RUDI DORNBUSCH (FEBRUARY 2002): ENRON: THE CORRUPTION OF CAPITALISM

We cannot expect to sell capitalism around the world if malpractice leads many skeptics to find just cause. True socialism has failed terribly, but is capitalism beyond reproach; isn’t it just a system that works for the insiders and their cronies? Wasn’t Enron a prime example of the inmates having the guards in their pocket? If America wants to lead it must decisively exorcize the culture of corporate crony capitalism.

The choice is not, of course between socialism and capitalism. Socialism always becomes a mess. What starts with great expectations for a workers paradise soon gets bogged down in an administrative logjam. Without incentives and radical decentralization, economic progress remains an illusive dream. That is what the past century has shown, that is no doubt why China, all rhetoric notwithstanding, has opted for out-and-out capitalism. . Deng Xiao Peng saw that mechanism and recognized its potential – "to get rich is glorious" was his astounding comment. Did he foresee the large inequality that resulted; quite possibly the answer was yes, higher standards of living for all, never mind inequality at this stage of China’s game. But both to function and to be socially acceptable, capitalism must at least be clean. It will never be true that everybody has a chance to get big-time rich. But at least the system should not be perceived as so rigged that some make it systematically and without merit because they are insiders and others pay the bill.

If inequality is one negative aspect of radical capitalism—to some extent mitigated by public sector redistribution which is never efficient as well-captured by the famous image of the leaky "bucket"—the other one is the potential corruption of capitalist institutions, i.e. the Enron syndrome. By the time congressional committees are bought to weaken regulatory oversight, accounting firms lose their independence because of the lure of mega-contracts, corporate boards can’t say no because their fees are stunningly large relative to their small efforts, and corporate management is in a frenzy of self-dealing. The stage is thus set for capitalism to lose its good name. That clearly has been the case of late in the US. Capitalism involves a delicate problem of agency and trust; giving managers the green light for entrepreneurship is not enough for investors to participate and see their interests safeguarded, for stock markets to price securities realistically. While the evidence is not fully in, it is fair to say that Enron has been one of the great moral scandals of capitalism. It throws a very stark light on the institutions, more so since employees lost their short in the process.

The witch-hunt is underway—as politicians and regulators and even the White House are trying to save their political skins—is totally appropriate and indeed essential. It has inevitably the overtones of populism and anti-business sentiment; it almost looks like global protesters are taken over. But in the swing of the pendulum the excesses of yesterday inevitably lead to extreme scrutiny and a tough rulebook on the other side. That is all for the good. Capitalism is a public trust, it works if everybody has a fair chance and corporate theft has its highly visible punishments. If in the gotta-get mega-rich atmosphere we have lost our bearings, lets find them again in a ritual witch-hunt. One of America’s great exports is capitalism. The only way we will succeed in making capitalism acceptable, and hence deliver its growth and prosperity bonus around the world, is to now practice exorcism on the public stage. Business will not agree, they will argue that all this is excessive; lets put it behind us as bygones and just move on. But that is not enough to convince the doubtful and restore a clean image; indeed, it would just be the ultimate creation of moral hazard around corporate crime without punishment. Some will say how can you get good boards if members can be sued; some will say what will happen to stocks if you start asking hard questions about reporting. But a broom that sweeps clean ultimately is good for stocks, indeed, much better than cover up and persistent doubt about what the books in truth looked like.

Capitalism needs its morality tales. But there are distinctions to be made. The failure of LTCM was a lesson about risk management and the need to not be dreamy-eyed about a string of unending huge returns. Nothing remotely illegal, no government bailout or facilitation, the investors made a mistake, they lost big time; a good lesson for risk management everywhere. By contrast the Enron affair involved the impropriety and perhaps criminal conduct of just about anyone coming close to management. At this point it is not even clear whether top managers won’t walk away with a bundle while the workers lost their retirement assets.

Chinese capitalism, too, is rife with corruption and self-dealing. The government’s reaction is ever so often to behead a bunch of particularly obvious villains. Perhaps that seems extreme as a solution for Western democracies. But surely, jail for corrupt managers, regulators and politicians is an essential part of functioning and respected capitalism. Because capitalism redistributes aggressively, it is all-important that there be trust, transparency and accountability. After Enron—standing not just for the single event but a slip in corporate culture altogether —we need to regain our bearings.