Crime Pays

The Economist writes that in the past three months alone firms in Britain and America have agreed to pay out over $10 billion because of wrongdoing, over-charging, mis-selling and price-fixing.  Barclays was fined $450m for its part in the price-fixing scandal of LIBOR. HSBC admited guilt and is expected to receive a hefty fine for allegedly flouting money-laundering regulations. Two pharmaceuticals firms, GlaxoSmithKline and Abbott Laboratories, have been fined for illegal marketing.  MasterCard and Visa this month agreed to a $7.3 billion settlement to resolve retailers’ lawsuits alleging collusion over credit-card fees. An April 2010 study in The Daily Beast, in partnership with the think tank Transparency International, listed the 17 most corrupt industries. Wall Street/Securities was in fact number 2,

The economics of crime prevention starts with a assumption: executives simply weigh up all their options, including the illegal ones. Given a risk-free opportunity to mis-sell a product, or form a cartel, they will grab it. In his 1968 paper on the economics of crime, Gary Becker of the University of Chicago set out a framework in which criminals weigh up the expected costs and benefits of breaking the law. The expected cost of lawless behaviour is the product of two things: the chance of being caught and the severity of the punishment if caught. Corporate crime makes good economic sense.

It is thought that ripping someone off, whether a customer or a supplier, through time a firm acting in this way will lose business, meaning that crime will not pay. The problem with this view is that the costs to customers of switching their custom, say, or the barriers to entry for competitors—can allow exploitative firms to escape punishment. Market constraints alone are not always enough to ensure good behaviour. In a 2007 paper, John Connor and Gustav Helmers of Purdue University examined 283 international cartels that operated between 1990 and 2005. The aggregate revenue increase these cartels achieved by acting as they did was over $300 billion.

  Even apparently hefty fines look pretty weak. Gary Becker of the University of Chicago estimates that with a 50% detection rate, and fines ranging between 10-40%, the expected cost of cartel crime is in the 5-20% range. Use a 10% detection rate, and expected punishment costs fall to 1-4%. So the expected benefits outweigh the costs. At the moment, it seems, some corporate crimes pay handsomely.

Litigation and criminal charges tend to take years to emerge; many wrongdoers are able to avoid court.