Matching Expectations: Source of Decline and Remedy for Wealth of Societies Shyam Sunder, Yale University Forum on Financial Structures and Management Office of the Comptroller General of the Republic of Colombia Bogota, Colombia, December 15, 2011

An Overview Source of wealth and prosperity of societies: holding high expectations and incentives to match them Contract model of society and organizations Control in organizations and societies versus absence of control Consequences of control for social evaluation and policies Financial reporting for good control: All participants in an organization expect to receive a part of the surplus generated by the organization What is corruption and lack of control How can control be recovered and corruption eliminated? Why is it in the interest of all? Sunder: Matching Expectations 9/20/2018

Source of Wealth and Prosperity Why are some societies in the world so prosperous and other are not, even with comparable natural resources? The distinction: members of prosperous societies Expect all members to avoid hurting the society through their actions, and Their incentives are arranged in such a way that their own self-interest matches (does not conflict with) what others expect them to do Holding high expectations of our fellow citizens, and Matching self-interest with such expectations are the two keys to wealth and prosperity of organizations and societies. Let me explain why. Sunder: Matching Expectations 9/20/2018

Contract Model of Organizations and Society Many participants, all seeking their own goals In business: investors, employees, customers, suppliers, government and community In society: citizens, organizations with various interests, civil servants and politicians All participants contribute resources Organization/society prosper if it generates a surplus (total value of output – sum of opportunity cost of all contributions) All participants expect to get at least as much as the opportunity cost of their contributions Shyam Sunder. 1997. Teoría de la contabilidad y el control. Universidad Nacional de Colombia, Facultad de CienciasEconómicas. Sunder: Matching Expectations 9/20/2018

Resource Inflows to the Organization Investor Employees Customers Suppliers Sunder: Matching Expectations 9/20/2018

Resource Outflows from Organization Investor Employees Customers Suppliers Sunder: Matching Expectations 9/20/2018

Contract Model of Organizations All parties expect to get at least the opportunity cost of their contribution; all parties look after their own interests, including the customers Investor Employees Customers Suppliers Sunder: Matching Expectations 9/20/2018

Contract Model of Public Good Organizations Customers are replaced by beneficiaries, and investors are replaced by government or donors; beneficiaries not able to protect their interests Government Or Donors Employees Beneficiaries Suppliers Sunder: Matching Expectations 9/20/2018

Difference between Public and Private Good Organizations Customers can discipline managers of private good organizations easily by denying them revenue Beneficiaries of public good organizations cannot do so easily. Public good organizations do not get their revenue from beneficiaries; Beneficiaries dissatisfied with the performance of public good organizations cannot deny revenue to the organization This makes the challenge of control and efficient operation of public good organizations more difficult than running private good organizations Sunder: Matching Expectations 9/20/2018

Control in Organizations and Societies We assume that most people in organizations and societies act what they see is in their self interest Members of a society can expect others to behave well (i.e., throw trash in trash cans) or poorly (i.e., throw trash on the street) If expectations are of good behavior, and if reasonable care is taken to align incentives with such expectations, this match achieves control If expectations are of bad behavior, it is easy for incentives to align with bad behavior, and we get out of control organizations and societies Match incentives with expectations of good behavior to for society to become wealthy and prosperous Sunder: Matching Expectations 9/20/2018

Failure of Control Leads to Corruption When control fails, we have a corrupt organization or society Most anticorruption drives fail To increase the chance of success, we explore the nature of corruption How does corruption arise in a non-corrupt society? Why is it so resistant to reform? Given the record of failure to root out corruption in so many countries, what could be an effective strategy to limit corruption? Sunder: Matching Expectations 9/20/2018

Corruption as a social Disease of Degenerated Expectations in Society Corruption is not just a matter of individual greed It is a social disease in which the members of society lower their expectations of one another’s behavior Mutual expectations of good behavior is a very special kind of wealth or capital of society This social capital of high expectations is at least as important as natural and human resources When we expect corrupt behavior from one another, this social capital is depleted Rebuilding it to a high level needs sustained effort There are no quick fixes Sunder: Matching Expectations 9/20/2018

Social Norms Social norms of behavior are sustained by sanctioning deviations from the norms by all members of society When people expect ethical behavior from others, they tend to behave ethically themselves Unethical behavior by some tempts others to do the same Transformation of a society from non-corrupt to corrupt occurs when this social capital is depleted Sunder: Matching Expectations 9/20/2018

Building Social Capital of Expectations of Good Behavior It take time and effort by all members to build various kinds of capital, including social capital Once accumulated, social capital sustains itself, lowers transaction costs, raises productivity and prosperity for all It cannot be transferred across societies It is depleted in times of stress (natural disasters, wars, inflation, etc.) when some people start taking short cuts to survive When others (public, civil servants, and politicians) start doing the same, the society descends on a slippery slope to corrupt state if other members of society fail to sanction them for behaving badly Sunder: Matching Expectations 9/20/2018

Addressing Corruption Periodic scandals destroy self-esteem of society by highlighting the gap between their ideals and reality Responses to scandals: Cynical: everyone is corrupt Cover up: set up a board of inquiry, or Naïve: vigilance commission These solutions fail because solving the problem with the existing administrative set up amounts to cleaning a dirty window with a dirty cloth Rebuilding depleted expectations capital necessary through a multi-pronged program Sunder: Matching Expectations 9/20/2018

Eight Steps Limit government to its essential functions Cut employment and increase productivity of these functions Pay market wage to government employees Reform financing of elections Transparent and accessible government Modernize payment system Education Enforcement Sunder: Matching Expectations 9/20/2018

Limit Government to Essential Functions Need government to provide public goods and services, not private goods and services Given the difficulty of efficient management of public good production, government should concentrate on those functions Concentrate limited resources and ability of government on competent and efficient delivery of policing, justice, law and regulation, infrastructure, foreign affairs, and defense, etc. Expansion of government to non-essential areas is an invitation to corruption Sunder: Matching Expectations 9/20/2018

Lower Employment and Raise Productivity in Government Avoid operating government as an employment agency Demand productivity from civil servants in delivery of essential services Sunder: Matching Expectations 9/20/2018

Pay Market Wage to Civil Servants Attract talent to civil service by paying market wages Remove rationalization for bribes Enforcement and punishment to the corrupt who may “double dip” by continuing to take bribes Sunder: Matching Expectations 9/20/2018

Election Financing Reform Devise open and realistic methods of financing democratic elections It is not possible to rebuild expectations capital without a fair and open system of election financing Sunder: Matching Expectations 9/20/2018

Transparent and Accessible Government Easy citizen access to government rules and policies Transparency of government decisions and actions Make it easier for citizens to monitor the civil service and one another Most effective way of rebuilding expectations capital in society E-government Sunder: Matching Expectations 9/20/2018

Control in Organizations and Societies We assume that most people in organizations and societies act what they see is in their self interest Members of a society can expect others to behave well (i.e., throw trash in trash cans) or poorly (i.e., throw trash on the street) If expectations are of good behavior, and if reasonable care is taken to align incentives with such expectations, this match achieves control If expectations are of bad behavior, it is easy for incentives to align with bad behavior, and we get out of control organizations and societies Match incentives with expectations of good behavior to for society to become wealthy and prosperous Sunder: Matching Expectations 9/20/2018

Modernized Payment System Replace currency by documented electronic payment systems Auditable money trail discourages corruption Information technology makes it easier Sunder: Matching Expectations 9/20/2018

Education Effective education campaign necessary To inform and convince the civil servants that they will receive a fair compensation for their skills and that they can proudly serve society without accepting bribes To inform public that they will be treated fairly by government Most people prefer a simple life of honor to a lavish but corrupt existence All religions say this Sunder: Matching Expectations 9/20/2018

And Finally, Enforcement Enforcement is the final, not the first or only device to raise social expectations to a higher level It will inform those who continue corrupt behavior that they will pay a high price As expectational capital of society rises, dependence on enforcement can be reduced But it must always be available Sunder: Matching Expectations 9/20/2018

Concluding Remarks Societies and organizations can be thought of as contracts among people Behavior of people depends on how they expect others to behave, and on their incentives Good behavior matched with self-interest builds prosperous societies, bad behavior generates conflict and misery Building prosperity requires raising expectations of good behavior by all members of society It requires sustained effort, but can be done, and has been done Fair, balanced, integrated, and long term program to build expectations of good behavior, and matching expectation of behavior to self-interestis a way to address the problem Sunder: Matching Expectations 9/20/2018

Shyam.sunder@yale.edu www.som.yale.edu/faculty/sunder Thank You. Shyam.sunder@yale.edu www.som.yale.edu/faculty/sunder