The Canadian Paradox
Some places in the world are what they call “low-trust societies.” The political institutions are fragile and corrupt, business practices are dodgy, debts are rarely repaid, and people, rightly, fear being ripped off on any transaction. In the “high-trust societies,” conversely, businesses are honest, laws are fair and consistently enforced, and the majority of people can go about their day in the knowledge that the overall level of integrity in economic life is very high. With that in mind, given what we know about the following two countries, why is it that the Canadian financial sector is so fraud-ridden that Joe Queenan, writing in Forbes magazine in 1985, nicknamed Vancouver the “Scam Capital of the World,” while shipowners in Greece will regularly do multimillion-dollar deals on a handshake?
We might call this the “Canadian Paradox.” There are different kinds of dishonesty in the world. The most profitable kind is commercial fraud, and commercial fraud is parasitical on the overall health of the business sector on which it preys. It is much more difficult to be a fraudster in a society in which people do business only with relatives or where commerce is based on family networks going back for centuries. It is much easier to carry out a securities fraud in a market where dishonesty is the rare exception rather than the everyday rule.
The existence of the Canadian Paradox suggests that there is a specifically economic dimension to a certain kind of crime of dishonesty. Trust—particularly between complete strangers, with no interactions besides relatively anonymous market transactions—is the basis of the modern industrial economy. And the story of the development of the modern economy is in large part the story of the invention and improvement of technologies and institutions for managing that trust. In other words, many things about the way the business world is organized make a lot more sense when you realize that they exist because of the constant drive for countries to become less like Greece and more like Canada.
And as industrial society develops, it becomes easier to be a victim. In The Wealth of Nations, Adam Smith described how prosperity derived from the division of labor—the eighteen distinct operations that went into the manufacture of a pin, for example. While this was going on, the modern world also saw a growing division of trust. In previous eras, when people set out across continents to discover new worlds, they had known that they were stepping out into the unknown, but Mr. Gauger was at the cutting edge of a new reality. Already, he belonged to a class of people whose natural assumption was to take things on trust, to assume that the fact that an offer was extended publicly meant that it was probably legitimate. Nearly two hundred years later, his equivalents in the ICO craze were no more likely to expend personal effort on checking things for fraud than to throw their own pots and sew their own trousers. The more a society benefits from the division of labor in checking up on things, the further you can go into a financial fever swamp before you realize that you’re in one.
The Economic Geography of Fraud
Check kiting is a characteristically American crime, but other countries have their own national dishes too. There is a form of fraud, for example, whereby you invent a fictitious asset that has something wrong with it—say, a large bank deposit that is the subject of a freezing order, or a quantity of gold bars that need to have taxes paid on them in order to establish ownership. You then approach your victim with a story about the asset and its problems, and offer to split the ownership of the asset with them if they contribute toward the cost of solving the problem. These days, this is ubiquitously known as the “Nigerian advance-fee fraud,” the geographical epithet being attached to what used to be called a plain old advance-fee fraud because the criminal classes of Nigeria adopted it so enthusiastically from the 1980s onward.
As far as anyone can tell, the key technological development was the discovery by Nigerian crooks that they could forge stamps reasonably easily, allowing them to send messages internationally to potential victims. Nigeria was an environment with an inflationary economy, a series of famously kleptocratic governments, and with an oil industry that contributed a class of educated English speakers who had a familiarity with doing business overseas. Given that, it seems natural that the kind of fraud that would emerge would be one that echoed the scams of the colonial past (fake tax collectors were rife in the 1910s) and that looked outward to generate hard-currency proceeds, trading off the international image of Nigeria as a land of corruption and hydrocarbon wealth.
There are not so many frauds that have become so locally famous as to be eponyms, but it is a general proposition that, because frauds have to be built around the institutions of the overall economy, they have an economic geography to them. Canada has securities fraud and mining fraud, because it’s a high-trust economy with a prospector tradition and extremely inefficient and fragmented securities regulation. The last of these is a result of Canada’s federal structure—securities law is mainly a provincial responsibility (although the Royal Canadian Mounted Police do have a role in enforcing it, presumably dismounting in order to do so). This means that Canada has half a dozen independent securities commissions, only one of which has a large and internationally recognized financial center to supervise (Ontario, with the Toronto Stock Exchange). Things have slowly gotten better over time in terms of cooperation among the regional exchanges, the Ontario Securities Commission, and the RCMP, but international scammers have continued to take advantage, most recently by using dormant Canadian shell companies in “reverse takeovers” so that fraudulent Chinese companies could make use of their stock market listings.
Even these national particularities, though, can be seen as the result of universal underlying principles of equilibrium. The reason for the variety of different national experiences, and for the existence of the Canadian Paradox, is that there are multiple forces at work, and so there is a multiplicity of possible equilibrium states. We could say that, in general, the effort expended on preventing fraud should be in equilibrium when the marginal cost of checking is equal to the marginal saving from avoiding fraudulent transactions. But checking is not the only way of preventing fraud; you can also reduce your exposure to the risk of being taken advantage of by simply reducing the amount of business you do, particularly the amount of business with people who are not part of your close social network. Trust is one social technology that can be used instead of checking, but “mistrust” is an alternative solution, and one that can be rational if the perceived risk of fraud is very high. And we should also observe that the underlying incidence of fraud is not the same thing as the popular perception of its risk, which is likely to be at least partly a result of culture and history.
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