Wednesday, March 14, 2012

The Emergent Nature of Doing Good

Ex-Goldman employee Greg Smith wrote a New York Times editorial on the standard lament that his company doesn't care about the customer any more:
Today, many of these leaders display a Goldman Sachs culture quotient of exactly zero percent. I attend derivatives sales meetings where not one single minute is spent asking questions about how we can help clients. It’s purely about how we can make the most possible money off of them.
He sees the problem that his company maximizes profits, not helping the customer. This is a common refrain, one made by Einstein, who noted that socialism was better than capitalism because one system produces for everyone, the other for profit.

People serve others in modern society in very nonintuitive ways. In small tribes we are pretty aware of who is part of the team and who is a loafer, and how our stuff gets there. In modern society, by contrast, we have things as simple as pencils that we simply could not make even if we knew how to make it. We all rely on a vast number of things we have no way of making ourselves, from our iPad to our breakfast, and it isn't possible for everyone to go back to being a hunter-gatherer even if we wanted to, our productivity would be insufficient to feed everyone.

Adam Smith presented the argument on the invisible hand, how the self-interest of the butcher and blacksmith incented them to create goods and services that, in a competitive market, lead to specialization, cost minimization, and gains from trade. As a businessman, profit is one of the better signals of value out there simply because everyone else likes profit too, so you have identified an area where you are literally creating value. This is a highly counterintuitive point, and so most people simply don't believe self-interest is consistent with a good society, because that's not how their family works.

The problem is, altruism is very specialized in focus, whereas self-interest is not. Altruism is centered on people related to us, where I would sacrifice myself for my two siblings, or 8 cousins, thus, unconditional charity does not generalize from kin to non-kin very well. However, there is reciprocal altruism, basically helping other who can help you regardless of genome, and this is where it truly pays to understand how to service a customer--but only for the end-result of making money! It happens all over the animal world, as you see animals expending valuable resources towards another, yet only if there's some quid pro quo (eg, flower and bee, plover and alligator).

Recent support for this comes from a variety of sources, and the latest is a paper in Science--Markets, Religion, Community Size and the Evolution of Fairness and Punishment--by Joe Henrich et al, who administer fairness experiments across 15 diverse populationsand found that more commercial societies tended to be fairer. That is, people are nicer the more commercial they are, because being nice is good business. It took McDonald's to get Muscovites to smile.

The world is not filled with people like your mom and dad who showered you with love and resources merely for being you. It is filled with people totally indifferent to you except in so far as you can help them. If that makes you sad you really haven't thought about it, because a society of that much love would be really oppressive--even just one mom can be smothering, imagine thousands of her.

Smith then ends with a riff that really underscores the weakness of his point:

My proudest moments in life — getting a full scholarship to go from South Africa to Stanford University, being selected as a Rhodes Scholar national finalist, winning a bronze medal for table tennis at the Maccabiah Games in Israel, known as the Jewish Olympics — have all come through hard work, with no shortcuts.
Talk about selfish, such accomplishments didn't help anyone but him! There is no customer that will pay for self-indulgent status climbing in irrelevant hierarchies, regardless of how much we encourage our kids to play such games. That is, ping pong is a fabulous avocation, a pathetic vocation. We all want our children to play and engage in poetry, and when they excel at these things we are rightfully proud. Yet these are things kids do to develop skills like discipline, creativity, courage, that ultimately are valuable because of what they can do for others. They are not good in themselves, at least to society at large.

A similar quandary comes up in other domains such as science. The objectivity of science is not primarily from the integrity of scientists, but by scientists competing with others about how to explain the real world. As the left-brain is constantly rationalizing beliefs and data it receives from the right side, rationalization is the default method of reasoning whether we like to admit it or not. It helps to be on the side of truth because it's a lot easier and more fruitful, but it is not essential, and generally we make some base assumptions off our intuitions and then apply an 'anything goes' rhetorical style. It is naive to present your side of some scientific debate as being better because it is filled with people of integrity, as all sides in any large debate involve omitting inconvenient data and exaggerating the consistent data. They key is being on the right side, having the right biases, prejudices, assumptions, because confabulation is hard-wired into the human mind.

Being a good businessman is like being a good scientist. The most important thing is having the correct foresight to see the long-run, as in the long run the truth or value will win out. Having empathy for the customer or a respect for the truth in science is helpful in achieving those ends because you are better able to correct yourself before becoming too tied to bad causes via sunk costs and golden handcuffs. Day-to-day a simple focus on profits cuts through a lot of confused thinking about vague concepts like 'serving our customers', a subject that has produced its share of tiresome essays. Alternatively, nonprofits do this all the time if you really enjoy that kind of focus, or you can go off Jerry Maguire-like and start your own thing if really inspired, many people do.


Dave Pinsen said...

All well and good, Eric, but you are eliding some issues specific to Goldman Sachs that don't apply to Smith's butcher, candlestick maker, etc.

JAL said...


I usually like your posts but you've missed the point here. He's not stating Goldman shouldn't be profitable, he's stating that by deliberately putting short term selfish goals over long term customer satisfaction they are doomed. If UPS decided to steal 10% of the packages instead of deliver them they would be profitable for a year and then disappear.

Eric Falkenstein said...

If so, that will hurt Goldman and their share price will suffer, so I don't worry about correcting their incentives, other that trying to remove government guarantees (which is politically impossible to move because of sincere but I think misguided ideas about contagion). Personally, I don't see Goldman as having different ethics than anyone else in general, and am skeptical that some regulator or outsider understands how to improve the vague and unsubstantiated assertions Mr. Smith alleges.

Dave Pinsen said...

"If so, that will hurt Goldman and their share price will suffer, so I don't worry about correcting their incentives..."

What if their incentives are based on leveraging relationships inside government (such as Goldman alumni in key positions)?

Eric Falkenstein said...

Well, that's true for just about every large company. I think it's bad too, and think the best way to reduce this problem is to minimize the scale and scope of government, rather than to hope businessmen forsake the crony capitalism quid pro quo.

B. A. said...

good post Eric. I think the guy is full of sh#t.

in general, I have little admiration for people who tell some wide audience exactly what that audience was hoping to hear at that point. he is the equivalent of a populist politician in this respect. I admire people who stand for their own opinions while knowing they go against the trend of their times.

and when it comes to GS, I happen to be their client on a number of derivatives. I am in contact with several of their salesmen and structurers. from what I can tell, they are educated, professional, hard working and also nice people. I may well be wrong about them, but the important thing is that I don't really care how much THEY care about MY own interests. if they give me a good price, I will trade with them. if not, I will trade with one of their competitors, who are equally professional. it is my job as a client to know whether I am being ripped off, and mine alone.

I don't think morals are bad thing. caring for others is a good thing. but better morals are not the solution to the financial mess we are in. people need to understand better what it is that they are trading, and if they don't, they should stay out. you can't compensate for that with more "empathy" or care for the client's interest. the client needs to think for himself.

Anonymous said...

Once you announce that you're Gary Cooper, you're not Gary Cooper.

cig said...

@BA not everybody can study surgery before employing a surgeon. So surgeons sell services and reputation they generally do a fair job even for patients who are not surgeons. Greg Smith seems to be arguing that Goldman was selling trust to clients less sophisticated than you, and that sooner or later they will loose these now they have abandoned the trust bit. Hopefully he's helping those clients (the muppets) understand they need to switch suppliers.

B.A. said...

@ cig

" Hopefully he's helping those clients (the muppets) understand they need to switch suppliers."
Actually a sales woman working for a competitor of GS just sent a mail to all her clients with the full "Today is my last day at Goldman Sachs…" article. I find that pretty low. She is obviously hoping that the clients will "switch suppliers". Of course I am talking about the representatives of the clients (I am just a trader).

I may be wrong about this, but the guy's email is talking about institutional clients with one trillion dollars under management. The directors of those clients should better know what they are getting themselves into. It's their job, and if they need to switch suppliers, it's their job to do so. For retail clients, I take your point about the surgeon.

BlackRaven said...

It appears that Mr. Smith doesn't distinguish between "customers" and "counterparties".

Anonymous said...

You may like this bit from MR:

Even in small tribes social benefit was not sufficient.

Patrick R. Sullivan said...

This reminds me of that Mad Men episode where Don Draper writes a 'Why I Won't Take Any More Dirty Tobacco Money' piece...because Lucky Strike took their business elsewhere.

cig said...

@BA It's not a retail-only question. Pension funds, states, foundations, etc, can be quite large yet not large enough to be able to afford an in-house finance team with Goldman-league skills. These guys need third party suppliers who sell finance-with-trust, and Goldman used to provide that service and justifiably acquired a reputation for it. Then they changed business model and started treating every single client as a trading counterparty, which would be OK if they had advertised the change. Milking that reputation by pretending to still supply trust is disingenuous.

Reputation is unfortunately quite sticky, so it's taking ages for all potential clients who are not industry insiders to get the message, so any way this info can become more visible is a public good. The silver lining is that once you get to some threshold a reputation can be comprehensively destroyed pretty quick. It'd be interesting to see how Goldman fares if they do lose all the confidence trick clients.

B. A. said...

@ cig

let me start with a more general point. I think caring for the others is a great thing, but expecting others to care for you is bad. altruism is a precious and very limited resource that should be spared as much as possible. instead of asking why isn't there more of it in the world, it is more productive to set things up in such a way that we have to rely on it as little as possible. save it for really important things.

when it comes to finance, I think the best advice for those clients is to never expect GS or any other bank to "put the clients' interests before their own". they should actually be suspicious of anybody claimng to do that. what those clients should do is get enough knowledge to understand for themselves how well they are being served, instead of staying ignorant and expecting "trust". they don't have to be at the same level as GS in terms of sofistication to achieve that much.

I think small practical things can do much more good to the world than public appeals to integrity. I think it's of no practical use trying to shame bankers for their "evil ways". all this moralistic drive against bankers is implying that most people who are not bankers, if faced with the same choices, would act in a morally superior way, which I think is pure myth. this approach also provides too easy an excuse for one's ignorance by placing the entire blame on others. a culture where people are more responsible for their own decisions is better I think.

Anonymous #5 said...

I think it's of no practical use trying to shame bankers for their "evil ways".

Right, if we want shaming to have practical results we need to restrict it to poor people...

Anonymous said...

The firm, like most all of wall street, is slimy. It has nothing to do with specialization in a free market, and much more to do with harvesting freshly printed greenbacks and burning counterparties who have been sold on the notion they are clients. To be charitable, Wall Street is 10% productivity and 90% a casino where the government juices the pot and guarantees bets.

Anonymous said...

The firm, like most all of wall street, is slimy. It has nothing to do with specialization in a free market, and much more to do with harvesting freshly printed greenbacks and burning counterparties who have been sold on the notion they are clients. To be charitable, Wall Street is 10% productivity and 90% a casino where the government juices the pot and guarantees bets.