Roger W Ferguson, Jr: Economics and ethical behaviors
Remarks by Mr Roger W Ferguson, Jr, Vice-Chairman of the Board of Governors of the US Federal
Reserve System, on the occasion of his acceptance of the 2004 Distinguished Alumni Award, Sidwell
Friends School, Washington, DC, 22 May 2004.
* * *
I am pleased to be here today and honored to accept the Sidwell Friends School Distinguished Alumni
Award for 2004. It is awe-inspiring to be included in the company of so many accomplished graduates,
including Walter Gilbert, Hanna Holborn Gray, Antonio Casas, Helen Colson, and Bill Nye. All of you,
as Sidwell Friends graduates and friends, clearly understand the value of a good education. Indeed,
economists have long noted an "education premium" in compensation, with college-educated workers
earning approximately fifty percent more than workers with no more than a high school education.1
However, you also know that a good education is more than just the classroom-based learning of
facts, or even the skill of critical thinking. A truly outstanding education also encourages moral
behaviors and appropriate decisions. Sidwell Friends, with its grounding in Quaker traditions, certainly
values the moral and ethical development of its students. Fortunately, many schools teach the
importance of choosing the "hard right over the easy wrong." That is where I will focus my brief
remarks. From my perspective as a policymaker, I want to commend the emphasis on a complete
education, with technical, critical thinking, and ethical components, and encourage you and other
schools to, if anything, redouble your efforts to instill moral values and ethical behaviors. Obviously,
we as Sidwell graduates hope to exemplify those values as much as possible in our personal and
professional dealings. Similarly, I encourage the current generation of students to take advantage of
the moral and ethical training available at these schools. Do not forsake a solid grounding in those
topics that will help you to do "good" while you are learning the skills required to do "well."
Some of you may have noticed that I encouraged this focus on teaching and practicing ethical and
cooperative behaviors as an economic policy maker. In that role, shouldn't I encourage you to be only
a coolly self-centered, utility-maximizing, homo economicus? The answer is no. Economic outcomes
are improved when market participants "play by the rules." This fact has a strong grounding in
economic theory and empirical research. In fact, you may be surprised to know that the economics
profession, even with its hard-headed assumption of rational actors pursuing their own self interest,
has for the last few decades also focused on the role of moral and cooperative behaviors in leading to
better economic outcomes.
As one major example, a recent Nobel Prize in economics was shared by George Akerloff, who in a
classic paper in 1970 showed that a failure of markets arises when the seller does not share honest
and complete information about the quality of a product, in his paper, used cars, with would-be
buyers.2 Akerloff went on to show that such asymmetry in information and opportunistic behavior will
ultimately drive honest dealings out of the market unless it is overcome by new institutional structures.
Some of those structures arise from the private sector. As a policymaker, I see many of those
structures arise in the form of regulation. In those markets in which there is a strong likelihood that
self-policing behavior will not emerge, and opportunistic behavior is a real risk, the government must
create regulation to protect the weaker or less-well-informed party from the stronger, better-informed
one. These regulations are well intended and often have the desired outcome; however, in spite of the
regulators' best efforts, they can be burdensome, and compliance with them may well consume
resources that might go to providing more or better goods and services. This is not an argument
against regulation; sound regulation is needed. It is an example of the cost imposed on society by the
unscrupulous behaviors of a few.
Not only have economists identified theoretical failures that come from unethical and opportunistic
behaviors, social scientists have also demonstrated real world benefits from cooperative behaviors.
For example, a study of engineers found that individual workers who are more generous with their time
with other workers, and in turn frequently benefit from the help of others, are more productive and
have higher social standing.3
More recently of course, the entire economy, that is to say all of us, have experienced the costs of
unethical behaviors in a matter of great macroeconomic consequence. The recent accounting and
governance scandals were sufficiently numerous and serious to generate widespread concern among
investors about the reliability of financial reporting in general. These scandals were a notable factor
behind the U.S. stock market slide in the spring and summer of 2002, amidst the cascade of scandals
culminating with WorldCom's revelations in June that year. And concerns about corporate governance
probably contributed, at least in some measure, to the heightened business caution and sharp fall-off
in business investment during this period. Thus, although other, more important factors were also
working to restrain real activity during this period, it seems likely that the scandals exacerbated an
already weak economic situation. Just as opportunistic behavior by individuals calls forth regulations
as a counterweight, so too these corporate governance scandals have called forth new laws and
regulations, which were probably the proper response and required to restore confidence, but which
have almost surely added to the cost of doing business.
The negative effect from lapses in corporate governance at the macroeconomic level in the United
States is a very visible example of the national costs of poor corporate governance. Social scientists
have also found that at the level of the individual company poor corporate governance costs and good
corporate governance pays, quite literally. Some researchers have found that investments in firms
which engage in unethical behavior earn abnormally negative returns for prolonged periods (Long and
Rao, 1995).4 Others find that firms that have better corporate governance also have higher stock
market valuations, higher profitability and faster sales, and there is evidence that buying shares of
firms that score high in corporate governance and selling shares in firms that do not yields abnormally
positive returns (Gompers, Ishii and Metrick, 2003).5
All of this is true not just in the United States, but globally as well. At the macroeconomic level, the
World Bank has identified corruption as the single greatest obstacle to economic and social
development. The Bank states that "corruption undermines development by distorting the rule of law
and weakening the institutional foundation on which economic growth depends."6 Fortunately, there is
some evidence from studies of emerging markets that firm-level corporate governance matters more in
countries with weak legal systems, and one can infer from this work that firms can partially
compensate for ineffective legal systems by practicing ethical behavior.7
Let me close by saying that the economy of the United States depends greatly on an educated
workforce. My own research demonstrates that our productivity boom of the last nine years requires a
talented and flexible work force.8 Education, however, must be broadly defined to include moral and
ethical behaviors and good decisionmaking. There is plenty of evidence that such behaviors pay an
ample reward to the individuals who make them and, unfortunately, the absence of such behaviors
extracts a cost, potentially from all of us. I am pleased to have attended a school that continues to
value such an education, encourage all schools to emphasize such training, and am truly honored to
accept this award from my fellow alumni.