Whenever the topic of fraud in the financial sector is discussed, the conversation soon moves on to Ethics. There is usually the subtext that by enforcing ethical behaviour, all backed up with effective teaching of the topic in school, colleges and business schools, fraud will be minimised. It’s not that simple. Ethics is not an absolute and singular notion, however, it is taught as if it is well-defined, usually as some variant of Judeo-Christian morality. That naïve stance does not bear close scrutiny.

In her book Systems for Survival, Canadian economist Jane Jacobs proposed a very interesting model for the ideal community, based loosely on her reading of Plato’s Republic. By looking at how humanity deals with its needs, she divided us up into two groups, each with radically differing value systems; she calls them ‘moral syndromes’. One ‘produces and trades’: this is the ‘commercial’ syndrome and includes the occupations that produce and supply our physical needs. The other ‘scavenges and takes’: this is the ‘guardian’ syndrome composed of individuals who maintain the cohesion and coherence of society. In order to trade effectively commerce needs the guardians both to ward off predators, and to set down and enforce standards of probity. The costs of this service are paid for out of the profits of commerce. The trick is getting the balance right.

Jacobs’s book describes a series of conversations between various characters as they compare and contrast the syndromes. They concluded that each syndrome has a code of ethics, which is not only distinct from the other, but also they are often mutually incompatible, as can be seen in the table below. A society is healthy when members from the two syndromes co-exist in relative harmony. However, Jacobs warns us that “you can’t mix up such contradictory moral syndromes without opening up moral abysses and producing all kinds of functional messes”. She states her “Law of Intractable Systemic Corruption”. Any compromise to the ethical standards of a particular syndrome, for example by employing the ethics of the other, will corrupt the former syndrome’s integrity. The expediency needed to function in such a world of distorted values will convert some virtues into vices, or at the very least individuals become morally inconsistent.

Jacob’s book is full of examples. The transfer of titles and property from father to son is perfectly acceptable in aristocratic societies, but in commercial groups this is considered nepotism. The Mafia was originally formed to protect a Sicilian community from exploitation by its political elite. Only when they moved in on trade to fund their operating costs did their guardian attitudes trigger the Cosa Nostra’s mutation into “a monstrous moral hybrid”. Then their definition of trade began to involve intimidation and bribery. By the same token, whenever economic planning is subsumed by political guardians, as in socialism, the claimed material support of the masses always degenerates into cronyism.

Table: the two codes of ethics

Source: Jane Jacobs, Systems for Survival, Appendix, Page 215

Commercial planning for guardian priorities, as in the Soviet Union, indeed all socialist states, leads to a collapse of commercial endeavour. Mikhail Gorbachev summed it up beautifully: “they pretend to work, and we pretend to pay them”. By the same token, the imposition of commercial measures will inevitably corrupt the guardian’s sense of honour. Placing key performance indicators on police officers will lead to them ‘fitting up’ innocents so they meet their targets, or letting guilty parties go free ‘for the greater good’.

Practicing guardianship under commercial precepts will lead to ethical dilemmas. Legal systems across the world see nothing wrong in ‘Plea Bargaining’. The accused plead guilty to a lesser charge to save the cost of an expensive trial. However, it ends up with innocents pleading guilty rather than risk both the lottery of a trial and the huge costs of legal fees to themselves. Paradoxically, convicted criminals are routinely set free after serving only a fraction of their sentence because the cost of jailing them has become prohibitive.

Paul Condon, head of the Metropolitan Police for most of the 1990s coined the phrase “noble cause corruption”. In other words officers believed they were justified in bending the rules to get a conviction of career criminals even though they had no proof. By the same token criminals were let off charges provided they ‘traded’ the names of other criminals, or were charged with lesser offences if they admitted to a string of offences (many of which they didn’t commit) just so that the police ‘clean-up’ rate would improve. Jacobs herself describes how officers from the New York Transport Police falsely arrested innocent African American and Hispanic men systematically, just so their productivity measures (arrests-per-working-hour) looked good. It all came to light when they booked an off-duty policeman.

‘Noble cause corruption’ is coursing through the veins of both HMRC and IRS. Virtuous with indignation, tax collectors are targeting the rich, and see nothing wrong in assuming High Net Worth Individual (HNWI) taxpayers are ‘guilty until proven innocent’ – they assume the rich are automatically guilty of not paying their ‘fair share’. Sending out arbitrary tax demands and then insisting that the target must pay up or go to jail, and that it’s the taxpayer’s problem to prove overcharging and claim back the excess. Imagine what would happen if this process is incentivized! What if the tax collectors receive a percentage of every extra dollar/pound/euro they pull in to treasury coffers. We would see Jacob’s ‘Law of Intractable Systemic Corruption’ in operation, and tax collectors would revert to the archetypal social pariahs known from biblical stories.

The stressing of commercial priorities contaminates guardianship, as when politics becomes a profession and politicians display no sense of pride and no sense of shame. “When buying and selling are controlled by legislation, the first things to be bought and sold are legislators”.

Ogden Nash hit it on the head “professional people have no cares, whatever happens they get theirs”. The 2009 scandal of British MPs fraudulently receiving substantial expenses claims is a classic example – Jacqui Smith, the then Home Secretary no less (with the role of overseeing law and order in the U.K.), reclaimed amounts both small (the cost of hiring pornographic movies) and large (declaring her sister’s house in London as her second home, and thus chargeable).

When the normal practices of a group, whether a guardian or a trader, diverge from the ethics of its syndrome then virtue and vice become indistinguishable. The rules of the game lose all meaning. Most of the disgraced MPs saw nothing wrong with what they were doing, because they were operating within the letter of the law, but not the spirit – for example Sir Peter Viggers using taxpayers’ money to furnish a duck house on the family lake! Added to this there are numerous stories of MPs selling influence and access.

Jane Jacobs makes it totally clear that no single system of morality can accommodate both commerce and guardianship. Taking and trading are two fundamentally different syndromes. Mixing them up eventually must create enormous tensions … but not straight away. A series of minor misdemeanours, each in itself trivial and convenient, useful even, are the first steps on the road to perdition. No alarm bells ring; but whenever a ‘nice little wheeze’ is copied, or there are variations on the theme, society gradually slides into full-blown corruption. Drip, drip, drip, until the floodgates open. Then the guardians, instead of being the source of standards, and the punisher of wrongdoers, are corrupt and corrupting. Meanwhile the traders are making you ‘an offer you can’t refuse’. No one asks quis custodiet ipsos custodes? (Juvenal); ‘who guards the guardians’ when morality collapses into vice.

Throughout most of human history, trade and guardianship were rigidly separated, a fact that has been carelessly ignored since the Industrial Revolution. Mediaeval orders of chivalry barred any man whose parent, grandparent, or great-grandparent was a merchant. Anyone who was remotely involved in trade would lose all rank and privileges. Usury, lending money at interest was singled as particularly repugnant. Dante’s Inferno placed usurers alongside sodomites in the seventh circle of hell – both apparently guilty of heinous sins against the natural order of God’s will. This is why it was left to communities on the margins of society to undertake this necessary but distasteful chore of money lending: the slaves in Ancient Athens, the Jews in medieval Europe. According to Franciscus Gratianus, a medieval monk from Bologna “business is nothing but the struggle of wolves over carrion, men of business can hardly be saved for they live by cheating and profiteering”.

India has had the caste system for millennia, with the guardians (warriors and priests) at the top, and trade and crafts in subservient roles. For example, just after the time of Alexander the Great, the Maurya Empire (321-184BC) maintained a huge standing army (200,000 men by some accounts) on the back of trade. The tentacles of the requisite bureaucracy that supported this military state insinuated its way right down to the village level. Tax collectors kept detailed records of people, land and livestock, and all this was supported by a sophisticated network of informants.

The modern day nation-state may seem more sophisticated, but many are still based on the assumption of the same tribal values in that citizens are all property of the state, or rather of the leaders of the state. HNWIs believe that politicians seek to harvest their wealth in order to support the idle poor in society, who in return vote the political elite into power. Although it must be said that it is not just the rich who are targeted. Everyone who is merely successful in what they do can expect to see their consequent above-average income ‘fairly’ redistributed, to support those that the wealthy deem parasites in society, by demanding the right to the good life, free of effort. As a consequence the unemployable observe governments stealing from anyone who works, and so see no point in even seeking work. The problem of moral jeopardy arises when the employed also start questioning the merits of working.

The well-run state recognizes the need for harmony between the guardians and trade. The guardians must deliver the freedom for commerce to operate, and in return they should receive a fair payment from taxes. Death and taxes are always with us, but those taxes should be set at a level where trade sees them as fair payment for services rendered. The state should be one large social network of trust; and trust will only flourish where honesty is the norm. We have witnessed a growing resentment. The HNWIs see their tax dollars being spent on unnecessary wars, on vanity projects, on pork barrel politics, and dissipating in inefficient bureaucracies. This is made worse when interfering and excessive regulations become ‘a denial of service attack’ on the freedom of business to operate effectively.

In a well-run state, the rule of law must be maintained, and the social status of the parties in dispute should not impact on the result of arbitration. In Jacob’s ideal society high rank or political connections should not permit the holder “to terminate a lease on a whim, evade a legitimate debt, welsh on a promise to deliver, withhold agreed-on wages, and so on”. It is the guardians who enforce these virtues, which is why it is best that they are in no way involved in trade, and do not force their ethical values onto traders. To avoid Jacob’s “Law of Intractable Systemic Corruption” disrupting the practice of both trade and guardianship, then the two groups must remain separate. This means that ex-politicians should be barred from taking up highly paid consultancies and directorships in business.

The situation is further complicated when freewheeling HNWIs decide not to stay in a jurisdiction where they are treated as second-class citizens. Having flown the coop at least once, they think nothing of fleeing again, and again, totally undermining the state’s ability to tax and regulate the super-rich. If the guardians want the wealthy to stay, and thus benefit the local economy, then tribal leaders must not overly intimidate the entrepreneurial elite in their society (immigrants and home grown) no matter what the demands of the great unwashed. Any attempt to extort excess wealth from them for the ‘common good’ would be a grave mistake. As far as the HNWIs are concerned the ‘common good’ isn’t good, it is merely common! They agree to pay their ‘fair share’, as long as it is also fair to them: they will insist that their money is spent on projects of which they approve, and from which they see the benefit. The rich did not sign up for excessive taxes and regulation. And yes, they did sign up; but only by default, and unlike the poor, the rich have the choice of leaving. They can un-sign. A world full of regulatory arbitrage and tax holidays awaits. This freedom inevitably places a huge strain on the relationship between trade and guardians.

According to Judge Billings Learned Hand: “Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.” Flying in the face of this logic, nowadays perfectly legal tax avoidance schemes are being treated as anti-social behaviour. To HNWIs all enforced taxation, solely in support of a political machine, is theft; it is the state obtaining money with menaces. For then government has fallen prey to the “Law of Intractable Systemic Corruption” and mutated into legitimate organized crime.

In a healthy society the commercial and guardian syndromes are symbiotic and synchronized, and the abuse of government power by officials is not tolerated. Richard Nixon’s analysis of the state’s power, “When the President does it, that means that it is not illegal”, is simply not allowed. Neither should the behaviour of political elites of the European Union, which ignore the stench of cronyism, corruption and economic mismanagement that hangs heavily over Brussels.

This leaves democratic governments in a quandary. Today’s informed voter demands that their representatives deliver value for money. However, any consequent ‘payment by results’ strategy will inevitably merge the two incompatible moral syndromes into systemic corruption. Therefore Ethics has itself become a problem, and certainly is not a solution.

Ian Angell
Emeritus Professor
London School of Economics