Markets and Morality

Many people believe that capitalism and especially free markets necessarily leads to a debasement in morality. They point to the corrupt business leader or the tendency of people to cheat when confronting a competitive situation. Barney Frank tells us that the free market got us into the fiscal crisis and the government will have to get us out. Do free markets destroy morality?
I was recently asked to speak to or carry on a discussion with a group of high income citizens about markets and morality, especially the recent financial crisis. (How did I know they were high income? They told me so and also informed me that they had a guilt as a result and wanted to help the downtrodden and redistribute wealth. It would be more moral than this current situation of huge inequality, they said.) In preparing for the talk, it was necessary to define morality. I consulted a number of sources and found many different definitions – most could be couched as normative or simply one’s opinion. I think it is moral to follow the golden rule; I think it is moral to treat others well; and so on. As a conceptual experiment I said, if I took all definitions and created a Venn diagram with them, the mutually inclusive definition would be the non-aggression principle:
People own their own bodies and minds. They also own the land they have mixed with their labor to create output. Anything people own can not be taken, attacked, or damaged by anyone else.
It does not matter whether this principle comes from religion or is accepted as natural law. It does not matter where it comes from, only that it is the mutually inclusive definition. So are markets moral when morality is defined in this manner? A market is the voluntary exchange of a good or service. A market can only exist if people have private property rights. If people don’t own something they can not trade it or exchange it. If people do have PPR and voluntarily exchange something, then both parties to the exchange are made better off. How do we know that? Because if not, then the exchange would not take place. So markets are founded on morality. Without this morality there would be no markets.
Consider some immoral actions. A taking is an aggression against property rights. It is immoral. What are takings? They are the use of coercion to acquire another person’s property. Theft, bodily harm, but also taxes, eminent domain, involuntary conscription, etc. are takings. Whenever the govt takes from one and redistributes to others, it is acting immorally.
Creating money out of thin air is counterfeiting and theft, no matter who does it. Thus, the fiat money system is immoral. Bonds that can never be paid are promises that cannot be kept, and are dishonest or immoral. Government debt is, in most instances, immoral.
DO MARKETS CREATE CORRUPTION AND DESTROY MORALITY?
Adam Smith said that if everyone acts in their own self interest, their actions will as a whole benefit society. I was told during my talk that this was all crap. What about the greedy business man? He will throw contamination into the rivers and destroy the earth. I responded – really? What is greed? It is self interest ; I care more about myself and my family than I do strangers. But, to get what I want, I will SERVE strangers. Bill Gates is greedy but he has to SERVE you to get you to purchase his products. And if Bill Gates contaminates the landscape and you care about that landscape, he is not serving you; he will not be able to stay in business.
The government has to step in a protect us from the greedy businessmen said the participant. I asked, What about government officials – are they greedy? Of course they are. The difference between them and the business person is that the government official does not have to SERVE you. The govt can “command” you and “aggress” against you.
Now with these points in mind, let us see what immoral acts led to the recent financial crisis. A very brief history of the problem in housing markets begins with FDR but really got going in 1967 with the Community Reinvestment Act (CRA). This act instituted the idea that “affordable” or subprime loans had to be made. Everyone has a right to the American Dream of owning a house don’t they. (In fact, one of the participants in my discussion said exactly that.) So as government continued expanding the pressure on providing high risk loans for housing, Fannie and Freddie fell in line. These government sponsored enterprises (GSEs) began accumulating more and more subprime mortgages. This distorted the market very significantly since there is an implicit government guarantee on any purchases or loans made by the government enterprises. The government guarantee means if the loan goes bad, the holder of the mortgage will not lose. As a result, large profit opportunities existed with little risk, to purchase, trade, and sell mortgage backed securities. Of course, the “greedy” business person made loans. We shouldn’t expect anything different. The incentives were there to loan more and more with fewer and fewer restrictions. Incentives were created for everyone to leverage as much as possible by obtaining the adjustable rate loans and subprime loans. Investors began purchasing houses and “flipping” them using no money of their own.
The loans were bundled and sold as mortgage backed securities (MBS). Each MSB would contain different risk tranches – some high risk mortgages, some low risk, etc. It was up to the rating agencies to evaluate the securities and provide ratings. The problem is that the government allowed only Moody’s, S&P’s, and Fitch’s to do the ratings. Moreover, the rating agencies were paid by those holding the mortgages – a conflict of interest that would not have occurred had competition in rating agencies existed.
In short, the crisis was created by government intervention, not by free markets and a lack of government regulation. A great deal of corruption on the part of various Senators and House members took place. There was some dishonesty and corruption in the private sector – again incentivized by the government guarantee. But, the private sector has to SERVE you and would not have been able to act immorally had the government not been involved.
MORALITY IS NOT THE SAME AS ALLOCATION
One of the issues of concern for those who oppose capitalism and free markets is that some people get left out – specifically the poor. What these critics fail to recognize is that necessarily, some people get left out no matter the allocation mechanism. That is what scarcity means – not enough for everyone to have everything they want. The important question in economics is how do we decide who gets the stuff and who doesn’t? Consider the following scenario: At a sightseeing point, reachable only after a strenuous hike, a firm has established a stand where bottled water is sold. The water, carried in by the employees of the firm, is sold to thirsty hikers in six-ounce bottles. The price is $1 per bottle. Typically only 100 bottles of the water are sold each day. On a particularly hot day, 200 hikers want to buy at least one bottle of water. How is this scarcity situation resolved? On method would be for the firm to increase the price until the quantity of bottles hikers are willing and able to purchase exactly equals the number of bottles available for sale. Another could be for the local authority (government) to buy the water for $1 per bottle and distribute it according to its own judgment. Most people would agree that the best solution is for the firm to raise price although some argue that the government should give everyone a half bottle. What is the difference? It is in the incentives created. Suppose 200 people (or perhaps 300 or more) keep showing up at the water stand wanting a bottle of water. The firm would experience a rising profit and hence bring additional supplies of water while at the same time competitors would arise. The result is that more bottles of water would be available. The business man has to SERVE you. If government allocates water, then it might give one half of the bottle to each hiker when there are 200 hikers, one-third when 300 show up, one-fourth when 400 show up, etc. But, the supply of water bottles does not increase; there is no profit incentive for the firm to increase supplies. In fact, seeing the profit confiscated by the government, the firm might decide to leave the business.
Now consider another scenario that is a similar situation but involves a different product. A physician has been providing medical services at a fee of $100 per patient and is unable to see more than 30 patients per day. One day the flu bug has been so vicious that the number of patients attempting to visit the physician exceeds 60. Indicate what you think of each of the following means of distributing the physician’s services to the sick patients by responding with one of the five answers shown above. Again, if the physician can raise price and increase profits, a larger supply of physician services will arise. If the government allocates the services, either the quality will decline (if more people have to be tended to) or some people will be left out. No additional services will be provided.
Finally, the following describes an all too familiar situation of shortage. The number of people needing new kidneys far exceeds the number of kidneys being donated for transplant. Now if a market for kidneys can be created (especially a futures market) the supply of kidneys will increase. But, if the government decides who gets the transplants, the supply will not rise and someone will be left on dialysis and perhaps left to die. Only the free market creates the inc3entives that will increase supplies and improve standards of living.
CAPITALISM VS. CRONY CAPITALISM
If the free market is so wonderful, why do we hear about so many businesses getting special favors from government. Isn’t this immoral? In one of the most famous passages in The Wealth of Nations, Adam Smith cautions, People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. . . .
Adam Smith rightly warned us of the dangers of business conspiracies. But in the same famous passage, he went on to warn of the even greater danger of relying on government institutions to combat such conspiracies:
It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.
Transparency and free markets is the best protection against crony capitalism. Markets are not simply based on morality but they protect and defend morality.