Only Government Intervention Can Stop Corrupt Capitalism

After scandals at Barclays and GlaxoSmithKline, it's clear that a no-regulation approach to markets won't work.

At a branch of Barclays Bank in London, a protestor from the group Move Your Money hangs up posters. (Reuters)

At the core of capitalism are powerful forces that, if unconstrained, cause corporate corruption, as reflected in two recent corporate scandals, one involving Barclays and a second involving GlaxoSmithKline.

These cases raise starkly, yet again, the issue of how to realize the benefits of market capitalism while restraining the powerful impulses to cut corners, cheat, and commit fraud. This ageless question is of special moment in this polarized political season, in which the role of government is central. The cases rebut the assertions of the Republicans, Tea Partyers, libertarians, and corporate leaders who wish to reduce the reach of law and government and who believe that markets will always self-regulate -- people from Ayn Rand and Russell Kirk, to Ron Paul and Grover Norquist, to Tea-Party Republican majorities in the House who want to "starve government," to individual and corporate donors to super PACs, all of whom are today shaping the Republican message

The cases support people who believe in a mixed economy that gives a central role to economic freedom and free markets -- but a system that also places important legal and regulatory limits in order to prevent corruption and protect social goods.

Barclays agreed to pay $453 million to settle U.S. and British allegations that it manipulated the London interbank offered rate, or Libor, which is the benchmark for interest rates (the cost of money) on an estimated $500 trillion in mortgages, credit cards, and other loans and derivatives affecting individuals and businesses around the world. Libor is based on submissions from major banks which report on their own borrowing costs -- and Barclays falsified those reports, often in collusion with others, in order to hide a weakened financial position during the melt-down or fraudulently to improve profitability. The chairman, the CEO, and the COO of Barclays were all forced to resign, with the CEO calling his bank's actions "reprehensible." The governmental investigation has targeted 18 financial institutions, and a dozen firms have fired or suspended traders for manipulation of the rate. The far-reaching scandal has just begun to reveal its dirty secrets.

GlaxoSmithKline (GSK), the huge UK pharmaceutical firm, agreed to plead guilty to federal crimes and pay approximately $1 billion in fines because it promoted two prescription drugs for unapproved uses and failed to report safety data to the FDA about a third. In addition, GSK agreed to pay an additional $2 billion to resolve civil claims brought by both federal and state authorities alleging, among other things, that the company paid kickbacks to physicians to prescribe drugs, made false and misleading statements about drug safety, and committed fraud under a Medicaid drug rebate program. The $3 billion total payment "is the largest health care fraud settlement in U.S. history," said Justice Department, "and the largest payment ever by a drug company," eclipsing other settlements on similar charges with Pfizer ($2.3 billion), Eli Lilly ($1.4 billion) and Johnson & Johnson ($1 billion in process of being completed).

Corporations large and small apply relentless internal pressure on their people to hit basic financial goals for net income, cash flow, and stock price. Other commercial targets, too, may be critically important: achieving specific returns on investment, equity or assets; hitting sales or service goals; meeting product development or product launch schedules; and attaining productivity increases. Companies, especially those in the global economy, also face external pressures such as endemic corruption, weak rule of law, pervasive conflicts of interest, and extortionate demands from government officials.

Personal incentives are driven, in important part, by "making the numbers." There are ubiquitous temptations and pressures to behave badly. Employees at all levels may feel that their salaries, bonuses, promotions -- and even their job security -- depend on falsifying accounts, cutting corners, colluding with rivals, and generally ignoring law and ethics.

Presented by

Ben W. Heineman Jr.

Ben Heineman Jr. is is a senior fellow at the Belfer Center for Science and International Affairs, in Harvard's Kennedy School of Government, and at the Harvard Law School's Program on Corporate Governance. He is the author of High Performance With High Integrity.

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