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The Economics of Innocent Fraud by John Kenneth Galbraith


Rating: (Mildly Recommended)


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Who would expect that an exploration of the differences between appearance and reality could be entertaining from an economist? John Kenneth Galbraith presents his view of the real world in a new book, The Economics of Innocent Fraud. Many executives who read this book will disagree that they hold as much power as Galbraith claims. Nonetheless, all readers will find this book to lead to extended thinking about how our current transfer of power from citizens, shareholders and customers to corporate managers creates serious problems for the economy and for society. Here’s an excerpt, all of Chapter V, “The Corporation As Bureaucracy,” pp. 23-28:


The head of the large corporation—the chief ex­ecutive, as he, or more rarely she, is called—is the product of a successful passage through the corpo­rate world, one that requires the appropriate education, ex­perience, mental acuity, bureaucratic agility, all in career competition. The major task, the successful command of the large corporate enterprise, is, however, far beyond the energy, expertise, experience and assured commitment of any single individual. Group effort, intelligence, specializa­tion—a bureaucracy—is needed. Success comes from col­lective energy, general and specific knowledge, self-asser­tion, pursuit of financial reward and a well-developed ability to survive, lead, prevail. This the schools of business administration recognize; of this they seek to teach. The vital role of bureaucracy, even though almost never so des­ignated, and success therein is unmentioned. In common discourse, bureaucracy and bureaucratic achievement exist in government, not in the corporate world.

On another feature there is also reticence. As with all bureaucracies, that of the corporation has a powerful ten­dency to self—enlargement. Pay is determined in substantial measure by the number of one’s subordinates; life is more pleasant and more effective when thought and action are delegated to lesser ranks. Here an escape from specialized knowledge and tedious effort. Distinction is accorded above by the number of those below. How many does he (or she) have under him? So strong is the resulting force for expansion and so indifferent can it be to need that surgical action, called downsizing, is often required a routine step toward greater efficiency and better earnings. The estab­lished bureaucratic tendency common to all great organi­zations inevitably produces some redundant staff that re­flects changed need and uncorrected error.

The modern corporation, the reality notwithstanding, condemns the word “bureaucracy.” That is for government. Corporate management, the established reference, has an activist tone. Participants in the management structure can be unnecessary, inept, self-concerned, but they are not bu­reaucrats. In government organization, group decision, de­layed and less than competent action, is normal; here there is bureaucracy. Not in private industry. A small rnanifesta­tion of mostly innocent fraud.



The management-controlled corporation is the cen­terpiece of the modern economic system, but it is not all. There is small business, most often in the service of con­sumers. There are corporations, notably in technology and finance, where an initiator, not an owner, retains authority. And there are small-scale agriculture and small-scale retail and personal services. But the modern economic world centers on the controlling corporate organization; let no one escape the word, on bureaucracy.

It is accepted in small business, and particularly in what remains of family agriculture, that toil may be tedious. The owner labors in the enterprise; he or she is responsible for its direction and its success. The small businessman, the small retail and service enterprise, like the family farmer, are still featured in economic instruction and in political oratory. They are the economic system as classically de­scribed in the textbooks of centuries past. They are not the modern world; they sanction only a cherished tradition.


For the small retailer, Wal-Mart awaits. For the family farm, there are the massive grain and fruit enterprise and the modern large-scale meat producer. For all, there is the recurrent squeeze from price and cost to loss. The eco­nomic and social dominance of big business is, however, accepted. The continued political and social celebration of small business and of family agriculture is a mildly inno­cent form of fraud. Tradition, romance; not the reality.



The role of the individual innovator and owner in tech­nological effort can have financial and other rewards. These are considerable—on occasion to the point of seeming near disaster, as in the great Silicon Valley experience of the last decades of the twentieth century. There unrecognized was, as ever, the terminal character of the small enterprise.

Talent for creation without organizational and diverse business skills is not enough. With age, retirement and im­posed reality, power passes to a larger entity—to a management, to organization, to Microsoft. Or there is failure and oblivion. The names of founders may be remembered, even revered, but their onetime authority has passed to corpo­rate organization to a bureaucracy.

The corporate management illusion is our most sophis­ticated and in recent times one of our most evident forms of fraud. The derogatory word “capitalism” having been es­caped, there is a valid designation that could be applicable corporate bureaucracy. “Bureaucracy,” however, is a term that, as indicated, is scrupulously avoided; “management” is the accepted reference. Ownership, the stockholder, is rou­tinely recognized, even celebrated, but all too evidently is without any managerial role.


As sufficiently noted, guiding the modern large cor­poration is a demanding task, far exceeding the authority or ability of the most determined individual. From this comes a further transparent and not entirely harmless fraud. It is the effort to accord the owners, stockholders, shareholders, investors as variously denoted, a seeming role in the enterprise. Capitalism having given way to manage­ment cum bureaucracy, an appearance of relevance for owners is contrived. Here the fraud.

This fraud has accepted ceremonial aspects: One is a board of directors selected by management, fully subordi­nate to management hut heard as the voice of the share­holders. It includes men and the necessary presence of one or two women who need only a passing knowledge of the enterprise; with rare exceptions, they are reliably acquies­cent. Given a fee and some food, the directors are routinely informed by management on what has been decided or is already known. Approval is assumed, including for man­agement compensation compensation set by management for itself This, not surprisingly, can be munificent. In the spring of 2orn, during a period of stock market weakness, the New York Times, not a radical publication, ran a full page on the contrast between falling stock market prices and rising managerial rewards. The latter, including stock options (the right to buy stock at favored prices), could, on occasion, amount to some millions of dollars a year. All was routinely approved by the compliant directors. Executives of the spectacularly bankrupt Enron were a prominent ex­ample, as were those of the reputable General Electric. Gen­erous reward to management extends throughout modern corporate enterprise. Legal self-enrichment in the millions of dollars is a common feature of modern corporate gov­ernrnent. This is not surprising; managers set their own compensation.


There are times when the need for economic and po­litical understanding requires direct, openly adverse comment: Reference to corporate management compensation as something set by stockholders or their directors is a bogus article of faith. To affirm this fiction, stockholders are invited each year to the annual meeting, which, indeed, resembles a religious rite. There is ceremonial expression and, with rare exceptions, no negative response. Infidels who urge action are set aside; the management position is routinely approved. The shareholders who previously sug­gested some social policy or environmental concern have their proposals printed with supporting argument. These are uniformly rejected by management. The only signifi­cant recent exception has been at the meetings of the highly intelligent, socially eccentric and financially successful Berk­shire Hathaway, Inc., of Omaha, Nebraska. Proposals by its stockholders are frequently accepted; some have thought this by prearrangement with management. In any case, it represents a highly exceptional tolerance on the part of the corporation.

No one should be in doubt: Shareholders—owners— and their alleged directors in any sizable enterprise are fully subordinate to the management. Though the impression of owner authority is offered, it does not, in fact, exist. An ac­cepted fraud.

Whether you agree or disagree with Galbraith’s arguments in The Economics of Innocent Fraud, reading the book will make you think about these issues in more depth.

Steve Hopkins, October 25, 2004


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The recommendation rating for this book appeared in the November 2004 issue of Executive Times

URL for this review: Economics of Innocent Fraud.htm


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