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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COMMENTS: 61


  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.

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    • 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”.

      Thumb up 7 Thumb down 11
  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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  9. Josh says:

    Is this really a new perspective? It seems like a description of a microcosm of Smith’s Invisible Hand to me: Markets allow people and entities with primarily selfish ambitions to ultimately benefit the greater good through competition.

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  10. SomeCallMeTim says:

    As a graduate of the University of Rochester with Economics and Political Science degrees, I respectfully have to call *bullshit* on Dean Zupan’s theory. This is based on recent observations.

    – BP has been around for a long, long time, and will most likely be around for much longer. However, they have a history of failure when considering safety and environmental issues. They’ve failed to keep the Alaskan Pipeline maintained, which cause tremendous environmental damage due to oil spills. Their failure with the Deepwater Horizon not only caused massive environmental damage, but also killed 11 people.
    – The major banking and insurance firms failed the “integrity” test with their derivatives and mortgage securitization activities. Some of the companies did ultimately fail, but most are still in business, with the whole 2007-2009 fiasco just a dip on their income statements.

    The theory may hold water at the local level – a deli that fails to treat the neighborhood properly may not survive, but once a company hits a certain size the theory fails. After all, “integrity” and “cooperation” are not words I think of when I think of Exxon, BP, CitiCorp, Haliburton, etc. (well, “cooperation” does come into play when considering collusion, but that kind of cooperation is hardly ethical).

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    • RogerP says:

      Perhaps I’ve missed something obvious, living outside the First World, but surely those institutions that were up to they eyeballs in the 2007-2009 fiasco would have gone to the wall if the free market held sway.

      My simple understanding is that the governments in those countries took over the toxic debt that would have sunk those institutions and passed it on to the citizens in the form of spending cuts. The alternative would have been a collapse of the banking system, in which case it would be the morals of political establishment that allowed the institutions to survive, not the morals of the free market.

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    • ChrisB says:

      I don’t think Zupan’s theory is negated by your example of BP and large banks because you have to remember that a large company that has existed over a long period of time has had many leaders at the helm and those CEOs and corporate executives have each had a different view of how to best guide their company. The tenures of those leaders may have started out brilliantly but their decisions along the way became self-certained, corrupted, or just plain stupid. Contrast that with a small biz owned by a single proprietor: it can also suffer from bad leadership and eventual ruin, but its existence will be much shorter.

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  11. rationalrevolution says:

    No, the basic idea isn’t sensible. Why is economics still so filled with obvious hacks and dominated by evidence-less thought experiments? Why are “thought experiments” that have been disprove by facts hundreds of times still given any consideration at all in the field of economics? This isn’t true is pretty much any other field. Well we know why, because people stand to profit from this misinformation is why, but good lord, why do so many people keep falling for it?

    First of all, what is a “free market”? Is it an “unregulated market”? Unregulated by whom? Define regulation. Is a market that isn’t regulated by any government authority, but is dominated by a monopoly “regulated”? What about trade groups, what about the mafia?

    In a market with no “regulation” what prevents “manipulation”? Again, trade groups, mafia, monopoly, oligopoly, etc.?

    Now lets get to some examples, examples of market obfuscation. Let’s talk about natural gas extraction companies.

    Now, given that consumers never purchase natural gas from natural gas extraction companies, there is no market mechanism by which the actions of natural gas extraction companies can be impacted by consumers. Natural gas is extracted by a combination of small to large extraction companies, who then sell the gas to middle-men, who then sell the gas to energy suppliers, from whom the consumers buy it. The interests of the various middle-men may have nothing in common with the consumers.

    The actions of the natural gas companies have no discernible impact on the consumers. If they engage in practices in another state that taint the drinking water of people, then buy off the local officials to prevent action and buy off the news to keep them from reporting on it, how would consumers even be aware of this? Why should their buyers (the middle-men) even care?

    Furthermore, if people in one state are buying gas that’s extracted in other state, and the ill effects of the extraction process don’t effect them, instead they just effect the people of the other state, even if they were aware of it, why should they, acting in rational self-interest, even care? Indeed they could prefer such gas because it would reduce production of pollution in their own state.

    What “free markets” do in practice is they create layers of obfuscation, which we can plainly see right in front of us. We buy goods made in China and Vietnam under conditions we would never allow our own children to be subject to and would never tolerate if the same practices were employed here and we as consumers watched the processes taking place in front of us.

    Look at our industrial farming system. If consumers had to watch the treatment of the animals and harvesting of food from end to end at the point of purchase there is no doubt that people’s purchasing decisions would be much different than they are today. The producers intentionally obfuscate and hide their practices from the consumers. The result is not that integrity is rewarded, but rather that deception is rewarded.

    Furthermore, there is a clear contradiction between the short-term and the long-term, because in order to survive for the long-term you first have to survive the short-term. If you don’t survive in the short-term you never make it to the long-term.

    The 2008 mortgage crisis is a clear real-world example of this. There were many loan originators who KNEW, KNEW, KNEW that what they were doing was wrong, who didn’t want to write these loans and knew that they would invariably blow up down the road. They had a very clear understanding of the problem, but guess what, they couldn’t do anything about it, because of the “dictatorship of the market”.

    The dictatorship of the market is a situation where if you don’t go along with the market you lose or go out of business, etc. It’s when you know the market is wrong, but you have no choice but to follow.

    You see, if the originators didn’t take on these bad loans during the peak of the bubble they would have lost all their business at that time and gone out of business, because everyone WANTED the bad loans! So if the originators were responsible and honest what would have happened is they would have lost all their business in 2005-2007 because the lenders would have stopped using them and gone to other originators that were giving them what they wanted, which was far more business, indeed this is the real experience of originators. So the “bad” originators created a situation where you had to follow their practices in the short-run in order to survive. The long-run wasn’t even a part of the picture. You would have gone bankrupt trying to plan for the long-run in the “free market”. Runs and bubbles and short-term schemes driven by bad information and intentionally dishonest actors can dominate the short-run, thereby making the long-run irrelevant.

    The point is this, long-term benefits don’t matter if there are no short-run benefits, or if there are short-run forces that trump the long-run benefits. This is why markets fail, over and over and over and over and over and over again, and idiots like Zupan keep spouting total f*ing bs and more idiots keep buying it…

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    • Joshua Northey says:

      Excellent post. I just don’t understand how these people who understand mathematical models so well don’t understand:

      1) How wild the oscillations in them can be and how this makes them completely inapplicable to the real world. If your free market paradise ends up at value 10 on the hedon scale but on the way there passes through point -7, there is no recognition that at point -7 there will be revolution and civil war and the rules of the game will change, ensuring you never get to value 10.

      2) People are really really really really really really really short sighted and irrational. They did not psychologically evolve for this environment. It is ridiculous what a poor model of human behavior is plugged into most of these models predicting sanguine outcomes to little math games. People cannot even make effective decisions about simple questions like whether to buy this TV now or 6 months from now, much less the much more complicated decisions they encounter on a day to day basis. When most college graduates cannot answer the Monty Hall problem correctly you know you still have a long way to go before you can turn governance over to a trust in people’s rationality.

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    • Clancy says:

      Absolutely right.
      Also, what this paper and almost all thought experiments about “free markets” fail to deal with are information asymmetry (marketing, PR, advertising, etc.) and externalities. The free market (in its purest form) has no method to prevent negative externalities or encourage positive ones. Drillers who sell their gas to energy companies have no market incentive to avoid a reputation as polluters.
      Most importantly though, what firms need to maintain in the paper is not morality per se, but the reputation or image of morality. If a company has an image problem, the executives will sit down and run the numbers and decide which is more cost effective: A companywide restructuring and purging of “immoral” employees and executives and a program to change the corporate culture to become a truly “moral” company? Or a massive PR campaign with lots of images of smiling, diverse working-class folks with puppies in undulating wheat fields, etc. which will be more effective?

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    • Clifton Griffin says:

      Your examples are not necessarily representative of the average transaction in the market place.

      Natural gas drillers deal in commodities. Commodity markets have many suppliers with essentially identical goods at set prices. And, in that sense, you’re right, they are pretty immune to the consumer.

      But, no one is really arguing for anarchy here. They are discussing whether the basic forces at work in a free market lead to virtuous behavior by most participants. It isn’t that there are no examples of evil, just that the incentives push the other way. You can’t anecdotally unseat that assertion.

      Your second examples deals with the intra-bank transactions: the buying and selling of mortgages as a product. This is also a good example of a market that is somewhat removed from the consumer, but it is not unlike a commodity market in that sense. Almost no one cares what happens to their loan after they get the desired principal at the desired rate.

      Your description of immoral practices of bundling and selling toxic loans is historically accurate, except you do not account for why those loans were even in in the system: the Community Reinvestment Act.

      This law requires lenders to make loans to low income applicants in minority communities. The effect of this is that lenders are forced to provide loans that do not make economic sense in order to make loans at all. They are forced to make the percentages come out right, or they are essentially unable to continue lending to more economically qualified applicants.

      This artificial market pressure created this stream of toxic loans. And each lender acted rationally (if immorally) in selling them up stream. They knew if they could get them far enough away from their own balance sheets, the half-government, half-private Fannie/Freddie conglomerates (another great government idea) would absorb the real cost.

      This also created incentives for speculation on those loans. Ad naseum.

      The point is, you can’t use the actions of actors an artificial economy with high amounts of government intervention as an example of why free markets don’t work. In the free market, those loans would have never been approved in the first place.

      I know I will get voted down for this post and the view point it represents, but I offer it anyway. I enjoy these discussions.

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      • rationalrevolution says:

        No, the CRA was not the CAUSE of the housing market bubble, that has been disproven many times over. Not to mention that the CRA went into effect in 1977, why did it take until 2003ish for it to have the effect? Anyway its not even worth getting into that.

        I’ll make this much more fundamental.

        Market theory states that in a “perfect market” profits would be zero. A perfect market is a market in which all participants are completely rational and have total knowledge of every aspect of the market, and there are no barriers to entry, with no individual having the ability to set prices.

        Under such conditions competition would drive profits to zero, and it is by this principle that market theory, especially as advocated by Adam Smith, is used to argue that “free markets” operate for the public good, because profits are deemed a product of inefficiency and a rent on the system. In a “free market” competition is supposed to drive profits down, toward zero, and the driving down of profits is the public good that is the supposed product of markets.

        But the participants in the market don’t WANT profits to be zero, indeed their objective is to MAXIMIZE profits, to levy the biggest rents on the system they possibly can.

        The theory is that competition prevents this from happening.

        But, the participants in the market are incentivized exactly to undermine market principles. They are incentivized to restrict or misrepresent information, to encourage irrational decision making, erect barriers to entry, and try to fix prices.

        That’s exactly what every market participant is incentivized to do in order to maximize their own self-interest, in other words, every individual participant has the incentive to undermine the system in order to maximizes profits.

        Can anyone look at the real world can honestly claim that that isn’t how market participants act? Marketing is nothing but a clear attempt to encourage irrational behavior. Market participants don’t want people to make rational buying decisions, exactly the opposite, and every school of marketing plainly says so.

        Market participants don’t share information, indeed the opposite. A huge portion of our economy is dedicated to hiding information and keeping it proprietary. John Paulson didn’t come out in 2006 and 2007 and say, “Hey guys, this housing market is going to crash, I’ve seen the books of the banks, this is a bubble, we need to let ease this down.” No, he secretly collected as much information as he could, held it close to his chest and cheered the bubble on waiting for it all to come crashing down so he could GET (not make) a killing.

        Every business model out there is built on trying to create barriers to entry for possible competition. Heck, that’s what patents are, its enforced right into our legal system. As a business you want to block competition. Why? So you can maximize profits.

        Now, here is the thing that makes the whole concept of “free markets” an oxymoron: In an “unregulated market” (which is what most people call a “free market”) the focus of all market participants will be working to undermine the markets, because that is how you maximize profits. That’s why we’ve long had regulated markets, to prevent people from undermining market principles.

        This is why “free markets” are an oxymoron, because in a “free” (unregulated) market, the market participants will undermine market principles.

        And if you want another example of an unregulated market, the biggest unregulated market in the world is the illegal drug market. Would you say that participants in the illegal drug market display the qualities espoused by Zupan? Heck no, all kinds of cutting and bad drugs, etc. are involved. According to Zupan’s logic, we should expect illicit drugs to be of higher quality than the regulated pharmaceutical drugs that are governing by the FDA and numerous other bodies.

        So you tell me, if you go to the street and buy cocaine or ecstasy and I go to Walgreen’s and buy aspirin or Vicodin, which one do you think will test out to be more pure?

        If Zupan’s reasoning is sound, the illicit drug market should be of superior integrity to the regulated pharmaceutical market.

        I’d argue that neither market fosters integrity, but that the regulated pharmaceutical market fosters more integrity than the unregulated illicit drug market. My view is that in a world of “unregulated markets” all the world would resemble the drug trade.

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      • Joshua Northey says:

        This is exactly the heart of the matter:

        “But, the participants in the market are incentivized exactly to undermine market principles. They are incentivized to restrict or misrepresent information, to encourage irrational decision making, erect barriers to entry, and try to fix prices.

        That’s exactly what every market participant is incentivized to do in order to maximize their own self-interest, in other words, every individual participant has the incentive to undermine the system in order to maximizes profits.”

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      • Dave Johnson says:

        The CRA did not “require lenders to make loans to low income applicants in minority communities.”

        Banks were encouraged to make loans in the communities where they are chartered — consistent with safe and sound operation.

        Race had nothing to do with it, and this story being spread about forcing banks to make loans to minorities should tell us all who is circulating this story and why. And the racial aspect of this story tells us a lot about the people who repeat it.

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    • ThatMattGuy says:

      “You see, if the originators didn’t take on these bad loans during the peak of the bubble they would have lost all their business at that time and gone out of business, because everyone WANTED the bad loans! So if the originators were responsible and honest what would have happened is they would have lost all their business in 2005-2007…”

      Ummm…does that mean that BB&T went out of business without anyone knowing? And as to people not caring who’s hurt by the acquisition of the products they buy, you must have not heard of the Fair Trade movement. Or the Wal-Mart/Nike/Kathie Lee Gifford sweatshop stories that were all over the news a few years back. Do people still care? Nope. They continued to buy the products after the start of the next news cycle. Don’t blame what you see (for whatever reason) as a free market for all of these things, blame the average American. Corporations aren’t your enemy, the family sitting around their fiberboard dining table watching a sitcom who “don’t have time” to watch anything approaching actual news that doesn’t reinforce their beliefs are.

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  12. Jaime says:

    I would need some serious convincing to believe the premise that Markets lead to firms that survive for lon periods of time. I believe that is a fallacy and without it the moral argument crumbles.

    But maybe I’m just cynical from having met too many people make it rich by shorting a firm’s assets.

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  13. BL1Y says:

    When you put a letter in the mail, do you trust the post office to get it to its intended destination? Of course (and if not, why are you putting it in the mail?). But, the post office doesn’t operate in the free market. There are other parcel services, but no one else does door-to-door letter carrying.

    Even authoritarian regimes are concerned with reputation. As reputation in certain areas (security, economic competence, criminal justice) declines, the chance of revolution increases.

    There are also plenty of examples of regulations increasing trust. Disclosures filed with the SEC help increase trust in companies and the stock market at large; the FDA and USDA save you the time and effort of interviewing the manager of your grocery store to make sure the food is safe.

    Zupan’s article reads more like an advocacy piece than a serious look at how different market structures affect honesty and integrity. The free market really has little to do with it. What matters is information disclosures and the the ability to punish bad actors.

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    • Clifton Griffin says:

      The post office is absolutely subject to the forces of the free market.

      If their reputation became so poor that people no longer trusted them to deliver mail, they would absolutely feel the pain in one way or another. They would not be able to sustain ineffectiveness without consequences (political and market). Their virtuous behavior is absolutely a product of market forces.

      The real crime concerning the post office is that tax dollars allow them to operate with inefficiencies and a price scheme that is economically impossible. They are able to get billions from congress to shore up their yearly losses.

      People essentially pay less than the actual cost required to deliver their mail. Who wouldn’t use a service like that?

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      • BL1Y says:

        The chance that you will feel consequences for poor performance does not mean that you are in a “free market.”

        If a nation institutes a draft,t hey have to work on making sure that the war is seen as just and necessary by the public, and that the strategy is sound so that lives are not merely being thrown away. Poor administration of a war will increase draft dodgers. That doesn’t make the draft a “free market.”

        Slave owners who are particularly cruel to their slaves, giving them little food, working them extremely hard, and administering savage beatings, will run an increased risk of having their slaves run away, facing a slave rebellion, or having non-slave owners abolish slavery. Doesn’t make slavery a “free market.”

        Community dictatorships always run the risk that too much oppression and economic mismanagement will result in a revolution. Doesn’t make communism a “free market.”

        Or, maybe all these things are a “free market,” in which case everything is a free market, and Zupan’s claim is meaningless.

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  14. Joshua says:

    And so, the invisible hand of self interest causes them to act in a way which benefits society.

    http://books.google.com/books?id=rBiqT86BGQEC&lpg=PA1&dq=editions%3AGWLRkDvoXOwC&pg=PA264#v=onepage&q=invisible%20hand&f=false

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  15. Dave says:

    I think reputation is only a force in a relatively small market. In national or global markets there are enough customers who either don’t know or don’t care about a firms bad reputation so it doesn’t make any difference.

    Then there are cases where all the available providers have a bad reputation. For example, I can only get internet access from Comcast or AT&T, both of which I despise. Of course, that’s not really a free market as competition is limited by the government.

    Someone mentioned BP and I think they’re an example of the global economy being so big and so convoluted that you end up supporting them indirectly without even knowing it so they’re bad reputation doesn’t matter.

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  16. nobody.really says:

    How do market forces shape people’s empathy for others? Consider how the Ultimatum Game is played in various countries.

    Briefly, the Ultimatum Game studies people’s demand for egalitarianism. You are told that someone has received a windfall of $X on the condition that he shares a portion with you. You have the option of accepting the amount offered to you (in which case you get the money offered) or rejecting it (in which case you both get nothing). Classical economics suggests that you’d take whatever is offered to you; after all, it’s free money! But research indicates that Americans are prone to reject offers that are less than 45% of the windfall amount. One interpretation of this result is that people are willing to pay money for the privilege of punishing those who offend our sense of egalitarianism.

    Ok, that’s fine for Americans. But can we generalize to people in other cultures? Some research (can’t find the cites right now) indicate the people who live in market economies also have this same demand for egalitarian treatment, but people who live in smaller, tribal hunter/gatherer communities don’t. One interpretation of these results is that the Ultimatum Game is influenced by the amount of experience you have serving – and relying on service from – strangers. People in tribal communities may not have as much experience with strangers. Loyalty to the tribe is the primary virtue. To extend egalitarian treatment to a stranger means to retain fewer resources for your own clan.

    In short, traditional societies tend to encourage a “love thy family” philosophy; market economies tend to encourage a “love thy neighbor” philosophy.

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  17. Deron says:

    Let’s say there’s a bank that owns a couple of skyscrapers in San Francisco. Some of my analysts take a look at the properties and figure that the property is under water. What’s the virtuous thing to do? Keep paying on it, or give the bank to the creditors?

    From the stand point of the owners of a very big bank, the virtuous thing to do is to give the bank away. From the standpoint of the creditors the virtuous thing to do would be to continue making payments. From the standpoint of the broader society it might be that the decision that causes the least market disruption would be the right one.

    In any case, should the move be considered non-virtuous some funding to the arts or health sciences should make everyone feel better.

    I submit that a small business or a household would not be considered virtuous in any circumstance. Default is bad. Continuing to pay is just deserts for foolish decisions.

    On a micro-scale markets the power of reputation is a hangman’s whip, and “sorry” won’t suffice. On a very large scale reputation can be nodded to, apologies accepted, and donations heal all wounds.

    Markets are basically amoral, but they do exhibit certain human traits. Only the sick will ever get behind the murder of a shopkeeper because he’s the wrong ethnicity, but kill large groups of that ethnicity and whole societies will fall in line. Scale matters, when issues hit a certain scale morality becomes very flexible.

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  18. Joshua Northey says:

    Free markets may *generally* foster integrity and cooperation. I would need some pretty strong arguments to believe that is the case absent a lot of assumptions about agents having access to information and not simply relocating to greener pastures once the shit all over the place they are currently eating. In any case, you need to be very aware of and ready to intervene in the situations where the market does not cause good outcomes, because in some of those places the outcomes can be catastrophic or reach unacceptable local minima while equalizing.

    A free market policy that briefly passes through a minima of thermonuclear war on its way to some higher maxima of good fortune is not one we probably want to unleash.

    If we completely “freed” the economy 25% of the population would consume/borrow itself into indentured servitude/slavery within a few generations. Surely we don’t want that?

    Markets are a powerful amazing thing, but they cannot just “be free” they need constant monitoring, safeguards, and intervention.

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  19. Ed B says:

    There are two primary issues I see. For one, firms do not make decisions, individuals do. The individual incentive for a large bonus check does not necessarily line up with the firm’s incentive to keep a good reputation. So, as need in thousands of instances in the last several years, individual desire’s trump the “desires” of the firm. Firms can disappear, but deposited bonus checks don’t.

    Also, we seem to be stuck in the Adam Smith days when we think about the virtues of the market. We act like BP, Goldman Sachs, and GM are the baker, the cobbler, and the candle-stick maker from Smith’s example who live within blocks of each other and are mutual dependent for a healthy economy. This is obviously not true. Global firms are so far removed from being dependent on any individual customer or even any individual country that the incentives to be a good actor are simply not there anymore.

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  20. Kevin says:

    But a more basic force in the markets is creative destruction, which requires firms to regularly be shut down. If competition is very intense in a given industry, then there’s no reason to expect firms to live long enough to exhibit these virtues.

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  21. Gary says:

    Any transaction bears several costs besides the price of the item being traded. One of those costs is for “insurance” on the likelihood of being cheated. Both buyers and sellers bear this cost in terms of prolonged negotiations, enticements, skepticism, etc. Businesses that can optimize the trust of their customers that their products are well-made, reliable, and perform as advertised will reduce the cost of that insurance. Trustworthiness is a moral quality so free-markets that provide information about it (through word-of-mouth, consumer reports, customer reviews, etc.) certainly are more moral than controlled markets where customers are kept in the dark (a case of lying by omission, as it were).

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  22. AaronS says:

    I used to think, like millions of Americans, that capitalism was on the side of good and truth…while communism was of the devil himself.

    I was wrong.

    First, to have integrity because you HAVE TO (in order to remain in business) is not a moral virtue at all. That is, if I am an honest dealer only because I know you won’t come back otherwise, or because I know I’ll go to jail, that is not really what we mean be “honesty,” is it?

    I’m sure that many, maybe even most, capitalists are honest because they are virtuous. But when you get to corporation-size, that personal virtue becomes a drop in a wider ocean of profit-maximization, harsh competition, etc.

    What capitalism does have over the other economic systems is a much better PR campaign. Why, you’d think God Himself invented it, what with all this talk of freedom, individual liberty, personal excellence, drive, motivation, hard-work, and the such.

    But then along comes socialism and communism, both built on the foundational premise that no one should get left behind, that those who do the work should not be overlooked. “Thou shalt not muzzle the ox that treads the corn,” the Bible says. Hmmmm, that seems to have a moral flavor.

    Very simply, TO ME, the morality of an economic system is not how high it can allow someone to go…but how it deals with those at the bottom. Raw capitalism (something we do no have in full force in America) lets the church and do-gooders take care of the poor. Raw capitalism is a machine that eats up men and children, then spits them out to get more.

    Just today I was reading that many companies avoid hiring people that have been out of work. They do not take into account that the economy wrecked the lives of millions. But that’s capitalism for you.

    Of course, in their IDEAL states, all of these economic philosophies work perfectly. But in the real world, I have to believe that it is SOCIALISM that combines the best of capitalism and the best of communism (by the way, the early Church practiced communism–read about it in the Book of Acts–the sold what they had and held all things in common).

    Communism sought to end the oppression of workers by capitalists. In Russia, Lenin put his own brand on communism by coupling what was supposed to have been an organic worker’s revolt with arms, violence, and organization. In America, we were able to take the wind out of the sails of rightfully angry workers by offering “concessions” such as unions, the minimum wage, overtime, age limits, benefits, and the such–in other words, a move in the direction of socialism.

    With our economic circumstances, we see that capitalism has the moral standing of a dog in heat. The financial players cared only about money. Not about the welfare of our nation. Not about the welfare of their workers (they give them benefits ONLY because if they didn’t, the workers could go elsewhere to get them). MONEY. PROFIT.

    Maybe Jesus was making a telling point when he said that it was easier for a camel to go through the eye of a needle than for a rich man to enter into the Kingdom of Heaven? Maybe He recognized that moral shortcuts that many of our most powerful and wealthy men have taken to be powerful and wealthy.

    I don’t know where the right balance is, but I know that it’s NOT raw capitalism nor the almost necessary totalitarian state for communist nations. Somewhere in the middle there is freedom, room for creativity, advancement, and profit, yet also a solid standard of living for the poor.

    While other nations use guns and force to keep the masses in their places, we use the more genial persuasion of the media. We must never forget that just beneath the surface of this great nation that we all deeply love, we have done dark deeds. We have enslaved others. We have stolen Indian nations, putting them on reservations. We have played just as dirty as anyone else…we’re just better at getting away with it.

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  23. thebok says:

    Seriously, free market? There is no such thing. Until you can show a society wherein private enterprise paid for, built, and maintained the infrastructure necessary to have a society, the words ‘free market’ have a zero basis in reality. That is just the beginning; never mind all the government policies that affect businesses. The government plays the key role in markets through its laws and policies. For example, pollution was routinely dumped into our air, land, and water until- and only until- the government was prodded to regulate. The government did not really want to affect its best buddy, business, but when our water began to catch fire, and we couldn’t breathe, and Love Canal came along, well, even government decided to correct the immorality.

    And we won’t even talk about sweatshops, child labor, discrimination, etc., etc…. Markets can be moral- thanks for the laugh.

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  24. Paul Clapham says:

    That article seems to be mainly concerned with the relationships between buyers and sellers (as is fairly normal for articles written by economists). It doesn’t deal with externalities (as is fairly normal for articles written by economists).

    Consider the News of the World. They produced a product and acted fairly with respect to the people who bought that product. This was all totally fair and trustworthy and everybody was happy with the situation. None of the buyers and the sellers of the News of the World were cheated, and there was a free market in newspapers so nobody was coerced into buying it or not buying it.

    So yeah. Everybody behaved in virtuous ways and business was great.

    But the people producing the News of the World were engaging in all kinds of bad conduct to do that. It appears that many people consider the actions which have recently been reported to be “immoral”. Not to mention that the police seem to consider them “illegal”. Can we then say that this free market in newspapers is immoral?

    I guess we can say what we like, but the article referred to here doesn’t have anything to say about that. Which is unfortunate, because that’s the interesting part of the question.

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  25. Lars Marius Garshol says:

    > Reputations are important to firms

    This assumes that the people running firms (C*Os) are (a) rational and (b) have equally long-running incentives. It also assumes that markets are (a) rational and (b) well-informed about firms.

    None of these four assumptions seem very likely to me.

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  26. Neil Lovatt says:

    Surely the basic flaw in the assumption is that firms themselves are rational actors, they’re not they are psychotic.

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  27. Jason says:

    The biggest problem with this is that “firms” don’t take actions, people do. If a person can take an action that will improve their status in the firm, but won’t come to light until they are working somewhere else, then they have strong incentives to do it.

    The people who inherit the mess then have strong incentives to cover it up, which makes things even worse.

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  28. Ulysses says:

    Eric Schmidt responded in an interview to the question “why should we trust you with all our data?” He replied with something along the lines of, if Google were deceitful and immoral in their actions they would quickly fall out of favor with their customers. Sounds pretty basic and simple but it tends to hold up. If they would compromise our privacy and piss everyone off in some hypothetical way, we would stop doing business with them and they wouldn’t be able to continue working on the innovations they like to do, all for a short term gain in whatever those evil pursuits may be.

    Plus, PR departments exist.

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  29. Peter says:

    Enron, BP, GE (PCBs in the Hudson river) prove otherwise. A company will skirt around regulation and when possible maximize profits at the expense of anyone in their way. This is the same fallacious thinking that Greenspan made until he saw what happened with the investment banker in 2008. Oops Alan. Well this is all part of the magical thinking that is part of the Freemarketers Religion.

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  30. anon nymous says:

    It’s a nice theory, but is there any data to back it up. There is an assumption that corporate executives are thinking of the long term. Given the current state of things and the egregious make lots of money quick and push the consequences onto others mentality that created them, it is hard to accept. It’s like Milton Friedman’s efficient market theory. It works fine as long as we ignore all of the many examples in history where it fails.

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  31. Paul Mooney says:

    Markets lead to moral or immoral behavior to the extent that they reward or punish that behavior. I think there are far too many examples of companies behaving immorally to take seriously the claim that there is a something inherently moral about free markets. More to the point, ascribing moral agency to a corporation is problematic. People have moral agency, and will often due immoral things as party of their corporate role if that thing rewards them and has little or no personal risk — regardless of the risk to the company or market as a whole. For example, not single executive of a mortgage lender has gone to jail yet despite all their fraud and damage they did. The moral is that markets don’t regulate themselves any better than people do, which is why we need laws and watchdogs.

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  32. JHG says:

    All markets foster cooperation, otherwise there is not a market. Whether this “market” has integrity is a supposition. This is all a comparative exercise. We have a market that has more freedom than most others. Does this mean we have fewer liars, cheaters and stealers than less “free” markets? How is this proven?

    Our “free market” economy has more people in jail than any other. I submit that “free markets” create more, not less, criminality.

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  33. Binky the Bear says:

    Isn’t that notion the same one Alan Greenspan used to help deregulate the financial markets into a mafia-like free for all of Griftopia?

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  34. Jonathan says:

    Another great source of insights on this topic is the recent work of Deirdre McCloskey. She has published two hefty volumes (Bourgeois Virtues and Bourgeois Dignity) with more in the planning stages.

    http://www.deirdremccloskey.com/

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  35. MinnItMan says:

    Thanks for the reference to the Monty Hall problem – I’d never heard of it. As a sidenote, I MISread it before my first coffee as the Monty Python problem, “What is your quest …, etc.” Made me think of Plato’s “Timaeus,” which if I recall correctly, implies that thought and experience essentially compound error and inaccuracy ad infinitum, although occasionally, you can learn something, if you don’t mistake Monty Hall for Monty Python. (Thanks to google for automatically searching after a block control-C).

    Two related thoughts though, to the actual post here:

    1) I think it was the pilot of Mad Men where Don Draper is trying to figure out an ad campaign for a cigarette company in light of the impending Surgeon General’s report, which among other things, will undercut the current campaign where medical doctors actually recommend the company’s cigarettes. His insight is that “other company’s cigarettes give you cancer. Ours are ‘Toasted.”

    2) I’m a lawyer, not an economist, although I did get a fellowship for a summer program in economics while in law school. Anyway, during a five or six year period, I was solicited for Amway and a few other MLM “business opportunities” at least a half dozen times. I’m not sure there is a company out there that has a worse reputation than Amway, and I’m not sure there is a worse business model than MLM, at least for solicitees. And I’m not sure there is a group of people who talk up morality more, yet are fundamentally committed to falsity, greed and ripoffs in plain sight. (I certainly agree with previous posters about the blue chip bad actors, btw). My question used to be how does this company (and its methods) exist? But more apropos of this thread is how have they have continued to exist for so long?

    A final comment about the mortgage business, particularly say 2001 to late 2007. I was in a position to clearly observe that making bad loans with a high likelihood of default was far more profitable than making good loans that wouldn’t default. It was [is] universally understood that any monkey could do the latter, but it took real ability to do the former. It was really as if they were two different businesses. Part of what I did involved surveying originators for the relative make-up of their pipelines, conforming to non-conforming (aka subprime). People would more gladly tell me about their porn-viewing habits than give me remotely accurate information about the relative volumes. The best answer I ever got was: “Oh, we concentrate on A paper (conforming), but very occassionally, we’ll do b-c-d paper.”

    It turned out that this answer entirely depends on what the meaning of “very occasionally” is.

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  36. Amos Newcombe says:

    This is an amusing point of view for me, living as I do in an economy that was recently hammered by widespread fraud generated by unregulated free-market capitalism. And not for the first time. This is an old story for capitalist apologists, and it’s just as bogus now as it always was.

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  37. bdbd says:

    In the long run, we’re all gone to heaven.

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  38. TheSpaceBetween says:

    This is simple…but extremely profound. Ask Ayn Rand, ha. Need a real life example? Specifically Ebay as an example. It is the best example of capitalism and free markets today. EVERYTHING is about reputation. How may times are you begged to rate a company positive, or beg you to contact them if not satisfied.

    Another profound statement I’ve come to understand as true: free markets don’t crash. I’d like to see a politician start chanting that economic life lesson.

    Trouble with free economy, is certain people loose control and cannot skip off the spoils of regulation.

    :)

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  39. Adam Acosta says:

    This paper is itself an indictment of the state of economic analysis. It derives a conclusion about the real world by generalizing from a game theoretical abstraction. I’m a big believer in math and use it myself in my work, but here we have a question with an empirical answer that can be studied empirically. How many of our largest and most successful firms actually display integrity? I challenge a social researcher to design a way to study this scientifically rather than trying to derive an answer from abstract first principles, because there has to be a way.

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