Episode 17: When Does it Make Sense to Cheat?

for all investors. Hi, and welcome back to Bloomberg Benchmark Up podcast about the global economy. It is Wednesday, December three. I'm Tori Stiwell, an economics reporter with Bloomberg News in d C. And I am joined by my co host Akdo, our editor for Benchmark in San Francisco. Hey, Tory, how's it going pretty good? This weather that we're having is crazy heading into the holidays. I know we've been getting a lot of rain here in California, which is kind

of nuts. It's like, what is this thing falling out of the sky. Nowhere carries umbrellas anymore? What are you doing for Christmas? I am going home to North Carolina, so we'll see the fam very nice. I'm going skiing in Tahoe, which is why I've been obsessed about this rain. If it's raining here, it's snowing in Tahoe. So that's a good thing. Yeah. So, as we're nearing the end of and I was reflecting back on the news of the year, I couldn't help but realized just how much

cheating went on. You know, we had the Volkswagen diesel scandal. Goldman Sacks and JP Morgan both had to fire analysts for cheating on internal training tests. There's this former trader for Ubs and City Group. He was sent us over a decade of prison time after he was found guilty of rigging library. There was deflate Gate. How could we forget deflate Gate? And most recent and most recently, there's Martin Screlly, the price gouging Parma exec who was charged

with securities fraud this month. Right, So we wanted to use today's show to you know, talk about the economics

behind cheating. Um, not just those big examples that Tori you just gave, but also little incidents of cheating, to like when I don't follow the regular traffic laws of San Francisco when I'm on my bike, because otherwise, you know, if cheating wasn't this prevalent, we wouldn't need meter maids, we wouldn't need judges, we wouldn't need an umpire at a recreational softball game, or the little scanner things at the doors of the stores that bleep when you try

to wake walk off with something you didn't pay for just generally get very close to them in my experience. Oh yeah, I hate those things. But it's it's that level of ubiquity document that you just mentioned that makes it almost possible to calculate how much cheating costs our society, which is what I first set out to do when I got to thinking about this topic. You know, how much this cheating cost. It is not really easy to

come up with that figure. So instead we want to talk about why people cheat in the first place, from an economic standpoint, because sometimes there is a case to be made in favor of cheating. Also, why do society is discourage cheating? And how does globalization mean that it's going to get a lot harder to police cheating in our world? And for that we're bringing on Robert Stonebreaker and economics professor at Winthrop University in rock Hill, South Carolina.

Hello professor, Hello, Hey, thanks so much for joining us. Professor. Let's walk through the act of cheating from an economic standpoint, because I think a lot of people out there are prone to think of cheating as sometimes being this knee jerk decision, something you do without thinking about it. But it's often a lot more rational than that. Right. Yes, economists would argue that our decisions are always made on

the basis of our perceived costs and benefits of those decisions. Uh. For example, if I'm watching TV, I must have thought the benefit of watching TV exceeded the cost of watching TV. And it's the same thing for cheating. People understand that there are potential benefits of cheating, they understand their potential costs of cheating. But if they think that those benefits are going to be greater than the costs, it is rational for them to cheat. So we make our choices

about cheating. It's just like we make our choices about anything else. We ask ourselves what are the benefits, what are the costs? If we think cheating is more beneficial than costly, we cheat. In my economics classes, we often talked about cheating in the context of game theory. You know, we talked about cartels and collusion, etcetera. Can you walk us through exactly what game theory is and how cheating would fit into that concept. Sure, game theory is just

uh theory designed to predict strategic behavior. So when we talk about game theory, we're not talking about playing monopoly or shoots and ladders. We're talking about strategic games. How do we react to other people in strategic situations. One of the things that crops up quite a bit in game theory is the idea that it is sometimes very difficult for individuals to make cooperative agreements. For example, suppose two countries decide to try to limit a military arms race.

The difficulty is there's an incentive for both countries to cheat. For example, if my country thinks the other country is going to cheat, then I have to cheat too, because you're going to cheat and I don't, I'm gonna lose. So if I think you're going to cheat, my best choice is also to cheat. But it turns out that if I think you're not going to cheat, it's still true that my best choice is to cheat, because if

you don't cheat, and I do. I win. So cheating in that situation becomes what economists would call a dominant strategy. If I think you're gonna cheat, I'm going to cheat. If I think you're not going to cheat, I'm going to cheat. No matter what I think you're going to do. My best strategy is to cheat, and of course your best strategy is also to cheat, because if you think I'm going to cheat, you'll cheat. If you think I'm

not going to cheat, you can cheat and win. So we both have a dominant strategy to cheat, and we end up cheating each other and we get into a what's sometimes called up a prisoner's dilemma from a game theory perspective. But it's very difficult for us not to cheat in those cases. Can we walk through maybe a smaller example of cheating? So, Professor, I bike to work every day and I often blow through stop signs. Oh it's illegal. I'm pretty terrible, and I get yelled at

all the time. But can you walk us through what's going on in my head in terms of the perceived costs and benefits of that decision. You're asking yourself first, what are the benefits of blowing through that soft sign. The work earlier I can, I don't have to sit and wait, and what are the costs? And the question

is is there a police officer sitting beside you. I'm also thinking about the probability of getting caught exactly, in other words, convinced that one it's not likely that you will be caught, or two that even if you are caught, the penalty will be basically nothing and go through. In other words, there are two aspects of the cost. One is what's the probability that you will be caught, and two is what will the penalty be if you are caught,

And you need both of those. If I'm sure I'm not going to get caught, I don't care what the penalty is, it won't matter. And if the penalty is minimal, I don't care if I'm caught because the penalty won't matter anyway. So you need both probability of being caught and you need a penalty. That makes a lot of sense to me because I have not been caught yet in my four years in San Francisco advertising this, but maybe the next time. Let's let's talk about an example

from the business world. Volkswagen So for the last three months or so, they've been dealing with the fallout from a pollution cheating scandal. Um the company's diesel cars weren't passing the strict emission standards in the US, so they devised a cheat that eventually made its way into about eleven million vehicles, and now they're facing roughly seven point five billion dollars in diesel recall costs, not including fines and potential damages from hundreds of lawsuits, and they've also

lost consumer trust. Their sales are falling, and they've been slow to recall the vehicles. One analyst put the total financial burden of the scandal at as much as twenty two billions. So, Professor Stonebreaker, you're telling me that someone at Volkswagen thought about all of these things and was like, yeah, let's do it. Since well, they did. The problem was

they misestimated the likelihood that they would be caught. We certainly make mistakes, and what happened at Volkswagen, I presume, is that the people making those choices were convinced that they would not be caught. And indeed it took many, many years before they were caught, and it was almost an accidental uh case in which they were caught. So in that case, I'm sure that the Volkswagen people made a rational choice, But our rational choices don't always turn

out the way we think. All of us have made choices that we were absolutely convinced we're going to be the right choices, only to find out later whoops. You know, I misestimated this probability, I misestimated this cost, And I'm sure that's what happened to Volkswagen. Yeah, it happens to

me when I eat like pizza late at night. Well, we're going to take a quick break for a word from our sponsor, but when we come back, we will walk through how societies can stop cheating and the possibility that it might be getting more prevalent as we become an increasingly global society. When we come back, what do traders want to limit risk? Access every opportunity and trade on a level playing field. Nate x binary options let you set your maximum profit and loss before the trade,

so your risk is always limited. Find opportunities in multiple markets, stock indussees, commodities for US, even economic numbers, and bitcoin, all from one account and platform. Nat X is a CSTC regulated exchange with transparency, free market data, and fairness guaranteed innovations of financial industry needs and nat X already has. That's why we think binary options are the future of trading, and it's here now at n A d e X dot Com Futures options and swaps. Trading involves risk and

may not be appropriate for all investors. Okay, so now we know about this economic framework behind whether we decide to cheat or not to cheat. Um, So let's talk about why societies try to stop it and how they can do that, um, professor, what's so wrong with cheating if it's the rational thing to do. The problem is that what is rational for the individual making the choice is not necessarily rational for the larger group. When one

person cheats, they impose costs on others. For example, if I cheat on my taxes, surely I would never do that. But if somebody does their taxes, that may be perfectly rational from their perspective, but they're imposing costs on all other taxpayers. Other taxpayers either going to have to pay more or else people are going to lose benefits from

the programs that their taxes could have supported. So my decision to cheat imposes costs on other people, and I might find to me there's a sort of a benefit of five from cheating, but maybe I impose costs of thirty five on other people. So my benefit of five certainly doesn't offset the thirty five costs to others. And

that happens in all kinds of situations. If students cheat on exams, which is something I deal with on a day to day basis as a teacher, they impose costs on other people the ones that don't cheat, and in fact, in education, online education online courses have this problem. Normally, if you have a degree, a college degree, its signals

employers that you have certain qualities. But many people look at online degrees as being less valuable signals because it's difficult to know whether or not students cheated in those online exams. And a classroom, I can monitor what's going on, you know, peop all out of textbook or talk to

a classmate. I can see that, But many times when people take online exams, it is difficult to monitor whether or not they are in fact answering the questions, whether they're even the ones answering the questions, or whether they're using other kinds of sources to help them answer the questions, and employers understand that, and employers sometimes look at online degrees as being less valuable signals. In other words, is some cheat, it destroys the value of that signal for

those who don't cheat. That's a really good perspective. I mean, so, we we know now why societies are trying to curb cheating. But is there a point at which the cost of trying to prevent this cheating outweighs the benefits of successfully doing so. Oh? Sure, it's like anything else. You want to do it only if the benefit covers the cost.

If you look, for example, briefly that crime prevention h I could stop everybody in America from speeding, or I could stop everybody in America from blowing through a stop sign. All I have to do is station a police officer every twenty feet along every road. But the cost of doing so would be enormous compared to the benefit. Cann't be the same thing with cheating. I can stop people from cheating if I spend enough time and energy on

monitoring what they do. But at some time, the cost of monitoring people just exceeds the benefit, and you find that in the workplace. My guess is that you've all seen people in a workplace who don't work as hard as they possibly could. At Bloomberg, no way, not possible. But if we monitored every employee, we could do something about that. You imagine you had a supervisor hanging over your shoulder every minute of every day. We probably wouldn't goof off as much as we otherwise would. But the

cost of doing that would be enormous. It would be counterproductive. So we only want to cure a problem if the benefit of curing that problem is going to exceed the cost of curing that problem. You know, I kind of feel like I hear about cheating a lot more these days. And you know, maybe it's because I work in, you know, the news industry and we talked about this a lot. But you know, for example, you just talked about online schools. Um. I feel like it's gotten easier to cheat thanks to

the Internet. So do you think it's the case that we're becoming more immoral or um? Why do you think cheating is becoming seems to be becoming more prolific these days. I'm hesitant to say we're less moral than we were in the past. I think immorality has been a problem since there's been humanities. I think it's a matter of changing costs and benefits. I think you can identify some cases in which it is more beneficial and or less costly to cheat today than it would have been in

the distant past. First, it's a matter of what economists would call is are people involved in what they would call a one shot game or repeated game. If I go back to the game theory piece for a minute, If I'm going to interact with you one time and one time only, that's a different world that if I'm going to have to interact with you over and over and over again. If I'm a sort of the proverbial traveling salesperson, you know, I walk into a town, I con the people in that town out of money, and

I leave. I get away with it. But if I'm going to try to do business there with the same people day after day, week after week, month after month, if I cheat them today, They're going to retaliate and get back at me the next time I interact with them rightly customers after So the more often I have to interact with you, the less likely it is I'm going to want to cheat you this time, because if I cheat today, say you'll retaliate and get back at

me the next time. So one of the issues is are we interacting with people more or less than we did in the past. If you think it's sort of a proverbial small town American where everybody knows what everybody else does, the likelihood that I'm going to be caught cheating is high, and the likelihood that word of mouth will tell everybody in town that I cheated is high, and that will make it very difficult for me to interact with people in the future. That imposes a real

cost on me of cheating. But suppose you look at a world in which you're interacting with different people every day. Suppose I'm living not in a small town, but I'm living in the middle of New York City. I could cheat you today and maybe never interact with you again for the rest of my life. So the more sort of transient we become, the less we interact with the same people over and over again, the more likely it is we can get away with cheating. That's really interesting.

And also, like I guess, from a global standpoint and from a company standpoint, when we're thinking about businesses cheating. I feel like the globalization of commerce has got to impact the cost benefit that these companies undergo when they're deciding to cheat. Yeah, I think that's true of one of the things that the companies worry about. And if I get away from the small town analogy where word

of mouth tells people who cheats and who doesn't cheat. Uh, how do you know if a firm you've never dealt with before is reliable? How do you know if a product you've never used before is a good product. How do you know if a restaurant you've never eaten in before is a good restaurant. Do you look at online reviews? Definitely? But do people cheat on online reviews? This is a problem. If we don't interact with these groups on an ongoing basis, it's difficult for us to know if these companies are

trustworthy or not. The best we can do is to look at things like online reviews, But even though we find out are not always reliable. I think there have been studies which have shown that companies pay people to give them good online reviews and pay people to give their competitors bad online reviews. So the more difficult it is for us to know whether people are trustworthy or not, the easier it is to cheat, I would say, also,

the stakes are higher too for these companies. It was the other thing I was going to suggest, the stakes are much larger in a globalized world. If I cheat and win customers in a local market, that's nice. But today, if I cheat, I can win not just the local market, I can win a global market. And I'm talking again about millions, billions of extra dollars as potential benefits. The larger the market, it's the bigger the stakes, the larger

the market, it's the biggest potential games from cheating. Well, this is this is all great fodder for me, especially as we as we head into the holidays when I'm probably going to cheat on my plans to eat healthily. But thank you so much, Professor Stonebreaker for joining us. I really appreciate it, and I hope you had fun. Oh I did. Thank you. I enjoyed it, and thanks

to you all for listening to Bloomberg Benchmark. We will be back next week, and until then you can find us on the Bloomberg terminal and Bloomberg dot com, as well as on iTunes. Pocketcast, Stitcher, Google Play, et cetera. And while you're there, please take a minute to rate and review the show so more listeners can find us. Please and let us know what you thought of the show. You can talk to us and follow us on Twitter, Atto seven and Tori still Well. See you next week.

We're proud of our new and growing suite of original podcasts, all designed to help you navigate the complexities of business, financial markets, and the global economy. In addition to Bloomberg Benchmark, which you're listening to now, don't miss Odd Lots, a deep dive into the intersection of markets, economics, and finance

with Joe Wisenhugh and Tracy Alloway. There's also Deal the Week with our mergers and Acquisitions reporter Alex Sherman, looking at a breakdown of the biggest deals and giving you an inside peek into corporate boardrooms. All three shows are available on iTunes, SoundCloud, pocket Casts for Android, Bloomberg dot Com, and of course, the Bloomberg Terminal. Check them out and

subscribe today. This episode was brought to you by nat X. You know, any long term investment is going to go through short term dips and price fluctuations nat X binary options that you turn those short term movements into trading opportunity. You decide your maximum profit and loss before each trade, so your risk is always limited. Trade stock in dissees, commodities for X, even bitcoin in economic numbers, all from

one account on a CFTC regulated US exchange. Instead of just watching the markets ups and downs, turn them into trading opportunities at nate x dot com. It's the future of trading n A d e X, dot com, futures options, and swaps. Trading involves risk and may not be appropriate for all investors.