The Virtues of Free Markets?


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.


he doesn't seem to cite this study ( which shows that competition does build trust... trust attitudes have to come from somewhere!

Peter Wung

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.

Clifton Griffin

What firm doesn't care about its reputation?

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

Joshua Northey

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.


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."

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."


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.


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.

Tom Lawson

The USA sells a majority of cheap, disposable items that come from a variety of places. This is not a free market economy, it is a FLEA market economy.

It's not immoral as much as it is de-moralizing.


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.

Clifton Griffin

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.

Joshua Northey

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?

Clifton Griffin

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.


Joshua Northey

"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.


"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.

Clifton Griffin

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".


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.


Leonard Read, not Friedman.,_Pencil


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.


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).



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.


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...


Joshua Northey

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.



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.


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.


Clifton Griffin

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?


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.



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


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.


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.



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.


Joshua Northey

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.


Ed B

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.



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.