (FATF), is clear-cut. It says countries should take all necessary measures to
prevent their misuse, such as ensuring that accurate information on the real (or “beneficial”)
owner is available to “competent authorities”. More than 180 countries have pledged to
follow it. A study* scrutinises the level of compliance worldwide. The results are depressing.

Posing as consultants, the authors asked 3,700 incorporation agents in 182 countries to form
companies for them. Overall, 48% of the agents who replied failed to ask for proper
identification; almost half of these did not want any documents at all. Contrary to
conventional wisdom, providers in tax havens, such as Jersey and the Cayman Islands, were
much more likely to comply with the standards than those from the OECD, a club of mostly
rich countries. Even poor countries had a better compliance rate, suggesting the problem in
the rich world is not cost but unwillingness to follow the rules (see chart). Only ten out of
1,722 providers in America required notarised documents in line with the FATF standard.

Business Ethics 112

Providers were often strikingly insensitive even to clear criminal risks. The authors sent three
main types of e-mail: the first from a low-risk alias from a country such as Norway or
Australia; the second from a high-corruption-risk individual purporting to work in
government procurement in such places as Kyrgyzstan and Equatorial Guinea; the third a
terror-financing risk, working for a Muslim charity in Saudi Arabia. Providers were less likely
to respond to the corruption category than the low-risk one, but also less likely to ask for
identification when they did reply. Finding takers for the terrorist financier was harder, but
not impossible: one in every 17 providers was willing to set up an anonymous shell for him.

Informing the incorporators of the international rules they should be following made them no
more likely to do so, even when penalties were mentioned. When the undercover authors
offered to pay a premium to flout the rules, the rate of demand for identity documents fell
precipitously. “Your stated purpose could well be a front for funding terrorism,” one
American provider replied—and then indicated he would consider establishing and
administering the shell for $5,000 per month.

This study, by far the most thorough of its kind, makes sobering reading for anyone who
worries about the link between financial crime and corporate secrecy. OECD countries show
little willingness to tackle their own weaknesses and end their hypocrisy. In America, by
some measures the least compliant of all, the incorporation-friendly states and business
groups opposing reform continue to have the upper hand, despite valiant attempts by Senator
Carl Levin to push through legislation that would require the registration of beneficial owners.
Movers of dirty money know where the best shells are to be had, and it is not on a Caribbean
island.
* “Global Shell Games: Testing Money Launderers’ and Terrorist Financiers’ Access to Shell Companies”, by Michael Findley, Daniel
Nielson and Jason Sharman, 2012.

Business Ethics 113

Banca Etica
Ethical banking in Italy

A bank that takes its name seriously

Jun 1st 2013 | FLORENCE |From the print edition, p. 67.

ANOTHER Italy was on display this month at Florence’s 16th-century Fortezza da Basso,
where Banca Etica, an ethical bank, held its annual meeting. Outside, stands were selling all
sorts of bio foods. Inside, casually dressed shareholders discussed weighty subjects such as
social responsibility and the economic crisis.

Until a few months ago Banca Etica was known only to insiders. But then the new
parliamentarians of the anti-establishment Five Star Movement, which won more than 25% of
the vote at the general election in February (but flopped at local polls on May 26th and 27th),
queued to open accounts when parliament convened. That helped spread the word. Now
people are curious.

Ethical banks are nothing new, but Banca Etica takes its name seriously. Its annual report
calls for a citizens’ revolt against casino finance, the use of tax havens and speculation in
commodities. Executive pay is not allowed to exceed six times the lowest wage at the bank.
And it does not want to get involved with anything having to do with pornography, oil or
arms (a rule that even applies to shareholders: the directors’ report raised concerns that two,
Banca Popolare di Milano and Banca Popolare dell’Emilia Romagna, are now on a list of
banks related to arms production and sales).

Such ideas may explain why Banca Etica is small: it has only 17 branches, around 230 staff
and loans of less than €1 billion ($1.3 billion), and made a profit of €1.6m in 2012. The firm
provides mainly credit to the non-profit sector and green businesses. It was, for instance, the
first Italian bank to lend to co-operatives of young people who farm land confiscated from the
Mafia.

Yet Banca Etica has attracted a broad range of shareholders. They number 38,400, of which
5,900 are firms, including 83 financial institutions. By some measures, it is among Italy’s
best-run banks: only 0.4% of loans are in default and only 4.9% of loans are classified as
“problematic”. And its managers seems inventive. They have set up a platoon of 24 travelling
bankers to drum up business in areas far from its branches.

Can Banca Etica grow beyond its niche? That probably depends less on the firm itself than on
Italy’s established banks. If there are more scandals such as the one surrounding Monte dei
Paschi di Siena, the world’s oldest bank, which lost billions in dubious derivatives deals,
Banca Etica may attract more business than it can deal with.

Business Ethics 114

Sharia in the West
Whose law counts most?

Finding an accommodation between Islamic law and Western legal

codes is difficult. But there are some ways forward
Oct 14th 2010

ANY Western politician, judge or religious leader desiring instant fame or a dose of
controversy has an easy option. All you need do is say “sharia” in public.

Sharron Angle, a Republican candidate for the Senate, proved the point when she suggested
that Frankford, Texas, and Dearborn, Michigan, were both subject to a sharia regime, as a
result of the “militant terrorist situation” that existed in those places. Critics retorted that
Frankford, after its absorption by Dallas, no longer existed as an administrative unit.
Dearborn’s mayor, Jack O’Reilly, tartly told her that his town’s 60 churches and seven
mosques were flourishing happily under American jurisdiction. But for some tea party fans,
she was guilty at worst of slight exaggeration.

Less weirdly, but just as controversially, Archbishop Rowan Williams, leader of the world’s
80m Anglicans, will never be allowed to forget saying in February 2008 that some
accommodation between British law and sharia was “inevitable”. Lord Phillips, then
England’s senior judge, drew equal ire by adding that sharia-based mediation could have
some role as long as national law held primacy.

It is easy to see why the word sharia has emotional overtones, especially today. The appalled
reaction to the case of Sakineh Ashtiani, an Iranian woman who has been sentenced to death
by stoning for adultery, has stoked a global campaign for her acquittal. The sentence was
suspended last month, but her fate looks dicey. She could still face execution on a murder
charge.

Such cases reflect only one part of sharia: the system of corporal and capital punishments
such as stoning for adultery, death for murder or apostasy (abandoning Islam), whipping for
consuming intoxicants or the cutting off of a hand for theft. Muslims themselves disagree over
how, if at all, these penalties should be practised in the modern world. Tariq Ramadan, a
prominent European Muslim thinker, caused a furore in 2003 when he suggested that stoning
and other physical punishments should be “suspended”. Hardline Islamists regarded that as
backsliding. Nicolas Sarkozy (then the interior minister, now the president of France) pointed
out that the formulation could imply a future resumption of physical punishment.

Horrifying as these punishments might be to modern sensibilities, there is no prospect of their

exercise in any Western country. Muslims living in the West may (as has sometimes
happened) take the “law” into their own hands by killing an apostate. But that counts as
murder pure and simple.

Where sharia poses genuine dilemmas for secular countries with big Muslim minorities is not
in the realm of retribution but in its application to family matters such as divorce, inheritance
and custody. English-speaking countries boast a strong tradition of settling disputes
(commercial or personal) by legally binding arbitration. This already includes non-secular

Business Ethics 115

institutions such as longstanding rabbinical tribunals in Britain and many other countries, or
Christian mediation services in North America. Now Islam-based outfits are entering the
market.

Perhaps inevitably, the procedures and general ethos of Muslim mediation are very different
from those of a secular court. Many of Britain’s 2m or so Muslims come from socially
conservative parts of South Asia, such as rural Kashmir. The practice of sharia-based family
law both reflects and to an extent mitigates that conservatism. A network of sharia councils—
whose two main founders come from purist schools of Islam, the Deobandis and the Salafis—
has offered rulings to thousands of troubled families since the 1980s. Much of their work
involves women who have received civil divorces but need an Islamic one to remarry within
their faith. The councils can overrule a husband’s objections. Few would decry this. But the
woman may well also forfeit her mahr (marriage settlement). Critics call that unfair. They
also complain that, when faced with domestic violence, these councils merely administer a
scolding or prescribe an “anger-management” course, rather than the safe house and
prosecution that the state-run system should offer.

Still, British sharia arbitrators may alleviate a peculiarly British woe. Some Muslim Britons
contract an Islamic marriage (but not a civil one) and then fail to confer on the bride the
marriage settlement that would be obligatory in say, Pakistan. If the union sunders, such men
then escape their obligations under both English law and Pakistani custom. The councils
advise against such deviousness.

A rival set-up, the Muslim Arbitration Tribunals, now offers dispute resolution in half a dozen
British cities. Founded in 2007 by followers of the Barelvi school of South Asian Islam, they
are less strict than the Deobandis. But when asked to divide up an intestate’s assets, they
follow Islamic law, giving daughters half as much as sons. The tribunals say they operate
under the Arbitration Act of 1996. That makes rulings binding once both parties have given
authority to the arbitrator.

In Canada legislation framed with secular arbitration in mind but used by religious courts is a
hotter issue than in Britain. In 2003 a Toronto lawyer, Syed Mumtaz Ali, proclaimed an
“Islamic Institute of Civil Justice” and urged Muslims to use it. The province of Ontario
reacted in 2005 by stripping religious tribunals (including Jewish and Catholic ones) of legal
force. It also stiffened rules on arbitrators’ qualifications and record-keeping. Quebec
tightened its law too.

That has not stopped devout Canadian Muslims from seeking religious guidance on family
and personal matters. As Harvey Simmons, a York University professor, wrote last month:
“Because religious arbitration now takes place mainly outside the scrutiny of the Ontario
courts, there is no way to tell whether women are being treated well or badly by informal
religious arbitration.”

In the United States both secular and religious arbitration are firmly established, operating
under a Federal Arbitration Act that gives robust standing to the procedure but also allows the
parties to counter-appeal to ordinary courts on certain grounds (though America’s church-
state separation stops courts hearing arguments about doctrine). Christian and Jewish
arbitration is well-organised. The Muslim variety is lower-key and less formal, but so far not
(barring outbursts from tea-partistas like Ms Angle) especially controversial.

Business Ethics 116

The legal and political systems in continental Europe are most prescriptive and leave little
room for cultural exceptions, at least in theory. But knotty issues of Islamic family law have
arisen in courts all over Europe. Many residents of France and Germany remain citizens of
their native countries. Courts usually deal with foreign passport-holders in the light of their
home countries’ law, while also upholding the principle that outcomes must not violate
“public order” (ie, outrage local opinion).

One tricky issue is polygamy. French law explicitly outlaws it, and denies second wives the
right to join their husbands in France (though if a second wife dies, her children are
sometimes allowed to join their French-based father). Another is a form of divorce known as
talaq in which a man simply renounces his wife. That has no standing in French or German
law, but when both parties to a failed marriage freely testify that a talaq has taken place in
some Islamic country, European courts have been forced to acknowledge the fact.

When high legal principles clash with a quite different social reality, the results are inevitably
messy. Islamic rules on religiously mixed marriages have harsh consequences for many
couples in Italy, for example. Islam prohibits Muslim women from marrying non-Muslim
men (the reverse, however, does not apply). Italian marriage rules require a woman from
Algeria or Egypt, say, to obtain her embassy’s consent, which is likely to be refused unless
the would-be husband converts (or “reverts”, in Islamic parlance).

In most parts of Europe migration has made sharia a pressing issue. But in one European
region, by a quirk of history, a community with deep local roots lives under Islamic family
law. This is northern Greece, where a Muslim community of at least 100,000 was allowed,
under the 1923 Lausanne treaty, to retain cultural autonomy, including widespread
jurisdiction over family matters for local muftis.

Nothing stops a Greek Muslim from going to the state courts, but communal pressure impels
most people to settle family affairs through the muftis. The community, which is sensitive to
perceived slights from the state, would react badly to any change. “People see sharia as their
cultural right and they would be angry if it was taken away,” says Ali Huseyinoglu, a doctoral
student from northern Greece. “If Muslim tribunals are starting in Britain, it would be odd to
abolish sharia in a place where it has been applied since Ottoman times.”

Business Ethics 117

The Libor scandal
Year of the lawyer

Banks face another punishing year of fines

and lawsuits
Jan 5th 2013 | from the print edition, p. 55.

THE lights still burn late into the night at the offices of the “magic circle” of London’s
biggest law firms, but they are now on in different bits of the building. The legions of
transaction lawyers who worked late before the crisis drawing up merger contracts are home
to tuck the children into bed. Yet even as a dearth of dealmaking has slowed one part of the
legal business, there is booming demand for litigation and regulatory lawyers who are
preparing banks for another year of fines and lawsuits.

The main legal risk facing big international banks relates to a widening scandal over attempts
to rig benchmark interest rates, including the London Interbank Offered Rate, or LIBOR. The
most recent LIBOR-related fine was levied on December 19th, when British, Swiss and
American authorities imposed penalties of SFr1.4 billion ($1.5 billion) on UBS, a Swiss bank.
In its legal settlement with regulators UBS admitted to “widespread and routine” attempts to
manipulate LIBOR rates. Its fine came six months after an earlier settlement and admission by
Barclays that its traders, too, had tried to rig LIBOR.

The UBS case marked an escalation of the risk faced by big banks in two respects. The first
was in the size of its fine, which was three times larger than that paid by Barclays, and far
larger than many expected given that UBS (like Barclays) had co-operated with investigators.
Moody’s, a ratings agency, noted the fine was “credit negative not only for UBS, but for all
banks with sizeable capital-markets activities.”

Business Ethics 118

The fine was so large partly because of the pervasive violations at UBS: investigators found
more than 2,000 documented attempts to manipulate rates. But it also confirms that the
authorities in America and Britain are ready to impose far harsher penalties than they used to.
The Royal Bank of Scotland, which hopes to reach an agreement with regulators within the
next two months, is thought likely to pay a fine of at least $500m. It will not be the last. More
than 20 banks in total are understood to be under investigation or co-operating with various
regulatory authorities.

A second reason the UBS settlement upped the ante for banks is that it exposes them to
greater risk from LIBOR-related civil lawsuits that are currently making their way through
New York courts. Lawyers involved in the main class-action lawsuit against banks—brought
by, among others, the City of Baltimore, Charles Schwab and holders of mortgages linked to
LIBOR—say the disclosures in the UBS case point to wider efforts to manipulate rates than
previously thought, including allegations of banks making improper payments to some
interdealer brokers. (For their part, banks argue that even the recent revelations contain no
evidence of a concerted conspiracy to fiddle LIBOR.)

The LIBOR scandal is not the only thing keeping the lawyers busy. One measure of the
litigation risk facing banks can be found in the latest quarterly report of JPMorgan Chase, a
large American bank with an unusually open policy of disclosing its litigation risks. It reckons
that the range of “reasonably possible losses” it faces from litigation runs from zero to as high
as $6 billion. Among the cases it is contesting are relatively recent ones, such as those brought
over the losses incurred by its trading arm in London in 2012, as well as others dating back
years, including one relating to Enron.

Its ongoing litigation expenses are also hair-raising—$3.8 billion during the first nine months
of 2012, compared with $4.3 billion in the same period of 2011. Making comparisons with
other banks is difficult, as few quantify their potential exposure in the way that JPMorgan
Chase does. But most large international lenders face a similar raft of lawsuits and
investigations.

One bank boss says he now spends about half of his time dealing with regulatory and legal
issues, rather than meeting clients or running the business. Worse, the costs of pursuing the
banks for wrongdoing are difficult to contain: uncertainty over legal risks may make it harder
for them to attract capital, which would affect their capacity to lend. Only the late-night
lawyers will be happy with that.

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Prosecuting bankers
Blind justice

Why have so few bankers gone to jail for their part in the crisis?
May 4th 2013 |From the print edition, p. 63-65.

CRIME sometimes pays unusual social dividends. In 2010 São Paulo’s museum of modern art
hosted an exhibition of works that had been seized from a variety of crooks and drug
traffickers. Some of the art had belonged to the founder of a Brazilian bank, Banco Santos,
that had collapsed in 2005. After the bank’s liquidation Edemar Cid Ferreira lost his art
collection and his home, was convicted of “crimes against the national financial system” and
money-laundering, and sentenced to 21 years in jail.

For better or worse, many people would love to see more bankers behind bars for their role in
blowing up the West’s financial system. In Britain not one senior banker has faced criminal
charges relating to the failure of his institution. A handful have faced the lesser sanction of
being barred from running another bank or company, or agreeing in settlements with
regulators not to do so. (Policymakers have proposed introducing a “rebuttable presumption”
that the directors of a failed bank should be automatically barred from running another unless
they could prove they weren’t at fault.)

In America the Federal Deposit Insurance Corporation has filed over 40 lawsuits against
officers and directors of failed institutions since 2010; more actions are expected. But
prosecutors have brought few criminal charges against high-profile bankers. The American
government secured its first crisis-related conviction of a senior banker, a Credit Suisse
employee charged with mismarking mortgage-backed securities, only in April; Kareem
Serageldin will be sentenced in August.

The prosecutorial coyness of British and American authorities contrasts with the harder-
charging approach taken by their predecessors and by authorities elsewhere. During
America’s savings-and-loans (S&L) crisis in the 1980s more than 800 bankers were jailed. A
decade later directors of Barings, a British bank that was felled by the rogue trader Nick
Leeson, were barred from holding directorships despite having no direct connection to his
wrongdoing. Other countries, such as Iceland and Germany, have taken a more muscular
approach in this crisis (see table).

Some of these differences seem to be down to political will. In America the federal
government dedicated considerable resources to investigating fraud during the S&L crisis.
William Black, a professor at the University of Missouri at Kansas City and a former bank
regulator involved in charging S&L executives, has testified to lawmakers that regulators
have given the FBI scant help during the current crisis.

Iceland managed to assemble a dedicated team of more than 100 investigators who have won
convictions against executives in charge of Glitnir, a failed bank, and are bringing charges
against other high-profile bankers and businessmen, including the bosses of Iceland’s other
two big banks. In Spain the behaviour of some 90 former bank executives and board members
is under investigation. Dodgy deals with cronies, soft loans for themselves, allegedly irregular

Business Ethics 120

salary and pension packages, inflated golden handshakes and overgenerous fees for attending
rubber-stamp meetings are all being scrutinised.

There are also differences in the laws that can be applied. The main reason that American and
British regulators give for the paucity of prosecutions is that they have struggled to connect
wrongdoing lower down in the bank, such as the LIBOR scandal, to those running it. Another
is that it is generally not illegal to run a bank into the ground through incompetence (although
British and German policymakers are consulting on the introduction of criminal sanctions for
reckless management).

The threshold for getting bankers banged up is lower in some places than others, however.
Germany, Switzerland and Austria, for instance, have an elastic concept called Untreue, or
breach of trust, which is defined as a derogation of duty that causes real damage to the
institution. Since the crisis German prosecutors have charged bankers at firms including
WestLB, BayernLB, HSH Nordbank and Sal Oppenheim on offences including Untreue.

In Brazil, the law is stricter still. It holds banks’ executives and directors (and even their
controlling shareholders) personally liable to repay the debts of failed banks even where no
fault is proven. “The idea is really to put the management’s net worth at stake,” says José Luiz
Homem de Mello of Pinheiro Neto, a São Paulo law firm.

Yet imposing stricter standards of liability has costs. It would overturn a tradition in English
and American law in which courts avoid second-guessing business decisions that are honestly
made but wrong. Heinrich Honsell, a law professor, sees the use of Untreue recently in
commercial cases as a disturbing phenomenon. “It’s not right to criminalise negligent

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mistakes,” he says. “Very soon judges will be telling us how to manage risk.” Opponents of
the idea of a law against reckless management warn that the effect would be to discourage
risk-taking of any sort.

But if locking people up for incompetence goes too far, regulators could still get a lot tougher.
Summary justice isn’t desirable. Some justice is.

Corporate crime
The age of the whistleblower

Life is getting better for those who expose

wrongdoing, but companies continue to
fight back—often against their own
interests
Dec 5th 2015 | From the print edition, p. 55-57.

LISTEN carefully and you can hear the sound of corporate lawyers rummaging through dirty
laundry. Volkswagen, caught up in two devastating emissions scandals, is belatedly
embracing whistleblowers. Desperate to put the mess behind it, the carmaker set a deadline of
this week for employees to come forward with information, even if self-incriminating, in
return for avoiding dismissal or damages claims (but not protection from prosecution).
Whistleblowers have already played a part in exposing the company’s exaggerated claims on
carbon-dioxide emissions—though no one from within VW lifted the lid on its other scandal,
the fiddling of its vehicles’ output of nitrogen oxides during tests. That was uncovered by an
NGO, possibly with help from leakers in the European Commission.

As VW began to process the results of its amnesty, whistleblowers were making headlines
elsewhere, too. It was reported that Takata, a Japanese firm mired in scandal over defective
airbags, might have avoided the worst of its problems if it had paid more attention to

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American employees who rang alarm bells a decade ago. An investigation aired this week by
BBC Television alleged that British American Tobacco had bribed officials from a World
Health Organisation tobacco-control programme. Its conclusions were supported by
documents provided by a manager who had participated in the alleged palm-greasing. BAT
said it does not tolerate corruption.

Whistleblowing has been on the increase since the 2007-08 financial crisis sparked a
crackdown on corporate corruption and collusion. The number of tips received by the
“Whistleblower Office” of America’s Securities and Exchange Commission (SEC) has risen
steadily since it was opened in 2011, to nearly 4,000 a year. “We live in the age of the
whistleblower,” says Jordan Thomas, a former SEC official now at Labaton Sucharow, a law
firm. Surveys by the Association of Certified Fraud Examiners, a global group for financial
sleuths, consistently find tips to be the leading mechanism for unearthing wrongdoing, well
ahead of audits or regulatory reviews (see chart 1).

Despite this, companies have often punished rather than praised whistleblowers. “The
institutional equivalent of animal instinct is to strike back,” says Tom Devine, legal director
of the Government Accountability Project, who has worked with 6,000 whistleblowers in the
public and private sector since the 1970s.

Take the case of Paul Moore, who was sacked as head of regulatory risk at HBOS in 2004
after warning that the British bank was lending recklessly, and then took his complaints
public. The scrutiny that followed caused Mr Moore to battle depression and alcoholism; he
has said he “wouldn’t have had the courage to do it” if he had known the misery it would
cause. He was vindicated last month, with publication of a stinging official report on the
failures that led to the bail-out of HBOS. Partly in response to that debacle, Britain’s financial
regulator now insists that the firms it oversees explicitly tell staff they can complain directly
to regulators, and that they nominate a senior manager as a “whistleblower’s champion”.

According to one recent study, Britain is the third-best of the G20 large economies in terms of
legal protection for whistleblowers (see chart 2). Enforcement of laws matters, too, of course.
Few would say Turkey is a kinder climate for whistleblowers than Canada, which has weaker
protections but applies them more assiduously. Europe is “where the action is” when it comes
to improving protections, says Mr Devine. What has helped is a strong set of “best practice”
guidelines from the Council of Europe, a club of 47 western and eastern European states, as
have pro-whistleblower rulings from the council’s judicial arm, the European Court of Human
Rights. Newer entrants to the 28-country European Union, such as Romania, had to adopt
high standards as a condition of joining. The situation among older members is patchier.
Protections are particularly weak in Germany, where whistleblowers who go public after
failing to get a response internally face defamation suits, says Anja Osterhaus of

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Transparency International. Non-EU Switzerland is another with an unforgiving climate (see
article).

America is the best place for whistleblowers. The SEC’s programme, created by the Dodd-
Frank financial-reform act of 2010, is arguably the strongest of the more than 40 federal
whistleblower-friendly laws on the books. It rests on three pillars: job protection, anonymity
and bounties. It has handed out 22 awards, averaging $2.5m; these can rise to 30% of any
fines that get levied on the employer. Though the programme is not marketed abroad, it has
taken on a global hue: tips have come in from 96 countries, and several of the awards have

Business Ethics 124

gone to foreigners. In October a court ruled that whistleblowers can sue individual board
members as well as the firm, if these were personally involved in any mistreatment of them.

America is not always kind to whistleblowers. It has given some public-sector and national-
security leakers a torrid time. And it sometimes acts inconsistently. Bradley Birkenfeld, who
provided American authorities with vital information about Swiss banks and their tax-evading
clients, won a (taxable) $104m award from the IRS. But the Department of Justice prosecuted
him. His 66 months of prison and probation ended on November 28th.

Europeans have debated but so far rejected the idea of American-style bounties. “The
mentality here is different,” says a London-based lawyer. “The Wild West, bring-me-the-head
approach would undermine rather than bolster support” for whistleblowers. The SEC has
admitted to having a problem with “serial submitters”, who file dozens of spurious claims in
the hope that one will lead to a payout.

Though official encouragement of whistleblowers is growing, corporate retaliation remains a

problem. Of those who report internally first, the number who perceive that they suffered
retribution has been steady at around 20% since 2011 and is higher than in 2007, according to
America’s National Business Ethics Survey.

The confidentiality agreements that many firms ask employees to sign are another
disincentive. Examples include preventing them from consulting outside lawyers, requiring
notice before they report anything to an outside body and demanding waivers of any future
whistleblower awards. In one survey almost a fifth of respondents felt their employer’s
confidentiality policies obstructed the reporting of potentially illegal activity to law enforcers.

In America, such agreements are legal unless they are designed to stifle whistleblowing, as
opposed to, say, protecting trade secrets. The SEC considers this area a priority and this year
brought its first cases against firms deemed to have gagged or retaliated against workers.
Among those fined was KBR, an engineering group, for making staff sign agreements which
said they could be sacked if they discussed an internal investigation with outside parties
without the firm’s approval. “The SEC has sent a strong message about restrictive language. It
isn’t messing around,” says Mr Thomas. But Mr Devine fears that companies are growing
more creative in how they craft agreements to sidestep restrictions. “If there’s one thing I’ve
learnt in over 30 years, it’s that it is fatal for whistleblowers’ legal rights to remain static,” he
says.

Ideally, firms would put in place a formal system for hearing and noting complaints—for their
own sakes, as well as those of whistleblowers. When people fail to report wrongdoing, the
main reason is often not the fear of retaliation but the suspicion that nothing will be done
about it. Companies often see whistleblowers as motivated by revenge or greed. But studies
consistently show that most are driven to right a wrong. That is why more than 90% of them
sound the alarm internally first, rather than running straight to the authorities or newspapers.
Given the choice, they would rather warn than accuse.

So, to stifle whistleblowing is to harm the business. Bad news tends to come out eventually,
and looks worse if it appears that bosses tried to suppress it. Apart from which, wrongdoing is
less likely to occur in the first place if employees know that their bosses are more inclined to
hug a whistleblower than to put him in a headlock.

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Whistleblowers
A $64m question

A new sort of investment coup

Mar 15th 2014 | NEW YORK | From the print edition, p. 65.

IT IS still possible for the little guy to make a fortune on Wall Street. Keith Edwards had a
miserable five-year run at JPMorgan Chase before being sacked in 2008. His title, assistant
vice-president, straddles the lowest ranks of management and for much of his tenure,
according to court documents, his supervisors were displeased with his work and ignored his
suggestions.

Although this would normally not be a formula for financial success, recent years have not
been entirely normal. On March 7th, in a filing with a federal court in Manhattan, it was
disclosed that Mr Edwards would receive $63,870,000 because of his role as a “relator” of
key facts leading to JPMorgan paying $614m to settle violations of the False Claims Act, a
statute designed to protect the government from fraud.

Neither the formula used to determine the overall settlement nor the one used to determine Mr
Edwards’s share of it was disclosed. He may even be aggrieved he did not get more, given
that informers often receive in excess of 15%. But others may be luckier: Mr Edwards’s
lawyer, David Wasinger, is now in the final phase of another whistleblower case that led to a
guilty verdict in October for mortgage fraud against Bank of America. The government is
seeking $2.1 billion in penalties. Mr Wasinger’s client could be in line to receive hundreds of
millions of dollars as his part of the settlement (Bank of America is arguing that a more
reasonable number would be zero).

The largest impact of the Edwards settlement could be to open up the area to more cases, with
the payout inspiring both employees and plaintiff law firms, says Anthony Casey, a professor
at University of Chicago Law School. The time lag since the financial crisis would ordinarily
curtail many legal actions, but the normal limitations are suspended while America is at war,
which has been true since the invasion of Afghanistan in 2001.

Making a false-claims case requires the direct involvement of the government in the business.
There has been no shortage of that in the housing market, where various federal agencies
provide insurance against borrower default. The Edwards cases revolved around mortgages
issued by JPMorgan that were guaranteed by the Department of Housing and Urban
Development through the Federal Housing Authority (FHA), and by the Department of
Veterans Affairs. Thanks to this government backing, the mortgages could carry a lower
interest rate than would have been demanded in private markets, given the riskiness of the
borrowers.

One-third of all new mortgages were covered by the FHA alone, according to the complaint.
Banks would originate these mortgages and certify their appropriateness for insurance, and
then provide documentation to the responsible government agencies. The Justice Department
argued that the data it received were flawed, and had been for more than a decade. Mr
Edwards helped its case by supplying observations drawn from his tenure.

Business Ethics 126

The intention of mortgage insurance was to provide credit to vast numbers of people at terms
a private market would find unreasonable. The result was a system overseen badly for years
by public bureaucracies. Ideally, this system would have been on trial along with JPMorgan.
Instead, the message of Mr Edwards’s experience is that the larger the failure, the larger the
payday.

Schumpeter

The corruption eruption

Saying “no” to corruption makes commercial as well as ethical
sense
Apr 29th 2010 | From The Economist print edition

IT IS 15 years since Moisés Naím coined the memorable phrase “corruption eruption”. But
there is no sign of the eruption dying down. Indeed, there is so much molten lava and
sulphurous ash around that some of the world’s biggest companies have been covered in it.
Siemens and Daimler have recently been forced to pay gargantuan fines. BHP Billiton, a giant
mining company, has admitted that it may have been involved in bribery. America’s
Department of Justice is investigating some 150 companies, targeting oil and drugs firms in
particular.

The ethical case against corruption is too obvious to need spelling out. But many companies
still believe that, in this respect at least, there is a regrettable tension between the dictates of
ethics and the logic of business. Bribery is the price that you must pay to enter some of the
world’s most difficult markets (the “when in Rome” argument). Bribery can also speed up the
otherwise glacial pace of bureaucracy (the “efficient grease” hypothesis). And why not? The
chances of being caught are small while the rewards for bending the rules can be big and
immediate.

When in Rome, behave like a Swede

But do you really have to behave like a Roman to thrive in Rome? Philip Nichols, of the
Wharton School, points out that plenty of Western firms have prospered in emerging markets
without getting their hands dirty, including Reebok, Google and Novo Nordisk. IKEA has
gone to great lengths to fight corruption in Russia, including threatening to halt its expansion
in the country, firing managers who pay bribes and buying generators to get around grasping
officials holding up grid connections. What is more, Mr Nichols argues, it is misguided to
dismiss entire countries as corrupt. Even the greasiest-palmed places are in fact ambivalent
about corruption: they invariably have laws against it and frequently produce politicians who
campaign against it. Multinationals should help bolster the rules of the game rather than
pandering to the most unscrupulous players.

And is “grease” really all that efficient? In a paper published by the World Bank, Daniel
Kaufmann and Shang-Jin Wei subjected the “efficient grease” hypothesis to careful scrutiny.
They found that companies that pay bribes actually end up spending more time negotiating
with bureaucrats. The prospect of a pay-off gives officials an incentive to haggle over
Business Ethics 127
regulations. The paper also found that borrowing is more expensive for corrupt companies,
probably because of the regulatory flux.

The hidden costs of corruption are almost always much higher than companies imagine.
Corruption inevitably begets ever more corruption: bribe-takers keep returning to the trough
and bribe-givers open themselves up to blackmail. Corruption also exacts a high
psychological cost on those who engage in it. Mr Nichols says that corrupt business people
habitually compare their habit to having an affair: no sooner have you given in to temptation
than you are trapped in a world of secrecy and guilt. On the other hand, the benefits of
rectitude can be striking. Texaco, an oil giant now subsumed by Chevron, had such an
incorruptible reputation that African border guards were said to wave its jeeps through
without engaging in the ritual shakedown.

Moreover, the likelihood of being caught is dramatically higher than it was a few years ago.
The internet has handed much more power to whistle-blowers. NGOs keep a constant watch
on big firms. Every year Transparency International publishes its Corruption Perceptions
Index, its Bribe Payers Index and its Global Corruption Barometer.

The likelihood of prosecution is also growing. The Obama administration has revamped a
piece of post-Watergate legislation—the Foreign Corrupt Practices Act (FCPA)—and is using
it to pursue corporate malefactors the world over. The Department of Justice is pursuing far
more cases than it ever has before: 150 today compared with just eight in 2001. And it is
subjecting miscreants to much rougher treatment. Recent legislation has made senior
managers personally liable for corruption on their watch. They risk a spell in prison as well as
huge fines. The vagueness of the legislation means that the authorities may prosecute for
lavish entertainment as well as more blatant bribes.

America is no longer a lone ranger. Thirty-eight countries have now signed up to the OECD’s
1997 anti-corruption convention, leading to a spate of cross-border prosecutions. In February
Britain’s BAE Systems, a giant arms company, was fined $400m as a result of a joint British
and American investigation. Since then a more ferocious Bribery Act has come into force in
Britain. On April 1st Daimler was fined $185m as a result of a joint American and German
investigation which examined the firm’s behaviour in 22 countries.

Companies caught between these two mighty forces—the corruption and anti-corruption
eruptions—need to start taking the problem seriously. A Transparency International study of
500 prominent firms revealed that the average company only scored 17 out of a possible 50
points on “anti-corruption practices” (Belgium was by far the worst performing European
country). Companies need to develop explicit codes of conduct on corruption, train their staff
to handle demands for pay-offs and back them up when they refuse them. Clubbing together
and campaigning for reform can also help. Businesses played a leading role in Poland’s Clean
Hands movement, for example, and a group of upright Panamanian firms have formed an
anti-corruption group.

This may all sound a bit airy-fairy given that so many companies are struggling just to survive
the recession. But there is nothing airy-fairy about the $1.6 billion in fines that Siemens has
paid to the American and German governments. And there is nothing airy-fairy about a spell
in prison. The phrase “doing well by doing good” is one of the most irritating parts of the
CSR mantra. But when it comes to corruption, it might just fit the bill.

Business Ethics 128

Bribery
Graft work

A new study lights up the shadows

Dec 6th 2014 | From the print edition, p. 62.

GONE are the days when multinationals could book bribes paid in far-flung countries as a
tax-deductible expense. These days would-be palm-greasers have to contend with ever-
tougher enforcement of old laws, such as America’s Foreign Corrupt Practices Act of 1977,
and a raft of new ones in countries from Britain to Brazil.

As policing is stepped up, however, much about the practice of bribery remains murky. The
OECD’s first report on the subject, published on December 2nd, sheds some light by
analysing more than 400 international bribery cases that have been brought since the anti-
bribery convention of this group of mostly rich countries came into force in 1999.

Some findings confirm what was known or suspected. The most briberiddled sectors are oil,
gas, mining, construction and transport. At the other end of the spectrum, financial services
and retailing are fairly clean. Most bribes go to managers of state-owned companies, followed
by customs officials. And America leads the enforcement pack, with 128 cases that resulted in
sanctions (see chart).

But the report also undermines some common beliefs. Bribery is not a sin of rogue employees
or poor countries. In 53% of cases payments were made or authorised by corporate managers
(and in 12% of them by the chief executive). More than 40% of the time, the bribe-taking
official was in a developed country (though this figure is probably inflated by rich countries’
greater willingness to criminalise bribery and co-operate with cross-border investigations).
Authorities are often alerted by firms themselves: those that co-operate quickly are often
treated leniently.

Business Ethics 129

Nevertheless, the cleanest countries tend to be rich, and the dirtiest poor. Four of the five best-
performing countries in Transparency International’s latest corruption-perceptions index, also
published this week, were Nordic. The worst were North Korea and Somalia. (Interestingly,
China’s score slipped despite a recent high-profile campaign against corrupt officials.)

The cost of bribery varies by industry. Builders pay a modest average of 4% of a transaction’s
value, extractive companies a hefty 21%. Add to that the rising costs of paying penalties and
conducting internal probes—these cost Siemens, for example, $2.4 billion when it was mired
in a graft scandal a few years ago—and bribery starts to look bad not just for reputations, but
also for bottom lines.

Even for firms that are not caught, the business case for bribery is far from clear. A 2013
study by Harvard Business School and America’s National Bureau of Economic Research
found that what bribe-paying companies gain in higher sales in corrupt countries, they lose in
lower profit margins. According to the OECD, the average bribe costs 11% of the
transaction’s value and 35% of associated profits.

Nevertheless, graft remains alive and well. One of the OECD report’s authors told a
conference this week that 390 cases are under investigation—not far short of the total number
resolved since the OECD convention took effect 15 years ago. The number of cases
concluded each year has dipped since a peak in 2011 as the time taken to complete
investigations and prosecutions has climbed to more than seven years, from under four in
2008.

One possible reason for the slowdown is that bribery techniques are growing more
sophisticated and thus harder to detect. Another could be the widespread use of opaque
corporate structures to conceal wrongdoing. These can be devilishly difficult to unpick,
especially when they are stacked in several layers and fronted by nominee directors.
Anonymous shell companies and other intermediaries—sometimes dressed up as
“consultants”—were used to move or to house payments in more than 70% of cases. The
OECD report underlines the importance of cracking down on the misuse of shell companies
and enforcing more clarity over ownership of companies and trusts, whether through
accessible corporate registers—a move being pushed by some G20 countries, led by Britain—
or by tougher regulation of service providers that do the paperwork for new firms.

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Corporate bribery
The anti-bribery business

As the enforcement of laws against

corporate bribery increases, there are risks
that it may go too far
May 9th 2015 | From the print edition, p. 58-59.

EVEN for a company with Walmart’s heft, $800m is a sizeable sum. That is what the giant
retailer will have spent by the end of this fiscal year on its internal probe into alleged bribing
of Mexican officials, into whether subsidiaries elsewhere may have been greasing palms and
on related compliance improvements. By the time bribe-busters at America’s Department of
Justice (DOJ) are done with their own investigation, which began in 2012, Walmart’s bill for
lawyers’ and forensic accountants’ fees will be well above $1 billion—and perhaps closer to
$2 billion. To that can be added whatever fines it may incur, any bills for settling related
private litigation, and the harder-to-quantify cost of the tens of thousands of man-hours
managers have spent on what has become a big distraction from everyday business.

The case is not trivial, to be sure. It involves suspicions that bribes were paid to clear the way
for construction of dozens of new stores and warehouses, thus helping Walmart to outflank
competitors. The case has been widened to include the granting of permits in China, Brazil
and India. There should be no complaint that such cases are being scrutinised closely: the
corrosive effects of bribery, in eroding trust in government and dampening innovation, are
well documented. Nevertheless, some see the expensive and time-consuming Walmart case as
part of a mounting body of evidence that the war on commercial bribery is being waged with
excessive vigour, forcing companies to be overcautious in policing themselves. Some of those
under investigation are starting to push back.

Business Ethics 131

Until a decade ago, giving bribes to win business or speed up transactions was widely seen as
a necessary evil, especially in emerging markets. In parts of Europe, companies were even
allowed to deduct kickbacks they had paid against tax. But anti-bribery enforcement has been
transformed since the early 2000s, when NGOs started to raise a stink and America stepped
up use of its Foreign Corrupt Practices Act (FCPA).

This law was passed in 1977, but in its first quarter-century it was largely ignored by
prosecutors. As recently as 2007, the largest fine under the FCPA was less than $50m. Now
the worst offenders pay 10-15 times that. Foreign firms, if they have a presence in America,
can also be caught in its prosecutors’ net. Alstom, a French industrial group, paid up $772m
last year in the largest FCPA criminal penalty to date, after allegations it had spent $75m on
bribes in countries including Egypt and Indonesia. 2014 was a record year for FCPA penalties
(see chart 1). This year is shaping up to be busy too, as new fronts are opened up to probe, for
instance, the hiring by banks of “princelings” (relatives of important Chinese officials).

Though America remains the toughest enforcer, in the past few years other countries have
started to flex their muscles (see chart 2). This second group includes Germany, South Korea
and Britain, which consolidated and improved upon a hotch-potch of previous legislation with

Business Ethics 132

its Bribery Act of 2010. Brazil has passed a new law and is using it to go after firms caught up
in the Petrobras scandal. China’s anti-corruption drive under Xi Jinping has ensnared GSK, a
British drugmaker. It was found guilty last year of using travel agencies to create bribery
slush funds and fined $490m—though local managers got away with suspended sentences
because the company showed remorse.

Enforcement remains patchy. In much of Africa, relevant laws (if they even exist) are
unenforced. Around half of the 41 signatories to the OECD’s anti-bribery convention have yet
to impose any sanctions. But there is no doubt about the direction of change. As the chance of
wrongdoing being detected grows, so does the chance of the investigation being “messy and
multi-jurisdictional”, with several countries looking for redress, says Crispin Rapinet of
Hogan Lovells, a law firm.

Business Ethics 133

The costs can keep coming in after a company has paid for an investigation and a settlement
to prosecutors. Increasingly, firms are required to bear the cost of being overseen for several
years by an independent compliance monitor. Firms that have recently been involved in
bribery investigations may also be excluded from procurement processes, may suffer a higher
cost of capital (large fines can trigger credit-rating and loan-facility reviews), and be hit by
shareholder lawsuits.

Siemens, a German industrial group, has spent more than $3 billion on bribery-related fines
and costs since 2008. Its compliance department has ballooned from a handful of people to
more than 400. Avon, an American cosmetics company caught bribing in China, spent nearly
$350m on a variety of legal and compliance fees, more than double the penalties it incurred,
and not far short of its 2014 operating profit. At worst, the overall financial consequences can
be more than ten times the settlement a firm agrees to pay prosecutors, calculates Mike
Koehler of Southern Illinois University, who writes the “FCPA Professor” blog.

The huge amount of work generated for internal and external lawyers and for compliance staff
is the result of firms bending over backwards to be co-operative, in the hope of negotiating
reduced penalties. Some are even prepared to waive the statute of limitations for the
conclusion of their cases. They want to be sure they have answered the “Where else?”
question: where in the world might the firm have been engaging in similar practices?

In doing so, businesses are egged on by what Mr Koehler calls “FCPA Inc”. This is “a very
aggressively marketed area of the law,” he says, “with no shortage of advisers financially
incentivised to tell you the sky is falling in.” Convinced that it is, the bosses of accused
companies will then agree to any measure, however excessive, to demonstrate that they have
comprehensively answered the “Where else?” question. So much so that even some law
enforcers have started telling them to calm down. Last year Leslie Caldwell, head of the
DOJ’s criminal division, said internal investigations were sometimes needlessly broad and
costly, delaying resolution of matters. “We do not expect companies to aimlessly boil the
ocean,” she said.

Her words have provided scant comfort: defence lawyers say that their clients feel that if they
investigate problems less exhaustively, they risk giving the impression that they are
withholding information. Some say the DOJ is maddeningly ambiguous, encouraging firms to
overreact when allegations surface. It does not help that it has cut its staff-training on how to
run such complex cases.

Partly as a result of this, and partly because bribery schemes are growing more sophisticated
as law enforcers up their game, cases are taking much longer to resolve than they used to. Big
ongoing cases, such as those of Alstom and Walmart, may stretch for up to ten years; in
contrast, that of Siemens, the giant case of the past decade, took under three. In a recent article
Paul Pelletier, formerly a senior prosecutor, argued that the DOJ’s processing of cases has
become so drawn out that it now oversees a bribery “sinkhole”.

Others worry that the America-centred model that has emerged for resolving international
bribery cases fails to deliver justice. More than four-fifths of FCPA cases against companies
since 2010 have been settled with deferred-prosecution or non-prosecution agreements—that
is, out-of-court settlements in which the prosecution’s case does not undergo the scrutiny of a
judge. In the law’s 38 years, only one case against a public company has gone to trial. When
settlements are announced, there is often sparse detail, and thus little on which to build a body
of case law.

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Surely companies with a strong defence would refuse to roll over and settle? Not necessarily.
Even those that do have a good case are scared to fight and risk a criminal indictment that
would clobber their share price. It is commercially rational to roll over, all the more so given
how severely any failure to co-operate is punished. Ask Marubeni of Japan, whose coyness
towards the DOJ led to its being forced to plead guilty and pay an elevated fine. This hands
prosecutors a lot of discretion. “The FCPA often means what enforcement agencies say it
means,” says Mr Koehler. “We have only a façade of enforcement.” That matters all the more
since other countries are copying the American approach: Britain, for instance, has allowed
deferred-prosecution agreements since 2013.

Some companies are starting to resist prosecutors’ expansive legal interpretations. Wall Street
bankers have recently locked horns with government agencies over their reading of the
FCPA’s stance on hiring relatives of senior officials in China. The moneymen dispute the
claim that hiring someone with the intent of winning business could itself be illegal.

In the few cases where matters do reach court, the results are mixed. Last year a federal court
approved the DOJ’s broad definition of “foreign official”, to include some managers at partly
state-owned firms. However, another court dismissed an indictment against two Ukrainians,
in a case in which the only American link was the tangential involvement of a federal agency.
The judge said he had never seen a more misguided prosecution, and accused the DOJ of
foolishly trying to play bribery policeman to the world. In 2013 Britain’s Serious Fraud Office
suffered several embarrassing setbacks in court, including the collapse of a case against
Victor Dahdaleh, a billionaire who had been charged with paying bribes to Bahraini officials
on behalf of Alcoa, an American firm.

Such occasional defeats show that bribery cases, which rely on tracking international paper
and money trails, can still be hard to build. But more countries are trying, which means that
firms under investigation will increasingly find themselves pursued from several directions.

Different countries will not necessarily take each other’s penalties into account. Even allies
like America and Britain are not beyond conducting duplicative probes, as Alstom can attest.
Nathaniel Edmonds, a former government FCPA lawyer now with Paul Hastings, a law firm,
does not think enforcement has gone too far. But he accepts that it can be “extraordinarily
difficult [for firms] when numerous governments are involved, with sometimes competing
interests.” Klaus Moosmayer, chief compliance officer of Siemens, says the lack of co-
ordination in cross-border investigations is “a huge challenge” for business. “The largest
multinationals will always have the occasional case of suspected bribery. They need
reassurance that if they disclose it they won’t be punished twice.”

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Bribery
Daft on graft

A hard line on commercial bribery is right.

But the system is becoming ridiculous
May 9th 2015 | From the print edition, p. 14.

IN 2008 Siemens, a German conglomerate, was fingered for handing out bribes in emerging
markets. It has since spent a staggering $3 billion on fines and internal investigations to atone
for its sins. Half of that has gone to advisers of one sort or another. Walmart, an American
retailer, will soon have spent $800m on fees and compliance stemming from a bribery
investigation in Mexico. The most complex bribery probes used to take three years. Now they
last an average of seven.

In recent years lots of big economies, from Britain to Brazil, have followed America’s lead in
tightening anti-bribery enforcement (see article). Offences that once drew a slap on the wrist
now attract fines in the hundreds of millions of dollars as well as prison terms for palm-
greasing managers. It is right that bribery should be punished. The economic effects of graft
are insidious. Bribery distorts competition and diverts national resources into crooked
officials’ offshore accounts. But the cost and complexity of investigations are spiralling
beyond what is reasonable, fed by a ravenous “compliance industry” of lawyers and forensic
accountants who have never seen a local bribery issue that did not call for an exhaustive
global review; and by competing prosecutors, who increasingly run overlapping probes in
different countries.

To stop a descent into investigative madness, enforcement needs to be reformed in four ways.
First, regulators should rein in the excesses of the compliance industry and take into account
the cost to firms of sprawling investigations. When firms admit to having uncovered bribery
among their managers, regulators expect them to investigate themselves. The authorities
should tell them what level of investigation they want so that companies are not overzealous
out of fear of seeming evasive. This is slowly starting to happen, with officials telling firms
they should not “aimlessly boil the ocean”.

Second, governments should lower costs by harmonising anti-bribery laws and improving co-
ordination between national probes. The OECD, whose anti-bribery convention has gained
wide acceptance, is the natural body to lead this effort.

More justice, please

Third, more cases should go to court. Too often, prosecutors strong-arm firms into agreeing to
settlements based on controversial legal theories (one being peddled by American law
enforcers is that hiring relatives of well-connected officials counts as bribery). Taking such
matters to court would have the advantage of establishing clear precedents. When firms are
loth to go to trial, because they are worried about the financial costs of a criminal charge, the
terms of settlements should at least undergo more judicial scrutiny.

Business Ethics 136

Lastly, anti-bribery laws should be amended to offer companies a “compliance defence”. If
firms can show that they had sound anti-bribery policies, that they were making reasonable
efforts to uphold them, that the wrongdoing did not involve senior managers and that they
came forward to the authorities promptly, the penalties should be greatly reduced.

As corrosive as bribery is, the response must be proportionate. Investigations that drag on are
a waste of management and public resources. The starting-point for up to half of all cases is a
firm’s voluntary disclosure, but if costs continue to rise then firms may be more tempted to
bury their bad news. Anti-corruption campaigners would have nothing to cheer if the cure
ended up being more harmful than the disease.

Corruption and natural resources

A fight for light

NGOs and governments grapple over

ownership of mining and energy firms
Oct 24th 2015 | From the print edition, p. 61.

WHETHER the awarding of a licence, the sale of state production quotas or some other
transaction, dealings in oil, gas and mining are notoriously prone to corruption. This is a
problem in countries that have weak rule of law and rely heavily on extractive industries. Sub-
Saharan Africa is particularly at risk: its ten largest oil-producing states derived 56% of their
public revenues from oil exports in 2011-13.

Light is the best disinfectant, say anti-corruption campaigners—and many think the best hope
for greater transparency lies with an emerging global standard known as the Extractive
Industries Transparency Initiative (EITI), which has grown to include 48 members (either
compliant or candidate countries) since it was formed 12 years ago. But the EITI has reached
a crossroads: it must now choose either to push ahead with bold disclosure requirements first
floated in 2013, or back away under pressure from those who argue that revealing the true
(“beneficial”) owners of companies involved in extractive deals with the state is tricky. This
was to be discussed at a gathering of the EITI’s “multi-stakeholder” board—including
representatives from NGOs, companies and governments—which was due to finish on
October 22nd, after The Economist went to press.

Tracking ownership is important because opaque shell companies are the vehicle of choice for
those seeking to divert public oil wealth into private pockets. In a ground-breaking move two
years ago EITI members agreed that from 2016 private firms making or receiving payments in
extractive industries should be required to disclose their ownership. This put the EITI at the
front of a global push to reveal more about who is behind shady firms.

After testing this requirement in 11 countries, the EITI must now decide whether to extend it
to all members. Everyone agrees the pilot was only a partial success, but not on why.
Campaigners say information was often not gathered because disclosure was, in practice,

Business Ethics 137

more encouraged than required. Governments retort that getting to the bottom of who really
controls firms whose registered owner is another obscure company or a three-year-old child
can be devilishly difficult.

Whatever the reason, pro-transparency groups say the EITI urgently needs to make public
disclosure of ownership a condition of membership, with the threat of suspension for
countries that drag their feet. The campaigners fear that if the 2016 deadline is allowed to
drift, transparency will become less of a priority. The EITI faces a “credibility test”, says
Brendan O’Donnell of Global Witness, an NGO.

Another worry is that back-pedalling will encourage countries to use the EITI as a figleaf. A
new report by Global Witness details how in recent years $4 billion was siphoned off to
opaque companies, some of them linked to current or former officials, in just a handful of
deals in four African countries: Nigeria, Angola, the Democratic Republic of Congo and
Congo-Brazzaville. Three of the four are full members of the EITI.

Congo-Brazzaville hosted the last EITI board meeting, in April. Yet secrecy continues to
surround the beneficiaries of companies profiting from its oil wealth. Some fear that the
situation has not improved much since 2005, when a British court ruled that AOGC, a firm
that had bought cargoes at below-market rates from the national oil company, SNPC, was
owned and controlled by the then director-general of the SNPC, Denis Gokana. This
arrangement was ostensibly to disguise the state’s interest and avoid claims by sovereign-debt
holders.

Mystery continues to surround firms involved in key deals, including three joint-ventures
between SNPC and the 88 Queensway Group, a Hong Kong-based outfit that has brokered
many Chinese-backed energy deals in Africa (and whose presumed head, Sam Pa, was
detained recently in Beijing). The firms were reportedly set up to sell Congolese oil in Asia.
Global Witness found that their directors include Mr Gokana and Denis Christel Sassou
Nguesso, a son of the president who has held various positions in the national oil industry.
Though the opacity of these arrangements raises questions, there is no evidence of
wrongdoing.

Clare Short, who chairs the EITI board, says the initiative has greatly increased the flow of
information about payments to and by governments in just a decade. But she acknowledges
that progress can be painfully slow at times, with the risk of setbacks. The broad composition
of the EITI’s board ensures that “conflict is entrenched in the very model”, she sighs. The
fight to shine more light on oily deals goes on.

Whose are the dirtiest hands?

Business Ethics 138

Corruption in Latin America
Democracy to the rescue?

Despite an epidemic of scandal, the region is

making progress against a plague
Mar 14th 2015 | BUENOS AIRES, LIMA, MEXICO CITY AND SÃO PAULO | From the
print edition, p. 42-44.

WHEN Dilma Rousseff, Brazil’s president, delivered a televised speech to mark International
Women’s Day on March 8th, it was almost impossible to hear her in some districts.
Thousands of middle-class Brazilians drowned her out by banging pots and pans, a traditional
way to show dissent in neighbouring countries. Brazil’s panelaço is new.

Brazilians have plenty to grumble about, from a stagnant economy to fiscal austerity, but the
pot-bangers’ main grievance is the scandal at Petrobras, a state-controlled oil giant. On March
6th a Supreme Court judge agreed to open investigations into 34 sitting politicians, including
the speakers of both houses of Congress, whom a prosecutor suspects of participating in a
multi-billion-dollar bribery scandal. All but two are allied with Ms Rousseff’s ruling
coalition. She was not on the list, but she was Petrobras’s chairman in the mid-2000s, when
much of the alleged corruption took place. On March 15th Brazilians plan rallies across the
country to demand her impeachment.

Brazil’s disquiet is not unique in Latin America. In Mexico the disappearance of 43 students
in the southern state of Guerrero, and their apparent murder by drug-traffickers in league with
police, have sparked protests since September. Revelations of a housing deal between the wife
of the president, Enrique Peña Nieto, and a company linked to a businessman who won
government contracts added to the fury about corruption; the finance minister has been
similarly embarrassed.

Allegations that Argentina’s president, Cristina Fernández de Kirchner, and her late husband,
Néstor Kirchner, who preceded her as president, enriched themselves during a dozen years in
power, have brought out the pot-bangers, too. She denies wrongdoing. The son of Chile’s
president, Michelle Bachelet, recently quit as head of a state charity over accusations of
influence peddling. Her popularity has dropped to its lowest level since she returned to power
a year ago.

Resistance to corruption in Latin America has a long and largely futile history. Antonio de
Ulloa, a naval captain, tried and failed in the 1750s to eradicate fraud at a mercury mine in the
Andean town of Huancavelica. Corrupt leaders have been ousted in the democratic era
without much effect on corruption itself. Hugo Chávez’s fulminations against it in Venezuela
helped his rise to power; under his “Bolivarian” regime it worsened. The jailing of Alberto
Fujimori, under whom the Peruvian state became a criminal enterprise, did not purge the
country. His system has been dismantled, but “scale models” of it persist at regional level,
says José Ugaz, a Peruvian lawyer who is chairman of Transparency International, a Berlin-
based NGO.

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Yet in today’s scandals, and the indignation they have aroused, lie hopeful signs. The
unrelenting pursuit of executives and politicians responsible for the Petrobras scandal (the
petrolão) shows that Brazil’s judicial institutions are functioning as they should. In Mexico
Congress is pushing through anti-corruption reforms. There are promising experiments in
Central America. Latin America’s young democracies may be starting to get to grips with one
of their worst and most enduring problems.

The viceroys of the colonial era set the pattern. They centralised power and bought the loyalty
of local interest groups. “In Peru abuse starts with those who ought to correct it,” wrote Ulloa
and a collaborator in 1749. Caudillos, dictators and elected presidents continued the tradition
of personalising power. Venezuela’s chavismo and the kirchnerismo of Ms Fernández are
among today’s manifestations.

This is a damaging pedigree. Though Latin America is a middle-income region, two-thirds of

its countries come in the bottom half of Transparency International’s “corruption perceptions
index”. In South America only Chile and Uruguay stand out from the dismal regional norm
(see map), perhaps partly because in colonial times they were backwaters; Costa Rica is the

Business Ethics 140

Central American exception. Even more corrupt countries have islands of integrity: Mr Ugaz
points to Peru’s central bank and tax-collection authority.

Anatomy of vice

Graft is hydra-headed and has multiple causes. Presidents who plunder make the biggest
headlines. But presidential misbehaviour can take the milder forms of conflict of interest (as,
apparently, in the case of those Mexican houses) or nepotism. Such temptations extend to
anyone in authority, especially if, as is often the case, he or she is ill trained and badly paid. A
fifth of Latin Americans report having paid a bribe over the course of a year, most often to the
police. Colombia’s anti-corruption tsar, Camilo Enciso, says that no sector of the country is
untouched by corruption.

The costs are hard to quantify, but surely immense. In 2010 FIESP, the industry federation of
São Paulo state, estimated that corruption cost 1.4-2.3% of GDP every year. In Peru stolen
public money adds up to 2% of GDP, says Ana Jara, the prime minister. Almost a fifth of
businessmen think corruption is the main obstacle to doing business in Mexico, says the
World Economic Forum. Paying bribes for basic services such as water supply makes the
poor even poorer. In Mexico it eats up a quarter of their income, according to one estimate.
Richer folk pay fixers, such as Brazil’s despachantes and Argentina’s gestores, to get things
done. Popular anger at corrupt officialdom can become hostility toward democracy itself.

Many Latin America watchers assumed that democratisation and the market reforms that
began in the 1980s would curb corruption. Instead, they provided new opportunities for it.
Democracy gave rise to parties hungry for donations and politicians eager to reap the rewards
of elected office. In Mexico, it brought an “out of control [corruption] booze-up”, wrote Luis
Carlos Ugalde, a consultant, in Nexos, a magazine. In Brazil, where entire states count as
single constituencies, campaigns are ruinously expensive. Candidates spent 4.1 billion reais
($1.3 billion) in last year’s state and national elections, not counting the race for the
presidency. Campaign-finance laws are riddled with loopholes. In Chile donors are meant to
give money through an agency that hides their identities from the candidate. But within the
country’s small elite, such secrets leak out. Surveys find that political parties are Latin
America’s least trusted institutions.

Economic reform also incited graft. Proceeds from the privatisation of state companies
enriched ruling cliques in Argentina and paid for social spending aimed at supporters of ruling
parties in Peru and Mexico. The commodities boom of the early 2000s brought more money
and more ways of pilfering it. The petrolão would not have been so huge without the rise in
oil prices of the past 15 years. Even more destructive was an upsurge in drug-trafficking from
the 1980s, which implanted the idea that everyone, from policemen and judges to ministers
and presidents, “has a price”, says Mr Enciso. Torrents of new money, from both legitimate
and illicit sources, greatly increased what Mr Ugaz calls “grand corruption”.

Many Latin Americans have long shrugged their shoulders, which has made corruption harder
to stamp out. Rouba, mas faz (he steals but he acts), say Brazilians indulgently of politicians
who leaven their greed with efficiency. Campaigning to be mayor of San Blas, a town on
Mexico’s Pacific coast, Hilario Ramírez Villanueva admitted at a rally last year that in an
earlier term in office “I did steal, but only a little.” Besides, he added, “I gave back with the
other hand to the poor.” He was elected, and celebrated by throwing banknotes to supporters.

Business Ethics 141

This is discouraging. But there are signs that corruption’s hold, tenacious as it is, may be
loosening. Today’s anti-graft efforts, in some countries at least, are not just a backlash against
the scandals of the moment; they are the work of institutions that are starting to mature, in
some cases because of popular pressure. This is true in the region’s two biggest economies,
Brazil and Mexico, but not only there.

Brazil’s constitution, enacted in 1988, conferred independence on the public prosecutor’s

office and the judiciary. But they have exercised it only in the past decade or so. Geraldo
Brindeiro, the chief prosecutor during the presidency of Fernando Henrique Cardoso from
1995 to 2003, was mocked as “mothballer-general of the republic” for his apparent reluctance
to pursue corrupt officials.

Brazil’s feisty media have lowered the tolerance for corruption among ordinary folk and the
officials responsible for rooting it out. Time has brought a change of generations. Mr
Brindeiro’s successor was the first to be chosen by prosecutors themselves. The next went on
to denounce the Workers’ Party, to which Ms Rousseff belongs, in Brazil’s previous epic
scandal, the mensalão, which uncovered payments to congressmen in exchange for pro-
government votes. Rodrigo Janot, the prosecutor in charge of the petrolão, and Sérgio Moro,
the judge who presides over the case at the federal court in Curitiba, belong to a cohort that
sees corruption as not just a moral failing but a cause of tangible damage, says Luiz Felipe
d’Avila of the Centre for Public Leadership, a think-tank. “Corruption kills,” says Mr Janot.

Waking up the watchdogs

Better Brazilian judges and prosecutors are part of an institutional upgrade—disconnected

improvements brought about by legislation and new technology. It is still partial at best, but
should make a difference. The “clean companies act”, which entered into force in January
2014, extends sanctions from bribe takers to bribe givers. Lawyers say it has prompted
companies to take compliance seriously. Cash payments to the poor through the Bolsa
Família programme—which are made electronically—cannot easily be stolen or directed to
supporters of a local potentate. São Paulo state’s transport department has made it possible to
renew a driver’s licence online, cutting out bribe-taking bureaucrats. It plans to install
cameras in examiners’ cars.

The monopoly of power held by Mexico’s Institutional Revolutionary Party (PRI), to which
Mr Peña belongs, was broken only in 2000. Mexico’s press, with some exceptions, is less
obstreperous than Brazil’s, in part because much of it relies on government advertising. But
pressure for reform has increased. The Guerrero murders and revelations about house
purchases triggered an outpouring of anger against the president and the political elite. Mr
Peña’s ambitious programme of reforms to energy and other sectors will fail if their integrity
is not protected.

The elite has begun to respond. In late February Mexico’s lower house approved a
constitutional change to create a “national anti-corruption system”. Rather than entrust
responsibility to a single commission, as some Latin American countries have done, Mexico
aims to share it out among different organs of government as well as the judiciary. “We
favour checks and balances, institutions rather than heroes,” says Mauricio Merino, lead co-
ordinator of the Accountability Network, a grouping of NGOs that pushed for the legislation.

Until secondary legislation is passed to regulate conflicts of interest and specify the powers of
the new bodies, it is impossible to say how well the new system will work, says Mr Merino.

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Already, there is opposition from state governors, especially those within the PRI. The
reforms could be as important as those that ushered in democracy, but it “will take at least a
generation to change habits,” he says.

Other countries are taking encouraging steps. Honduras’s president, Juan Orlando Hernández,
has signed an agreement with NGOs to act as “parallel auditors” in education, health, and
other government services. They persuaded him to appoint an education minister, who has
slashed the payment of salaries to “phantom teachers”. Chile will soon close loopholes in its
campaign-finance legislation. In Peru Mr Ugaz sees hope in activism among students, who
protested successfully against the appointment of unqualified candidates to the constitutional
court and the ombudsman’s office. This was “a reaction of youth against a corrupt class,” he
says.

Such gains are fragile, and in some countries absent. October’s presidential election in
Argentina is unlikely to bring improvement. Where governments crimp press freedom, for
example in Ecuador and Venezuela, corruption is likely to flourish. Brazil needs electoral
reform to upgrade the quality of its politicians. Even the progress in the judiciary is not
secure. The prosecution in the petrolão is impressive, says Mr Moro, the judge, “but
institutional reaction must be the rule. And it isn’t yet.”

However, as Latin America grows richer, more educated and more equal, citizens will press
harder for honest politicians and officials. At long last democracy is working for them. It is
“thanks to political plurality that, despite everything, we are taking steps in the right
direction,” says Mr Merino. That bodes well for Mexico, and its neighbours.

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Bribery
Supply side

A new index of bribe-payers highlights slow

progress in curbing sleaze
Nov 5th 2011 | from the print edition

BRIBERY involves two parties, not one. Lambasting officials in poor countries for their
sticky fingers is usually easier (and less open to legal challenge) than investigating those who
suborn them.

But on November 2nd Transparency International, a Berlin-based campaigning group,

published an updated version of its Bribe Payers Index. Based on questions to 3,000
businessmen, this ranks 28 countries (accounting for 80% of global trade and investment) by
the perceived likelihood of their companies paying bribes. Russia and China scored worst by a
hefty margin. Dutch and Swiss companies were seen as the cleanest, with Belgium, Germany
and Japan close behind. Construction and industries involving government contracts,
unsurprisingly, were the dirtiest.

Disappointingly, the latest version of the index shows no significant change since the previous
edition in 2008. That comes despite some big shifts in national legislation and international
anti-bribery activity. Recent prosecutions under America’s Foreign Corrupt Practices Act
have sent culprits to jail for record terms. The former boss of an America-based telecoms
firm, Joel Esquenazi, received a 15-year jail sentence on October 25th for paying nearly
$900,000 in bribes to Haiti’s national telephone company. An accomplice received a seven-
year sentence.

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Britain has introduced a tough anti-bribery law too. Laurence Cockcroft, a British economist
who specialises in anti-bribery campaigns, says the dozen recent prosecutions by the Serious
Fraud Office belie its reputation for feebleness: “it’s a huge improvement on five years ago.”

Even countries best known as sources and recipients of corrupt payments are trying to meet
international standards, at least on paper. Saudi Arabia has set up an anti-corruption agency.
China, India and Indonesia have passed anti-bribery laws. So too has Russia, in what most
observers think is an attempt to ensure membership of the World Trade Organisation and
support a pending application to join the Organisation for Economic Co-operation and
Development (OECD), a Paris-based think-tank for advanced industrialised countries.

But practical progress has been a lot thinner. Transparency International complains that
Germany, Japan and Saudi Arabia have not yet ratified a UN convention on bribery. 21 of the
38 states that signed the OECD anti-bribery convention, including Australia, Brazil, Canada,
Mexico, South Africa and Turkey, show “little or no enforcement” of it. Attempts to get the
G20 group of the world’s biggest economies to tighten rules on transparency and bribery have
also bogged down. The agenda for a summit this week in Cannes was dominated by avoiding
an immediate economic meltdown, rather than dealing, as the incumbent French presidency
initially hoped, with financial mischief.

Robert Palmer of Global Witness, a London-based campaigning group, says that bribery
indices, though welcome, fail to highlight the crucial role of intermediaries: banks that handle
corrupt payments and lawyers who advise clients how to get around anti-bribery laws—for
example by making “facilitation payments” which are a common loophole. He and other
campaigners want new rules to make companies record payments to governments publicly
and to publish accounts reporting their activity country by country.

But perhaps the biggest pressure is likely to come from shareholder ire. Next year
Transparency International will publish an updated ranking of big global companies,
highlighting their use of offshore finance and their perceived willingness to pay bribes. A
plunging share price may be the biggest disincentive to the corrupters of the weak and greedy.

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Business Ethics 146
Corruption and the economy
Is anti-graft anti-growth?

Weighing the economic impact of the anti-

corruption campaign
Aug 2nd 2014 | JIEYANG | From the print edition, p. 44.

EVEN by Chinese standards, growth in the southern city of Jieyang was remarkable under
Wan Qingliang, the local boss with bouffant hair who cultivated an air of frugality in his
personal life. When he took over, in 2004, annual expansion was 4%. By 2007 Jieyang’s
growth rate had surged to 18%. Dirt roads were paved, banana groves uprooted and high-rises
planted in their place. Propelled by these achievements, Mr Wan’s ascent up China’s political
ranks was swift. He was made vice-governor of Guangdong, China’s wealthiest province, and
then mayor of Guangzhou, the province’s capital and China’s third-biggest city.

Yet Mr Wan’s fall was even more precipitous than his rise. In June investigators accused him
of widespread corruption; he has disappeared from sight. The man who said he owned no
homes allegedly dispensed favours worth at least 600m yuan ($97m) to one property
developer, Comhope, and the charge sheet is growing. But the takedown of Mr Wan, who
knew how to get the local economy fizzing, raises a question about President Xi Jinping’s
fight against corruption: is it a drag on growth?

The scars of Mr Xi’s campaign are visible in Jieyang. At a Comhope complex down by the
river, bamboo scaffolding lies in a heap at the base of what were supposed to be 30-storey
towers—construction was abandoned at the 11th floor. Across China, luxury retailers and
fancy restaurants are suffering from an edict against wasteful government spending. A chill
has crept into karaoke parlours and brothels; mistresses also face a hard time. One maker of
condoms estimates demand has fallen in China by 1m condoms a day in recent months. In
June casino revenues fell in Macau, a popular destination for cadres, for the first time in years.
The government has made it harder to transfer cash to the gambling enclave.

When the economy wobbled early this year, one common explanation was that officials were
reluctant to approve investment projects lest they be accused of taking backhanders. Some
executives with state-owned enterprises do not want to travel abroad, for fear that enemies
will portray such trips as junkets. After rising strongly for a decade, foreign direct investment
by Chinese companies fell by 5% in the first six months of the year, compared with a year
earlier.

Businesses are adapting to more abstemious times. Five-star hotels, now virtually off-limits to
officials, have downgraded themselves to four stars. Private dining clubs have opened their
doors to the public. Still, the view that anti-corruption efforts are hurting the economy has
become pervasive enough for leaders to confront it head-on. In July Lou Jiwei, the finance
minister, said that those who think corruption helps lubricate growth are “making fools of
themselves”.

He has a point. For all the short-term dislocations, the crackdown is surely good for China’s
economy. Most economists these days no longer regard corruption as greasing the wheels of
Business Ethics 147
business in developing economies, as used to be argued. Rather, they realise, it deters private
investment, misallocates resources and generates social grievances.

China’s past anti-graft campaigns, though admittedly less extensive than the current one, hurt
the economy little and may even have boosted it. Investigations directed at the local
government of Beijing in 1995 and of the port-city of Xiamen in 1999 coincided with growth
slowdowns of roughly three percentage points. Both cities quickly recovered. When
Shanghai’s party chief was toppled in 2006, growth accelerated the following year. Across
China, counties that are strongly against corruption tend to have higher incomes than those
that go easy on sleaze, according to research by Yiping Wu of the Shanghai University of
Finance and Economics and Jiangnan Zhu of the University of Hong Kong.

Not that the anti-graft campaign is necessarily encouraging open and transparent behaviour. In
Sihong county in Jiangsu province this month, authorities panicked when they heard that
inspectors from the central government were coming. Having illegally converted farmland
into highways, the bureaucrats carted in lorryloads of soil overnight to cover them up. Photos
of the buried roads, now planted with soyabeans, have since become something of a hit
around the country.

Corruption in eastern Europe

From Bolshevism to backhanders

Corruption has replaced communism as the

scourge of eastern Europe
Apr 14th 2011 | PRAGUE AND RIGA | from the print edition

JUTA STRIKE won’t say where she has spent the past few weeks. But the fact that Latvia’s
best-known anti-corruption official (pictured above) had to leave the country for her own
safety, amid political attempts to nobble her agency, is evidence of a rising tide of sleaze in
ex-communist Europe, and of the troubles, and even dangers, facing those who try to tackle it.

A corruption scandal that links a political party to a private security agency is rocking the
Czech government. In Bulgaria brazen attempts to rig a nuclear-power tender seem to have
left politicians helpless. In Romania and Slovakia attempts to reform the judiciary have
stalled. Even starry-eyed outsiders who win elections on anti-corruption tickets seem to be
captured by the system within months.

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Corruption is hard to measure and varies widely. Estonia is cleaner than some west European
countries; few easterners have a reputation worse than Greece. But it is striking that even
hardened warriors in the war against sleaze are so gloomy. Alina Mungiu-Pippidi, a
Romanian campaigner and academic, likens the corrosive effects of rent-seeking from corrupt
governments to the curse of easy money from oil and gas in Russia. Anti-corruption efforts
have failed to engage the wider public, she says, so activists soon become dispirited.

Jan Urban, a doughty Czech ex-dissident turned clean-government campaigner, agrees. “You
need at least a bit of success”, he says. Activists in Czech groups with such names as
“Defenestration” and “Change the Politicians” gleefully ousted much of the old guard in an
election last year. But the new government has descended into squabbling, shown itself to be
in hock to business interests and failed to deliver on its sleaze-busting promises.

The causes are manifold. The financial crisis has made people readier to cut corners.
Whistleblowers are ill-protected. Firms not willing to pay bribes lose out to those that are,
such as Russian, and increasingly Chinese, competitors. Businesses fear that taking a stand
will bring retribution: bureaucratic harassment, arbitrary tax demands or missing out on public
contracts. Leverage from the European Union loses its force once countries have joined.
Indeed, the billions of euros flooding from Brussels to modernise infrastructure and public
services often prove a fount of corruption. Companies, politicians and officials collude to rig
tenders, usually with impunity: legal scrutiny is weak, and voters seem apathetic and cynical.

The media are given to indiscriminate barking but little biting. Puny editorial budgets mean
that investigations fizzle out. Advertising campaigns associated with publicising EU contracts
and rules give great power to officials and politicians wanting to reward favourable coverage.
The biggest advertiser in Lithuania, for example, is the agriculture ministry. There is scant
critical scrutiny of its activities. State-owned industries often play a similar role.

Profitability in the media has plunged since the financial crisis. That has made many foreign
owners eager to unload their ailing assets; influence-hungry local tycoons have found plenty
of bargains. The Swedish owners of Latvia’s main daily, Diena, sold it via an obscure chain
of transactions to an unknown owner. Many of its senior journalists, including those involved
in anti-corruption investigations, have left or been fired.

The only investigative programme on Czech public television came under pressure after it
scrutinised some startling legal manoeuvres surrounding the government’s mistreatment of a
foreign blood-plasma company. “This is typical of the way in which governments of all
stripes have tried to squash investigative journalism,” says Mr Urban. Having faced down the
communist-era secret police, he is not scared of a lawsuit against his caustic blog. But the
threats continue elsewhere.

Tycoons tilt the media field by subsidising tame outlets. Bodo Hombach, the boss of WAZ, a
big German media investor, has said that “the close intertwining of oligarchs and political
power is poisoning the market.” Such owners, he claimed, were buying up the media to exert
political influence, not in search of profit. Some worry about a descent to Italian standards.

Solutions are rare. Voters hanker for a strong hand, perhaps from the spooks. But as Russia
shows, that cure can be worse than the disease. Ivan Krastev, a Bulgarian analyst, says that
the real problem with corruption is the complicity it creates. “We end up with shadow
networks that make countries ungovernable, or governable by somebody else.” Just 20 years
after it regained its freedom, much of eastern Europe risks compromising it.

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Business in Bulgaria
Succeeding in spite of the state

Honest Bulgarian firms specialise, stay

small and steer clear of the government
Nov 16th 2013 | SOFIA | From the print edition, p. 61.

MILEN GEORGIEV’S father had bought him a kit of cheap magic tricks. That was lucky,
because it helped the young Bulgarian figure out the sleight-of-hand in the hustlers’ three-card
con trick at an open-air market in Sofia. Over ten weeks, Mr Georgiev made 1,000 lev (then
around $18 at official rates), while getting just 90 lev a month on his student stipend. The
hustlers started turning him away.

“This was good capital at this time,” he says. It was 1991. He and a friend went into business.
First they bought and sold plastic bags, then bought a machine for making them. Mr Georgiev
financed new machines at 6% a month from local lenders. He fended off one protection racket
by hiring another at cheaper rates, and paying the police for a panic button in his offices.
Palms had to be greased to get telephone lines set up, and imports through customs.

But today his business, Extrapack, is thriving, with 50m lev ($34m) in annual sales and a
profit margin of around 4%. He says he paid his last bribe in 2004. It is possible to do clean
business in Bulgaria. But it is complicated. Surveys by Transparency International, a
watchdog, find that businesspeople perceive it as the most corrupt country in the European
Union. Bulgarians often say that winning a government contract is impossible without corrupt
connections. Krasen Stanchev of the Institute for Market Economics in Sofia says the
government breaks contracts into chunks, to discourage big foreign companies from bothering
with them.

Bulgarians took to the streets this year, in daily protests in front of the parliament. (The spark
was the nomination of a well-connected but otherwise unqualified 33-year-old to run the
national-security service.) But people have been grumbling about corruption for years.
Successive governments have passed modest reforms to make doing business cleanly a little
easier. A 10% flat corporate and income tax limits the scope for bribes, but a proliferation of
social-security contributions means that firms spend more hours filing tax forms in Bulgaria
than in any other EU country. Bulgaria is in the EU’s middle ranks as regards the time and
money needed to start a business. But for the time required to get licences, it ranks near the
bottom—though Cyprus, Malta and Spain are worse.

Successful Bulgarian entrepreneurs take a spiky kind of pride in making it in their home
country. Ivaylo Penchev left Extrapack to found Walltopia, now the world’s largest maker of
climbing walls for gyms. With the trim physique and energy of a climber himself, Mr
Penchev thinks that only mediocre bosses spend their time griping about the government:
“Complaining is a national sport in Bulgaria.” Walltopia sells to 50 countries, and because its
walls are considered structures, it must get building permits for them. Although he
acknowledges the problems in his country, he says “California is much worse. France is
dramatically worse.”

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The biggest problem Bulgaria has is the education system, Mr Penchev says. In particular, he
laments the generation educated just after the fall of communism. They lost the communist
era’s discipline, but had not yet learned Western ways. Kiril Asenov agrees. Asked his top
three priorities from the government, he repeats: “Increase education spending ten times.” His
father founded Arexim in 1991 by dismembering a forklift for parts that he used to make an
injection-moulding machine. Arexim now makes precisely engineered plastic parts for the
likes of Bosch and Siemens, two German high-tech manufacturers. Mr Asenov sees foreign
firms moving some low-skilled work to Bulgaria. But growth in any higher-value-added work
will be constrained by the quality of schools and universities.

The formula for business success in Bulgaria seems to be to specialise, produce for export and
stay small enough to avoid upsetting powerful interests. Anything requiring the state’s support
(skilled labour, infrastructure) will take forever arriving. Bulgarian entrepreneurs say things
are not as bad as they were. But EU membership and years of rising living standards have
raised ordinary people’s expectations. If businesses meet them it will be despite the
government, rather than with its help.

Driven up the wall

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Business Ethics 152
Affinity fraud
Fleecing the flock

The big business of swindling people who

trust you
Jan 28th 2012 | SALT LAKE CITY | from the print edition, p. 51-52.

WITH a nudge from their pastor, the 25,000 members of the New Birth Missionary Baptist
Church near Atlanta opened their hearts, and their wallets, to Ephren Taylor. And why not,
given his glittering credentials? Mr Taylor billed himself as the youngest black chief
executive of a publicly traded company in American history. He had appeared on NPR and
CNN. He had given a talk on socially conscious investing at the Democratic National
Convention. Snoop Dogg, a rapper, had tapped him to manage a charitable endowment.

So when Mr Taylor’s “Wealth Tour Live” seminars came to town, faithful ears opened wide.
Eddie Long, the mega-church’s leader, introduced Mr Taylor at one event with the words:
“[God] wants you to be a mover and shaker…to finance you well to do His will.” Mr Taylor
offered “low-risk investment with high performances”, chosen with guidance from God.

Divine inspiration, alas, has given way to legal tribulation. For many investors, the 20%
guaranteed returns proved illusory. Mr Taylor (whereabouts unknown) stands accused of
fraud in a number of lawsuits. Bishop Long, a co-defendant, has urged Mr Taylor to “do the
right thing” and cover any losses. The charges are not the first blot on the minister’s
reputation: last year he settled for an estimated $15m-25m claims that he had coerced young
men into oral sex.

An essential element of Mr Taylor’s approach was to make those he targeted want to invest in
him personally, says Cathy Lerman, a lawyer representing some of the victims. “He was a
master of creating a marketing presence. He would say: ‘If you want to check me out, just
Google me.’” He had no problem convincing them that he was an ordained minister, even
though he had no formal seminary training, according to court documents.

It will take time to gauge the full extent of the losses, not least because it will require
untangling a web of companies, some of them shells. Victims, many of whom entrusted their
life savings to Mr Taylor, are still coming forward. Some call him “the black Bernie Madoff”.

Let us prey

Mr Madoff, whose victims lost perhaps $20 billion, perpetrated the largest “affinity fraud”
ever. The term refers to scams in which the perpetrator uses personal contacts to swindle a
specific group, such as a church congregation, a rotary club, a professional circle or an ethnic
community. Once the scammer gains their trust, his scam spreads like smallpox. Most affinity
frauds are Ponzi schemes, in which money from new investors is used to repay old ones, or is
siphoned off by the promoters.

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The Madoff fraud fed on multiple affinity circles: wealthy Jews in Florida and Israel, country-
club types and European old money, lured with help from marketers running “feeder” funds.
The next-largest alleged investment fraud of recent years, the $7 billion collapse of Allen
Stanford’s empire, also concerned specific groups, including the Latin American and Libyan
diasporas and Southern Baptists. Mr Stanford’s trial began on January 23rd. He denies
wrongdoing.

Beneath the mega-scams swirls a mass of smaller cons, spanning the world. Any close-knit
community can be a target. Last August a South Korean pastor was indicted for
misappropriating 2.4 billion Korean won ($2.3m) that the faithful had handed over to set up a
Christian bank. In Britain, Kevin Foster’s KF Concept targeted the former coal-mining towns
of South Wales, bilking more than 8,000 victims with the help of glitzy roadshows.

The problem is a global one but best-documented in America. Besides the Madoff saga,
Marquet International, a consultancy, has identified more than 300 sizeable Ponzi schemes
from the past ten years, with combined losses for investors of $23 billion. It estimates that up
to half of those were affinity-based. No one has a reliable number for smaller frauds over the
same period, but guesses range from $5 billion to $20 billion. In all, affinity-fraud losses in
America could be as much as $50 billion.

The FBI is probing some 1,000 cases of investment fraud, more than double the number
outstanding in 2008. Six state securities commissioners contacted by The Economist all say
the problem is growing.

The increase is partly a result of better

detection, post-Madoff. The SEC filed more
than twice as many Ponzi cases in 2010 as in
2008. The number of Ponzis exposed each
month began to climb just as the financial
crisis struck in 2007 (see chart). Frauds are
more prone to collapse in a weak economy as
investors try to pull money out to cover
shortfalls elsewhere.

Bad times also make get-rich-quick schemes

more tempting. Desperation breeds gullibility.
The median annual return offered by scammers
in the Marquet study was 38%. In a case in
Montana, victims were promised 800% back in
a week.

Mistrust of mainstream finance helps the scammers. The big guys on Wall Street have shown
they can’t be trusted, they say; better to go with someone you know. This was part of Mr
Taylor’s pitch in Georgia.

Brent Baker, a former SEC lawyer who now works on affinity-fraud cases, has seen ones
involving “just about every type of community you can think of”, including one where loyal
listeners of a Persian-language radio show were bilked by its presenter. But religious fraud is
particularly common, because people find it hard to imagine that the pastor is a perp. Joseph
Borg, Alabama’s securities commissioner, reckons half of all affinity frauds in the American
South are faith-based.

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The problem stretches across all types of belief, and ranges far beyond the Bible Belt. In
September, a 77-year-old man from Ohio was indicted for allegedly defrauding 2,700 fellow
Amish of $17m (though he had somehow resisted the temptation to trade his horse and cart
for a Ferrari).

The hook of Mormon

The state thought to have the most affinity fraud per head is Utah, where 60% of the
population are Mormons. In 2010, regulators and the FBI were investigating cases there with
4,400 victims and perhaps $1.4 billion (or $500 for every Utahn) in losses. The numbers have
surely climbed since, with the three largest cases alone involving combined losses of up to
$700m, says one investigator.

Mormons tend to be both trusting and welcoming of newcomers, says Keith Woodwell, head
of Utah’s Division of Securities. As soon as you pull up to your new house, neighbours
appear to help you unpack. A scammer who gets his foot in the door can exploit this
closeness.

LuElla Day, for example, lost $1.2m in a deal hatched by Daniel Merriman, a fellow Mormon
she had known for four years. “He’d spoken at our meetings. When I sold my farm, he came
and said the bishop had asked him to help me invest the proceeds,” says the 81-year-old. He
told her the money would go into government debt. The transaction was done on a handshake.
Ms Day never got a penny back.

Credulousness is not confined to sweet old ladies. One of Ephren Taylor’s victims was an
electrical engineer with an MBA. A man in Utah was taken for $50,000 by his next-door
neighbour, who offered a chance to invest in a new type of ice machine. Nothing remarkable
there, except that the victim was a retired federal agent who had worked on white-collar fraud
cases.

Why do such people let their guard down? “Everyone is looking for a shorthand way to judge
character, and affinity settings offer that, at least in theory,” says Jeff Robinson, head of the
Utah County Attorney’s investigations bureau. Tribal ties foster trust, which is usually a good
thing (see article). But it can be abused.

Another factor is the rise of “prosperity theology”, or the belief that God wants Christians to
be rich as well as good. This idea has taken root fastest in black and Hispanic churches. The
problem is that it puts pressure on congregations to invest successfully, which makes them
more vulnerable, says Ole Anthony of the Trinity Foundation, which investigates church
fraud.

Social media make affinity fraud quicker. Bonds that used to take years to establish can be
forged in days on Facebook or Twitter. Fraudsters read potential victims’ online profiles, and
use the information they glean to refine their pitches. In a recent case, the SEC won a
restraining order against a scam targeting users of chat sites popular with the deaf.

At a federal level, the American government’s response has been inadequate. The SEC has
launched some high-profile cases, but done little to educate investors. The agency “has chosen
to stick some ambulances at the bottom of the cliff rather than build fences at the top,” as one
former employee puts it.

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American states have tried harder. Pennsylvania, for example, holds hundreds of meetings a
year to teach investors how to be more careful. Utah ran a billboard campaign showing a
series of respectable-looking types saying: “I’m your friend. I’m your neighbour. I’m a con
man.” People should “be trusting but verify”, says Gary Herbert, Utah’s governor.

A new law in Utah increased penalties for fraudsters who abuse a relationship of trust.
Another pays whistle-blowers up to 30% of recoveries. (The SEC operates a similar scheme,
but only for cases larger than $1m.) Both bills were sponsored by Ben McAdams, a state
senator who returned to his native Utah from New York to help ensure that “as much energy
went into shrinking the fraud economy as growing the ski economy.” In Utah, suspected
fraudsters’ property can be seized before charges are brought, if there is “probable cause” that
a crime was committed.

Other ideas are percolating. Sean Reyes, a lawyer who is running for state attorney-general,
supports the creation of a “fraudsters registry”, similar to the one for sex offenders. “It’s
amazing how many are repeat offenders,” he says. He also wants to explore the idea of
reducing sentences for scammers who lead investigators to assets they have salted away. Most
victims see a few pennies on the dollar returned, if that.

Investigators face strong headwinds. One is that victims are often reluctant to come forward.
Some cannot admit to themselves what they have lost. Others don’t want their families to
know: older victims often fear being deemed unable to manage their lives and shoved in a
home. In religious cases, there is often an unwritten rule that what happens in church stays
there, with disputes handled by the church elders or the minister. Many frauds are dauntingly
complex. One Ponzi, at the Baptist Foundation of Arizona, used 120 shell firms to extract
$590m from members.

There is only so much governments can do to protect people from their own credulity. Mr
Baker thinks that private groups are better-placed to build those fences on the cliff top. He has
set up a “Fraud College” in Utah (and on the web) with help from Mr Reyes. This self-styled
“neighbourhood watch” for fraud offers online advice and holds events to raise awareness.
The next conference, on February 15th, will hear from state and federal fraudbusters, victims
and, in a first, a senior figure from the Mormon church. Amen to that.

Business Ethics 156

Fighting corruption in India
A bad boom

Graft in India is damaging the economy.

The country needs to get serious about
dealing with it
Mar 15th 2014 | From the print edition, p. 20-22.

IN THE early hours of February 20th 2010 Uday Vir Singh, an Indian forestry officer, bluffed
his way past a private militia guarding a dusty port called Belekeri. For months suspicious-
looking convoys of trucks had been thundering across India to the port’s quays on the
country’s west coast, just south of the Goan beach where the super-spy mayhem which
opened “The Bourne Supremacy” was filmed.

Mr Singh is no more a Jason Bourne than the next entomologist—he has a doctorate on
metamorphosis in insects—and the infiltration he mounted with a few colleagues led to no
gunplay. But it did uncover a massive scam, with hundreds of officials and politicians in the
state of Karnataka in the pockets of an illegal mining mafia that, over five years, had made
profits of $2 billion or more shipping illegal iron ore to China.

Such scandals have rocked Asia’s third-largest economy in the past decade. A lot of
transactions that put public resources into private hands—allocations of radio spectrum, for
example, and of credit from state banks—have come under suspicion. Of the ten biggest
family firms by sales, seven have faced controversies. The brash new tycoons who came of
age during the boom years of 2003-10 are under a cloud, too. Before he became boss of the
central bank last year, Raghuram Rajan worried publicly that India could start looking like an

Business Ethics 157

oligarchy along the lines seen in Russia: “too many people have got too rich based on their
proximity to the government.”

In a recent poll 96% of Indians said corruption was holding their country back, and 92%
thought it has got worse in the past five years. One senior figure in the ruling Congress party
worries about the feeling that “the law for the common people doesn’t apply to the political
princelings and industrialists.”

In December voters in Delhi’s state elections supported the anti-graft Aam Aadmi Party
strongly enough for it to get into power. Its leader, Arvind Kejriwal, held his new job only
briefly before resigning to fight the national election taking place in April and May. Narendra
Modi, the Bharatiya Janata Party (BJP) candidate for prime minister who is currently ahead in
the polls, says he will purge India. That said, critics note that his personal rapport with
tycoons, credited for some of the industrial success of his home state of Gujarat, may not
make him the most thoroughgoing of purgatives. For his part, the outgoing prime minister,
Manmohan Singh, claims history will absolve his administration of its reputation for graft.
The leader of the Congress campaign, Rahul Gandhi, a scion of India’s most famous political
dynasty, says he is a reformer, though it is hard not to see his family’s secretive habits as part
of the problem.

India needs its private sector to build roads, factories and cities. But the relationship between
companies and the state is broken. Corruption produces bad decisions; concern over
corruption produces indecision. Graft does not function, as some claim that it does elsewhere,
as an unseemly but expedient market solution to inert bureaucracy, greasing the seized-up
wheels of industry. It has put grit in those wheels. Loans to industries with graft problems
have infected the largely state-run banking system; at least a tenth of its loans are sour. Inept
cronies have messed up vital road and power projects. Mines and other assets lie idle as courts
dither over how crooked their owners are.

Private paralysis

Faced with this mess, private firms have cut investments; a fall in investment from 17% of
GDP in 2007 to 11% in 2011 is one reason why GDP growth has slumped to 5%, the lowest
level for a decade. And ineffective efforts to deal with corruption seem only to have made
things worse. India’s cranky legal system, its overlapping investigative agencies and its
raucous media have meant that responses to the problem may have done as much to paralyse
business in general as to punish wrongdoers. Few senior people go to jail; but officials fear
being accused of malfeasance, so many think the safest course of action is to make no
decisions at all.

To rumble the iron-ore scam Mr Singh, the forestry officer, first went undercover in a town
called Bellary, the hub of illegal iron-ore mining in the state of Karnataka. The task fell to him
because many mines come under the remit of the forestry agency, and work on a previous
pink-granite scandal had earned him a reputation in the area. A day’s drive north of the
gleaming technology campuses of Bangalore, Bellary felt like the wild west. The Reddy
family, which had close connections to the state’s BJP-led government, appeared to rule the
roost. A businessman who visited a Reddy associate recalls being escorted by men with
automatic weapons to a mansion with a Bell helicopter and a collection of 13 cars. “They
were like Indian warlords,” he says.

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Each day up to 2,000 trucks took the ore to the port at Belekeri in convoys as much as 25km
(16 miles) long. Accounts and bank details found on computers taken into custody at Belekeri
created a trail to 70 families who had bribed officials and politicians effectively enough to
cause an “administrative collapse”. Karnataka’s anti-corruption body prepared a 25,000-page
report. The affair is now in the hands of the police and the courts.

Rumours and rupees

Iron ore is a smallish part of the picture, but how small is hard to say; quantifying graft in
India is a frustrating affair, and distracting conspiracy theories and innuendo abound. Bankers
in Mumbai claim that the rupee, one of the world’s most actively traded currencies, is
manipulated by politicians for personal gain. The business interests of the present cabinet—if
you believe the rumours—include a real-estate empire in Singapore and an insider-trading
ring run by a minister’s son.

To try to get to grips with the problem The Economist has interviewed politicians,
industrialists, bureaucrats, financiers and investigators. Their views, provided on a basis of
anonymity, point to a well-established system of graft, partly linked to political funding. Few
people think that anyone important will go to jail, but despite this some reckon that the next
decade will be less corrupt than the last one.

Petty corruption includes slipping banknotes to the police and to officials to get paperwork
done. According to Transparency International, an organisation that tracks corruption, 54% of
Indians say they paid a bribe in the last year, compared with 44% in Nigeria and 36% in
Indonesia. Jobs with opportunities for extortion are sought after and a slice of the profits
funnelled up the ranks.

Firms offer “speed money” to avoid red tape. “Everybody pays,” admits an executive at a firm
known for its good governance. A billionaire says, “it is hard for any business to be fully
compliant…When you are dealing with the tax people or the environmental people the
consequences for the business become very severe—they can hold money in escrow or
imprison you.” But it is the boom in large-scale rent-seeking—the use of wealth to distort the
allocation of resources from which more wealth could be produced—that has opened up a
new era of corruption.

In the old days graft was almost quaint. Before the liberalisation that began in 1991 firms
faced the “licence-permit Raj”, a regime of rules and quotas that was more easily navigated
with the help of carefully deployed smallish bribes. Occasionally there were big scandals. In
the 1980s allegations that a $50m kickback had been paid on an Indian arms deal by the
Swedish firm Bofors engulfed the government of Rajiv Gandhi.

But India’s entry into the global economy created unprecedented opportunities for dishonesty.
Property became a multi-billion-dollar business governed by officials paid a pittance. The
value of mining licences soared along with commodity prices. Privatisations and public-
private partnerships became common, and prone to manipulation. At the same time the elite
cadre of the civil service, the Indian Administrative Service (IAS), has decayed. A top officer
puts the clean and motivated proportion of its 5,000 members at just 10%—and adds that at
the other end of the spectrum 15% are “scum”.

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 The Economist has looked at three ways of
quantifying the profits from rent-seeking.
The first is to tally the money made from
scams, based on estimates from officials
and investigators. (Our calculation uses
realised profits, or the present value of
anticipated profits. We use the low end of
some official estimates.) The second
approach, which is applied more widely in
our new index of cronyism (see article),
measures the relative performance of
billionaires in industries, such as mining
and property, that are prone to rent-seeking
relative to those in other lines of business
(see chart 1). A final method tracks the
relative performance of an index of
politically linked listed firms constructed
by Saurabh Mukherjea of Ambit Capital, a broker (see chart 2). An average of the approaches
suggests the gains from rent-seeking over the past decade peaked at about $80 billion. That is
equivalent to 7% of the stockmarket’s value today. It is worth noting, though, that the share of
GDP for the rent-seeking billionaires and the premium on politically connected firms are no
longer what they were in the boom years.

Not all of the gains were achieved

through corruption. But if one were to
assume politicians and officials got an
average cut of 5-15%—a rate
consistent with the trail investigators
have found in the iron-ore and
telecoms scams, then total bribes paid
would amount to $4 billion-12 billion.

Many bribes, like much else in India,

can be paid for in cash, which can be
deposited at banks using “Benami”, or
nominee, accounts, or accounts in
servants’ names. Gold is another
possibility; there is a lot of it about,
with India’s bullion imports since
2002 worth 14% of current GDP.
Property deals are also used to
launder cash—even legitimate deals
often have a cash component.

Funnelling funds

On big deals the obliging politicians and officials may get a stake in the business. India’s
audit agency believes land deals near Delhi Airport involved firms that were fronts for
politicians. By using layers of legal shells politicians can be made beneficiaries without being
easily traced. Taking the trail offshore can add still more concealment.

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In an office in Delhi an anti-corruption tsar is looking at a piece of paper. On it is the name of
a fixer in Singapore who is active in the Indian city of Hyderabad and who funnels illicit
funds offshore. The official says there are about 25-50 such individuals, known as “settlers”,
serving India, mainly from Singapore, Dubai and London. The scale of activity is “immense”.
By cross-checking India’s trade statistics with those of its trading partners, Global Financial
Integrity, a research organisation, estimates that gross illicit outflows from India have
averaged $52 billion a year since 2007.

One way of transferring bribes offshore is “mis-invoicing”. For example, a firm in India
controlled by a politician will buy diamonds or software from a party abroad at inflated prices
before importing them. The excess profit booked by that second party, also controlled by the
politician, is pocketed outside India—tax-free and with little risk of investigation if it is a
shell company domiciled in a free-trade zone such as Dubai. Mr Singh found widespread mis-
invoicing in the iron-ore scam.

How much Indian money is stashed abroad? India’s tax authorities have a database of
offshore-account holders given to them by the German government, but appear to be under
political pressure not to release it. “They’re sitting on it,” says the anti-graft tsar in Delhi.

The ex-manager of a unit serving Indians at a large Swiss bank says the firm had $10 billion
of assets from resident Indians and a market share of 10-20%. The Russian and Far East desks
were much busier. (This fits with the finding that Indians buy just 3% of “prime” London
property, a popular investment with plutocrats.) The banker adds that India’s big political
clans may have been dealt with by a separate wing of the bank. Adding in an estimate for
them, he calculates that the offshore assets of Indian residents held in all global banks as
between $100 billion and $150 billion.

How does that fit with estimates of illicit wealth overseas? The anti-corruption boss says his
agency has identified assets of $2.3 billion, mainly held through trails of offshore shell
companies and accounts in tax havens, and that his understaffed agency tracks about 5-10% of
such activity—suggesting a total pot of $23 billion-45 billion.

Bringing it all back home

Some of this comes back to India through mis-invoicing. But wealth is also “round tripped”
back under the guise of foreign investment. An insight into round-tripping, in this case of
legitimate funds, came in a 2012 British legal case involving UBS in London. Its bankers ran
a scheme in which $250m of offshore funds belonging to Reliance ADAG, an Indian firm,
were invested in one of its subsidiaries in India via a vehicle in Mauritius. The London
tribunal judged that this broke Indian rules. (In a 2012 statement Reliance said that no action
had been brought against it in London and that the matter had been dealt with and closed by
Indian regulators.) Lawyers for a banker involved argued the practice was “widespread”.
India’s regulators say they have since cracked down.

When the bribes come home they undoubtedly enrich some Indian politicians. A 2008
telecoms scandal saw a minister allocating spectrum on iffy grounds. The government turned
a blind eye. “We knew some of the decisions taken by him were blatantly illegal…[and] done
to raise large amounts of money,” says another minister of that time who was close to the
prime minister. The more pernicious danger is that the political system as a whole depends on
the bribes. For one thing they seem to provide a significant source of election funds; for
another the big parties increasingly need to court small parties in order to rule, and allowing

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them to get rich when in power seems to be one of the ways that this is done (it was a factor in
the telecoms case).

To hold a rally at which Sonia Gandhi, the head of Congress, appears costs up to $330,000.
The buses, hats and sound-system all have to be paid for. To run a credible campaign in a seat
in a parliamentary election costs between $300,000 and $3m per candidate, depending on the
importance of the seat and the competition. Armies of volunteers have to be paid, and booze
and SIM cards given out.

Add in state and local elections and the total cost of politics in India between 2010 and 2015
for all parties will be $5 billion, calculates the top Congress politician, which would work out
as a substantial fraction of the estimated bribe pool. Strict campaign-finance rules mean most
of this has to be raised illegally.

A third of campaign funds are raised centrally by parties and the rest locally. Parties have
arms-length treasurers who act as their bankers. Those handling bribes take a cut for
themselves.

Illegal party funding is at the heart of corruption. But politicians are in denial, says the
Congress bigwig. “Nobody wants to admit that they have taken money. It is a completely
hypocritical system.” New laws, for example a Lokpal Act passed in December to create a
new anti-graft agency, just add to the huge weight of legislation dating back to the 1980s that
is cynically passed and not enforced.

There is certainly a lack of will to enforce rules. A second anti-graft boss cheerfully admits
that prosecutions take at least a decade; in the past three years only 25 top civil servants have
been investigated and none has lost his job. Regulators say that if they act against the interests
of industrialists they can get an earful from politicians.

But there is a more optimistic view. When it comes to low-level graft, reformers hope that
technology can eliminate the middlemen who seek to benefit. Putting train reservations online
has removed a lot of opportunities for bribery. Then there are chunks of the economy that are

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already pretty free of graft, such as consumer goods and the technology business; in the past
few years it is largely in those sectors, more than in the rent-seeking ones, that billionaires
have made hay.

Some institutions are clean, too. They include the central bank and the Supreme Court, which
on March 10th introduced rules to speed up trials of politicians. The banking system, despite
its bad debts, has not been captured by tycoons as were those in South-East Asia and Russia
in the 1990s. In February a chunk of radio spectrum was auctioned off smoothly, a process
that makes impropriety harder.

And the messy response to a decade of graft, though inefficient, has started to change
financial incentives. Sporadic court actions—mining suspended in some areas, some spectrum
allocations being cancelled—have made rent-seeking less profitable, and foreign investors
have begun to shun such sectors. Ambit’s index of politically linked firms, which did well in
the late 2000s, has underperformed badly since. India has only a middling rank on our
cronyism index.

Perhaps market forces and a backlash from voters will turn the tide. But even if they don’t,
citizens like Mr Singh, the insect-expert turned mafia-buster, will fight on. He doesn’t carry a
phone lest it betrays his location; he has a bodyguard, and police guard his home. But in an
office decorated with posters of plants the ferocity he brought to his fight can still boil over.
The iron-ore scam made him feel “so angry that I told myself either you do something or you
die,” he says. “What will I be doing in three years’ time? I am going to pursue this. I am going
to bring it to a logical end.”

Organised crime
Dealing with the devil

Should a government ever do a deal with gangsters?

In El Salvador, on balance the answer is yes
Feb 8th 2014 | From the print edition, p. 12.

IF YOU ran a country and had to find a reliable

partner to fight crime, you would probably not
choose Carlos Mojica Lechuga. The ageing
leader of one of El Salvador’s two fearsome
street gangs is now safely behind bars. But for
years his mob, Barrio 18, and its deadly rival,
the Mara Salvatrucha, made war-zones of many
poor parts of El Salvador, as well as terrorising
a fair few districts in the United States, where
the gangs were formed. Mr Mojica himself has
been accused of ordering the decapitation of a
teenage girl, whose body was then mutilated
with a floor-polishing machine.
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Yet in March 2012 President Mauricio Funes took a risk on Mr Mojica. The government
brokered, somewhat shiftily and at arm’s length, a truce between the two gangs. In return for
them giving up the killing, it has moved the gangs’ incarcerated leaders to lower-security
prisons and created jobs in bakeries and farms for their members. Since then, in a region
where the murder rate is climbing, El Salvador’s has fallen by half, saving perhaps 4,000 lives
in two years (see article).

Was it worth it? That is an immediate question in El Salvador, which held the first round of its
presidential election on February 2nd. But neighbouring Honduras and Belize have
experimented with similar pacts. Last month Mexico’s government joined forces with a band
of vigilantes to try to drive out a drug cartel. By contrast, although police in some American
cities turn a blind eye to gangs if they keep the peace, the idea of a formal deal is anathema in
the rich world. The United States is uneasy about the Salvadorean truce.

The opponents of such pacts say they erode faith in already-weak justice systems and bolster
gangsters’ standing. El Salvador’s swaggering kingpins have been allowed to act like
community leaders, at one point holding press conferences in their prisons. And though they
have stopped killing each other, they have shown little interest in giving up crimes such as
extortion, which ruins lives. Polls show that most Salvadoreans dislike the deal. Although Mr
Funes is not running again, his vice-president, Salvador Sánchez Cerén, is stuck in a run-off,
despite avoiding talking about the truce in the campaign.

That does not mean the truce was a mistake. In a country as weak as El Salvador, “zero
tolerance” policing of the sort pioneered in New York does not work. The truce followed
decades of mano dura (“iron fist”) policies, which succeeded only in turning El Salvador’s
squalid prisons into heaving universities of crime. When cracking down failed, governments
tried súper mano dura, but that did not work either. The year before the truce, the country of
6m endured more murders than all of western Europe. The ceasefire has let children cross
gang turf to go to school and adults go to work without fear of attack. Though Salvadoreans
dislike the truce, they also seem unimpressed by the iron fist: in the election on February 2nd
the right-wing opposition, which had promised a tough line on the gangs, did worse than
expected.

From fist to handshake

The next president will face a choice. The gangs have offered to extend the pact’s terms, to
stop recruiting in schools and to cease telephone extortion (a phishing-type ruse, conducted
from prison). Their demands—more jobs and better prison conditions—are not especially
sinister. Meanwhile, as the commitment of politicians to the deal has wavered, so has that of
the gangs: the murder rate has already started to creep back up. With the promise of state-
backed jobs starting to evaporate, mobsters are returning to illegal sources of income.

That argues for extending the truce, but doing so in a different way. First, the government
should use the time to build up institutions—not just the police, but also schools to help give
youngsters an alternative career; it could provide more cash to get firms to hire people from
the barrios. Second, this time, the government must play it straight. It failed to spell out the
terms of the deal, at first barely acknowledging its existence and later only reluctantly
releasing details. If elected, Mr Sánchez Cerén, a former guerrilla, should bring the agreement
into the open, explaining how the lull in violence can be used to strengthen communities
vulnerable to the gangs’ reach. The truce has saved lives. But the deals must be done in
daylight.

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Food crime
A la cartel

Organised gangs have a growing appetite

for food crime
Mar 15th 2014 | From the print edition, p. 29.

Crime and nourishment

GANGSTERS used to send their enemies to sleep with the fishes. Today they are more likely
to mislabel the fishes and sell them at a profit. Organised criminals who have long trafficked
drugs are diversifying into humdrum areas of commerce—particularly food, booze and cheap
consumer goods.

The horsemeat scandal last year drew attention to food fraud. Such scams are not unusual.
Some 22 tonnes of long-grain rice being sold as pricier Basmati were recently seized as part
of an operation led by Interpol and Europol, respectively the world’s and Europe’s police
agencies. In Worthing, in Sussex, trading standards officers spotted nearly 2,500 jars of honey
that contained nothing but sugar syrup. Another scam, involving substituting a cheap species
of white fish for a pricey one, is hard to spot once the fish has been flaked, breaded and fried.
Others dilute expensive olive oil with low-cost soyabean oil. Criminals even sell counterfeit
washing powder.

The ancient crime of bootlegging alcohol is reviving, too. The operation that caught the rice
bandits also snared a lorry carrying over 17,000 litres of fake vodka worth £1m ($1.7m). That
was probably not an isolated shipment. Criminal gangs import truckloads of cheap beer from
places such as Belgium and sell it to small retailers without paying duty. HM Revenue and
Customs estimates that beer smuggling costs the Treasury around £500m a year. Duty has not

Business Ethics 165

been paid on at least one in ten, and possibly one in five, of all cans and bottles of beer on sale
in Britain, thinks the all-party parliamentary beer group.

This brand of crime is growing. In 2007 the Food Standards Agency set up a food-fraud
database. That year it received 49 reports of food fraud. In 2013 it received 1,538. The scale
and organisation required to produce fake food points to criminal groups. And this is no flash
in the pan, reckons Huw Watkins of the Intellectual Property Office. Gangs are investing
heavily in the machinery, raw materials and labour necessary to make fake food products.

Some crooks who once focused on drugs have switched to food, says Chris Vansteenkiste of
Europol, partly thanks to the falling profitability of the former. The proportion of Britons
reporting having taken drugs in the past year dropped from 11% in 1996 to 8% in 2012. Not
everyone is a junkie, but everyone buys food and drink. Stagnant wages and unusually high
inflation since the financial crisis have increased people’s hunger for bargains.

Perhaps most important for crooks, humdrum crime is safer. Penalties for hawking counterfeit
biscuits are considerably lighter than those for smuggling drugs or guns. For some
intellectual-property theft, such as ripping off DVDs, criminals might face ten years in prison,
says Stuart Shotton of FoodChain Europe, a food-law consultancy. If there are no fears about
safety, he reckons that six months is more likely for crimes involving food.

Criminals are less likely to be caught in any case. The Metropolitan Police, who deal with
much of Britain’s organised crime, are less likely to investigate food crime than other kinds of
offence, says Gary Copson, a former detective. Mr Copson, who was involved in a review of
Britain’s food-supply networks ordered by the government after the horsemeat affair,
compares Britain’s approach unfavourably with that of the Netherlands. The Dutch have a
unit of 110 staff dedicated to investigating food crime; Britain has none.

Meanwhile, other controls weaken. In December another parliamentary group, the public
accounts committee, noted that border police had given priority to passenger checks over
other duties, including examining freight for illicit goods. Cuts to local government mean that
the number of trading-standards officers is dropping. Worcester County Council proposes to
slash spending on trading standards by 80% over the next three years. Britons can expect
more corn fakes for breakfast.

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Organised crime in Italy
Mafia in the middle

Italian mobsters have spread from the south

northward
Dec 13th 2014 | ROME | From the print edition, p. 29.

IN THE crime movie “The Italian Job” Charlie, played by Michael Caine, upsets a mafia boss
by trespassing on his turf to steal gold. The plot is entertaining, but absurd: the film is set in
Turin in 1969, when organised crime in Italy was confined to the downtrodden south.

No longer. On December 10th police arrested 61 people in an operation against the

’Ndrangheta, the mafia from Calabria, the toe of Italy. Such dragnets are common. But this
one was launched from Perugia, the capital of Umbria, a region famed for beautiful hilltop
towns and Renaissance art—not for mobsters.

Operation Fourth Step was the most startling sign yet of the pervasiveness of Italy’s
traditional mafias. Police found evidence that Calabrian gangsters settled in Umbria had
planned a murder and violently intimidated shopkeepers, builders and others.

Of all Italy’s main organised-crime groups, the ’Ndrangheta has the deepest roots outside the
south. A six-year investigation culminating in 2010 found that its presence in the industrial
north was extensive. More than 150 people were arrested.

There are two causes of the spread of Italy’s mafias. One is that richer parts of the country
offer more possibilities for laundering the proceeds of crime. The other is a 1956 law that
allowed mafiosi to be uprooted from their normal surroundings and sent north. In Umbria
investigators point to a third factor: two high-security prisons, which mean that relatives of
jailed mobsters have bought houses in the area so they can visit their loved ones more easily.

Operation Fourth Step shifted attention away from another organised-crime scandal, in Rome.
Arrests on December 2nd highlighted a gang that has established close links with local
officials and politicians of left and right. Prosecutors call the gang, which is led by a one-eyed
former far-right terrorist, Mafia Capitale. Its bosses are known to have had links with
established crime syndicates. But it is unclear whether they aspired, like genuine mafiosi, to
replace the authorities by asserting territorial control of a specific area.

What is most alarming is the ease with which they suborned officials to win contracts for
firms in their sway. Among those accused of taking the gang’s money are a former head of
Rome’s waste-management company and a former boss of a big municipal property scheme.
Most skulduggery took place while Gianni Alemanno, a former neo-fascist, was mayor. But
the mobsters also had good relations with several leading members from the centre-left
Democratic party (PD). One was arrested.

The PD’s leader (and prime minister), Matteo Renzi, has moved swiftly to limit the damage
by announcing a bill to stiffen the penalties for corruption. If it survives its passage through

Business Ethics 167

parliament it will be a welcome step in the right direction for a country that earlier this month
slipped to joint last place in the European Union in Transparency International’s corruption-
perceptions index.

Business Ethics 168

Business Ethics 169
Bankers’ pay
The law of small(er) numbers

Pay at investment banks is starting to fall,

but not because politicians have capped it
Jan 4th 2014 | From the print edition,p. 52-53.

“NAUGHTY or nice” is not a discussion investment bankers have with Santa before
Christmas but one they have with their bosses early in the new year. The haggling usually
opens with the boss saying what a tough year it has been and the bankers, often experienced
traders and dealmakers, talking about how valuable they are. This year’s negotiations will be
unusually tense. At stake will not simply be pay,
an issue complicated by the introduction on
January 1st of a bonus cap in Europe, but also
jobs.

After peaking at the end of 2010, employment in

the investment-banking industry has been
declining steadily. Deutsche Bank reckons that
the number of bankers employed by the ten
largest firms will fall by about 3,000 in 2014,
leaving the total 20% below its peak. Add in job
losses at smaller firms and declines in support
staff, and total worldwide employment in the
industry may fall by 20,000 this year.

Pay is dropping too. At Goldman Sachs and

JPMorgan Chase average pay slipped by about 5% in the first nine months of last year, a
figure that is probably representative of the wider industry. Over the longer run, average pay
at the world’s biggest investment banks has barely changed (see chart), which means it has
fallen slightly after inflation. The pace of pay cuts is likely to accelerate, senior bankers say.

The biggest reason for the cutbacks is that after decades of growth in revenues (punctuated by
brief declines), the investment-banking industry is facing a structural downturn. Regulators in
America have banned banks from trading securities for their own profit. Higher capital
standards everywhere are forcing investment banks to shrink their balance-sheets and
regulations are making banks move much of their derivatives trading from opaque and
profitable “over-the-counter” transactions onto exchanges and into central clearing-houses,
where fees are likely to fall.

Although final figures are not available, the investment-banking revenues of the industry’s
biggest firms probably fell by about 5% in 2013, according to Coalition, a data-provider. That
leaves them about a quarter lower than their peak in 2009.

In fact, the industry’s revenues and profitability have fallen far more sharply than pay and
employment. McKinsey, a consultant, reckons that for the 13 biggest investment banks
revenues have fallen by 10% a year since 2009, while costs have dropped by just 1% a year.
Business Ethics 170
The main reason for this mismatch is the relentless optimism of those who work in the
industry. Most big banks hired energetically after the financial crisis, hoping to gain a greater
share of the market as rivals cut back.

Another reason is the difficulty in making incremental cuts at investment banks without
shutting down whole departments. Trading businesses often have large fixed costs such as
computer systems and compliance departments that are difficult to shrink. Simply thinning the
numbers of traders and bankers often results in revenues falling faster than costs.

A failure to cut costs fast enough means that the industry’s profitability has been ruined.
Average returns on equity for the biggest investment banks slumped to about 8% last year,
according to McKinsey. Without deep cost cuts it reckons this figure will fall to 4% by 2019.
That sobering prospect is now prompting deeper cutbacks, particularly at European banks
such as UBS, Credit Suisse and Royal Bank of Scotland which are getting out of whole lines
of business. UBS, for instance, has decided to get out of most debt trading and is trimming
about 10,000 jobs.

Against this backdrop there is one part of bankers’ pay that is likely to rise. New rules that
came into force at the start of the year in Europe will prevent banks from paying thousands of
key employees bonuses that are bigger than their annual salaries. The result will not be the cut
in total pay that European lawmakers expected. Instead banks have already figured out
wheezes to work around the rules.

The first is to bump up basic salaries while reducing the portion of pay allocated to a bonus.
This cuts against much of the work done by regulators to tie bankers’ pay to performance and
to defer large chunks of it so it can be withdrawn if the bank subsequently does badly. In
Britain, for instance, the country’s highest-paid bankers received bonuses in 2012 that were
3.8 times their salaries.

Across the industry most big banks have signed up to international principles under which
60% of bankers’ total pay should be deferred (and thus not part of basic pay), according to
Oliver Wyman, another consulting firm. That trend is likely to reverse in Europe, bankers say.
“The more I pay in fixed, the less I have to claw back,” complains the boss of the European
arm of a large international bank. “This doesn’t do what the legislation wanted it to do.”

A second wheeze being tried by international banks is to exploit a loophole that allows them
to pay bonuses that are twice as large as normally allowed if shareholders approve this in a
vote. Since many are structured as subsidiaries whose only shareholder is their parent bank,
getting shareholder consent is a doddle.

Other ploys include paying monthly cash “allowances” or granting forgivable loans that only
have to be repaid if the banker leaves within a certain period of time. The impact of these
ruses will, however, be limited, mainly because
of relentless pressure on banks to cut pay to
improve returns for shareholders. After years of
watching their employees naughtily pocket large
cheques while passing losses on to shareholders
and taxpayers, the owners of banks are in no
mood to be nice.

Business Ethics 171

Bankers’ pay
Bonded labour

European rules may scotch plans to pay

bankers in bonds that reward caution
Nov 29th 2014 | From the print edition, p. 62-63.

PAYING workers with shares in their employer is a time-tested way to ensure hired hands
have the same interests as the firm’s owners. But the trick does not work so well with banks:
bosses paid in stock have an incentive to expand a bank’s balance-sheet but not its loss-
absorbing equity, increasing the likelihood of a bail-out as well as a bump in the share price.
So regulators are speaking highly of a new sort of instrument to align incentives better:
“performance bonds”. These are designed to make bankers cautious: they would not pay out
for as long as ten years, during which time their value would not increase, but might fall if the
bank founders.

The idea, promoted by Bill Dudley, the head of the New York branch of the Federal Reserve,
is roughly equivalent to demanding that senior bankers deposit their annual bonuses in the
bank’s vaults for ten years. The delay is to make sure that the deals struck by the employees
concerned do not eventually sour; if they do, the money would be used to help absorb the
associated losses.

Regulators think such bonds can be used to nudge financiers away from dodgy dealings, too.
Fines meted out to banks for misbehaviour—of which there have been plenty in recent
years—are in effect charged to shareholders. Deducting them instead from the pot of bankers’
future pay would punish those responsible instead.

Mark Carney, governor of the Bank of England and chairman of the Financial Stability Board,
a global group of regulators, went on to describe the idea as “worthy of investigation as a
potentially elegant solution”, a ringing endorsement for a central banker. George Osborne,
Britain’s finance minister, also registered his approval in a recent letter to Mr Carney.

The pair have latched on to the idea in part in response to European Union rules that cap
bankers’ bonuses at twice their base salary. That is troublesome because it is easy to “claw
back” bonuses, which are typically deferred for several years, but there is currently no way to
reclaim fixed pay. The problem is all the more acute since the bonus cap has tended to push
up salaries at the expense of bonuses. But performance bonds may also fall foul of the rule:
since their value is inherently variable, European regulators may declare them to be bonuses
and thus subject to the cap.

Investment banks in London have so far skirted the cap. Most are paying their staff “role-
based allowances”, de facto bonuses disguised as fixed pay. But EU watchdogs have cottoned
on to that trick and are trying to put an end to it. Meanwhile, Mr Osborne has abandoned a
legal challenge to the bonus cap after a preliminary ruling cast doubt on its chances of
success.

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Nobody is quite sure what will replace the allowances, if anything. Some banks are resigned
to paying their staff higher fixed salaries, while grumbling that this will make then
uncompetitive internationally and hamper cost-cutting efforts in a downturn. In many parts of
the industry, notably trading, overall pay is slipping as profits have disappointed. That is one
way in which bankers are already sharing their employers’ pain.

Bankers’ bonuses
Tilting the playing field

Regime change in Europe

Mar 9th 2013 | BERLIN |From the print edition, p. 66-67.

LONDON just became a less attractive base for bankers used to taking home bonuses worth
many multiples of their basic salary. On March 5th EU finance ministers decided that
European bankers’ bonuses should be capped at a maximum of one times their base salary,
rising to two times if shareholders explicitly agree.

The declared aim of the bonus cap, which was the brainchild of the European Parliament, is to
dampen the incentives for reckless risk-taking that in the past led to bank bail-outs and costs
to the taxpayer. In practice, the choice facing banks is either to find a way to compete with
rivals that are not bound by the cap, or to risk losing star employees to competitors.

George Osborne, Britain’s finance minister, was unable to block the measure despite arguing
that it will simply drive up base salaries and add rigidity to the banking system. That is a view
shared by many regulators, no friends of the banks. The cap is a departure from bank-capital
rules currently in force, known as CRD III, which include remuneration guidelines aimed at
encouraging a higher proportion of variable pay.

The impact of the new regime may take time to become visible. It is not due to come into
force until 2014, and may only take effect after next year’s bonus round. In a small nod to
British opposition, a bit of tweaking may be done to enable portions of deferred bonuses to be
treated more leniently in the calculations. That would mean the maximum bonus could end up
slightly larger than double base salary, but not by much.

Many banks had assumed the cap would be kiboshed. The realisation that it is going to
become reality has sparked a panicky reaction. Some wonder about the potential for a legal
challenge. Lawyers point out that the EU’s Lisbon Treaty forbids interference on pay by the
European Parliament or European Council. Ministers said on March 5th that they see no basis
for a challenge. They were not challenged on CDR III, which also deals with pay.

A legal contest is unlikely to interfere with the EU’s timetable, says Stephen Mavroghenis at
Shearman & Sterling, a law firm. Given bankers’ public standing, they are unlikely to seek a
head-on clash with the EU. The British Bankers Association is also coy about whether it will
take legal action. Other champions of the City might dare: Boris Johnson, perhaps, the far-
from-bashful mayor of London.

Business Ethics 173

Where there are laws, there are bound to be loopholes. There is talk of complex schemes in
which bankers are promised a large bonus pot in the future, which is made to look smaller by
applying a high discount rate. Subsidiaries of non-EU banks are wondering whether their
parent company counts as a “shareholder”. That would make it a lot easier for an American
bank in London, say, to get approval for a doubling of bonuses than a European one.

But since all this may look like banks getting

up to their slippery tricks again, the simplest
response will be to raise base pay. Not for
everyone, mind: average employees seldom
see bonuses of more than 40-50% and even
high-flyers are lucky to touch 130%. But for a
handful of top bankers in Frankfurt, Paris and
perhaps 5,000 of them in London, a higher
fixed salary beckons. For a sense of how much
higher, The Economist took figures on
London-based banks’ 2010 remuneration from
a new paper by Brian Bell and John Van
Reenen of the London School of Economics,
and worked out how far base pay would need
to have risen that year for risk-taking staff to
have taken home the same total pay with a 1:1
cap in place (see chart).

These numbers are only illustrative. Few would disagree that the banks’ bonus culture had to
change after pre-crisis excesses. But going against the grain of variable pay is no answer. The
cap will either drive the best people outside the EU and EU-domiciled banks, or add to fixed
costs. Neither is welcome.

Executive pay
Bosses under fire

Britain is a case study in how politicians miss the

point when they try to “fix” executive pay
Jan 14th 2012 | from the print edition, p. 11.

WHEN things went wrong for Middle Eastern tribes a

couple of millennia ago, the accepted remedy was to
send a sacrificial goat out into the wilderness to placate
the gods. The practice continues today, but the voters
have replaced the gods, and highly paid businesspeople
the goats.

The growth of inequality all over the world encourages

these rituals, and recent trends in remuneration certainly

Business Ethics 174

make bosses harder to sympathise with than goats. In Britain, where the latest bout of
politicking about pay has broken out, chief executives can expect to receive average
compensation in excess of £4.5m ($6.9m) this year. Pay at the top grew by over 300%
between 1998 and 2010. At the same time, the median British worker’s real wage has been
pretty stagnant. These trends mean the ratio of executive to average pay at FTSE 100 firms
jumped from 47 to 120 times in 12 years.

This is feeding the view that there is something wrong with British capitalism. Britain’s
political parties, although deeply divided on most economic policy, are competing for a
middle ground which demands action on pay. The prime minister, David Cameron, thinks
there is a “market failure”, and his coalition government wants to empower shareholders and
staff to constrain pay at the top. Specific options include giving shareholders a binding veto
on board pay, changing the make-up of pay committees and making compensation, including
pay ratios, more transparent.

This remedy will be about as effective as the goat. Bosses’ pay has gone up not because
corporate governance is failing but because of globalisation (see article). In the 1970s the
FTSE 100 was made up largely of parochial companies serving British customers. Now it is a
global index of multinational companies operating in many different industries and countries.
FTSE bosses are picked from a global pool. The skills they need, and the pay they receive,
have changed.

Nor is it clear that British shareholders are weak. British corporate-governance rules, which
allow shareholders to sack board members, are envied in America. At private firms, where
owners are more directly in control, top pay is less visible, but has risen at similar rates. FTSE
100 bosses are facing criticism not because their pay is the highest, but because it is the most
transparent. Heads of legal and consultancy firms (which are not, by and large, public
companies) are paid similar rates. British bosses are paid rather less than American ones and
less too than the bosses of top European companies.

The long and the short of it

Giving more power to British shareholders is not a bad idea, but it will not make any
difference. Getting and keeping a good boss matters more to a firm’s owners than how much
he or she is paid; and they invest internationally, so they know how much good bosses need to
be paid. This looks more like a market rate than a market failure.

Mr Cameron should have focused on the weakest part of British pay: its emphasis on short-
term performance. Tying bonuses to next year’s earnings encourages scrimping on investment
to buy back shares. Return-on-equity targets (until recently favoured by British banks) reward
leverage, prioritising risky over risk-adjusted returns. A greater share of total pay in Britain
should be tied to a firm’s long-term performance, as it is in America. But if that happens,
executives’ pay will probably go up further to compensate them for waiting for their cash.

Inequality is undoubtedly a serious political issue in the West. But governments that try to
deal with the problem by passing the buck to companies will at best fail, and at worst harm
the economy. Better sacrifice a goat.

Business Ethics 175

Executive compensation
If you hire them, pay will come

Surprise: bosses earn more when they hire

compensation consultants
Nov 22nd 2014 | From the print edition, p. 61.

WARREN BUFFETT once noted that if you want independent advice, don’t ask a barber
whether you need a haircut. But if, as a chief executive, you want to earn more, then it makes
sense to hire a compensation consultant. Or so concludes a new study* from the Judge
Business School at Cambridge University.

Though its findings hardly seem a shock, previous studies that tried to link bosses’ pay and
the use of consultants had found no significant effect. However, this new research was made
possible by a rule brought in by America’s Securities and Exchange Commission (SEC) in
2009. It says that when a company hires a consultant for advice on both compensation and
other matters, it must disclose the fees paid in each case. When consultants are hired solely to
give advice on compensation, the fee need not be disclosed.

The reason for this asymmetric rule was that the SEC feared some bosses were in effect
bribing consultants to recommend them for pay rises by bunging them lots of other, more
lucrative work. Making the fee structure more transparent would discourage the practice, the
regulator hoped.

The academics used three tests. First, they compared companies that kept their “multi-
service” advisers after 2009 with those that switched to using specialist compensation
consultants to advise them on executive pay. Those that switched were found to be paying
their CEOs almost 10% more than similar firms that had hung on to their multi-service
consultants. One obvious explanation is that the switchers were those firms that had been
offering extra business to their consultants mainly to
influence their advice on executive pay—for as long as
they could do so without revealing it—and that this had
worked.

The second test was to look at who chose any specialist

pay advisers hired after the rule change. In firms in
which the consultants were only chosen by the board,
the CEO was paid about 13% less than at similar firms
whose CEO also hired a second set of pay advisers.

The third test was consultant turnover. The academics

reasoned that “If an increase in pay is associated with a
subsequent lower probability of being replaced by a
competitor, then consultants indeed have an incentive,
on average, to recommend higher pay.” The trend was
again clear. When CEOs get big pay rises their
companies are less likely to replace their consultants in
Business Ethics 176
the following year.

All told, the academics found that firms that hire compensation consultants paid their CEOs
7.5% more than those that did not. They concluded that “our study finds strong empirical
evidence for the hiring of compensation consultants as a justification device for higher
executive pay.”

These findings make it a little harder to argue that higher CEO pay is linked to shareholder
returns or to greater talent; if that were the case, one would not expect such a clear correlation
between pay and the use of consultants. The trend smacks more of the lickspittle courtier of
Louis XIV, who, when asked the time, replied, “It is whatever time your majesty pleases.”
The modern equivalent is, it seems, “Whatever pay your majesty pleases.”

*"Do Compensation Consultants Enable Higher CEO Pay? New Evidence from Recent Disclosure Rule Changes", by Jenny Chu, Jonathan
Faasse and Raghavendra Rau

Reforming Leviathan
Mandarin lessons

Governments need to rethink how they

reward and motivate civil servants
Aug 9th 2014 | From the print edition, p. 11-12.

THE French call them hauts fonctionnaires, the Germans Beamte im höheren Dienst and the
British, somewhat more economically, know them as “mandarins”. The senior echelons of
civil services are a powerful arm of the state. They implement the reforms dreamed up by
politicians, and design public services ranging from welfare systems to prisons. Compared
with private-sector bosses, the bureaucrats who manage the public sector tend to be less well
paid but have more cushioned lives, with more secure jobs and far less pressure to improve
productivity. Now the mandarins face change (see article).

There has long been taxpayer fury when big projects go awry. Berlin’s new airport is three
years overdue and predicted to cost €6 billion ($8.1 billion), three times the original estimate.
But voters, and thus politicians, are especially intolerant of civil-service inefficiency
nowadays. One prompt is austerity. Another is technology, which is changing not only how
public services are delivered—think of “massively open online courses” in education—but
also the way they can be measured. Social networks enable users to grumble about hospital
waiting-times and mathematics results. Perhaps the biggest pressure is the passing of time:
private-sector workers are incredulous as to why civil servants should escape the creative
destruction that has changed other offices around the world.

Business Ethics 177

The reform of the public sector is a huge project, but people are at the centre of it.
Government is a service industry, and there is a basic talent problem. A few civil services—
Singapore’s is the obvious example—compete with the private sector for the best graduates.
But elsewhere even elite departments, such as the US Treasury and Britain’s Foreign Office,
struggle (or lose high-flyers quickly). The mandarins and their political masters need to
change tack.

Too many civil servants, especially in continental Europe, swirl around a bureaucratic
Gormenghast but rarely leave it. Nearly four-fifths of German senior public servants have
been in public administration for more than two decades. The French state under François
Hollande is governed by a caste of unsackable functionaries, resistant to reform. One reason
many officials become stuck is their generous pension deals: making pensions portable should
be a priority. But career structures also must adapt.

Most civil services still tend to be gerontocracies, where age and seniority are synonymous.
New Zealand has dismantled the system of rigid hierarchies and pay-grades that spawned the
likes of the phlegmatic Sir Humphrey in the BBC comedy “Yes Minister”. Instead, it appoints
departmental chief executives in its ministries, who sign contracts to meet specific targets and
can be dismissed if they fail. Singapore’s civil servants are frequently sent out to private-
sector jobs. Britain has appointed a senior figure from the oil business to run the agency that
deals with large-scale state projects. The idea is that private-sector experience in areas such as
contract management and negotiation can help avoid disasters like Berlin’s airport.

All this appeals to right-wing politicians. But the corollary of better performance is higher
pay. The British government’s chief operating officer announced this week that he is leaving
for a lucrative commercial job. Singapore, which runs a far leaner government than America,
pays its best people $2m a year. No Republican congressman would tolerate that, which is
foolish. The cost of higher salaries is offset by saving money on costly consultants to mop up
failing projects.

There is one area where less change would be useful. To plan careers, you need a long-term
strategy—and democracy throws up change every election. In Britain health-care officials talk
about successive “re-disorganisations”. One reason for authoritarian Singapore’s success is
that its voters have miraculously always chosen the party founded by Lee Kuan Yew since he
took control in 1959. Voters elsewhere are less obliging. New Zealand has tried to counter
this by boosting the powers of a state-services commissioner, whose duties include one of
lasting “stewardship”. That could be a useful model for elsewhere—especially America,
where too many senior
positions are filled by
political appointees
(who then take months
to get confirmed by
Congress).
Mandarinates have
their faults, but
somebody needs to
keep Leviathan
working.

Business Ethics 178

Civil-service reform
Modernising the mandarins

Tight finances and rising expectations are

remaking civil services
Aug 9th 2014 | From the print edition, p. 47-48.

THE senior civil servants huddled in an Oxford seminar room are some of the most discreetly
influential people in Britain. Known as “mandarins” (a tribute to imperial China’s rigorous
hierarchies), they oversee costly projects ranging from HS2, a planned high-speed railway, to
procuring aircraft carriers and a sensitive nuclear-energy deal with (post-imperial) Beijing.
When such a project goes awry it costs a fortune and damages politicians’ standing. So
governments across the rich world, as well as some in developing countries, are striving to
reshape their public services from ponderous bureaucracies into something nimbler and less
blunder-prone.

The seminar is run by the Saïd Business School and the Major Projects Authority (MPA), an
agency set up by Britain’s governing coalition in 2011. Senior businessfolk are invited to lead
discussions; officials share gripes with visiting permanent secretaries (the ministries’ top
brass). The MPA’s boss, John Manzoni, a bullish former oil executive, wants to import skills
more common in the private sector, such as managing risk, learning from competitors and
improving supply chains. He is also trying to build expertise in running complex projects and
(more ambitiously) to make the civil service an attractive place for high-fliers to spend part of
their careers.

According to Jocelyne Bourgon, who was head of Canada’s civil service in the 1990s when
the Liberal government squeezed 50,000 jobs out of a bloated public sector, the focus of
reform internationally has now shifted from mere staff-culling to recasting public services to
cope with “shocks, crises, cascading failures and surprising breakthroughs”. She leads New
Synthesis, a project that has convened six countries (Brazil, Britain, Canada, the Netherlands,
New Zealand and Singapore) to share approaches to thorny subjects such as welfare reform.

The greater availability of data gives today’s public servants advantages over their
predecessors—if they grasp the potential. Since 2010 Britain has published data about public
services on a single website, data.gov.uk, aiming to make them more transparent. America’s
government has launched a similar effort. Such initiatives make it possible to “crowd-source”
ideas and solutions, says Peter Ong, the head of Singapore’s civil service. Services designed
by distant bureaucrats no longer satisfy today’s demanding citizens. Public feedback must be
responded to in real time. As important, he says, is that officials study how their big ideas
work in practice, and tweak them as needed. Singaporean civil servants on the fast track do
stints helping to plan and run front-line services and listening to users’ gripes.

Singapore delivers high-quality public services remarkably cheaply—spending less than 5%

of GDP on health care, for example, around half the global average. But “expectations are
skyrocketing,” says Mr Ong, and Singaporeans want “more empathy and awareness of the
citizen’s perspective”. That might sound odd in an authoritarian system. But in the past
decade Singapore has moved ahead of many liberal Western countries, reshaping its criminal-
Business Ethics 179
justice system, for example, to prepare convicts for their return to society. Prison education,
mental-health services and drug treatment have been beefed up—and honed by civil servants
to create better links between the various agencies dealing with ex-offenders. Recidivism after
two years out of jail fell from 44% in 1999 to 27% for those released in 2010 (although it
edged upwards again a bit this year).

Since the financial crisis of 2007-08, public administrations have come under increasing
pressure not to let deadlines slip and costs spiral on big infrastructure projects. Over-runs can
often be avoided by investing time and money earlier than governments tend to, says Atif
Ansar of Oxford University’s Blavatnik School of Government. Officials often mistake slow
progress for prudence, he adds—“but the maximum risk of something going wrong occurs
once construction is under way, so you should keep that period as short as possible.” He cites
the extension of Madrid’s underground system in the mid-2000s as a complex project that
worked well because so much care went into planning and technical specifications. Metro de
Madrid, the state-owned firm that ran the project, has since won contracts to upgrade tube
systems in China, Russia and Latin America.

Having the right staff matters as much as giving them the right things to do. The fact that
Germany’s civil service consists almost entirely of longtime employees “does not exactly
make for an atmosphere of questioning and new ideas,” points out Gerhard Hammerschmid of
Berlin’s Hertie School of Governance. Performance-related pay, introduced in the 1990s,
means the hierarchy is slightly less rigid than in the 19th century, when Bismarck complained
about the stolidity of German officials. Better starting salaries and part-time working have
been brought in to attract new entrants. But it remains too costly and legally difficult to get rid
of underperformers.

Smaller countries can be quicker to change. In the past decade New Zealand has recast its
civil service, creating departmental chief executives who sign three- or five-year contracts to
meet specified targets. They manage their fiefs, making it harder to pass the buck between
them and transient ministers. The role of public-services commissioner has recently been
strengthened to reduce short-termism and get departments to work together. Iain Rennie, the
current commissioner, reckons the new approach has helped cut recidivism by 12%, by
focusing on details such as jobs and housing for ex-offenders.

Such inventiveness cannot entirely resolve the tension between capping spending and
governments’ appetite for new things to do. But it suggests that governance can be improved
without the state growing endlessly. Not a bad starting-point for rethinking the role of the
mandarins.

Business Ethics 180

Luxury goods
Counterfeit.com

Makers of expensive bags, clothes and

watches are fighting fakery in the courts.
But the battle seems to be getting tougher
Aug 1st 2015 | NEW YORK | From the print edition, p. 51-52.

THE grand golden doors of 500 Pearl Street, in Manhattan, have welcomed such glamorous
names as Hermès, Tiffany & Co and Kering, a French conglomerate whose treasures include
Gucci and Bottega Veneta. The building is not a posh hotel or department store. It is the
federal court for the Southern District of New York, a favoured battleground for the decidedly
unglamorous war against counterfeit goods.

The court is now the venue for Kering’s suit against Alibaba, a Chinese e-commerce giant.
Kering alleges that Alibaba helps fakers sell goods on its websites. The French firm is not the
only one to be incensed. On July 17th the American Apparel & Footwear Association
(AAFA) demanded that Alibaba crack down on counterfeits. Alibaba insists it has extensive
measures in place to do just that. It is trying to distance itself from counterfeiters, who are also
accused by Kering. On August 6th Alibaba plans to argue to the court that it risks being
unfairly implicated as a co-conspirator. A bitter trial looks likely.

The fight against copycats has been long and arduous. Kering’s suit is the industry’s most
important in a decade—Alibaba has more than 1 billion product listings and aspires to reach
consumers around the world. But its sites are hardly the only places shoppers can find copies.
Fake sales are proliferating online, with counterfeiters becoming more technologically adept,
more difficult to track and harder to pursue in court.

Counterfeit sales are, by definition, difficult to tally. Last year American border officials
nabbed copies that, had they been genuine, would have been worth $1.2 billion. Their
European Union counterparts seized €768m ($1 billion) of fakes in 2013. But these were
surely a fraction of the counterfeits being peddled. Estimates for the total value of fakes sold
worldwide each year go as high as $1.8 trillion.

The deluge of fakes includes everything from software and medicine to detergent and car
parts. On July 26th, for example, Chinese authorities said police had raided a factory turning
out huge quantities of iPhone copies. Nevertheless, watches, bags, clothing, jewellery and
perfume make up most of the goods seized at borders (see chart). On July 21st the European
Commission reported that lost sales due to fake clothes and accessories amounted to 10% of
the industry’s revenue in Europe. This makes luxury firms shudder. They cherish their
reputations for quality and exclusivity, explains Antonio Achille of the Boston Consulting
Group. Ubiquitous, flimsy copies undermine them.

Business Ethics 181

The problem has grown more complex as the fakery business has moved online. America’s
trade representative predicted in April that online sales of pirated goods might exceed those in
physical markets, adding glumly: “Enforcement authorities, unfortunately, face difficulties in
responding to this trend.” Online, counterfeiters can stay anonymous, reach across borders
and constantly launch new websites to evade legal action. Governments have a devilish time
tracking fakes sold online and delivered by post, explains Armando Branchini of Altagamma,
the trade group for Italian luxury firms. Fakes shipped in bulk, destined to be sold in physical
shops, are hard enough for border guards to spot. “But when it’s a matter of millions of
parcels, each with a pair of shoes or bag or shirt,” Mr Branchini sighs, “it’s quite impossible
to check.”

Since it is so difficult to fight both fake-goods websites and the counterfeiting operations
behind them—if you shut one factory, another will crop up nearby—luxury-goods firms are
increasingly taking aim at the legitimate firms that facilitate the business of counterfeiters,
such as auction websites, internet-domain registries and payment processors. Sometimes
brand-owners seek these firms’ co-operation in court. Sometimes they sue them.

This has had mixed success. In 2004 Tiffany claimed that eBay was liable for the counterfeit
sales on its site. eBay retorted that it could not prevent every illicit post, though it would work
to remove them. Courts agreed. eBay and Google, which has also been the target of lawsuits,
have systems to fight dubious sellers and advertisers. Neither, however, is foolproof.

Alibaba and the forty fakers

According to Kering’s lawsuit, Alibaba poses a new challenge. On eBay, a counterfeiter

might auction one or two handbags at a time. Kering alleges that one wholesaler on Alibaba
required a minimum purchase of 500 fake Gucci watches and claimed it could deliver up to
8m each month. Brand-owners tremble at the spectre of Alibaba’s 8.5m sellers hawking
masses of counterfeits both within China and around the world. Kering’s investigators, for
example, bought fake Gucci sneakers on Alibaba’s Taobao.com and had them shipped to New
York. Kering alleges that Alibaba not only provides a platform for these sales, but encourages
them. Kering complains that if you type “replica” in the search bar in Alibaba.com, the site’s
algorithm will suggest “wristwatches”.

Alibaba counters that it, too, is a victim of counterfeiters and is working to fight them. The
company has more than 2,000 staff devoted to the problem. They pore over dodgy listings

Business Ethics 182

flagged up by Alibaba’s algorithms and by brand-owners. In the run-up to its public offering
last year, the firm removed 90m listings. Indeed Alibaba has acquired some weighty
partners—it has signed agreements with Louis Vuitton, Coach and others to co-operate on
fighting counterfeits. But its disputes look likely to heat up. The AAFA wants Alibaba to set
up an automated system to take down dubious listings immediately, a demand that is unlikely
to be met. The fight with Kering will continue. The two parties have already tried and failed
to reach agreement outside court.

Meanwhile sales of counterfeits continue to sprawl across the internet. For example, it is
common for Chinese consumers to dodge the high price of luxury goods in their own country
by buying them on so-called daigou websites: a shopper might buy a handbag in Europe, then
resell it on one of these websites for more than the European retail price but less than the
Chinese one. Many products on such sites are genuine. Many are not.

More pervasive are the sites that pose as legitimate sellers of discounted goods. They may
have domain names registered in one country, servers in another, payment-processing
elsewhere and shipping from yet another place, according to MarkMonitor, which helps
companies protect their brands online. Roxanne Elings, a lawyer at Davis Wright Tremaine,
says one counterfeit outfit may run as many as 14,000 websites.

Firms have had some success in battling these sites, again by focusing their attention on
legitimate companies that serve them. In 2010 Ms Elings helped North Face and Polo Ralph
Lauren obtain court orders for domain registries to take down networks of rogue sites, and for
PayPal to turn over fakers’ assets. Tory Burch, Hermès and Michael Kors won similar cases
in 2011 and 2012.

Since then, however, counterfeiters have become more slippery. Ms Elings says that networks
of sites are using multiple registries and myriad fake names. Joseph Gioconda, a lawyer who
has represented Hermès, Michael Kors and Lululemon, says that catching up with copycats is
daunting when their assets are held outside America. Kering and Tiffany had sought to freeze
counterfeiters’ accounts at Chinese banks, but last year an American court refused to do so.
That will make it harder to obtain foreign records that might expose counterfeit rings.

The role of consumers in all this is complex. Some are looking for the real thing at discount
prices, and are deceived. Others are knowingly hunting for fakes. Both types may regret their
penny-pinching. The most troubling recent trend is that online counterfeiters have discovered
a new source of revenue. Some of their sites have no goods to sell, real or fake. They are
simply out to steal unwitting shoppers’ card details, a business that can enjoy higher margins
than any handbag.

Business Ethics 183

Internet access
Gordian net

Why network neutrality is such an

intractable problem—and how to solve it
Jan 31st 2015 | From the print edition, p. 8-10.

THE idea that certain businesses are so essential that they must not discriminate between
customers is as old as ferries. With only one vessel in town, a boatman was generally not
allowed to charge a butcher more than a carpenter to move goods. This concept, called
“common carriage”, has served the world well, most recently on the internet. The principle of
blindly delivering packets of data, regardless of origin, destination or contents, is welded into
the network’s technical foundations. This, more than anything else, explains why the internet
has become such a fountain of innovation.

Yet with the internet becoming more crowded and traffic-management tools improving, this
principle—known today as “network neutrality”—is under threat. Telecoms firms would like
to create lanes of different speeds, not just to manage their networks better, but to capture
more profits. Internet advocates fear this would lead to an online world studded with toll
booths and other choke-points. They fret that rent-seeking network operators would abuse
their market power. Prices would shoot up for those using the fast lanes; everyone else would
get much cheaper, but much crummier, service.

Governments are taking action. On February 5th America’s Federal Communications

Commission (FCC), which has been chewing on the problem for years, will put forward yet
another set of network-neutrality rules. Latvia, which holds the presidency of the European

Business Ethics 184

Union’s Council of Ministers, has just outlined its own European proposal (see article). Both
plans will face opposition: from Congress and in the courts on one side of the Atlantic, and
from the European Parliament on the other. How can the debate be settled?

More providers, fewer rules

Finding a solution has proved tricky. First, neutrality is a slippery concept. Although the
internet was designed to treat all data equally, it was never completely neutral: services such
as games or video have always been at a disadvantage because the public internet cannot
guarantee real-time connections. Second, any reform involves legal quandaries. Should an e-
mail campaign from a political party count as spam, or freedom of speech? After losing
several American court cases because the internet was held to be an unregulated information
service, the FCC wants to reclassify it as an old-style utility in order to impose network-
neutrality rules.

The debate is, therefore, unlikely ever to end—which means that trying to impose detailed
rules or even utility-type regulation, as the FCC is likely to do, looks misguided. Better to
stick with broader rules, such as insisting that a provider’s basic broadband service cannot be
much slower than the fast lanes it offers—and ensure that regulators and the public can police
them. Each operator should be required to publish detailed information about its network’s
performance. Broadband providers can then be exposed if they slow or ration customers’
access to, say, Netflix or Skype. Regulators should have the power to punish such underhand
tactics.

Wherever possible, however, they should leave the market to sort things out. The best way to
do this is to encourage vigorous competition in all parts of the internet, particularly between
broadband providers, so that none can become a bottleneck and exploit that position. That,
alas, happens all too often, particularly in America, where 75% of households have no choice
of provider for fast internet access. Get rid of those monopolies and there would be much less
need to worry about the mind-numbing intricacies of network neutrality.

Business Ethics 185

Miniature flying robots
Robodiptera

An insect-like robot, no bigger than a fly,

takes to the air
May 4th 2013 |From the print edition, p.69.

SOME people are convinced they are already out there: swarms of tiny flying drones
discreetly surveying the world on behalf of their shadowy masters. In 2007 anti-war protesters
in America claimed they were being watched by small hovering craft that looked like
dragonflies. Officials maintained they really were dragonflies. Whatever the truth, robotic
flies actually are now getting airborne.

This week the successful flight of what are probably the smallest hovering robots yet was
reported in Science by Robert Wood and his colleagues at the Wyss Institute for Biologically
Inspired Engineering at Harvard. These robots (pictured above) are the size of crane flies.
Most small flying robots are helicopters—kept aloft by one or more rotating wings. These,
though, are ornithopters, meaning their wings flap. Wingtip to wingtip they measure 3cm and
they weigh just 80 milligrams. Like true flies (those known to entomologists as Diptera), and
unlike dragonflies or butterflies, they have but a single pair of wings.

Dr Wood, as he is quick to point out, is not trying to build a military drone. Rather, it is the
basic science behind flying insects that he and his team are interested in. No doubt the armed
forces are taking a keen interest in this sort of work. But civilian applications such as search
and rescue, he thinks, are likely to be as important as military and security ones. Indeed, the
idea that inspired the study was that of using swarms of robotic flies to pollinate crops.

Flies, as anyone who has tried to swat one knows, are the most agile of flying creatures. Dr
Wood and his colleagues considered it impossible, even with the best miniaturised mechanical
and electrical parts currently available, to build an artificial version of one that would show
anything like that level of aerial prowess. They therefore had to come up with a new form of
manufacturing, which they call smart composite microstructures (SCM), to do the job. SCM
employs lasers to cut shapes from extremely thin sheets of material and then bonds them
together and folds them to make components. The materials’ properties come from their
layered structures.

Getting into a flap

The robot’s wings, for example, are powered by artificial muscles. These are made from
layers of a piezoelectric material—one that deforms when an electric current is applied to it.
Correct alignment of these layers creates a structure analogous to an insect’s flight muscles,
which it contracts and relaxes in order to flap its wings.

Dr Wood’s robots are modelled on a hoverfly called Eristalis. They have a long way to go
before they can mimic the precision of such a creature’s flight. They can, nevertheless, hover.

Business Ethics 186

They can also carry out simple manoeuvres. These include turning by flapping one wing
harder than the other.

These acrobatics are possible because of the flight-control system Dr Wood has designed.
Like jet fighters, flying insects are inherently unstable. And so are Dr Wood’s robots. Insects
have nervous systems to deal with this. Fighters have computers. Dr Wood’s flies are
similarly computer-controlled—and this, for the moment, is where the illusion breaks down,
because the computer is on a desktop and is connected to the robot by a thin copper wire.

That could be fixed with a suitable chip. But the wire also carries electric power: 19
milliwatts, which is equivalent to the power consumed by a flying insect of the same size.
Batteries light enough to fly with do exist. But they would keep the robot going for only a few
minutes.

Dr Wood’s robot is not the only experimental tiny flying machine around. The others, though,
are bigger and heavier than most insects. Some, such as the DelFly Micro, a robot with a
10cm wingspan build by Delft University of Technology in the Netherlands, are also
ornithopters. Others are helicopters. Researchers at the University of Pennsylvania have
demonstrated how a swarm of palm-sized devices with a rotor on each corner can fly together
in formation. And Seiko Epson, a Japanese firm, has built an 8cm-tall robot that uses contra-
rotating blades mounted on the same shaft to achieve stability.

What is really needed is a

breakthrough in battery
technology. In the meantime,
though, Dr Wood says there is
plenty of research to get on
with, in order to improve the
flying abilities of his new robots
and the way they are made. And
eventually, like real insects,
they will have to fly outdoors.
Buzzing around a cosy
laboratory is one thing. Coping
with rain, gusts of wind and even predators that cannot tell the difference between a robot and
the real thing is quite another.

Surveillance
Secrets, lies and America’s spies

A government’s first job is to protect its citizens. But that

should be based on informed consent, not blind trust
Jun 15th 2013 |From the print edition, p.12.

CONSTANT vigilance: that is the task of the people who protect society from enemies intent
on using subterfuge and violence to get their way. It is also the watchword of those who fear
that the protectors will pursue the collective interest at untold cost to individual rights.
Edward Snowden, a young security contractor, has come down on one side of that tussle by
Business Ethics 187
leaking documents showing that the National Security Agency (NSA) spied on millions of
Americans’ phone records and on the internet activity of hundreds of millions of foreigners.

The documents, published by the Guardian and the Washington Post, include two big secrets
(see article). One is a court order telling Verizon, a telecoms company, to hand over
“metadata”, such as the duration, direction and location of subscribers’ calls. The other gives
some clues about a programme called PRISM, which collects e-mails, files and social-
networking data from firms such as Google, Apple and Facebook. Much of this
eavesdropping has long been surmised, and none of it is necessarily illegal. America gives
wide powers to its law-enforcement and spy agencies. They are overseen by Congress and
courts, which issue orders to internet firms.

Barack Obama has responded to the leaks by saying that he “welcomes” a debate on the trade-
off between privacy, security and convenience. Despite the president’s words, however, the
administration and much of Congress seem unwilling to talk about the programmes they
oversee; and the politicians and executives who do want to speak out are gagged by secrecy
laws. Opinion polls show that Americans are divided about the merits of surveillance—which
is partly because they know so little about what is going on. But spying in a democracy
depends for its legitimacy on informed consent, not blind trust.

Guarding the guards

You might argue that the spies are doing only what is necessary. Al-Qaeda’s assaults on
September 11th 2001 demonstrated to politicians everywhere that their first duty is to ensure
their own citizens’ safety—a lesson reinforced recently by the attack on the Boston marathon
in April and last month’s gruesome murder of Lee Rigby, a British soldier, in London. With
Islamist bombers, there is a good case for using electronic surveillance: they come from a
population that is still hard for Western security services to penetrate, and they make wide use
of mobile phones and the internet. The NSA’s boss, Keith Alexander, says the ploys revealed
by Mr Snowden have stopped dozens of plots. The burden on society of sweeping up
information about them has been modest compared with the wars launched against
Afghanistan and Iraq. And the public seems happy: if there were another attack on America,
Mr Snowden would soon be forgotten.

Yet because the spies choose what to reveal about their work, nobody can judge if the cost
and intrusion are proportionate to the threat. One concern is the size, scope and cost of the
security bureaucracy: some 1.4m people have “top secret” clearances of the kind held by Mr
Snowden. Is that sensible? The WikiLeaks saga also exposed weaknesses in the system.

A second worry is the effect on America’s ties with other countries. The administration’s
immediate response to the PRISM revelation was that Americans have nothing to fear: it
touched only foreigners. That adds insult to injury in countries that count themselves as close
American allies: the European Union, in particular, fastidiously protects its citizens’ data.
Fears abound that the spy agencies practise a cynical swap, in which each respects the letter of
the law protecting the rights of its own people—but lets its allies do the snooping instead.

Lawyerly official denials of such machinations fail to reassure because of the third worry: that
governments acting outside public scrutiny are not to be trusted. James Clapper, America’s
director of national intelligence, told Congress in March that the NSA does not gather data on
“millions of Americans”. He now says he answered in “the least untruthful manner” possible.
Trawls through big databases may produce interesting clues—but also life-ruining false

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alarms, especially when the resulting decisions are cloaked in secrecy. Those on “no-fly lists”,
which ban an unknown number of people from most air travel, are not told what they have
done wrong and cannot clear their names. In desperation, 13 American citizens, including
some who were exiled from their own country by the travel ban, are suing the government.

Furthermore, governments tend to be opportunistic. After September 11th Dick Cheney, then
vice-president, and his staff exploited the rules to gain important new powers that they then
kept secret. Even Congress did not know of this. Today’s spooks are supposedly more closely
constrained. Yet America’s system involves judges sitting in a secret court who issue secret
data-collection orders which bind the recipients to secrecy. A handful of secretly briefed
lawmakers oversee the process. The legal opinions that govern the process are secret, too.
Attempts to cast light on this verge on the farcical: the Electronic Frontier Foundation, a
lobby group, is fighting a legal battle to get the secret Foreign Intelligence Surveillance Court
to release a secret opinion issued in 2011, which (unusually) blocked a secret NSA
programme. Perhaps the ends justify the means—we do not know—but that was not the case
with extraordinary rendition, “black jails”, waterboarding and the other ventures Mr Cheney’s
mob led America into.

Trust but verify

Our point is not that America’s spies are doing the wrong things, but that the level of public
scrutiny is inadequate and so is the right of redress. Without these, officials will be tempted to
abuse their powers, because the price of doing so is small. This is particularly true for those
who bug and ban.

Spooks do need secrecy, but not on everything, always and everywhere. Officials will
complain that disclosure would hinder their efforts in what is already an unfair fight. Yet
some operational efficiency is worth sacrificing, because public scrutiny is a condition for
popular backing. Even allowing for the need to keep some things clandestine, Americans need
a clearer idea of what their spies are doing in their name.

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The recorded world
Every step you take

As cameras become ubiquitous and able to

identify people, more safeguards on privacy
will be needed
Nov 16th 2013 | From the print edition, p. 13.

“THIS season there is something at the seaside worse than sharks,” declared a newspaper in
1890. “It is the amateur photographer.” The invention of the handheld camera appalled 19th-
century society, as did the “Kodak fiends” who patrolled beaches snapping sunbathers.

More than a century later, amateur photography is once more a troubling issue. Citizens of
rich countries have got used to being watched by closed-circuit cameras that guard roads and
cities. But as cameras shrink and the cost of storing data plummets, it is individuals who are
taking the pictures.

Through a Glass, darkly

Some 10,000 people are already testing a prototype of Google Glass, a miniature computer
worn like spectacles (see article). It aims to replicate all the functions of a smartphone in a
device perched on a person’s nose. Its flexible frame holds both a camera and a tiny screen,
and makes it easy for users to take photos, send messages and search for things online.

Glass may fail, but a wider revolution is under way. In Russia, where insurance fraud is rife,
at least 1m cars already have cameras on their dashboards that film the road ahead. Police
forces in America are starting to issue officers with video cameras, pinned to their uniforms,
which record their interactions with the public. Collar-cams help anxious cat-lovers keep tabs
on their wandering pets. Paparazzi have started to use drones to photograph celebrities in their
gardens or on yachts. Hobbyists are even devising clever ways to get cameras into space.

Ubiquitous recording can already do a lot of good. Some patients with brain injuries have
been given cameras: looking back at images can help them recover their memories. Dash-
cams can help resolve insurance claims and encourage people to drive better. Police-cams can
discourage criminals from making groundless complaints against police officers and officers
from abusing detainees. A British soldier has just been convicted of murdering a wounded
Afghan because the act was captured by a colleague’s helmet-camera. Videos showing the
line of sight of experienced surgeons and engineers can help train their successors and be used
in liability disputes. Lenses linked to computers are reading street-signs and product labels to
partially sighted people.

Optimists see broader benefits ahead. Plenty of people carry activity trackers, worn on the
wrist or placed in a pocket, to monitor their exercise or sleep patterns; cameras could do the

Business Ethics 190

job more effectively, perhaps also spying on their wearers’ diets. “Personal black boxes”
might be able to transmit pictures if their owner falls victim to an accident or crime. Tiny
cameras trained to recognise faces could become personal digital assistants, making
conversations as searchable as documents and e-mails. Already a small band of “life-loggers”
squirrel away years of footage into databases of “e-memories”.

Not everybody will be thrilled by these prospects. A perfect digital memory would probably
be a pain, preserving unhappy events as well as cherished ones. Suspicious spouses and
employers might feel entitled to review it.

The bigger worry is for those in front of the cameras, not behind them. School bullies already
use illicit snaps from mobile phones to embarrass their victims. The web throngs with furtive
photos of women, snapped in public places. Wearable cameras will make such surreptitious
photography easier. And the huge, looming issue is the growing sophistication of face-
recognition technologies, which are starting to enable businesses and governments to extract
information about individuals by scouring the billions of images online. The combination of
cameras everywhere—in bars, on streets, in offices, on people’s heads—with the algorithms
run by social networks and other service providers that process stored and published images is
a powerful and alarming one. We may not be far from a world in which your movements
could be tracked all the time, where a stranger walking down the street can immediately
identify exactly who you are.

Sovereign over your own body and mind—and face

This is where one of this newspaper’s strongly held beliefs—that technological progress
should generally be welcomed, not feared—runs up against an even deeper impulse, in favour
of liberty. Freedom has to include some right to privacy: if every move you make is being
chronicled, liberty is curtailed.

One option is to ban devices that seem irksome. The use of dashboard cameras is forbidden in
Austria. Drivers who film the road can face a €10,000 ($13,400) fine. But banning devices
deprives people of their benefits. Society would do better to develop rules about where and
how these technologies can be used, just as it learned to cope with the Kodak fiends.

For the moment, companies are treading carefully. Google has banned the use of face-
recognition in apps on Glass and its camera is designed to film only in short bursts. Japanese
digital camera-makers ensure their products emit a shutter sound every time a picture is taken.
Existing laws to control stalking or harassment can be extended to deal with peeping drones.

Still, as cameras become smaller, more powerful and ubiquitous, new laws may be needed to
preserve liberty. Governments should be granted the right to use face-recognition technology
only where there is a clear public good (identifying a bank robber for instance). When the
would-be identifiers are companies or strangers in the street, the starting-point should be that
you have the right not to have your identity automatically revealed. The principle is the same
as for personal data. Just as Facebook and Google should be forced to establish high default
settings for privacy (which can be reduced at the user’s request), the new cameras and
recognition technologies should be regulated so as to let you decide whether you remain
anonymous or not.

Silicon Valley emphasises the liberating power of technology—and it is often right. But the
freedom that a gadget gives one person can sometimes take away liberty from another. Liberal

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politicians have been lazy about defending the idea of personal space, especially online. The
fight should start now. Otherwise, in the blink of an eye, privacy could be gone.

Ubiquitous cameras
The people’s panopticon

It is getting ever easier to record anything,

or everything, that you see. This opens
fascinating possibilities—and alarming ones
Nov 16th 2013 | SAN FRANCISCO | From the print edition, p. 24-26.

ABOUT halfway through Dave Eggers’s bestselling dystopian satire on Silicon Valley, “The
Circle”, the reader meets Stewart, a bald, silent, stooped 60-year-old who has “been filming,
recording, every moment of his life now for five years”. Stewart is the first of the novel’s
characters to make all his actions visible to anyone with a computer who cares to look—the
first “transparent man”.

Cathal Gurrin, a computer scientist at Dublin City University, is not quite that transparent. But
to those with access to his archive he is pretty see-through. Mr Gurrin is a “life logger”,
someone who thinks that if, as Socrates claimed, the unexamined life is not worth living, the
life which is digitally recorded with an eye to potentially endless re-examination will have
much to recommend it. Patterns in their data, they hope, will reveal opportunities to be
healthier, happier and more effective.

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To this end Mr Gurrin wears a wide-angle camera around his neck which snaps several
pictures of his field of view every minute, recording its location and orientation each time it
does so. He has been using such devices for more than seven years. Over that time he has
built up an archive of 12m images, and he currently produces about a terabyte of data a year.
That is more computer memory than was available on the whole planet 50 years ago. Today it
can be bought, or leased in the cloud, for well under $100.

Mr Gurrin and his students have used image-scanning software to break that archive into
70,000 searchable “events”: meals, journeys, coffee-breaks, conversations and so on (on his
current camera a lens cover provides seclusion in the toilet). Every day the algorithms
recognise and index another 30. “If I need to remember where I left my keys, or where I
parked my car, or what wine I drank at an event two years ago,” he says, “the answers should
all be there.” But not all the answers are easily found. Searching by date and time is easy.
Searching by type of wine, or looking for the identity of someone encountered by chance, is
not. “What we need”, he says, “is a new generation of search engine.”

(To watch a video interview with Cathal Gurrin, click here.)

The Google Glass half-full

Hence the interest, among life loggers, in Google Glass, a thin headband which allows the
wearer to take pictures and to see data on a tiny screen held just above, and to one side of, the
right eye. (Disclosure: Eric Schmidt, Google’s executive chairman, this week became one of
The Economist’s non-executive directors; like the rest of our directors he has no influence
over our stories.) It is not the first wearable camera; but Google is hoping to make it the first
that lots of people want to wear. Unlike Mr Gurrin’s hardware, Glass is not designed to record
whole days, let alone whole lives; Thad Starner of the Georgia Institute of Technology, who is
an adviser to Google on the project, says that “Glass is a horrible life-logging platform.” But
if Glass is a hit it will be another step on the way to a world where those who wish to can
record, rewind and rewatch more of what they see more easily—and where everyone else can
end up recorded as part of the process.

Thanks to digital technology the world is replete with cheap and highly capable cameras.
ABI, a research firm, reckons there were a billion built into the mobile phones and tablets
shipped in 2012 (many boast more than one). Adding a run-of-the-mill digital camera to a
phone, or pretty much anything else, costs about $10. Narrative, a Swedish company that has
raised $500,000 through Kickstarter, is marketing a clip-on life-logger the size of a coin.

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Steve Ward of VIEVU, a Seattle firm that has been selling wearable cameras to police forces
for several years, and now has customers in 16 countries, says the devices can help protect
any professional who takes on legal liabilities: repairmen, estate agents, doctors, couriers and
more. After all, many firms already record phone calls for similar reasons. The availability of
a tamper-proof record often sorts out disputes before they escalate, expensively, into lawsuits.
A year-long experiment with the widespread use of another model of wearable camera by
police officers in Rialto, California, saw a spectacular fall in the number of complaints against
the police by the public. It also saw less use of force by officers.

Putting together evidence can provide a compelling reason for civilians to record their lives,
too. More than a million cars in Russia now sport dashboard-cams that record the road ahead.
This is mainly so that drivers can defend themselves against fraudulent insurance claims.

It may be in medicine and the care of the elderly, though, that wearable cameras will spread
quickest. For years some doctors have suggested that some patients with impaired memories
should wear such devices. Research shows that patients encouraged to regularly review their
lives by looking at a photostream stand a better chance of remembering important events or
conversations. There is hope that such approaches could alleviate some symptoms of
dementia and Alzheimer’s disease and make coping with them easier, both for the afflicted
and their carers.

I am a camera

Google aims to take wearable cameras out of their current niches and make them part of the
culture. It plans to start selling Glass to the masses in 2014. When, last February, the company
put out a call for beta testers with neat ideas, thousands of would-be “explorers” responded. In
a “base camp” in San Francisco, some of those whose pitches were successful come to pick
up the devices.

Tatiana Fitzpatrick, a jewellery designer from Arizona, wants to use Glass to record
masterclasses in beading. Many of the other explorers, too, see hands-free photography as the
thing that they want most; some talk of recording surgical operations, others want to capture
the moment at which they propose to their partner. But there is much more to Glass than
recording. A Google “guide” shows Ms Fitzpatrick how, with voice commands, head
movements and taps on a control panel mounted on the device’s arm, Glass can be used to
access a range of data services (on November 12th the company said it would soon add music
streaming). The plan is to perch all the functions of a smartphone on the bridge of the user’s
nose.

This, the company thinks, will be great for those who cannot get the most out of normal
phones; some of its explorers have quadriplegia. And all will benefit from a new immediacy.
By integrating data you want into the visual field in front of you Glass is meant to break down
the distinction between looking at the screen and looking at the world. When switched on, its
microphones will hear what you hear, allowing Glass to, say, display on its screen the name of
any song playing nearby.

David Gelernter, a Yale computer guru, imagines apps that provide historical information to
sightseers in foreign cities, or that help people identify plants and birds in their gardens.
Telling people what they are seeing can make them more observant, more absorbed: “You
will see finches and chickadees in detail where previously you saw only generic blurs of
feathers.”

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For all that he sees the technology’s possibilities, Mr Gelernter has a deep dislike for the way
it would interpose itself between the user and his world, including the other people in it.
“Developing and refining my own first reactions to my world is too important for me and my
children to allow smart glasses to mix in and muddy the waters.” He fears that people
surreptitiously using Glass as a teleprompter, perhaps to seem more knowledgeable, could put
at “risk the very frankness and honesty of human communications”.

Less high-flown criticisms include complaints that the technology is clunky and overhyped.
“A Segway for the face,” say some, recalling the ludicrous levels of pre-launch buzz that
made the Segway, a neat sort of scooter, such a disappointment when it was finally revealed.
Developed within Google’s secretive “X division”, which works on far-out ideas, Glass might
be one of those things which catches the company’s fancy for a bit but later gets dropped.

Yet there are good reasons to think that Google will dig deep to make Glass a success. One of
the company’s founders, Sergey Brin, is deeply involved in the project, giving it a powerful
champion. And Google, envious of the revenues that Apple, Samsung and others earn from
their sleek machines, is keen on selling popular hardware as well as clever software. Glass
offers the chance of defining an entirely new category of consumer product.

It could also contribute a lot to the company’s core business. Head-mounted screens would let
people spend time online that would previously have been offline. They also fit with the
company’s interest in developing “anticipatory search” technology—ways of delivering
helpful information before users think to look for it. Glass will allow such services to work
without the customer even having to reach for a phone, slipping them ever more seamlessly
into the wearer’s life. A service called Google Now already scans a user’s online calendar, e-
mail and browsing history as a way of providing information he has not yet thought to look
for. How much more it could do if it saw through his eyes or knew whom he was talking to.

This could easily edge over into areas consumers would find creepy. Take, for example, an
idea on which Google applied for a patent in 2011: a camera that would keep track of which
adverts and billboards its wearer noticed, and of any emotional responses they evoked. Glass
cannot analyse its wearers’ world, or its wearers, anything like this well yet, and many
companies patent ideas without planning to make use of them. But it is hardly paranoid to
think that a company which says its mission is “to organise the world’s information and make
it universally accessible and useful” might be interested in looking over its users’ shoulders, if
it can find a way to do so that they will think helpful and not find intrusive. If it could do so
usefully and acceptably enough, Google could help users interrogate their own histories in
much the same way as they now search for weather forecasts and celebrity news.

Me no Leica

People may in time want to live on camera in ways like this, if they see advantages in doing
so. But what of living on the cameras of others? “Creep shots”—furtive pictures of breasts
and bottoms taken in public places—are a sleazy fact of modern life. The camera phone has
joined the Chinese burn in the armamentarium of the school bully, and does far more lasting
damage. As cameras connect more commonly, sometimes autonomously, to the internet,
hackers have learned how to take control of them remotely, with an eye to mischief,
voyeurism or blackmail.

More wearable cameras probably mean more possibilities for such abuse. Face-recognition
technology, which allows software to match portraits to people, could take things further. The

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technology is improving, and is already used as an unobtrusive, fairly accurate way of
knowing who people are. Some schools, for example, use it to monitor attendance. It is also
being built into photo-sharing sites: Facebook uses it to suggest the names with which a photo
you upload might be tagged. Governments check whether faces are turning up on more than
one driver’s licence per jurisdiction; police forces identify people seen near a crime scene.
Documents released to the Electronic Frontier Foundation, a campaign group, show that in
August 2012 the Federal Bureau of Investigation’s “Next Generation Identification” database
contained almost 13m searchable images of about 7m subjects.

Face recognition is a
technology, like that of
drones, which could be a boon
to all sorts of surveillance
around the world, and may
make mask-free
demonstrations in repressive
states a thing of the past. The
potential for abuse by people
other than governments is
clear, too. If the creep taking a
creep shot, or looking at
someone else’s creep shot
found online, can find out who he is ogling, the practice becomes yet more disturbing. Well
aware of such concerns, Google has banned the use of face recognition in the apps that it
makes available for Glass (dubbed Glassware).

But face recognition has its attractions, too. Bar staff and bouncers could be warned of trouble
on the way (a British company already provides such a service); the ability to greet everyone
cheerily by name might be welcomed in many service industries. There are rampant
possibilities for phoniness, and for the loss of frankness Mr Gelernter fears. But not all
pretence is culpable. How bad is it to check Facebook in a head-mounted display so as not to
offend an acquaintance by momentarily being unable to place him? What of someone with
deepening dementia who just wants to be able to interact as he used to?

If demand for face recognition grows, Google’s stand against it might change. And Google is
not the only player. Both Microsoft (where the first of Mr Gurrin’s life-logging cameras was
developed as a research tool) and Sony are thought to be looking into Glass-like devices. Mr
Ward at VIEVU says that most companies currently providing wearable cameras for
professionals are looking at face recognition, “whether from a business perspective, or a
public-safety perspective.”

And then there are hobbyists and hackers. An unapproved software hack already allows
Glass-users to take photos simply by winking. The sanctioned way, designed so as to notify
observers of what is going on, is to use a voice command or to touch the top of the device in a
gesture that mimics that of clicking the shutter on an old-fashioned camera.

Not just recorded for training purposes

Even if private citizens do not make much use of face recognition to search their archives, it
seems a fair bet that governments will—perhaps only in special circumstances, perhaps not. In
America, warrants to seize user data from Facebook often also request any stored photos in

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which the suspect has been tagged by friends (though the firm does not always comply).
Warrants as broad as some of those from which the National Security Agency and others have
benefited in the past could allow access to all stored photos taken in a particular place and
time.

Different countries will react to this in different ways. In America businesses and citizens
enjoy broad freedom to collect photos and footage in streets and parks, as well as shops and
restaurants. There are no bars to extracting information about those depicted.

Several European countries, by contrast, require the subject of a photograph to give

permission before it is “displayed”. This once restrained newspapers and galleries, but now
applies to much online use, too. Drivers are forbidden from using dashboard cameras in
Austria; those who install them can face a €10,000 ($13,400) fine. Last year objections from
privacy advocates encouraged Facebook to disable facial recognition for users across Europe,
and delete the data it had already collected. In South Korea and Japan industry accepts it as a
norm that anything with which people can take a picture should notify others in the vicinity
by making a shutter-click noise that cannot be turned off.

Public opinion may encourage American jurisdictions to tighten up. Lawmakers in some
states have already clarified that no matter how public the setting, some sneaky photos (up
skirts, say, or down blouses) are intolerable. In May a concerned letter from members of
Congress appeared to accelerate Google’s decision to ban face recognition from Glass. In a
case involving tracking a vehicle by sticking a satellite positioning system on it, the Supreme
Court acknowledged that new forms of police surveillance may require stronger legal
safeguards, even if all the information is collected in public places. The Federal Aviation
Authority has recently made clear, for the first time, that the privacy implications of what
cameras on drones can see will be something it considers as it puts together a legal framework
for their use.

At the same time, pressure from companies and from users who want new services may erode
some of the privacy protections in Europe. Paolo Balboni of the European Privacy
Association, a think-tank supported by large technology firms, argues that if some European
countries choose to regulate Glass as if it were primarily a professional tool, not a personal
one European users could lose out.

The personal-use point is crucial. Most legislation and regulation, at the moment, protects
people’s privacy from companies and governments, to the extent that it protects them at all.
What about a world in which, simply by living their lives, people create vast searchable
records of all they have seen—a world, not of Big Brother, but of a billion Little Brothers?
Most governments and most citizens have barely given the question a thought. When should
people be able to have their images removed from another person’s non-commercial record?
Does it matter if your life-log records the sexy stranger on whom your eye happens to fall
without you explicitly asking it to do so? When should a wink be accompanied by the click of
a camera shutter?

The fact that technology makes these things possible does not mean that law and regulation
can put no check on them. But checks are unlikely to come about unless demanded. If people
have accepted, as Mark Zuckerberg, the founder of Facebook, has claimed, that privacy is no
longer a “social norm”, few will make such demands—fewer still if ever richer digital
memories offer real benefits. Mr Gurrin says that the life he has been logging has been
improved by the process. He intends to keep the cameras on until he dies.

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 By the end of Mr Eggers’s book, millions have followed Stewart into
transparency. In a nice irony, the fate of those who do not want to is not
explicitly recorded.

(Please click through to see more from our video series about wearable
cameras, featuring interviews with Saadi Lahlou, who uses wearable
cameras to study human behaviour, and Stephen Balaban, creator of the
Lambda Hat, a wearable camera and computer.)

Wearable cameras
Get a lifelog

A device that records every 30 seconds of

your life
May 11th 2013 |From the print edition, p. 61.

WILL future historians ever understand how dull and pointless life was in the 21st century?
Yes, if a new wearable camera catches on. Memoto, a Swedish start-up, is selling a stamp-
sized camera that you can pin on your shirt (see picture). It takes photographs every 30
seconds, ensuring that no experience—however mundane—will go undocumented. The
device also has an app and cloud-storage, so your pictorial record of commuting, shopping
and preparing pot noodles can be searched and shared.

Something about this idea appeals. Memoto tried to raise $50,000 last year on Kickstarter, a
crowdfunding platform. It raked in more than $500,000. The firm also obtained €500,000
($655,000) in seed funding from Passion Capital, a British venture-capital firm, enabling it to
build a prototype camera.

Exposing the product to the public at such an early stage generated useful feedback. Surprise,
surprise, many potential customers are worried about privacy. After a lively debate on Reddit,
a web-based discussion board, the firm dropped plans to have pictures automatically uploaded
to the cloud.

Those who are unwittingly snapped may be unhappy, too. Unlike a human, Memoto’s device
cannot ask for permission before taking a picture. It could therefore run afoul of strict privacy
laws in countries such as Germany. Memoto says it will inform its customers when they
might need other people’s permission to store images of them.

To make money, the firm plans to sell the cameras for $279 a pop and then offer support
services, such as storing pictures, for a subscription fee which has yet to be determined. The
balance between the two revenue streams will be tweaked once Memoto has a better idea of

Business Ethics 198

what people want. There are no plans to sell ads, despite the wealth of data that will be
created about Memoto users’ habits.

At the start of this month Memoto had around 2,000 orders from Kickstarter backers and an
additional 2,000 through its own website. But because of the inevitable teething problems that
come with designing new software, it has had to postpone its first shipping date several times
and is now declining to set a launch date.

Instead it posts regular progress updates on its blog. Memoto’s Kickstarter page is filled with
largely sympathetic commentary about the delays, including one post from a backer who
wants to know whether her camera will be ready in time for a summer hiking trip.

Lifelogging, as it is called, could prove popular. Most of us know, in our heart of hearts, that
future historians will not be interested in what we did last week. But our mothers may be.

Do I wear this in bed, too?

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Facial monitoring
The all-telling eye

Webcams can now spot which ads catch your gaze, read
your mood and check your vital signs
Oct 22nd 2011 | EINDHOVEN AND LONDON | from the print edition

We know what you’re thinking

IMAGINE browsing a website when a saucy ad for lingerie catches your eye. You don’t click
on it, merely smile and go to another page. Yet it follows you, putting up more racy pictures,
perhaps even the offer of a discount. Finally, irked by its persistence, you frown. “Sorry for
taking up your time,” says the ad, and promptly desists from further pestering. Creepy. But
making online ads that not only know you are looking at them but also respond to your
emotions will soon be possible, thanks to the power of image-processing software and the
ubiquity of tiny cameras in computers and mobile devices.

Uses for this technology would not, of course, be confined to advertising. There is ample
scope to deploy it in areas like security, computer gaming, education and health care. But
admen are among the first to embrace the idea in earnest. That is because it helps answer, at
least online, clients’ perennial carp: that they know half the money they spend on advertising
is wasted, but they don’t know which half.

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Advertising firms already film how people react to ads, usually in an artificial setting. The
participants’ faces are studied for positive or negative feelings. A lot of research, some of it
controversial, has been done into ways of categorising the emotions behind facial expressions.
In the 1970s Paul Ekman, an American psychologist, developed a comprehensive coding
system which is still widely used.

Some consumer-research companies also employ goggle-mounted cameras to track eye

movements so they can be sure what their subjects are looking at. This can help determine
which ads attract the most attention and where they might be placed for the best effect on a
web page.

This work is now moving online. Higher-quality cameras and smarter computer-vision
software mean that volunteers can work from home and no longer need to wear clunky
headgear. Instead, their eyes can be tracked using a single webcam.

One of the companies doing such work, Realeyes, which is based in London, has been
developing a system that combines eye-spying webcams with emotional analysis. Mihkel
Jäätma, who founded the company in 2007, says that his system is able to gauge a person’s
mood by plotting the position of facial features, such as eyebrows, mouth and nostrils, and
employing clever algorithms to interpret changes in their alignment—as when eyebrows are
raised in surprise, say. Add eye-movement tracking, hinting at which display ads were
overlooked and which were studied for any period of time, and the approach offers precisely
the sort of quantitative data brand managers yearn for.

At present the system is being used on purpose-built websites with, for instance, online
research groups testing the effect of various display ads. The next step is to make interactive
ads. Because they can spot the visual attention given to them, as well as the emotional state of
the viewer, these ads could tailor their responses.

As similar gimmicks become widespread, privacy concerns will invariably mount. People
would need to give consent to their webcams being used in this way, Mr Jäätma admits. One
way to persuade internet users to grant access to their images would be to offer them
discounts on goods or subscriptions to websites.

Realeyes is also working with Kaplan, an educational-services company, on a project in

Hungary which is using the system to measure how children respond to virtual games that
teach them English. The hope is that by performing the same emotion-reading trick that
marketers use, the type of tasks and the characters that appear in them can be made more
engaging.

The technology would make computer games more engaging, too. Sony, for one, thinks that
reading players’ emotions with webcams would let software pick up on their subconscious
behaviour and change the game in ways that would enhance the experience. The company
claims that in the future it will be possible to have something like a detective game in which
the camera can read players’ faces and measure their heart rates in order to have a stab at
deciding which ones are lying.

In fact, webcams that monitor a person’s heart rate are soon to appear. Instead of sticking
sensors onto the skin, Philips has developed a vital-signs camera system which the Dutch
company says can measure heart and respiration rates extremely accurately. To calculate the
heart rate the camera detects tiny changes in the colour of the skin. These changes,

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imperceptible to the human eye, occur as the heart pumps blood through the body. The
person’s breathing rate is measured by detecting the rise and fall of his chest. The firm will
soon launch an app for Apple’s iPad 2 which will allow people to measure their own heart and
breathing rates using the two webcams in that device.

Philips is developing the technology as a contactless system to keep a virtual eye on hospital
patients, such as newborn babies, who might find conventional monitors distressing. The
company is also eyeing anxious parents who always want to know what their tots are up to, as
well as anxious coaches and their athletes. Advertising firms will, no doubt, be just as keen to
measure heartbeats, especially for ads designed to get pulses racing. Those who find it all
smacks of Big Brother can turn their webcams off. If you are playing online poker, that is
probably a wise idea.

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Business Ethics 203
Mind-reading
The terrible truth

Technology can now see what people are

thinking. Be afraid
Oct 29th 2011 | from the print edition

DOUGLAS ADAMS, the late lamented author of “The Hitchhiker’s Guide to the Galaxy”,
dreamed up many comic creations. One of his greatest was the Babel fish. This interstellar
ichthyoid neatly disposed of a problem all science-fiction authors have: how to let alien
species talk to one another. It did so by acting as a mind-reader that translated thoughts
between different races and cultures. Universal communication did not, unfortunately, lead to
universal harmony. As Adams put it, “The poor Babel fish has caused more and bloodier wars
than anything else in the history of creation.”

For the moment, mind-reading is still science fiction. But that may not be true for much
longer. Several lines of inquiry (see article) are converging on the idea that the neurological
activity of the brain can be decoded directly, and people’s thoughts revealed without being
spoken.

Just imagine the potential benefits. Such a development would allow both the fit and the
disabled to operate machines merely by choosing what they want those machines to do. It
would permit the profoundly handicapped—those paralysed by conditions such as motor-
neuron disease and cerebral palsy—to communicate more easily than is now possible even
with the text-based speech engines used by the likes of Stephen Hawking. It might unlock the
mental prisons of people apparently in comas, who nevertheless show some signs of neural
activity. For the able-bodied, it could allow workers to dictate documents silently to
computers simply by thinking about what they want to say. The most profound implication,
however, is that it would abolish the ability to lie.

Who could object to that? Thou shalt not bear false witness. Tell the truth, and shame the
Devil. Transparency, management-speak for honesty, is put forward as the answer to most of
today’s ills. But the truth of the matter—honestly—is that this would lead to disaster, for
lying is at the heart of civilisation.

People are not the only creatures who lie. Species from squids to chimpanzees have been
caught doing it from time to time. But only Homo sapiens has turned lying into an art. Call it
diplomacy, public relations or simple good manners: lying is one of the things that makes the
world go round.

Minds matter

The occasional untruth makes domestic life possible (“Of course your bum doesn’t look big in
that”), is essential in the office (“Don’t worry, everybody’s behind you on this one”), and
forms a crucial part of parenting (“It didn’t matter that you forgot your words and your
costume fell off. You were wonderful”). Politics might be more entertaining without lies—

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“The prime minister has my full support” would be translated as, “If that half-wit persists in
this insane course we’ll all be out on our ears”—but a party system would be hard to sustain
without the semblance of loyalty that dishonesty permits.

The truly scary prospect, however, is the effect mind-reading would have on relations
between the state and the individual. In a world in which the authorities could divine people’s
thoughts, speaking truth to power would no longer be brave: it would be unavoidable.

Information technology already means that physical privacy has become a scarce commodity.
Websites track your interests and purchases. Mobile phones give away your location. Video
cameras record what you are up to. Lose mental privacy as well, and there really will be
nowhere to hide.

Reading the brain

Mind-goggling

It is now possible to scan someone’s brain

and get a reasonable idea of what is going
through his mind
Oct 29th 2011 | from the print edition

IF YOU think the art of mind-reading is a conjuring trick, think again. Over the past few
years, the ability to connect first monkeys and then men to machines in ways that allow brain
signals to tell those machines what to do has improved by leaps and bounds. In the latest
demonstration of this, just published in the Public Library of Science, Bin He and his
colleagues at the University of Minnesota report that their volunteers can successfully fly a
helicopter (admittedly a virtual one, on a computer screen) through a three-dimensional digital
sky, merely by thinking about it. Signals from electrodes taped to the scalp of such pilots
provide enough information for a computer to work out exactly what the pilot wants to do.

That is interesting and useful. Mind-reading of this sort will allow the disabled to lead more
normal lives, and the able-bodied to extend their range of possibilities still further. But there is
another kind of mind-reading, too: determining, by scanning the brain, what someone is
actually thinking about. This sort of mind-reading is less advanced than the machine-
controlling type, but it is coming, as three recently published papers make clear. One is an
attempt to study dreaming. A second can reconstruct a moving image of what an observer is
looking at. And a third can tell what someone is thinking about.

First, dreams. To study them, Martin Dresler, of the Max Planck Institute of Psychiatry, in
Munich, and his colleagues recruited a group of what are known as lucid dreamers. They
report their results in this week’s Current Biology.

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A lucid dream is one in which the person doing the dreaming is aware that he is dreaming,
and can control his actions almost as if he were awake. Most people have lucid dreams
occasionally. A few, though, have them often—and some have become good at manipulating
the process. Dr Dresler co-opted six self-professed practitioners of the art for his experiment.
He asked them to perform, in their dreams, a simple action whose neurological traces in a
brain scan are well understood. This action was to clench either their right or their left hand
into a fist. The test would be to see if Dr Dresler’s brain scanner could reliably tell the
difference.

Once a volunteer had dozed off and begun dreaming, he was to shift his eyes from left to right
twice, to show he was ready to begin the experiment. (Unlike other parts of the body, which
become limp in the phase of sleep during which dreams occur, the eyes continue to twitch.
Indeed, this phase is known as rapid-eye-movement sleep.) After this signal, he clenched his
left hand in his dream ten times, and then his right hand. (His real hands, of course, remained
motionless.) He indicated the end of each set of clenches by turning his eyes as before. A trial
was deemed a success if at least four sets of alternate clenches were performed in this way.

At first, only one participant managed to meet these exacting criteria, though he did so on two
occasions. Dr Dresler speculated that the reason was his chosen brain scanner. He was using a
functional magnetic-resonance imaging (fMRI) machine. This is the best sort of scanner, but
it makes a terrible racket and so is not conducive to dreamy slumber. Replacing fMRI with a
slightly less accurate technique called near-infra-red spectroscopy produced two further
successful trials involving a different volunteer.

Both techniques were able to see the brain acting to clench a volunteer’s fist in his dream in
exactly the way that it does when ordering fist-clenching in reality. This might not seem a big
deal, but it is the first time science has proved what was hitherto mere speculation: that the
brain, when dreaming, behaves like the brain when awake. In principle, then, it might be
possible to “read” dreams as they are happening, and thus perhaps solve one of the great
mysteries of biology: what, exactly, is dreaming for?

Though it may seem a stretch to suggest that the mind of a dreamer could be read in this way,
it is not. For the second paper of the trio, published in Current Biology in September, shows
that it is now possible to make a surprisingly accurate reconstruction, in full motion and
glorious Technicolor, of exactly what is passing through an awake person’s mind.

This study was done by Jack Gallant of the University of California, Berkeley. In the name of
science, three members of Dr Gallant’s team each endured two sessions of fMRI while
watching assorted film trailers. The researchers chose to experiment on themselves, rather
than calling for volunteers, because the experiment required them to sit perfectly still in an
fMRI machine for long periods. Two hours of being bombarded with excerpts from such
treats as the remake of “The Pink Panther”, they decided, would be too brutal a procedure to
visit on innocent outsiders.

Which will be the critics’ choice?

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Psychodrama

Unlike Dr Dresler, who focused on the sensorimotor cortex, which controls movement, Dr
Gallant and his team looked at the visual cortex. Their method depended on the brute power
of modern computing. They compared the film trailers frame by frame with fMRI images
recorded as those trailers were being watched, and looked for correlations between the two.
They then fed their computer 5,000 hours of clips from YouTube, a video-sharing website,
and asked it to predict, based on the correlations they had discovered, what the matching
fMRI pattern would look like.

Having done that, they each endured a further two hours in the machine, watching a new set
of trailers. The computer looked at the reactions of their visual cortices and picked, for each
clip, the 100 bits of YouTube footage whose corresponding hypothetical fMRI pattern best
matched the real one. It then melded these clips together to produce an estimate of what the
real clip looked like. As the pictures above show, the result was often a recognisable
simulacrum of the original. It also moved (watch at gallantlab.org) in the same way as the clip
it was based on.

The third study, published in August in Frontiers in Human Neuroscience by Francisco

Pereira and his colleagues at Princeton university, used a technique similar to Dr Gallant’s to
perform an equally impressive trick. Rather than recreating images, Dr Pereira was able to
determine what topics people were pondering. To do this, he re-examined data collected
during an experiment conducted in 2008, in which nine volunteers had been shown labelled
pictures of 60 objects, and then had their brains scanned as they were asked to imagine those
same objects.

Dr Pereira divided the data in two. He used half to generate his hypothesis and half to test it.
Though his pattern-detection algorithms could not distinguish exactly which objects the
volunteers had seen, they managed a task that was only slightly less demanding. They could
work out what type of object something was. In other words, they could not distinguish a
carrot from a stick of celery, but could say that it was a vegetable.

The similarity to Dr Gallant’s study came from the way the categories were established. This
was done by pillaging another huge website, Wikipedia, to find out how the names of objects
tend to cluster together in the online encyclopedia’s articles. Dr Pereira found that they appear
to cluster in similar ways in the brain, and to produce enough shared neural characteristics
there for the clustering to be detectable.

Mind-reading, then, has become a reality. It is crude. The results would not stand up in
court—yet. But, as the Franck report said of America’s first atom bomb, the thing does work.

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The right to be forgotten
Drawing the line

Google grapples with the consequences of a

controversial ruling on the boundary
between privacy and free speech
Oct 4th 2014 | From the print edition, p. 61-62.

SOMETIMES a local spark can cause a global fire. In 1998 La Vanguardia, a Spanish daily,
ran an announcement publicising the auction of a house to pay taxes owed by Mario Costeja
González, a lawyer. The event would have been consigned to oblivion had the newspaper not
digitised its archives a few years later. Instead, it came first in Google’s results for searches
for Mr Costeja’s name, causing him all manner of professional problems.

When the online giant refused to remove links to the material, Mr Costeja turned to Spain’s
data-protection authority. The case ended up in the European Court of Justice (ECJ), which
ruled in May that Google must remove certain links on request. The ruling has established a
digital “right to be forgotten”—and forced Google to tackle one of the thorniest problems of
the internet age: setting the boundary between privacy and freedom of speech.

The two rights had coexisted, occasionally uneasily, offline. But online, border skirmishes
have become increasingly common. “It’s like two friends who don’t always get along, but are
now being confined to one room,” says Luciano Floridi, a professor of philosophy and the
ethics of information at Oxford University.

Complicating matters is a transatlantic split. America allows almost no exceptions to the first
amendment, which guarantees freedom of speech. Europe, not least because of its experiences
of fascism and communism, champions privacy.

The ECJ’s ruling was vague. Even if information is correct and was published legally, the
court said, Google (or indeed any search engine) must grant requests not to show links to it if
it is “inadequate, irrelevant or no longer relevant”—unless there is a “preponderant” public
interest, perhaps because it is about a public figure. With no appeal possible, Google went to
work. It helped that it already had a procedure for removing links to copyrighted material
published without permission. Just a few weeks later it had put a form online for removal
requests.

The firm’s dozens of newly hired lawyers and paralegals have their work cut out. Between
June and mid-September, it received 135,000 requests referring to 470,000 links. Most came
from Britain, France and Germany, Google says. It will publish more detailed statistics soon.

Meanwhile numbers from Forget.me, a free website that makes filing removal requests easier,
give a clue to the sort of information people want forgotten. Nearly half of the more than
17,000 cases filed via the service refer to simple personal information such as home address,
income, political beliefs or that the subject has been laid off. Nearly 60% were refused. If the

Business Ethics 208

material is about professional conduct or created by the person now asking that links to it be
deleted, removal is unlikely. Requests relating to information which is relevant, was published
recently and is of public interest are also likely to fail.

Many of the decisions look quite straightforward. Google has removed links to “revenge
porn”—nude pictures put online by an ex-boyfriend—and to the fact that someone was
infected with HIV a decade ago. It said no to a paedophile who wanted links to articles about
his conviction removed, and to doctors objecting to patient reviews. In between, though, were
harder cases: reports of a violent crime committed by someone later acquitted because of
mental disability; an article in a local paper about a teenager who years ago injured a
passenger while driving drunk; the name on the membership list of a far-right party of
someone who no longer holds such views. The first of these Google turned down; the other
two it granted.

The process is “still evolving” says Peter Fleischer, Google’s global privacy counsel. A Dutch
court recently decided the first right-to-be-forgotten case, upholding Google’s refusal to
remove a link to information about a convicted violent criminal. After more appeals have
been heard by data-protection authorities and courts, the firm can adjust its decision-making.
The continent’s privacy regulators are working on shared guidelines for appeals.

Another steer will come from an advisory council set up by Google itself. Its eight members
include Mr Floridi; Jimmy Wales, the founder of Wikipedia; a journalist at Le Monde, a
French paper; and a former director of Spain’s data-protection agency. It has already held four
public meetings in as many European cities, with three more to come before it reports back to
Google early next year.

One question asked at the meeting in Paris on September 25th was how users should be made
aware of the fact that the results of a search have been affected by the ruling. Currently, a
notice at the bottom of the results page says that “some results may have been removed”,
which perhaps defeats the purpose by raising a red flag. Another was how publishers should
react. In Britain newspapers published articles about the fact that Google no longer linked to
previous articles, again bringing to prominence information that the firm had found merited
being forgotten.

More broadly, many wonder whether Google should remove links from searches everywhere,
not just on its European sites. That would lead to a transatlantic row, but could also trigger a
debate in America about why, for instance, American victims of revenge porn should not also
be able to ask Google to stop linking to such content.

Some have dismissed Google’s advisory council and its tour through Europe as a public-
relations exercise. “Google is trying to set the terms of the debate,” said Isabelle Falque-
Pierrotin, the head of France’s data-protection watchdog, last month. Predictably, those
involved see it differently. Asked why he joined Google’s council, one of the members said:
“Because it’s terribly interesting.” As the virtual world’s boundaries are redrawn, it matters
who gets to hold the pen.

Clarification: Google displays "some results may have been removed" at the bottom of the
results page for any search in Europe for a name (unless it is that of a public figure), not just
those for names of people whose removal requests have been granted.

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Digital identity cards
Estonia takes the plunge

A national identity scheme goes global

Jun 28th 2014 | From the print edition

THE founders of the internet were academics who took users’ identities on trust. When only
research co-operation was at stake, this was reasonable. But the lack of secure identification is
now hampering the development of e-commerce and the provision of public services online.
In day-to-day life, from banking to dating, if you don’t know who you are dealing with, you
are vulnerable to fraud or deceit, or will have to submit to cumbersome procedures such as
scanning and uploading documents to prove who you are.

Much work has gone into making systems that can recognise and verify digital IDs. A
standard called OpenID Connect, organised by an international non-profit foundation, was
launched this year. Mobile-phone operators have started a complementary service, Mobile
Connect, which allows identities of all kinds to be authenticated from smartphones.

But providing a digital ID that will be widely used and trusted is far harder. Businesses can
check their employees rigorously, and issue credentials for gaining access to buildings,
computers and the like. But what about outside the workplace? Facebook, Google and Twitter
are all trying to make their accounts a form of ID. But these are issued without verification, so
pseudonyms are rife and impersonation easy.

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Private providers are offering their own schemes; miiCard, for example, uses bank accounts
as a way of issuing a verified online identity. But these fall short of the reliability of a state-
backed identity, issued by a government official, checked against other databases, using
biometric data (such as fingerprints and retinal scans) and backed by law—in effect an
electronic passport.

There is one place where this cyberdream is already reality. Secure, authenticated identity is
the birthright of every Estonian: before a newborn even arrives home, the hospital will have
issued a digital birth certificate and his health insurance will have been started automatically.
All residents of the small Baltic state aged 15 or over have electronic ID cards, which are used
in health care, electronic banking and shopping, to sign contracts and encrypt e-mail, as tram
tickets, and much more besides—even to vote.

Estonia’s approach makes life efficient: taxes take less than an hour to file, and refunds are
paid within 48 hours. By law, the state may not ask for any piece of information more than
once, people have the right to know what data are held on them and all government databases
must be compatible, a system known as the X-road. In all, the Estonian state offers 600 e-
services to its citizens and 2,400 to businesses.

Estonia’s system uses suitably hefty encryption. Only a minimum of private data are kept on
the ID card itself. Lost cards can simply be cancelled. And in over a decade, no security
breaches have been reported. Also issued are two PIN codes, one for authentication (proving
who the holder is) and one for authorisation (signing documents or making payments). Asked
to authenticate a user, the service concerned queries a central database to check that the card
and relevant code match. It also asks for only the minimum information needed: to check a
customer’s age, for example, it does not ask, “How old is this person?” but merely, “Is this
person over 18?”

Other governments have tried to issue electronic identity cards. But costs have been high and
public resistance strong. Some have proved careless custodians of their citizens’ data. There
are fears of snooping. Britain had spent £257m ($370m) of a planned £4.5 billion on a much-
criticised ID card scheme by the time the current coalition government scrapped it after
coming to office in 2010.

That has left a gap in the global market—one that Estonia hopes to fill. Starting later this year,
it will issue ID cards to non-resident “satellite Estonians”, thereby creating a global,
government-standard digital identity. Applicants will pay a small fee, probably around €30-50
($41-68), and provide the same biometric data and documents as Estonian residents. If all is in
order, a card will be issued, or its virtual equivalent on a smartphone (held on a special secure
module in the SIM card).

Some good ideas never take off because too few people embrace them. And with just 1.3m
residents, Estonia is a tiddler—even with the 10m satellite Estonians the government hopes to
add over the next decade. What may provide the necessary scale is a European Union rule
soon to come into force that will require member states to accept each others’ digital IDs.
That means non-resident holders of Estonian IDs, wherever they are, will be able not only to
send each other encrypted e-mail and to prove their identity to web-service providers who
accept government-issued identities, but also to do business with governments anywhere in
the EU.

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Estonia is being “very clever”, says Stéphanie de Labriolle of the Secure Identity Alliance, an
international working group. Marie Austenaa of the GSMA, a global association of mobile-
phone firms, praises it too. Allan Foster of ForgeRock, a firm that is working on government
ID schemes in Belgium, New Zealand and elsewhere, thinks that the new satellite Estonians
will help change attitudes to secure digital identities in their own countries, too.

The scheme’s advantages for Estonia are multiple. It will help it shed the detested “ex-Soviet”
tag and promote itself as a paragon of good government and innovation. It will attract
investment: once you have an Estonian ID, setting up a company there takes only a few
minutes. And it will create an electronic diaspora all over the world with a stake in the
country’s survival—no small matter at a time when the threat from Russia is keenly felt.
(Estonia is also planning to back up all its national data to secure “digital embassies” in
friendly foreign countries.)

Struck by the X-road’s scalability and security, and the fact that it has already worked well for
over a decade, Finland and other countries are adopting the Estonian system in whole or in
part. But for foreign individuals, perhaps its greatest appeal is that it is optional. Those who
like the system’s convenience, security and flexibility can apply (though Estonia’s chief
information officer, Taavi Kotka, who is taking time away from his real-life job running an IT
company, stresses that the ID is a privilege, not a right). Those who feel queasy about a
foreign state having access to their personal data can steer clear.

Mr Kotka says that Estonia aims to do for identity what American Express cards did for
international travel in the 1960s: to simplify life. But the bigger point is that government-
verified identity has been divorced from location. If Estonia’s scheme takes off some other
countries may well decide to follow its lead. Some may aim at volume; others, to target the
top end, as with the market in non-resident investors’ passports. Soon, multiple satellite
citizenship may even become the norm.

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The Supreme Court
Hands off my phone

A win for privacy, a loss for internet

television
Jun 28th 2014 | From the print edition, p. 37.

THE framers of America’s constitution knew nothing about mobile phones, but they knew a
thing or two about unreasonable searches. In Riley v California, the Supreme Court
considered “whether the police may, without a warrant, search digital information on a
cellphone seized from an individual who has been arrested.” Unanimously on June 25th, the
justices said no, or, to be more precise, very rarely.

David Riley, a member of the Bloods street gang who was sentenced to 15 years to life for
attempted murder, and Brima Wurie, sentenced to 262 months on a drug charge, will be
happy to hear this. Except in true emergencies where searching a mobile phone could, say,
avert a terrorist attack, police prying without a warrant violates the Fourth Amendment’s bar
on “unreasonable” searches, the justices decided. Since both Riley and Wurie’s convictions
were based on evidence gleaned from such searches, they will be overturned.

Chief Justice John Roberts began by observing how attached Americans have become to their
mobile devices: “the proverbial visitor from Mars,” he wrote, might mistake them for “an
important feature of human anatomy”. Smartphones can contain “[t]he sum of an individual’s
private life...from the mundane to the intimate.” In fact, the ruling reads, thumbing through a
mobile phone is potentially far more revealing than “the most exhaustive search of a house”.
Without the benefit of “more precise guidance from the founding era,” Mr Roberts explained,
the court must weigh individual privacy against “the promotion of legitimate governmental
interests”. And since it is usually easy to grab a suspect’s phone, remove its battery or stash it
in an aluminium sack (to avert “remote wiping”) and hold onto it pending a warrant, there is
no good reason to allow police to rifle through the digital lives of anyone they pull over.

While Riley provides clear guidance for law enforcement, another technology-related case
decided on the same day does not. The effects of American Broadcasting Companies v Aereo
may not be known for years to come. At issue was whether a startup with a nifty way of
delivering broadcast TV programmes to customers for as little as $8 a month violated the
1976 Copyright Act. The Court said yes, by a vote of 6-3.

Aereo had sought to distinguish itself from cable and satellite providers, which have to pay
for transmitting programmes created by others. Rather than sending programmes directly to
customers’ homes, Aereo captures free, over-the-air broadcasts on wee antennae and transmits
them directly to digital recording devices, one per subscriber. Users then access the content on
the remote devices via an internet connection, streaming live television with only a few
seconds’ delay.

Justice Stephen Breyer, writing for the majority, was unimpressed with Aereo’s attempt to set
itself apart. “For all practical purposes,” he wrote, Aereo is “a traditional cable system”. It
uses its own equipment, transmits copyrighted material to users’ homes and lets them watch
Business Ethics 213
the shows “virtually as the programming is being broadcast”. Fancy technology does not give
Aereo immunity from copyright law.

Justice Antonin Scalia, writing in dissent, explored the wider implications of Aereo’s loss.
Aereo is more like a “copy shop” than a cable system, he wrote. Rather than “provide a
prearranged assortment of movies and television shows,” Aereo allows customers to choose
freely available shows they want to digitise; “subscribers,” in short, “call all the shots.” The
majority’s ruling, Justice Scalia charged, paves the way for similar curbs on cloud-based
technologies that hundreds of millions of Americans rely on every day—from Dropbox to
music-streaming services. “The Court vows that its ruling will not affect cloud-storage
providers and cable-television systems,” Justice Scalia warned, “but it cannot deliver on that
promise.” The boss of Aereo, Chet Kanojia, wrote that the ruling may have a “chilling” effect
on the technology industry. Whether or not this proves to be the case, it will force Aereo to
rethink its novel business model.

You can keep your phone, sir

Business Ethics 214

The Patriot Act
Reviewing the surveillance state

America argues anew over how much

snooping the NSA can do
May 23rd 2015 | WASHINGTON, DC | From the print edition, p. 35-36.

DEEP in the desert in Utah, the National Security Agency (NSA), America’s signals
intelligence branch, has built a $1.5 billion centre to scoop up and analyse data from the
internet. The building includes its own water-treatment facility, electric substation and 60
back-up diesel generators. It will use over a million gallons of water a day. Its data-storage
capacity would be enough, according to one estimate, to store a year of footage of round-the-
clock video-recording of over a million people. At this centre, communications from across
the globe are tapped directly from the fibre-optic backbone of the internet.

And yet even as these data are gathered, America’s politicians are fretfully discussing how
much of the pile government snoops can look at, and under what circumstances. Two years
after Edward Snowden, a contractor for the NSA, revealed the extent of it, the technical
capacity of America’s surveillance state has never been more dramatic. Its legal capacity,
however, is becoming markedly more restricted. In Congress and in the courts, the right of the
government to collect the data of Americans is being challenged. Politically, the consensus
that this level of surveillance (at least of American citizens) is necessary appears to be
breaking down.

As The Economist went to press on May 21st, Congress was in a fraught debate about whether
and how to renew Section 215 of the Patriot Act—a law passed in the immediate aftermath of
the attacks of September 11th 2001—which was due to expire. House Republicans, urged on
by Rand Paul, a libertarian-leaning senator who is running for president, were deadlocked
with Republican leaders in the Senate. On May 20th-21st Mr Paul spoke against renewal for
10½ hours, arguing that the act damaged both liberty and privacy. Senate leaders, though,
worried about hampering the ability of spooks to spy.

Americans are protected against much government spying by the Fourth Amendment, which
bans unreasonable searches. They are also buffered by a legal framework first constructed in
the 1970s after the bugging and dirty tricks of the Watergate scandal, and the discovery that J.
Edgar Hoover’s FBI had spied extensively on suspected communists and civil-rights leaders.
Under this system, a federal court (known as the FISA court) exists to issue secret warrants
for spying for counter-espionage purposes. Surveillance of Americans or people within
America by methods such as wiretaps requires permission from a judge. The Senate
Intelligence Committee oversees the court’s decisions.

The internet has muddied this picture considerably, however. As Mr Snowden revealed, the
capacity of the American state to spy has become spectacularly broad, partly because so much
internet traffic travels through America, and so can be easily tapped (something NSA agents
call “home-field advantage”). And its legal reach, too, has been far wider than most people
were aware of. The Patriot Act, in particular, has allowed more government spying than even
its drafters realised.
Business Ethics 215
For example, before Mr Snowden’s whistleblowing, few realised that Section 215 of the
Patriot Act had a secret legal interpretation which justified the collection of “metadata” of
phone calls made by hundreds of millions of Americans. This did not include the content of
phone calls, but did include details of who had phoned whom, when, and for how long.
Another programme, started under George W. Bush and ended in 2011, collected similar
metadata on e-mails sent and received.

Other concerns involve Section 702 of the Foreign Intelligence Surveillance Act, which
allows the NSA to eavesdrop on communications by people outside the United States. As well
as allowing America to spy on foreigners ad libitum, this allows the government to collect
inadvertent content in citizens’ communications: for example, if an American has e-mailed a
foreigner who is being spied on.

All this the government had deemed legal. But on May 7th the Second Circuit Court of
Appeals ruled in favour of the American Civil Liberties Union (ACLU) in a case against the
government over Section 215. Looking at metadata remains legal, the court ruled, but its
“bulk collection” is not. That, says Mark Jaycox of the Electronic Frontier Foundation, a civil-
liberties-minded pressure group, is a partial vindication of Mr Snowden’s whistleblowing.

Civil-liberties campaigners are now raising questions about the oversight of the intelligence
agencies. “What the Snowden revelations showed…was that the oversight structure is totally
broken,” says Neema Singh Guliani of the ACLU. In the FISA court, she points out, there is
no advocate for privacy—it is biased in favour of the agencies. Of 34,000 surveillance
applications put to the court between 1979 and 2012, only 12 were refused.

Neither, she argues, does the Senate Intelligence Committee’s oversight work properly. The
efforts of Senator Ron Wyden, a Democrat on the Senate Intelligence Committee who raised
concerns about mass surveillance before 2013, were choked off by more hawkish colleagues.
False claims, such as one in 2013 by James Clapper, the director of national intelligence, that
the NSA was not collecting data on hundreds of millions of Americans, went unpunished.

A few politicians are beginning to

change their tone. Mr Paul, for
example, has built a large part of his
campaign round the argument that
“what you discuss on your phone is
none of the government’s business”.
He hopes that this message will
appeal to young voters who do not
trust the feds. It certainly sets him
apart from other Republican
contenders, who tend to think that
the security agencies should have
more power, not less.

Yet according to Benjamin Wittes, a

legal scholar at the Brookings
Institution, a think-tank, the actual
legal failings of the security agencies
are relatively minor, given their
physical capacity to hoover data up.

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And public opinion is not as libertarian as some think. Although few Americans like being
spied on themselves, polling suggests they are perfectly happy to let the government spy on
terrorists, foreigners in general and even on American leaders (see chart). This suggests that
the dismantling of the security state is unlikely to go far. Should Mr Snowden ever return to
America (as he has said he would like to), he will probably still face tough charges. There is
little doubt that his revelations aided America’s enemies.

The security agencies have to prove they will not abuse the vast technical power they are
accruing. Sophisticated terrorists, foreign spies and criminals can use encryption software to
help them stay below the radar, but ordinary citizens post details of their lives online
routinely. For all that information to be instantly available to officials staring at screens in
Utah is worrying. Americans must be able to trust the law that determines when it can be
seen.

Intelligence and democracy

A new age of espionage

Electronic spycraft is getting easier but

more controversial. The old-style human
sort is getting harder but more useful
Aug 1st 2015 | From the print edition, p. 49-50.

CYBER-CAFÉS were once a favoured tool of Western intelligence and security agencies.
They were inconspicuous, cheap to establish and highly effective. Set up near an international
summit buzzing with targets, or close to a mosque favoured by Islamist extremists, these

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facilities allowed their masters to monitor browsing habits, obtain targets’ logins and
passwords, and plant spyware for future use. This was legal: consent was buried in the terms
and conditions which users clicked on without reading. And in a neat twist, security-conscious
people trying to avoid using their own computers favoured such places. Some would hop
between cafés, unaware that all the convenient ones were run by the authorities.

Not any more. Edward Snowden, a fugitive former contractor for America’s National Security
Agency (NSA) now living in Moscow, revealed the use of cyber-cafés to spy on the G20
summit in London in 2009. Now people are wary. In many countries the cyber-cafés have
been closed. The staff who ran them have had to be moved (and in some cases given costly
new identities). As a result, keeping track of terrorism suspects is now harder, spooks say.

The episode highlights one of the most important trends in modern intelligence work.
Collecting electronic information is generally getting easier. It is hard to lead a completely
non-digital life, and any activity using computers and networks creates openings for the
watchers. An e-mail is as easy to read as a postcard for anyone with modest technical skills.
With a few tweaks, mobile phones become tracking beacons and bugging devices. Most
people readily trade private information for convenience. And hacking into computers can
yield vast amounts of intelligence.

A lot of spying, however, has become trickier. It is much more difficult for intelligence
officers to maintain secrecy and create fake identities. And high expectations of privacy,
especially in the digital realm, mean that in many countries the work of intelligence and
security agencies arouses outrage, not gratitude.

Secrets and lies

In theory it should come as no surprise that spy agencies spy, and that the biggest and best are
good at it. But the Snowden revelations underlined some uncomfortable facts. Espionage is
inherently lawless. Supposedly private communications are fair game. Seemingly friendly
countries spy on each other. The news (subsequently dismissed by German prosecutors) that
America listened to Angela Merkel’s mobile phone was one of a corrosive series of
revelations which led to the CIA station chief’s expulsion from Berlin—a low point in the two
countries’ relations.

In particular, electronic intelligence-gathering is based on trawling and sifting huge amounts

of information. This includes private communications between people who have no
connection to crime, terrorism or statecraft. Western spymasters insist that this material is of
no interest to them: it is merely the inevitable by-product of collecting communications which
contain the material they are interested in. In some countries the public seems unworried. A
sweeping new spy law has caused few ripples in France, for example. In others, such as
Germany, spooked by its Nazi and Stasi past, it has led to blazing rows. Whose information
may be intercepted? Where should it be warehoused? For how long? Who should have access
to it? These questions go to the heart of the relationship between the state and the citizen.

Both Britain and America are rejigging their oversight arrangements in an attempt to assuage
public worries. America’s NSA no longer directly intercepts and stores electronic
communications between residents of the United States: it must apply for a warrant to obtain
them from internet and phone firms (access to foreigners’ communications remains
unaffected). Britain’s independent scrutineer of terrorism legislation, David Anderson, a
lawyer, has issued a report blasting what he terms ramshackle supervisory arrangements. He

Business Ethics 218

wants stronger judicial scrutiny instead of the existing system, which is based on government
ministers authorising intercepts.

Though the spy agencies remain incandescently angry with Mr Snowden and his supporters,
spymasters in Britain and America grudgingly admit that they now need to work to regain
public trust. The old combination of secrecy and public ignorance is no longer enough. Spies
now need a public consensus to legitimise their work—especially when it comes to activities
which intrude on the privacy of their own citizens. Building that will take years.

The Snowden revelations not only showed that electronic espionage was far more intrusive
than many had realised. They also gave clues about how to avoid it. Encrypted electronic
messaging, for example, is much tougher to intercept and trawl for clues than e-mails or
phone calls. The encryption keys may be held only by the communicating parties—so there is
no point in serving a warrant on, say, Apple to get access to messaging that uses its platform.
The spooks complain mightily about this—James Comey, the director of the FBI, says firms
which provide encryption software to their customers should have a duty to provide the
decryption keys to law-enforcement agencies. Critics see this as either futile or dangerous: a
warehouse full of keys would be a target for attack.

What the spooks talk about less is the many ways in which they can get round encryption.
However heavily encoded a communication is while in transit, it must be composed and
displayed in a way that humans can understand. This involves keyboards and computer
screens—known as “end-point vulnerabilities”. If you know what your target has written, and
what he is reading, the fact that it was transmitted with heavy encryption does not matter.
Spies may have to work harder on their targets but no communication, electronic or
otherwise, is completely secure: it is just a question of how much effort the other side can put
into getting hold of the message.

A much bigger worry for the spies is that the very vulnerabilities which make it easy for them
to steal other people’s secrets also make it hard for them to hold on to their own. In pre-
computer days, intelligence agencies kept files on paper. Access was strictly controlled;
making copies more so. That arrangement was cumbersome but made it possible to see
exactly who had looked at a file, when and why. Looting an intelligence registry of its
documents was all but impossible.

That has now changed. Computers are inherently leakier than cardboard files tied with ribbon
and kept under lock and key. Any network connected to the internet is at risk of penetration.
Even those that are “air-gapped”—kept physically separate—are vulnerable. A doctored
mobile phone can secretly plant spyware on a target’s computer and vice versa. Large
quantities of data can be carried on a computer chip the size of a cufflink. In some quarters,
for the most secret documents, manual typewriters and carbon paper are back in fashion.

This weakness was highlighted by Mr Snowden, who used his role as a lowly technician to
extract a huge cache of documents from the NSA and other agencies. Only a fraction has been
published (and, critics say, only a small number of those bear on his purported concerns about
privacy and oversight). The NSA and allied agencies are still struggling to work out what was
taken and assess the damage. Have the documents fallen into the hands of Russian and
Chinese spooks, for example? British and American spies have already been moved from
places where they may now be at risk; some have been given new identities.

Once more unto the breach

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The Snowden breach—termed at the time the West’s greatest intelligence disaster—is only
one of many in recent years. Jeffrey Delisle, a Canadian naval officer arrested in 2012, was
sentenced to 20 years imprisonment in 2013. For five years he had been passing Russia
information from Stoneghost, a secret intelligence-sharing network for the “Five Eyes”
countries (America, Australia, Britain, Canada and New Zealand). The Snowden files
undoubtedly added details and gave ammunition to anti-Western propaganda outfits. But
according to John Schindler, an American spy expert, the Delisle breach meant that Russian
intelligence already “had it all”.

Perhaps worse is the catastrophe at America’s Office of Personnel Management (OPM). This
low-profile agency handles security clearance for the millions of Americans who work for the
federal government, and many of their spouses and children. Yet for more than a year,
outsiders (probably Chinese spies, though American officials will not say so publicly) were
running freely across its networks and databases, with the loss, by the latest tally, of
information relating to 22m people.

This included the 127-page SF-86 security-clearance forms, on which candidates for sensitive
jobs have to give an exhaustive account of their past, including foreign contacts. The OPM
also lost another set of files: the so-called adjudication data, relating to sensitive personal
details which had caused difficulties at work, such as extramarital affairs, sexually transmitted
diseases and other health matters, as well as the results of polygraph tests. The OPM used
laughably weak security and did not encrypt the data it held. The breach came when hackers
stole the login and password of an employee working at a commercial contractor for the
agency. The OPM’s director has now resigned.

The OPM does not deal with current staff of the CIA and other agencies but that is no great
comfort. The information enables Chinese (or other) counter-intelligence services to play
“spot the spy”. The core activity of a Western intelligence agency is to send its officers
overseas as embassy officials. This is known as “official cover” and at some levels the
pretence is a matter of politeness. Titles such as “economics attaché”, “first secretary
(external)” and “counsellor (information)” give a semi-public signal of what the real job is.

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Other identities are tightly concealed. Spies may work as lowly administrators or consular
officials, performing routine tasks and seemingly of no interest to the hostile country’s
counter-intelligence services. But their real task is far more important: collecting clandestine
communications from dead drops, watching out for signals from sources and so on. They may
be in charge of meeting agents in inconspicuous places or supporting other spies working
under deep cover, without the protection of a diplomatic job.

If 28 of the 30 purported officials at a diplomatic mission, say, are listed on the OPM’s
database, then it is a fair bet that two who are not must be undercover intelligence officers. It
is also possible to work out which people have moved from the intelligence world to regular
diplomatic and other government service. In short, if the OPM tells you who the real
diplomats are, it is possible to identify the pretend ones. That helps a hostile foreign
intelligence service work out what the spies have been up to. Past patterns of activity and
contact, which seemed innocent at the time, can be re-examined to see if something else was
afoot. That can lead to sources being caught, jailed or, in some countries, executed.

A further difficulty is that information about personal weaknesses is ripe for exploitation.
Intelligence officers seeking to recruit a target work on four frailties, summarised in a CIA
dictum as money, ideology, compromise and ego (MICE for short). A frank account of a
target’s financial woes, political views, sexual peccadillos and personality quirks makes that a
lot easier.

Insiders reckon it will take decades for American intelligence to recover from the OPM
breach. But rebuilding a human-intelligence service will be a lot harder in the digital age.
Before the days of electronic databases and biometric checks, creating a new identity for a spy
was easy. A well-used passport in a fake name, a wad of travellers’ cheques and some visiting
cards were enough.

Now creating a convincing fake identity is much more difficult. Anyone without years of
credit-card, mobile-phone and utility bills is automatically pinpointed as a potential spy for
the other side. These can be falsified, but it takes time and effort. Worse is biometric
information. If you claim to be visiting Russia for the first time, but your facial bone structure,
gait, retina scan or DNA shows you were there before under another name, you are in trouble.
Spymasters cannot easily overcome these difficulties—using people with solid real-world
identities who act as spies on the side is far harder than faking identities.

Technology has turned the spy world upside down. The benefits of successful espionage have
never been greater. But so are the penalties for carelessness, both in public opprobrium and
secret disaster.

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Business Ethics 222
Prostitution and the internet
More bang for your buck

How new technology is shaking up the

oldest business
Aug 9th 2014 | From the print edition, p. 16-19.

WARNING: We rarely feel the need to alert readers to explicit content. But our discussion of
the online sex trade requires frank language, and some may find the topic distasteful.

FOR those seeking commercial sex in Berlin, Peppr, a new app, makes life easy. Type in a
location and up pops a list of the nearest prostitutes, along with pictures, prices and physical
particulars. Results can be filtered, and users can arrange a session for a €5-10 ($6.50-13)
booking fee. It plans to expand to more cities.

Peppr can operate openly since prostitution, and the advertising of prostitution, are both legal
in Germany. But even where they are not, the internet is transforming the sex trade.
Prostitutes and punters have always struggled to find each other, and to find out what they
want to know before pairing off. Phone-box “tart cards” for blonde bombshells and leggy
señoritas could only catch so many eyes. Customers knew little about the nature and quality
of the services on offer. Personal recommendations, though helpful, were awkward to come
by. Sex workers did not know what risks they were taking on with clients.

Now specialist websites and apps are allowing information to flow between buyer and seller,
making it easier to strike mutually satisfactory deals. The sex trade is becoming easier to enter
and safer to work in: prostitutes can warn each other about violent clients, and do background
and health checks before taking a booking. Personal web pages allow them to advertise and
arrange meetings online; their clients’ feedback on review sites helps others to proceed with
confidence.

Even in places such as America, where prostitution and its facilitation are illegal everywhere
except Nevada, the marketing and arrangement of commercial sex is moving online. To get
round the laws, web servers are placed abroad; site-owners and users hide behind
pseudonyms; and prominently placed legalese frames the purpose of sites as “entertainment”
and their content as “fiction”.

The shift online is casting light on parts of the sex industry that have long lurked in the
shadows. Streetwalkers have always attracted the lion’s share of attention from policymakers
and researchers because they ply their trade in public places. They are more bothersome for
everyone else—and, because they are the most vulnerable, more likely to come to the
attention of the police and of social or health workers. But in many rich countries they are a
minority of all sex workers; just 10-20% in America, estimates Ronald Weitzer, a sociologist
at George Washington University.

The wealth of data available online means it is now possible to analyse this larger and less
examined part of the commercial-sex market: prostitution that happens indoors. It turns out to

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be surprisingly similar to other service industries. Prostitutes’ personal characteristics and the
services they offer influence the prices they charge; niche services attract a premium; and the
internet is making it easier to work flexible hours and to forgo a middleman.

Websites such as AdultWork allow prostitutes, both those working independently and those
who work through agencies and brothels, to create profiles through which customers can
contact them. They can upload detailed information about themselves, the range of services
they provide, and the rates they charge. Clients can browse by age, bust or dress size,
ethnicity, sexual orientation or location.

Other websites garner information from clients, who upload reviews of the prostitutes they
have visited with details of the services offered, prices paid and descriptions of the
encounters. On PunterNet, a British site, clients describe the premises, the encounter and the
sex worker, and choose whether to recommend her. Such write-ups have enabled her to build
a personal brand, says one English escort, Michelle (like many names in this article, a
pseudonym), and to attract the clients most likely to appreciate what she offers.

TrickAdvisor

We have analysed 190,000 profiles of sex workers on an international review site. (Since it is
active in America, it was not willing to be identified for this article. A disclaimer on the site
says the contents are fictional; we make the assumption that they are informative all the
same.) Each profile includes customers’ reviews of the worker’s physical characteristics, the
services they offer and the price they charge.

The data go back as far as 1999. For each individual we have used the most recent
information available, with prices corrected for inflation. Some of those featured may appear
under more than one name, or also work through agencies. The data cover 84 cities in 12
countries, with the biggest number of workers being in America and most of the rest in big
cities in other rich countries. As this site features only women, our analysis excludes male
prostitutes (perhaps a fifth of the commercial-sex workforce). Almost all of those leaving
reviews are men.

The most striking trend our analysis reveals is a drop in the average hourly rate of a prostitute
in recent years (see chart 1). One reason is surely the downturn that followed the 2007-08
financial crisis. Even prostitutes working in places that escaped the worst effects have been
hit. Vanessa, a part-time escort in southern England, finds that weeks can go by without her
phone ringing. Men see buying sex as a luxury, she says, and with the price of necessities
rising it is one they are cutting back on. Even when she offers discounts to whip up interest,
clients are scarcer than they were. In places where the job market slumped, the effect is more
marked (whether prostitution is legal may affect prices, too, but the wide variation between
American cities shows that this is not the only factor). The cost of an hour with an escort in
Cleveland, Ohio, where unemployment peaked at 12.5% in 2010, has tumbled.

Large-scale migration is another reason prices are falling. Big, rich cities are magnets for
immigrants of all professions, including sex workers. Nick Mai of London Metropolitan
University has studied foreign sex workers in Britain. He has found that as they integrate and
get used to the local cost-of-living, their rates tend to rise. But where the inward flow is
unceasing, or where the market was previously very closed, immigrants can push prices
down.

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Since the European Union enlarged to include poorer eastern European countries, workers of
every sort have poured into their richer neighbours. By all accounts prices have been dropping
in Germany as a result of the arrival of new, poor migrants, says Rebecca Pates of the
University of Leipzig. Sally, a semi-retired British escort who runs a flat in the west of
England where a few “mature” women sell sex, says English girls are struggling to find work:
there are too many eastern European ones willing to accept less.

Twenty years ago most prostitutes in Norway were locals who all aimed to charge about the
same, says May-Len Skilbrei, a sociologist at Oslo University. Today, with growing numbers
of sex workers from the Baltic states and central Europe, as well as Nigerians and Thais, such
unofficial price controls are harder to sustain.

Inexperience is another reason newcomers to prostitution may underprice themselves, at least

at first. Maxine Doogan, an American prostitute and founder of the Erotic Service Providers
Union, a lobby group, learnt her trade from a woman who worked for years in a brothel in
Nevada, the only American state where prostitution is legal. The older woman taught her what
to regard as standard or extra, and how much to charge. When Ms Doogan started out, in
1988, standard services (vaginal sex and fellatio) cost $200 an hour, the equivalent of $395
today. But some of those starting out now still charge $200, she says, or offer extra services,
including risky ones such as oral sex without a condom, without charging an appropriate
premium.

The shift online has probably boosted supply by drawing more locals into the sex trade, too.
More attractive and better-educated women, whose marital and job prospects are therefore
better, are more likely to consider sex work if it is arranged online. Indoor sex work is safer
than streetwalking, and the risk of arrest is lower. Rented flats or hotel rooms are more
discreet than brothels, so family and friends are less likely to identify the new source of
income. Anonymity becomes a possibility, which lessens the fear of stigma. Creating an
online profile separates the decision to take up the work from parading for punters.

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Meanwhile, broader social change may be reducing demand—and thus, prices. Free, no-
strings-attached sex is far easier to find than in the past. Apps such as Tinder facilitate speedy
hookups; websites such as Ashley Madison and Illicit Encounters, adulterous ones. Greater
acceptance of premarital intercourse and easier divorce mean fewer frustrated single and
married men turning to prostitutes.

Dearer for johns

Our analysis shows how a prostitute’s hourly rate varies according to the nature of the
services she provides and her reported physical characteristics. As in other bits of the
economy, clients who seek niche services must pay more. Sex workers who offer anal sex or
spanking earn on average $25 or $50 more per hour, respectively (see chart 2). Those who
will accept two male clients at once or do threesomes with another woman command a larger
premium.

Appearance matters a great deal. The customers who reported encounters to the website we
analysed clearly value the stereotypical features of Western beauty: women they describe as
slim but not scrawny, or as having long blonde hair or full breasts, can charge the highest
hourly rates (see chart 3). Hair that is bleached too unconvincingly to be described as blonde
attracts a lower premium, but is still more marketable than any other colour. For those not
naturally well endowed, breast implants may make economic sense: going from flat-chested
to a D-cup increases hourly rates by approximately $40, meaning that at a typical price of
$3,700, surgery could pay for itself after around 90 hours. The 12% share of women featured
on the site who are described both as athletic, slim or thin, and as being at least a D-cup,
suggests that quite a few have already taken this route.

Business Ethics 226

A prostitute’s rates also vary according to her ethnicity and nationality. What attracts a
premium in one place can attract a penalty in another. According to our analysis, in four big
American cities and London, black women earn less than white ones (see chart 4).

We had too few data from other cities for a reliable breakdown by ethnicity. But Christine
Chin of the American University in Washington, DC, has studied high-end transnational
prostitutes in several countries. In Kuala Lumpur, she found, black women command very
high rates and in Singapore, Vietnamese ones do. In Dubai, European women earn the most.
What counts as exotic and therefore desirable varies from place to place, and depends on
many factors, such as population flows.

Local markets have other quirks. According to the site we analysed, an hour with an escort in
Tokyo is a bargain compared with one in London or New York. Yet a cost-of-living index
compiled by the Economist Intelligence Unit, our sister organisation, suggests that Tokyo is

Business Ethics 227

the most expensive city overall of the three. The apparent anomaly may be because escorts
who appear on an English-language review site mostly cater to foreigners, who are not offered
the more unusual—and expensive—services Japanese prostitutes provide for locals. These
include the bubble baths and highly technical massages of Sopurando (“Soapland”), a red-
light district in Tokyo, which can cost ¥60,000 ($600) for a session and involve intercourse
(although that is not advertised).

A degree appears to raise earnings in the sex industry just as it does in the wider labour
market. A study by Scott Cunningham of Baylor University and Todd Kendall of Compass
Lexecon, a consultancy, shows that among prostitutes who worked during a given week,
graduates earned on average 31% more than non-graduates. More lucrative working patterns
rather than higher hourly rates explained the difference. Although sex workers with degrees
are less likely to work than others in any given week (suggesting that they are more likely to
regard prostitution as a sideline), when they do work they see more clients and for longer.
Their clients tend to be older men who seek longer sessions and intimacy, rather than a brief
encounter.

How much brothels and massage parlours use the internet depends on local laws. America’s
legal restrictions mean that they keep a low profile, both offline and online. In Britain, where
brothels are illegal though prostitution is not, massage parlours advertise the rotas and prices
of their workers online but are coy about the services rendered. By contrast Paradise, a mega-
brothel in Germany, boasts a frank and informative website.

But it is independent sex workers for whom the internet makes the biggest difference. Mr
Cunningham has tracked the number of sex workers in American cities on one review site. In
the decade to 2008, during which online advertising for commercial sex took off, the share
describing themselves as independent grew.

For prostitutes, the internet fulfils many of the functions of a workplace. It is a “break-room
and hiring hall”, says Melissa Gira Grant, the author of “Playing the Whore: The Work of Sex
Work”. Online forums replace the office water-cooler. Women exchange tips on dealing with
the everyday challenges of sex work; a busy thread on one forum concerns which sheets stand
up best to frequent washing.

A mother in Scotland asks how other prostitutes juggle child care and selling sex, given that
bookings are often made at short notice so babysitters are hard to arrange. Another contributor
who is thinking of having children asks how much other women saved before taking time off
to have a baby, and whether the new calls on their time meant they earned less after giving
birth. One reply points out that prostitution is easier than many other jobs to combine with
motherhood: it pays well enough to cover child-care costs, and can be fitted around school
holidays, plays and sports days, and children’s illnesses.

Women who are considering entering the industry often seek advice online from those already
in it before making up their minds. Melanie, who earns £65,000 ($109,000) a year, says that
she is considering selling sex on the side for a few months to pay off debts. She asks which
agency to use and how to get the highest rate. But she also worries that a stint selling sex
would harm her future career. Experienced sex workers respond that anonymity will be easier
to preserve if she works independently, rather than through an agency, and warn her that she
is entering a crowded market. The stress of living a double life should not be underestimated,
they caution, and it will not be easy money.

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Many of those contributing to such discussions hold other jobs, often part-time, and tout the
merits of a steady source of additional income and something innocuous to put on a CV.
Sarah says her escort work means she can pay for her daughter’s dance and music lessons,
which would be unaffordable on just her “civvy job”. Some husbands and boyfriends know
about their wives’ and girlfriends’ work, or even act as managers, drivers and security. Other
women keep what they do a secret from those closest to them.

Advertising and booking clients online give prostitutes flexibility about where to work. They
can “tour”, using their own home pages or profiles on specialist websites to advertise where
they will be and when. In densely populated Britain, where prostitutes work in most places,
tours allow those who normally serve small towns to visit cities crammed with potential
customers. In Norway, says Ms Skilbrei, prostitutes are concentrated in the main cities, so a
tour is a chance to satisfy pent-up demand in small towns.

The freelancers, part-timers and temps the internet is bringing to the sex trade are likely to
help it absorb demand shocks. In 2008 the Republican and Democratic national conventions
were held in Minneapolis and Denver respectively. Around 50,000 visitors flocked to each
city. Another study by Mr Cunningham and Mr Kendall found that the numbers of
advertisements for sex on the now-defunct “erotic services” section of Craigslist, a classified-
advertising site, were 41% higher in Minneapolis and 74% higher in Denver around the
conventions than expected for those days of the week and times of year.

Health and safety

Sex work exposes those who do it to serious risks: of rape and other violence, and of sexually
transmitted infections. But in this industry, like many others, the internet is making life easier.

Online forums allow prostitutes to share tips about how to stay safe and avoid tangling with
the law. Some sites let them vouch for clients they have seen, improving other women’s risk
assessments. Others use services such as Roomservice 2000, another American site, where
customers can pay for a background check to present to sex workers. Both sides benefit since
the client can demonstrate trustworthiness without giving credit-card details or phone
numbers to the prostitute.

Sites that are active in restrictive jurisdictions must be careful not to fall foul of the law. In
June the FBI shut down MyRedBook, an advertising-and-review site with a chat section for
sex workers. Its owners face charges of money laundering and facilitating prostitution.
American police sometimes use such sites to entrap prostitutes. As they wise up to this, sex
workers are using sites that allow them to verify clients’ identities to help them avoid stings.
But that adds unnecessary hassle and distracts from what should be most important: staying
safe. “Screening for cops [is now] the priority over screening for rapists, thieves, kidnappers,”
says Ms Doogan.

In Britain, Ugly Mugs runs an online database that prostitutes can use to check punters’
names and telephone numbers. In America the National Blacklist, a “deadbeat registry”,
allows them to report men who are abusive or fail to pay. Other women can check potential
clients by names, telephone numbers, e-mail addresses and online aliases. Though not
specifically aimed at sex workers, apps such as Healthvana make it easy for buyer and seller
to share verified results in sexual-health tests.

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Moving online means prostitutes need no longer rely on the usual intermediaries—brothels
and agencies; pimps and madams—to drum up business or provide a venue. Some will decide
to go it alone. That means more independence, says Ana, a Spanish-American erotic masseuse
who works in America and Britain. It also means more time, effort and expertise put into
marketing. “You need a good website, lots of great pictures, you need to learn search-engine
optimisation…it’s exhausting at times,” she says.

Leaving the streets behind

Others will still prefer to have a manager or assistant to take care of bookings and social
media. “[Nowadays] you have people hitting you up on Twitter, Facebook, your website, and
e-mail,” says Ms Doogan. Eros.com, an international listings site, allows prostitutes to tell
clients whether they are currently available. But it means going online every hour or two,
which is a chore. And online advertising is not cheap. Ms Doogan used to spend 10% of her
income on print adverts; she spends far more on online ones because with so many people
advertising, returns are lower. Checking customers’ bona fides also takes time.

Meanwhile some traditional forms of prostitution are struggling. In the decade to 2010 the
number of licensed sex clubs in the Netherlands fell by more than half, according to a study
for Platform31, a Dutch research network. Much of the decline will have been offset by the
growth of sex work advertised online, it reckons. Many prostitutes would rather work from
private premises than in a club or for an agency, says Sietske Altink, one of the authors.
Dutch municipalities often bar such work—but the option of finding clients online makes
such rules harder to enforce.

That shift will make the sex industry harder for all governments to control or regulate,
whether they seek to do so for pragmatic or moralistic reasons, or out of concern that not all
those in the industry are there by their own free will. Buyers and sellers of sex who strike
deals online are better hidden and more mobile than those who work in brothels, or from clubs
or bars, points out Professor Weitzer of George Washington University. Ireland has banned
the advertising of sexual services since 1994. The prohibition has achieved almost nothing,
says Graham Ellison, a sociologist at Queen’s University in Belfast. Websites simply moved
to other jurisdictions. The closure of those such as MyRedBook may prompt American ones
to do the same; as they grow more specialised, the excuse that they merely host classified
advertisements is wearing thin.

In the long term there will always be people who, for whatever reason, want to hire a
prostitute rather than do without sex or pick up a partner in a bar. As paid-for sex becomes
more readily and discreetly available online, more people will buy it. A greater awareness
may develop that not all sex workers are the victims of exploitation. The very discretion—and
the hidden nature of such prostitution—may also mean that the stigma persists. But, overall,
sex workers will profit. The internet has disrupted many industries. The oldest one is no
exception.

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Prostitution
A personal choice

The internet is making the buying and selling of sex easier

and safer. Governments should stop trying to ban it
Aug 9th 2014 | From the print edition, p. 9.

STREET-WALKERS; kerb-crawlers; phone booths plastered with pictures of breasts and

buttocks: the sheer seediness of prostitution is just one reason governments have long sought
to outlaw it, or corral it in licensed brothels or “tolerance zones”. NIMBYs make common
cause with puritans, who think that women selling sex are sinners, and do-gooders, who think
they are victims. The reality is more nuanced. Some prostitutes do indeed suffer from
trafficking, exploitation or violence; their abusers ought to end up in jail for their crimes. But
for many, both male and female, sex work is just that: work.

This newspaper has never found it plausible that all prostitutes are victims. That fiction is
becoming harder to sustain as much of the buying and selling of sex moves online. Personal
websites mean prostitutes can market themselves and build their brands. Review sites bring
trustworthy customer feedback to the commercial-sex trade for the first time. The shift makes
it look more and more like a normal service industry.

It can also be analysed like one. We have dissected data on prices, services and personal
characteristics from one big international site that hosts 190,000 profiles of female prostitutes
(see article). The results show that gentlemen really do prefer blondes, who charge 11% more
than brunettes. The scrawny look beloved of fashion magazines is more marketable than
flab—but less so than a healthy weight. Prostitutes themselves behave like freelancers in other
labour markets. They arrange tours and take bookings online, like gigging musicians. They
choose which services to offer, and whether to specialise. They temp, go part-time and fit
their work around child care. There is even a graduate premium that is close to that in the
wider economy.

The invisible hand-job

Moralisers will lament the shift online because it will cause the sex trade to grow strongly.
Buyers and sellers will find it easier to meet and make deals. New suppliers will enter a trade
that is becoming safer and less tawdry. New customers will find their way to prostitutes, since
they can more easily find exactly the services they desire and confirm their quality. Pimps and
madams should shudder, too. The internet will undermine their market-making power.

But everyone else should cheer. Sex arranged online and sold from an apartment or hotel
room is less bothersome for third parties than are brothels or red-light districts. Above all, the
web will do more to make prostitution safer than any law has ever done. Pimps are less likely
to be abusive if prostitutes have an alternative route to market. Specialist sites will enable
buyers and sellers to assess risks more accurately. Apps and sites are springing up that will let
them confirm each other’s identities and swap verified results from sexual-health tests.
Schemes such as Britain’s Ugly Mugs allow prostitutes to circulate online details of clients to
avoid.

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Governments should seize the moment to rethink their policies. Prohibition, whether partial or
total, has been a predictable dud. It has singularly failed to stamp out the sex trade. Although
prostitution is illegal everywhere in America except Nevada, old figures put its value at $14
billion annually nationwide; surely an underestimate. More recent calculations in Britain,
where prostitution is legal but pimping and brothels are not, suggest that including it would
boost GDP figures by at least £5.3 billion ($8.9 billion). And prohibition has ugly results.
Violence against prostitutes goes unpunished because victims who live on society’s margins
are unlikely to seek justice, or to get it. The problem of sex tourism plagues countries, like the
Netherlands and Germany, where the legal part of the industry is both tightly circumscribed
and highly visible.

The failure of prohibition is pushing governments across the rich world to try a new tack:
criminalising the purchase of sex instead of its sale. Sweden was first, in 1999, followed by
Norway, Iceland and France; Canada is rewriting its laws along similar lines. The European
Parliament wants the “Swedish model” to be adopted right across the EU. Campaigners in
America are calling for the same approach.

Sex sells, and always will

This new consensus is misguided, as a matter of both principle and practice. Banning the
purchase of sex is as illiberal as banning its sale. Criminalisation of clients perpetuates the
idea of all prostitutes as victims forced into the trade. Some certainly are—by violent partners,
people-traffickers or drug addiction. But there are already harsh laws against assault and
trafficking. Addicts need treatment, not a jail sentence for their clients.

Sweden’s avowed aim is to wipe out prostitution by eliminating demand. But the sex trade
will always exist—and the new approach has done nothing to cut the harms associated with it.
Street prostitution declined after the law was introduced but soon increased again. Prostitutes’
understandable desire not to see clients arrested means they strike deals faster and do less risk
assessment. Canada’s planned laws would make not only the purchase of sex illegal, but its
advertisement, too. That will slow down the development of review sites and identity- and
health-verification apps.

The prospect of being pressed to mend their ways makes prostitutes less willing to seek care
from health or social services. Men who risk arrest will not tell the police about women they
fear were coerced into prostitution. When Rhode Island unintentionally decriminalised indoor
prostitution between 2003 and 2009 the state saw a steep decline in reported rapes and cases
of gonorrhoea*.

Prostitution is moving online whether governments like it or not. If they try to get in the way
of the shift they will do harm. Indeed, the unrealistic goal of ending the sex trade distracts the
authorities from the genuine horrors of modern-day slavery (which many activists conflate
with illegal immigration for the aim of selling sex) and child prostitution (better described as
money changing hands to facilitate the rape of a child). Governments should focus on
deterring and punishing such crimes—and leave consenting adults who wish to buy and sell
sex to do so safely and privately online.

* Cunningham, S and Shah, M. “Decriminalizing Indoor Prostitution: Implications for Sexual Violence and Public Health” (working paper,
July 17th 2014). dx.doi.org/10.2139/ssrn.2467633

From the print edition: Leaders

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Advertising to children
Cookie Monster crumbles

Are children fair game for sophisticated and

relentless marketing techniques? Many
countries think not
Nov 23rd 2013 | From the print edition, p. 59-60.

WHILE her husband’s health-care plans founder, Michelle Obama is pressing ahead with her
own. Last month, joined by Rosita, a turquoise Latina muppet, and Elmo, a shaggy red one,
she announced that Sesame Street’s puppets would promote fruit and vegetables rather than
sugary and fatty fare; Cookie Monster may need to find himself a new job. Mrs Obama’s fight
against childhood obesity has several fronts (she calls it “Let’s Move!”) but marketing is an
important one. In September she convened the first White House meeting on marketing food
to children. Their preferences “are being shaped by the marketing campaigns you all create”,
she told the assembled executives. “And that’s where the problem comes in.”

To market anything that might appeal to young consumers is to risk a scolding. Advertising
entices children to drink and smoke, makes them fat and sexualises them early, its critics
allege. To tout even wholesome products to children, some claim, is to exploit their naivety
and thus to deceive them. Crusaders like Mrs Obama have helped embarrass companies.
Coca-Cola said in May that it would not advertise to children younger than 12 anywhere in
the world. Last year Disney promised not to promote junk food on television programmes for
children.

Such gestures make the best of an increasingly constraining climate. Some of the many
restrictions on the marketing of tobacco and alcohol were imposed with youngsters in mind.
In America and the European Union big food manufacturers follow self-imposed codes of
conduct on marketing to children. These are to be tightened. Some European countries impose
stricter regimes. Britain bans advertising on television and radio of food high in fat, salt and
sugar to children under 16. Sweden and Norway outlaw all television advertising to
youngsters. Quebec prohibits advertising of any sort directed at children.

Will Gilroy of the World Federation of Advertisers notes a “surge” in regulatory activity since
2011, when the United Nations held a conference on non-communicable diseases in New
York. Mexican children see 12,000 junk-food adverts on television a year, more than in any
other country, a government commission complains. Having slapped taxes on junk food and
sugary drinks, Mexico now plans to ban adverts for them in the afternoons and evenings and
at weekends. In June Taiwan gave regulators authority to restrict the marketing and even the
sale of food they deem unhealthy for children.

As standards tighten, arguments rage. Is too much marketing still getting through to children?
Are companies like Coca-Cola and McDonald’s, which in September promised to stop putting
fizzy drinks on its “Happy Meals” menus, cynically determined to hook children in other
ways? Should more jurisdictions impose Quebec-like bans? Or extend protection to children
older than 12 or 13?
Business Ethics 233
Pinning down how advertising might harm children is tricky. One line of inquiry studies its
effects in the lab. Such experiments suggest that children eat more in response to food
promotion. British children who saw footage of Gary Lineker, who helps advertise Walkers
crisps, doing his other job as a football commentator ate more crisps than a control group.
Other types of study try to capture marketing’s effects on whole societies. An American one
found that young people who saw one additional alcohol advert per month (beyond the
average of 23) drank 1% more alcohol. Some research connects media consumption and
weight. A 2005 study of teenagers in 34 countries found in 22 of them a correlation between
their body mass index and the amount of television they watched.

Thin evidence

Such correlations do not prove that advertising causes obesity. Food and beverage producers
have a point when they claim it is one factor among many. But still one to be dealt with: “We
should be tackling all the causes of obesity, however small,” maintains Emma Boyland, a
psychologist at the University of Liverpool, one of the authors of the Gary Lineker study.

Some radical critics argue that any sort of marketing aimed at children damages them. It is
wrong to treat children as “economic objects”, says Bill Jeffery of the Centre for Science in
the Public Interest, a group that campaigns for good nutrition in America and Canada. Young
children do not grasp that they are being advertised to; marketing to them is thus inherently
deceptive. It undermines “creative play”, which stunts development and ultimately threatens
democracy, insists Susan Linn of the Campaign for a Commercial-Free Childhood, an
American group.

To such critics, any system of control that depends on companies policing themselves is
doomed to fail. Industries set the bar too low, exploit loopholes and find ways to broadcast
their toxic messages. “Self-regulation simply does not work in a highly competitive
marketplace”, contends the International Association for the Study of Obesity.

In America 18 companies are involved in the Children’s Food and Beverage Advertising
Initiative (CFBAI). They account for 80% of food adverts on children’s television and
promise to advertise “healthier or better-for-you” foods to children younger than 12 or, in
some cases, not to market to them at all. The “EU Pledge” is a similar European commitment
by 20 big firms.

But their definition of children’s television does not include programmes broadcast to
audiences in which less than 35% of viewers are under 12. That leaves out shows like
“American Idol”, watched by hundreds of thousands of children, points out Jennifer Harris of
the Rudd Centre for Food Policy and Obesity at Yale University. Companies define
“healthier” more liberally than public-health experts think right. Kellogg’s markets Froot
Loops cereal to children even though each serving has four times the sugar of a bowl of Corn
Flakes. The pledge-signers treat 13-year-olds as grown-up enough to
respond sensibly to advertising; the critics say the age of marketing
reason is higher.

Digital marketing offers new ways of reaching children for less

money. Brand-boosting “advergames”, can be more compelling than
conventional commercials. Such techniques are “outside the scope
of most regulatory and self-regulatory” regimes, says João Breda of
the World Health Organisation.

Business Ethics 234

Munch away

Even where the state lays down the law, product-pushers get through. Broadcasters based
abroad air popular children’s programmes in Sweden and Norway, bypassing their advertising
bans.

Most governments would rather co-operate with businesses than confront them. Taiwan’s new
law and Mexico’s proposed one give governments the whip hand. Closer to the norm is
Singapore: its health ministry is to lay down guidelines for a code of conduct to be followed
by firms. Norway, often a champion of tough controls, backed away last spring from a
proposal to ban advertising of unhealthy food to people younger than 18. Instead it has given
the industry two years to enforce a ban on marketing to children under 13, backed by a threat
of legislation if it fails.

This was a blow to prohibitionists. But pressure on the industry may be having an effect. The
companies behind the EU pledge say that children’s exposure to junk-food marketing on
television was 48% lower in 2012 than in 2005. In America spending on food-marketing to
the young fell by 19.5%, from 2006 to 2009 to $1.79 billion, according to the Federal Trade
Commission (though spending on online and “viral” marketing surged 50%). Self regulation
is tightening up. The EU pledge has covered company-owned websites since the end of 2011,
and will introduce uniform nutritional standards for its members from next year. The CFBAI
plans common standards at the end of 2013.

Packaged foods are becoming more wholesome, in part because consumers are demanding it.
American cereal-makers, for example, have cut sugar and added whole grains. From 2007 to
2011 sales of better-for-you food and drink produced by 15 big companies accounted for 72%
of sales growth, according to a study by the Hudson Institute, a think-tank. The profit motive
will do more to raise nutritional standards than threats of draconian regulation, suggests Hank
Cardello of the institute’s Obesity Solutions Initiative.

The argument over whether such progress is fast and far-reaching enough hides disagreements
about how resilient children are, whether marketing has a bright side and whether it deserves
the protection given to other forms of speech. Campaigners point to children’s vulnerability;
marketing folk highlight their shrewdness. Consumerism is not inherently corrosive,
advertisers say: their craft promotes choice, and thus responsibility. Without advertising you
end up with the “people’s toy” of Soviet-era planned economies, says Ian Twinn of ISBA,
which speaks for British advertisers.

Activists believe rule-makers should adopt the “precautionary principle”: protecting children
trumps other concerns. Marketers urge “proportionality”, giving weight to other interests like
competition and profit. In most countries proportionality seems to be winning. That is
probably a good thing. But you need first ladies to keep the pressure on.

Business Ethics 235

Who owns the knowledge economy?
Apr 6th 2000
From The Economist print edition

“IF NATURE has made any one thing less susceptible than all others of exclusive property, it
is the action of the thinking power called an idea... No one possesses the less, because every
other possess the whole of it. He who receives an idea from me, receives instruction himself
without lessening mine; as he who lights his taper at mine, receives light without darkening
me.” In Thomas Jefferson’s inspiring vision, there are no barriers to the acquisition of
knowledge. Nobody owns it, everybody partakes of it—and the world becomes richer.

Two centuries later, when knowledge has taken over much of the economy, Jefferson’s words
seem to take on a new power. After all, capital has always been one of the main economic
barriers to entry, and these days ideas are capital. If getting hold of capital becomes as easy as
getting a light, barriers to entry everywhere ought to be tumbling. So farewell, monopoly.

But how is it, in that case, that in America, one of the biggest antitrust cases in history reached
judgment this week, causing turmoil in financial markets? And how is it that new monopolies
in cyberspace are being created all the time? The reason is that ideas are not in practice the
free currency that Jefferson observed them to be in their natural state. Governments award
property rights over ideas, making them vulnerable to monopolists if the system is abused.

Property rights for a wired world

The Microsoft case (see article) is in many ways an old-fashioned sort of antitrust affair about
a dominant firm bullying smaller rivals. But behind it lies a systemic worry, about the wired
world’s natural susceptibility to monopoly. Increasingly, the value of any good (say, a
computer operating system) depends on the number of users; so a new entrant has little hope
against a widely used product (say, Windows). The American administration has rightly
become more alert to incipient network monopolies of this kind.

Which makes its policy on patents even odder. Patents are the strongest form of intellectual-
property right, since they give holders a claim over ideas encapsulated in a work, and not just
(as copyright does) on the work’s particular form. Their purpose is to reward inventors so as
to encourage future invention. Society is balancing the benefits of a free exchange of ideas
against future gains from further invention. And the means of striking this balance is to award
a legal monopoly to a patent-holder for 20 years from the date of application.

Patents are booming: last year, the United States Patent and Trademark Office awarded
161,000, nearly twice as many as ten years ago (see article). That is partly because the value
of knowledge has grown relative to other assets—so companies naturally want more of it. But
it is also because new kinds of patents are being awarded, in areas that might have been
thought unpatentable, such as computer software, genetic engineering and, increasingly,
Internet business methods. In this last category, America’s patent office has recently handed
out monopolies on such simple ideas as group buying, matching professionals with those
seeking advice, one-click shopping and reverse auctions.

The patent office says there is no reason not to issue such patents: they fulfil the criteria that
ideas embodied in a patent application must be novel, useful and non-obvious. But that invites

Business Ethics 236

a big question: does the law, which has barely been changed in two centuries, still work? The
patent office retorts that the system’s durability is testimony to its success, as are the waves of
technological change it has fostered. History’s great inventors armed themselves with sheaves
of patents—Edison, still the record-holder, had 1,093. Without such protection, they would
not have bothered.

The Internet casts doubt on the need for such strong protection today. Until recently, it was a
patent-free zone in which good ideas travelled freely. Clever people and capital flooded in.
They did not, apparently, need the incentive that patent protection would have provided.

The trouble with the law is that it does not differentiate between the incentives needed to
invest in different kinds of technologies. It accords as much protection to an idea thought up
in the bath as to a drug that may have taken many years and hundreds of millions of dollars to
move from conception to marketplace. Even Jeff Bezos, founder of the Internet retailer
Amazon and the holder of several business-method patents, has suggested in an open letter
posted on the Internet that software and business-method patents should have a shorter life
than other patents—say, three to five years.

Inventors still need some protection, but they are getting too much. America needs to scrap its
one-size-fits all system, and replace it with one that responds to the investment that an
invention represents. Patents should come in different shapes and sizes, or the system will go
on producing absurdities. The American Supreme Court foresaw the danger in 1882, when
ruling on the matter of boat-propeller technology: “Such an indiscriminate creation of
exclusive privileges tends rather to obstruct than to stimulate invention. It creates a class of
speculative schemers who make it their business to watch the advancing wave of
improvement, and gather its foam in the form of patented monopolies, which enable them to
lay a heavy tax on the industry of the country, without contributing anything to the real
advancement of the arts.”

Intellectual property
Can you keep a secret?

To patent an idea, you must publish it.

Many firms prefer secrecy
Mar 16th 2013 | SEATTLE |From the print edition, p. 62.

THE conventional way to protect intellectual property is to patent it. This gives an inventor
legal protection for his idea: if others want to use it, they must pay him. The snag is that he
must publish his idea, making it easy for someone in a less lawful country to steal it.

So a lot of companies are keeping their most valuable ideas under wraps. Alas, this is not
foolproof, either. Hackers are cunning, and China employs thousands of them to steal foreign
secrets, as a report last month from Mandiant, a computer-security firm, made clear.

Business Ethics 237

No one knows how many trade secrets companies keep, or how much they are worth. Some,
like customer lists, are generated during day-to-day operations. Others are kept secret because
patents typically last only 20 years. Had Coca-Cola patented its secret recipe, it would have
lost the rights to it long ago. And it would have lost its mystique straight away.

However, the main reason for favouring secrecy over patents is security. Elon Musk, for
example, refuses to patent technologies developed at his SpaceX rocket company for fear that
foreign space agencies would simply pinch them.

Many companies do not realise when their secrets leak. Richard Bejtlich, the chief security
officer of Mandiant, estimated last year that over 90% of firms penetrated by Chinese hackers
were unaware of the fact. A survey by ASIS International, a security-industry body, estimated
the annual value of stolen corporate intellectual property at $300 billion in America. Another
put it at over $1 trillion worldwide.

Digital thieves hail from all countries, but one stands out. In the 16 years since America’s
Economic Espionage Act (EEA) made the theft of commercial secrets a federal crime, a third
of all EEA prosecutions have involved people born in China or seeking to help its government
or businesses. Since 2008, 44% of cases have had a Chinese connection.

One defendant stole secrets relating to military aircraft and the Space Shuttle. Others have
spied on firms such as Ford, GM, Dow Chemical, Motorola and DuPont. The Chinese
government strenuously denies any involvement. It notes that its firms are victims, too. In a
2010 global survey by McAfee, another IT-security firm, Chinese businesses reported the
highest average losses from intellectual-property theft: $7.2m each, compared with just
$375,000 for British firms.

Most trade-secret thefts (and over 90% of EEA prosecutions) involve insiders. These are
typically employees or contractors who are given access to sensitive information, which they
snaffle via flash drive, mobile phone or e-mail. Respondents to the McAfee survey rated
insider threats above those posed by software vulnerabilities or cyber-terrorism.

Solutions are far from straightforward. America’s patent office is mulling whether to propose
a new class of “economically sensitive” patents whose existence could be kept secret until a
patent is granted (a process that typically takes over three years), to avoid giving thieves a
head start. This is unlikely to satisfy businesses. Of more use, say some, would be amending
the law to provide a federal right of civil action, allowing companies to pursue their own cases
against spies. At the moment civil cases are subject to state law.

Last month Barack Obama’s administration unveiled new proposals to prevent the theft of
American trade secrets. These include diplomatic efforts, voluntary industry initiatives,
smarter investigations and tougher laws. Congress has increased the penalties for infringing
the EEA and removed a loophole that allowed a Russian programmer to walk free after
copying source code for Goldman Sachs’s trading software. Even so, since 1996 there have
been only about 125 indictments under the EEA. Most thieves are not caught.

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