Does the Free Market Corrode Moral Character?

admin — Fri, 14 Aug 2009 14:18:08 GMT

Given events in the U.S. economy and around the world over the past year, we thought it might be appropriate to feature a related discussion. The Becker-Posner Blog offers a unique commentary on the free market and its potential impact on the morality of businessmen. University of Chicago economist Gary Becker speaks to several topics of interest to the Initiative in this discussion, including characteristics of free competition, the desire for profit maximization, and the effectiveness of regulatory interventions.

Does the Free Market Corrode Moral Character?
Gary Becker, November 2008

The title of this discussion is taken from a question put by the John Templeton Foundation to leading scientists, scholars, and public figures. The foundation published some of the answers in the New York Times on October19th. It is obvious from the revelations during this financial crisis, the Enron scandal, and other business scandals, that dishonest and morally corrupt figures sometimes are among the leaders in highly competitive industries. Hollywood has often highlighted these figures, such as the morally bankrupt Gordon Gekko in Oliver Stone's film "Wall Street", which probably contributed to the general perception of businessmen as corrupt. Moreover, polls in the United States and Europe usually find that businessmen get a low rating when people are asked about whether they respect them, or believe they are honest, although congressmen in recent polls get an even lower rating than businessmen.

If the question had been put to me, I would have first discussed whether corrupt and dishonest businessmen make greater profits than honest and morally admirable businessmen. Honest businessman would be more successful than corrupt ones when they compete against each other in a free market, as long as consumers can punish dishonest businessmen by not giving them repeat business, (when repeat business is necessary to succeed). Dishonest businessmen may make greater profits in the short run, but honest businessmen make higher profits in the longer run because cheaters cannot attract back customers who they cheated.

Two conditions must be operative for this process to be effective:1) customers must be able to detect when they are being cheated or misled, and 2) customers must be frequent enough buyers, so that repeat business is an important determinant of profitability. Both these conditions often prevail, but one or the other may be absent under certain circumstances. For example, repeat business is not so important in vacation areas where tourists seldom come back. Then morally corrupt and dishonest businessmen may do relatively well, although tourists do get recommendations from friends who have been there before, or from the hotels where they stay. Another example deals with certain durable consumer goods since consumers only infrequently purchase expensive goods like a car or home. Although repeat business is less important in these markets, consumers will put more time and research into considering decisions that require large expenditures. In addition, word of mouth information about the reputations of different sellers can hurt the dishonest sellers.

Even when repeat business is important, consumers would not be able to punish corrupt businessmen if they cannot readily determine whether or not they have been cheated or badly misled. For example, consumers who buy defective used cars that break down only after a year or so of driving may blame the breakdowns on their own actions rather than on the quality of the cars that were sold to them.

Adam Smith claimed that businessmen were, on the whole, more trustworthy than diplomats. His argument was based on the importance of repeated interactions. Essentially, Smith argued that repeat business was usually more important to businessmen than to diplomats. Smith argued that diplomats frequently broke treaties since treaties are made infrequently. As a result, the gain from breaking treaties often exceeds the gain from living up to the obligations imposed by the treaties.

Another, much more famous, result of Adam Smith shows that under certain conditions, businessmen in competitive industries would promote the general welfare, even though they were only trying to increase their profits. These conditions include that businessmen are prevented from colluding-Smith correctly argued that businessmen try to collude in order to exercise monopoly power- and Smith assumed consumers could punish dishonest businessmen.

Many critics judge the performance of free markets relative to alternatives the way a judge might make her decision about the winner of a beauty contest between two contestants. She chose the second contestant after seeing the warts on the first one. Prominent and not so prominent businessmen in market economies have been involved in various scandals where they have provided misleading information, lie, sell shoddy and dangerous products, and the like. When such scandals arise, there is a clamor for greater regulation in the sectors where the scandals occurred, and sometimes even for government takeovers of these enterprises. This presumes that regulators and government officials act with sufficient knowledge about the industries involved, and with great wisdom and morality. Unfortunately, often that is not the case.

Aside from the not infrequent cases of outright bribery of regulators and legislators, many other more subtle ways exist to bias, even corrupt, officials when their decisions replace the forces of market competition. Regulators often get "captured" by the companies they regulate, so that regulations are developed to keep out competition rather than promote greater honest competition (this capture theory was given an economic interpretation by our late friend, colleague, and Nobel-prize winning economist, George Stigler). One of the more notorious examples is the former Civil Aeronautics Board that was supposed to regulate competition among airlines, but had trouble giving approval to new airlines to compete against the established airlines.

Legislators sometimes bail out companies in financial distress, or restrict competition from abroad in order to raise the profitability of domestic companies-in effect they become tools of these companies at the expense of taxpayers and consumers. Why should American automakers get subsidies from the government during this present crisis, and in the past, when they have repeatedly made bad production, marketing, and labor contract decisions during the past 30 years? A free market in the automobile industry with less government involvement would have given American consumers faster and easier access to the cheaper and better cars made by Japanese, German, and now Korean companies.

I might add in concluding that I have spent my whole career in academia, and I have witnessed many examples of morally corrupt behavior by professors. So it is far from obvious to me that businessmen have worse morality than professors, although I may be making the same mistake in this inference as the judge did in the beauty contest I referred to earlier who had seen up close only some of the contestants.

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Photo by Emilio Labrador.

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Does the Free Market Corrode Moral Character?