The Virtues of Free Markets?

(Hemera)

In our books, Dubner and I have argued that economic analysis (at least the way we try to do it) is neither moral nor immoral. We try to start with a question, obtain a set of facts, and then understand where those facts lead, trying not to be prejudiced one way or the other by moral considerations when coming to a conclusion.

Similarly, I’ve never really thought of markets as being moral or immoral.

Mark Zupan, the dean of the University of Rochester’s William E. Simon School of Business, thinks differently. In a recent piece, Zupan makes an argument that most people will find counterintuitive: he claims that free markets foster integrity and cooperation.  I’m not sure I fully agree with him, but the basic idea is sensible and straightforward. Markets lead to firms that survive for long periods of time. Reputations are important to firms, which leads them to behave in virtuous ways, not because they’re inherently moral, but because virtue is good for business in the long run.

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  1. Pierre-Louis says:

    he doesn’t seem to cite this study (http://www.voxeu.org/index.php?q=node/3906) which shows that competition does build trust… trust attitudes have to come from somewhere!

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  2. Peter Wung says:

    But, in our era, firms really don’t care about their reputation. So, how does that affect the integrity and cooperation of the market? That is an awfully powerful caveat.

    Hot debate. What do you think? Thumb up 17 Thumb down 19
    • Clifton Griffin says:

      What firm doesn’t care about its reputation?

      Companies pay millions to preserve their reputations and standing in the community.

      Well-loved. Like or Dislike: Thumb up 11 Thumb down 2
      • Joshua Northey says:

        Firms that lack repeat business, firms that relocate frequently, firms where a single windfall is the preponderance of the total revenue….just to pick out a few examples.

        The largest construction contractor in our metro is constantly under investigation by the state attorney general’s office for its sales practices and shoddy workmanship. It gets horrible horrible reviews. But its high pressure tactics work and it does very well, granted people pretty much never use them twice, but it will be 20 years before the overall stink surrounding them is enough to make them close up shop, and in the meantime there are suckers to fleece.

        Well-loved. Like or Dislike: Thumb up 18 Thumb down 5
      • Czeslaw says:

        Firms spend a great deal of money to change perceptions about their virtue, but they don’t necessarily aim to change their actual level of virtue.

        Well-loved. Like or Dislike: Thumb up 8 Thumb down 1
  3. Rob says:

    This topic always reminds me of a great essay by the late economist Paul Heyne. It’s one of many in his “Are Economists Basically Immoral.” http://bit.ly/ooEKKc

    Specifically it’s Chapter 3: Income and Ethics In the Market System. As his moral metaphor he refers to the traffic system.

    “Let me now try to summarize in one sentence the social system for moving traffic with which we are all familiar. It is a system in which individuals pursue their own interests on the basis of the situation they perceive, obeying a few clear and stable rules of the game.

    And let me follow that up with an equally brief definition of capitalism, or a free-market economy. It is also a social system in which individuals pursue their own interests on the basis of the situation they perceive, obeying a few clear and stable rules of the game.”

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  4. Nosybear says:

    That’s not too surprising when you consider the following: Businesses driven completely by greed are motivated to get the most out of a customer possible. These are not businesses people want to do business with. Talking to the (good) contractors who have done work on my home they all say the same thing: Their goal is to give the customer good service at a reasonable price regardless of what the market is doing. The contractors who did shoddy work during the housing boom made a living then but they’re out of business now. The good guys are still doing work. Greed may be the motivation behind profit and may drive some businesses but the good ones are driven by the desire to make money through providing a good service at a reasonable price, in other words, acting with integrity.

    Well-loved. Like or Dislike: Thumb up 12 Thumb down 3
    • Cook says:

      I think that has to do more with competition than virtue. “Good guys” are those who (can) provide good services at reasonable prices, and that’s why they stay in business while those who charge the same or a higher price for a shoddy work can’t compete with them.

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  5. Tom Lawson says:

    Hidden due to low comment rating. Click here to see.

    Disliked! Like or Dislike: Thumb up 9 Thumb down 19
  6. Seiya says:

    The assumption is that long-term success is the goal, and the incentives for long-term success outweigh the incentives for short-term success. This is not always the case.

    Well-loved. Like or Dislike: Thumb up 30 Thumb down 1
    • Clifton Griffin says:

      But companies that only think in the short term hardly matter in the long term. If your goal is to defraud and go down in flames, your effect on the market is unlikely to be great (though there will always be an Enron or two that slip in). If your goal is to be a flash in the pan, the market is more than willing to speed that along.

      In the traffic example, those companies are the drunk drivers or the infamous LA car chases. They are the exception, not the rule and their actions hardly offer a reputable critique of the system.

      P.S. The market hates anthropomorphic references to itself.

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      • Joshua Northey says:

        Clifton, individually they might not matter in the long term, but collectively they may be a significant drag on the overall outcomes. People only live so long, and they might care a bit about their kids and grandkids, but generally not as much as they care about themselves.

        Sure if they were all hyper rational we could just turn everything over to the market, but have you spoken to an average schmoe?

        Well-loved. Like or Dislike: Thumb up 8 Thumb down 2
      • Clifton Griffin says:

        The average schmoe does not start a business…he works for one.

        It’s my assertion that selfishness leads to rational behavior. The rational actor is not mythical…he is acting rationally precisely because he is pursuing his own goals. While there may be a few out there who only want to quickly profit and then ditch and run, they are by far the exception.

        The type of person who starts a company is usually the type of person who takes personal pride in the success of that company. They enjoy the prestige, the acclaim, the feeling that they are in charge of something big. They usually have more ideas than a fat bank account. They work too many hours and try too hard all for selfish reasons. (I have never met a business owner that didn’t fall into this category in some fashion.)

        It’s all selfish and it all leads to rational behavior and millions of those decisions conspire to create wealthy, prosperous societies.

        I am not arguing for anarchy. I am arguing that many of the problems we try to legislate out of the system, are best handled in the system. The laws should be directed at exceptional occurrences.

        I’m also arguing that virtuous behavior stems from selfish rationality. I agree with the author of the study.

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      • Joshua Northey says:

        “The average schmoe does not start a business…he works for one.”

        But the business owners rationality will only lead to acceptable outcomes if his customers are also rational. You need the counter-parties to be rational as well, otherwise the whole system breaks down. Otherwise it will just devolve into a slave economy where the relatively rational prey on everyone else.

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      • Clifton Griffin says:

        That is a valid point, but I didn’t think that’s what we’re talking about.

        We were talking about whether virtue is only a byproduct of a business with long-term goals, and conversely not a byproduct of businesses with short-term only goals.

        I conceded that short-term goals do not necessarily lead to the same type of positive behaviors that long-term ones do. But my assumption is that these businesses also thrive by taking advantage of people. They don’t market themselves as evil, they just act in an evil fashion. They get lots of money quickly and then the revenue dries up from lack of returning customers.

        So, customers may not always be rational (or better described: may not always have enough information to act rationally), but they usually know when they are getting a good deal and they are unlikely to repeatedly patronize a company that is defrauding them.

        Unless of course they do, in which case there is probably no help for them. ;) (and they are probably an edge case)

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  7. Josh says:

    “virtue is good for business in the long run”

    I agree with this… unfortunately acting immorally is often good for business in the short term.

    This is a problem because humans are prone to act with short term interests in mind, rather than the long term, far more often than the imaginary “rational” actor assumed by traditional economists.

    The result is lots of people running around acting immorally in business.

    Markets foster integrity in the imaginary rational land of college economics class.

    In the real world we need cleverly designed regulations to counterbalance human behavioral/psychological tendencies if we hope to achieve this ideal.

    Well-loved. Like or Dislike: Thumb up 18 Thumb down 4
    • Clifton Griffin says:

      Cleverly designed regulations to create incentives may be useful at times, but I would argue they more often have unintended consequences.

      It’s stage one versus stage two thinking. I highly recommend Thomas Sowell’s “Applied Economics”.

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  8. michael says:

    Of course free markets foster integrity and cooperation! How else can you get complete strangers, of different nationalities and ethnic backgrounds, to interact voluntarily and in relative harmony. I am reminded of Milton Friedman’s example of how many people from all over the world it takes to make something as simple as a pencil.

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