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asked ago in General Economics Questions by (230 points)
Fraud and Negligence and Oligopoly.

I have consulted micro texts at all levels – principles, intermediate, advanced, graduate – but have not found the words fraud or negligence in any of their indexes.
Standard treatments of oligopoly consist of constructing ingenious game theoretic models of various types of oligopolistic behavior. Some texts discuss the fact that in the US oligopolistic industries can buy economic rents and lighter regulation from politicians. Although these resource distortions are significant they receive little emphasis.
Fraud and negligence are not supposed to occur because of the discipline of the stock market, but this argument can only be partially true because firms have engaged in fraud and negligent behavior. A non-exhaustive list of examples includes: airbags; airline manufacturers; automobile manufacturers; baby strollers; cigarettes; fixing financial markets such as LIBOR; oil spills; opioid manufacturers and distributors; financial institutions selling mortgage backed securities that were claimed to be less risky than the sellers knew, and financial institutions creating false accounts for their clients; suppressing the impacts of fossil fuels on climate change; and the plastics industry deciding not to pursue the problem of plastic waste disposal in the early 60s.
An interesting issue is why market discipline sometimes fails to work. Perhaps behavioral economists can explain this. One possibility is that the penalties of being discovered are seldom severe. A firm may do a cost-benefit analysis and decide that the profits far outweigh fines and damages. If firms faced a fine equal to 110% of the profits that they made through malfeasance then the cost-benefit calculations would come out very differently. Executives may also make different decisions if they faced possible prison sentences.
Fraud is the result of asymmetric information. Firms deliberately withhold information about their products, and often deny the defects even when they are taken to court.. The standard narratives of the lemons model emphasize the problem that markets may be much smaller than is socially optimal but do not mention that the seller is deliberately defrauding the buyer.
Fraud and negligence provide interesting examples of principal agent problems: between top management and stockholders; top management and middle management; and middle management and lower management.
They also raise issues of “bad” competition. Sally may deem it necessary to follow Sarah’s practice if she is to keep her job as CEO. Warnings to management may be suppressed or ignored, and the whistleblowers punished because of competitive pressures.
While it would be absurd to assume that all oligopolistic firms engage in fraud and negligence surely it is equally absurd to assume that none of them do.
I would be very interested to receive citations to the literature, which has not percolated down to the textbooks.

2 Answers

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answered ago by (1.6k points)
Law and economics textbooks discuss negligence, tort, and to some extent fraud, which is an important topic in accounting, especially forensic accounting. You are correct that economics textbooks rarely say much about these matters, largely because economics has traditionally assumed that the legal system works perfectly, and usually costlessly, in the background to prevent such activities. But research that brings together economics, law, politics, and other social sciences is flourishing; hopefully it will lead to useful analyses of the issues you raise.

The issues of asymmetric information and principal-agent problems you identify are surely important, but an equally important politico-economic problem in this context is one of collective action. The benefits of fraudulence and negligence are concentrated in firms and their senior management; the benefits of exposing such activities are spread out over a large number of consumers. Only a few people, for example investigative journalists, have any direct incentive to incur the costs of detection (and those may include retribution from those they seek to expose!). A good whistleblower law may help here.

Of course governments are instituted to solve collective action problems, but they have their own defects, and getting them to perform their supposed functions is itself a difficult collective action problem. Many aspects of this have been extensively studied in economics and political economy.

As you can see, studying these issues is a huge and difficult endeavor, requiring a combination of knowledge and skills from many disciplines. As far as I know, a thorough treatment with any coherence or unification doesn’t even exist at the research level and seems well beyond the scope of economics textbooks, especially undergraduate ones. But you are correct that they should recognize the importance of the problems, and perhaps spur some student readers to go on to do useful research on them.

By the way, fining firms 110% of their profits earned through malfeasance won’t help if the probability of detection and conviction is small; Becker’s classic analysis of crime is relevant here.
commented ago by (230 points)
Thank you for the law and economics reference, a topic I have not investigated. I find it odd that cynical economists believe that legal systems work perfectly.

As you note the problem is that we teach literally millions of students in many countries, most of whom never take any more economics, naive ideas about the efficiency of markets based on an unrealistic story about perfectly competitive markets.  Of course they ultimately learn about market failures and non-competitive markets but Marshall's scissors seem to leave an indelible afterimage on students.
I agree that harsh punishments are not likely to be effective if the probability of of detection is very low. I think that politicians should make sure that regulators are well funded. I believe that in China there are stiff fines for firms that mislabel food and that "food bounty hunters" receive substantial rewards for their efforts. Of course, monitoring oligopolists would be much more difficult but devising optimal regulations might be an interesting topic for research.
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answered ago by (410 points)
Have you checked out crime economists? (Specifically economists that focus on white collar crime and fraud.) I can't think of any specific citations to provide. Maybe talk to Jennifer Doleac? She has a new podcast on law, economics, and crime.
commented ago by (230 points)
Many thanks for the heads up. I'll look at Jennifer Doleac's podcast.

But the issues of fraud and negligence are essentially invisible in the mainstream literature.