The Economic Cost of Deception

The Sufi hero, Nasseruddin, one day entered a small town traveling with a group that included a wealthy man. Before entering the town, he talked the wealthy man into lending him his elegant coat. After they proceeded a bit farther, he offered the wealthy man a few coins if he would allow Nasseruddin to ride on his horse. They arrived in the town, and the man wanted his horse and coat back.

Nasseruddin, who had trickster as well as guru attributes, refused. A shouting match ensued, and they were promptly taken before the local magistrate to settle the matter. The judge asked what the issue was, and Nasseruddin explained that the man was claiming ownership of the horse, which was rightfully Nasseruddin's. At this point, the wealthy man screamed in fury about his right to his own horse, which Nasseruddin had obtained on loan with only a few coins. Before the man was able to calm down and properly defend his point, Nasseruddin added, "This man also has the audacity to claim my coat as his," and the man's outrage reached panic proportion. The judge awarded the horse to Nasseruddin and dismissed the case.

This story illustrates an important point about deception, which is that one's ability to deceive is dependent on the frequency with which deception occurs. Among a group of liars, nothing is believable. Nasseruddin and the wealthy man were new in town so their conflict appeared to be the first time, although Nasseruddin had probably done this many times before. In the particular case of the horse and the coat, the first lie might have resulted in a proper settlement, but two lies had a different consequence and are of a different magnitude than just one. This later point will be discussed extensively in this article.

In the course of ordinary daily life, most of us assume that most people we deal with are not lying to us. And that is a reasonable assumption in America. What are the consequences of a society where most people are not lying as opposed to one where nearly no one is? I would argue that a "small amount" of deception is significantly different from "rare cases" of deception. The former is costly.

The writer and prominent thinker about lying, Sissela Bok, defines lying as an act of intentional deceit. Her definition does not include confusion, stupidity, or the omission of information. She makes two exceptions for situations in which people give consciously wrong responses. One is social intercourse, in statements usually defined as "white" lies, such as : "Doesn't my new dress look just wonderful?" "Yes, dear, it's charming." The other exception is in the game of poker, in which deception is part of the strategy. Otherwise, lying is defined as intentional deceit.

Bok's observations help us deal with some cultures in which certain situations involve mutually agreed on and accepted deceit. Among Arabs, for example, business negotiations often includes the effort to outdo one another with praise and adulation: "Truly, sir, I am honored to be able to sell my wares to a person with such brilliant insight and recognized expertise as yourself." In a different vein, in Japan most acts of generosity are accompanied by self-deprecation: "Please accept this feeble last-minute gift, even though it is so much less than your great hospitality warrants". Neither of these are lies.

As for actual lying in the real world and its economic consequences, I have two sets of criteria, one for individuals who lie to me and one for businesses who try to deceive me. With individuals whom I know personally, my rule is that they only lie to me once, and after that I no longer trust them. But I am must also admit that the first lie is often cloaked in so much ambiguity that most people get a second chance.

With businesses, I am a little more tolerant. At a shopping center, being cheated once at a store will keep me away from that store permanently, and the same is true if any friend describes a similar experience, but I will go back to the shopping center. The second time it happens at the same shopping center will probably be my last visit to the shopping center. No institution, not even one so loosely bound together as a shopping center, gets three chances.

I have checked with friends and acquaintances and find that my behavior is only slightly more extreme than the norm. The implication, therefore, is that deception has a geometrically adverse quality. Only a very few deceptions will bring successively stronger consequences.

There is rarely any ambiguity about what deception in retail business is: Examples include the claim that certain items are in a shop when they are not; pricing or advertising that doesn't include the entire standard product (such as a computer without a keyboard or automobile without tires); and products that don't perform as described (which most commonly occurs when salespeople feel authorized to exaggerate).

The reason deception in business is possible at all is simple: The revenue from deception outweighs the cost. Deception occurs most commonly for businesses with transient customer populations, such as tourist traps, because the social mechanisms for warning potential customers are ineffective. The deceptions in those cases do not lead to a significant decline in new customers. Where the active enforcement of fraud laws is in effect, there would be added costs to deception. Such is not the case anywhere in the United States, as far as I know.

There appear to be three adverse results of retail deception: decreased revenue potential, increases in legal and associated costs, and ulceration. Decreased revenue potential is the effect of distrust on the part of customers and potential customers. This is relatively easy to measure, and we will do so in the next paragraph; the same is true for legal and associated costs. The third adverse result, ulceration, requires definition. An ulcer is the by-product of stomach acids burning the stomach. It is an act of physical self-destruction resulting from the overproduction of gastric acids. In business, when the owner or manager deceives customers, he or she invites imitation by suppliers, employees, and landlords, which can have a direct adverse effect on cost. The associated paranoia of deception also creates additional costs for increased surveillance, vigilance, and monitoring to avoid reciprocal treatment by associates. This is what I call ulceration.

The cost of lost revenue resulting from deception in business is readily calculable. You merely need to understand the term goodwill, as used in accounting. This is the value of a business that is not represented by the physical and financial assets owned by the company. It generally measures the degree of trust that the clients of a company invest in it. Actually, that definition is not far from accurate in describing the real world.

The accounting category of goodwill includes trade names that have a great deal of value in the market of business acquisitions. These include product and corporate names such as (the all-time winner for trust) Sony, as well as some of our domestic heroes such as Arm & Hammer, Ivory, and Hershey's. Some trade names have been sold for hundreds of millions of dollars in recent years. These names represent client trust.

Client trust can be used to measure its opposite, customer distrust, by comparing the goodwill value of the best company (in percentage of net worth) in the 30 largest categories of business, to the reported goodwill figures for the rest of the industry. The number is 20% of GNP. That means that if all companies in the United States were as trusted by their customers as the best company in each industry, the country would be 1.6 trillion dollars (1997 dollars) richer; this is the amount of the lost revenue cost of deceit.

The legal and associated costs of deception are also measurable. It includes all of the legal costs associated with business. It consists of the operating costs of law firms that deal with corporations; the corporations' internal lawyers; and the costs of the civil litigation, including the court system (which society pays for in taxes). You could argue that all corporate legal and civil costs are not directly the result of deception. This rebuttal evaporates, however, when the costs in the United States are compared to Japan and Sweden, where such cost are nil. Japan and Sweden are the countries with the least deception, thus they warrant this financial comparison. The legal and associated costs of deception in the United States, therefore, is 100 billion dollars. Combining these costs with lost revenue, the U.S. had a national deception cost so far of 1.7 trillion dollars in 1997 dollars.

Measuring the third factor, the ulceration cost, is not so easy because the definition first requires the establishment of some agreed-upon criteria. In a retail business, a deceptive owner would face increased staff and technical costs associated with (1) monitoring; (2) costs resulting from theft, embezzlement, and fraud perpetrated against him; (3) lost sleep and tranquilizer pills; and (4) battles with the IRS.

Since the "business" with deception problems that we are examining is in fact a society, the United States, it is necessary to demonstrate that we as a country are sufficiently deceptive in our business behavior to justify tabulating the ulceration cost for the country as a whole.

Our deceit toward our own business customers is most evident in advertising. By a recent personal count, one-fourth of all newspaper ads were deceptive, as were one-fifth of all television ads. Remember, lying is the intent to deceive, so the total number of cases is very large and commonly ignored. Daily examples include "Advil delivers twice the pain killer," which is a statement intended to deceive; so is "Amour light bologna is 98% fat free" and "You will lose 7 pounds in the first week and keep it off." These are all deceptive statements. We are so used to deceit that we hardly notice it. Fortunately, advertising surveys of audience views confirms that most of us know advertising has a very high component of deception.

One proof of this is that when Japanese or Swedes visit the United States, they often comment on the near-saturation level of deceit we are willing to tolerate in our daily lives. They also comment on the second most widespread form of deceit: product pricing. The most common pricing mechanism in the country is the "$9.95" tactic. The next most common is the quotation of prices without including the sales tax. Some stores in major U.S. cities that cater to Japanese and Swedes use neither of these deceits.

The question the reader must ask is whether these practices, which are clearly widespread and pervasive, constitute a major national practice of deceit. Are Americans dishonest? The answer is no. But the point of this article is that we are far from being a truly honest society, and that we tolerate a level of deceit that is significant, ulcerating, and costly.

How does the issue of crime and our prevailing dishonesty intersect? Crime is not the same as dishonesty, and a clear-cut comparison of crime in the United States to crime in countries with greater public honesty would not be considered fair, by most readers for two reasons. One is the heterogeneity of our society. Most people think our high crime rate is associated with the number of minorities in our country. Of course, they mean the number of blacks, since most other minorities have lower crime rates than whites. But rather than argue against such foolishness, we can resolve the problem by comparing crime in American cities that are mostly white, such as Minneapolis, to cities in other countries. Tokyo and Stockholm are examples. The other problem is that violent crimes, such as murder and armed robbery, cannot really be compared to dishonesty. Thus we must limit our discussion of crime to such white-collar crimes as embezzlement, fraud, shoplifting, bribery, corruption, and larceny.

Is it fair to take our white-collar crime rate, compare it to that in other nations and say that the excessof white-collar crime here is due to the pervasive dishonesty of the United States and that it reflects the ulceration of our economy? Yes. We have too high a tolerance for deception, and we pay for it in several ways.

A simple example will demonstrate this fact. In three cases reported in the press during the past five years, a Brinks truck lost cash in the street and all of the money was picked up by passersby and kept. What is so distressing about this to me? First, it wasn't their money, and so the acts were clearly dishonest. Secondly, in Japan, where data is kept on such events, and where this kind of event happens more often because of the greater use of currency, an average of 96 percent of all the money is voluntarily returned.

If the white-collar crime rate in the United States were the same as that in Sweden and Switzerland, we would have 94 percent less crime in this country. To get the dollar value. we need only know what a 94 percent reduction in law enforcement, corporate surveillance, and related insurance costs would be. The figure is 100 billion dollars in 1997dollars.

When we add our three figures for dishonesty together, we get 1.8 trillion dollars, which is 23 percent of our GNP. That means that every person of average income ($35,000 in 1997) earns $8,000 less per year than he or she would if this country had a higher standard of honesty.

How could we change this? By two simple acts: (1) The president should call for a regime of honesty: All prices for consumer goods are to be set in round numbers, with all taxes included; (2) Congress should pass an advertising-fraud act with real teeth, simple language, and an effective independent enforcement agency.

We can do it, and we should, now that we know the cost.


Michael Phillips, 1997 (revised 2000)


Home |Public Radio |Clear Glass Press |Resume |MP's Books |Articles |Misc |E-mail|