The Value of Virtue in the Market
by Paul Hazelden


Traditional economics, as you read it explained in the standard textbooks, does not work. Of course, like Newton's equations, in many situations, it provides a close approximation and works well enough. But, also like Newton's equations, you have to know what the limits are, and when you begin to stray outside them.

I refer to 'virtue' in the title here, because I am talking about the need for generally recognised moral values, and not for any particular single moral value. The sort of virtues, or moral values, I have in mind are honesty, integrity, self control, kindness, generosity, selflessness, and so on.


Markets are inherently unstable. One reason for this is the process of feedback.

Given the right conditions, markets will create 'bubbles' - times when people will pay absurdly high prices for some product. And eventually the bubble bursts, and many people ae left holding goods that are essentially worthless.

This is not a failure of the market or of regulation: it is the market behaving the way that markets always do. Regulation might inhibit such events but can never prevent them.

Greed is good?

That famous speech from Wall Street is nearly right. The market works, and works well, because people are frequently driven by self-interest.

But, as the film demonstrates, while self-interest and a desire to make a profit are potentially good and creative motives, greed is selfish and destroys. It destroys people, and it destroys the value of what they have created. In the end, it destroys itself.

The problem with buying into a 'greed is good' mentality is that it suffers from the same problem as the criminal mentality: after a while, any significant undertaking requires the participation of other people. You can't run a stockbroking firm, or rob a bank, on your own.

No rational person would choose a criminal career. Who in their right minds would trust their future to people who have been chosen on the basis that they can't be trusted?

Similarly, who in their right minds would get into business with someone who believes that greed is good, that it is okay to do anything as long as it produces a profit... who will lie to you and cheat you as long as they can make a profit out of you? Not me, for one. I want to be in business with people I can trust - with people who have a moral framework.

The market is not enough

Please understand what I am saying here. I am not saying that the market is wrong, or evil, or even inadequate to do the job we need it to do. Markets are great, and free markets on the whole are even better.

But for a market to work well, you need more than a market: you also need a moral framework within which the market operates.

Again, I am not saying that markets need to be regulated. Markets must have rules, and regulators are simply part of the system of rules, like the police and the courts and the prisons.

Markets operate well when people are motivated by self-interest on the one hand, and by self-restraint on the other. Yes, you want to make a profit, but you don't wnt to make too much of a profit too quickly.

It appears that Asian businesses have traditionally understood this better than most Western businesses. In the West, we tend to make deals which give us the greatest profit. In the East, the aim is to achieve a deal which delivers a good profit to both sides. This way, we are both richer and better able to do business again, and we both have a good experience and want to do business with each other again.

The Western mentality of maximising profit is short sighted: if I screw every penny I can out of you today, what incentive do you have to do business again with me tomorrow? Self restraint today will maximise my profits in the long term and leave us both better off.

It's all about values

The market needs people to exercise self restraint. It also needs people to trust each other, if for no other reason than the obvious fact that it is much more cost-effective for people to be honest and do what they say than to have every detail of every transaction recorded and checked so that any failure can be punished through the legal system.

The more you look at it, the more it becomes obvious that any marketplace, like any human social activity, depends on an underlying moral framework for its successful functioning.

In every market, every area of business, there is the possibility of doing things to increase your profit which are not illegal but are immoral. If not such possibilities exist, people will create them.

Sub-primes - a good example

The sub-prime market is a good example. Sub-prime mortgages served a small but distinct and worthwhile market: people who are not in regular employment could get a mortgage on the basis of their past earnings and on what they could reasonably expect for the future.

This sector of the market worked well for many years, but it worked on trust: the broker trusted you to give honest figures, and the insurance company trusted the broker to ask for honest figures.

Then greed began to set in. People who couldn't afford mortgages wanted to get in on the housing ladder. House prices keep going up, so you can't lose, right? And the mortgage companies wanted to lend to more people, so they were happy to be flexible: if the client says they can afford the mortgage, why not accept their word? If they are right, then no problem. If they are wrong, then you take their house - again, no problem.

The system works as long as most people act responsibly. But if too many individuals want to benefit from increasing house prices despite not being able to afford to buy a house, and if too many mortgage companies want to make a profit out of people who probably can't afford their services, then the problems start. The logic, on both sides, works - as long as only a few people are abusing the system. When too many people do it, they affect the market, feedback kicks in, and the market implodes.

No system to determine who can afford a mortgage will be perfect. Any system will exclude some people who can afford a mortgage, and include some people who cannot. As long as the numbers are small, this does not matter as the profit you make on the good deals covers the debts from the few bad ones. But the pressure is always to accept more mortgage applications because you only make a profit on the people you lend to. So fewer and fewer people who can afford a mortgage are excluded (which is good) but more and more people who can't afford one are included - which is bad.

It appears that the insurance companies did not think about the effect of feedback: the house sales from the bad debts depresses the prices of all houses. And when the house is worth less than the mortgage on it, it ceases to be an asset to the insurance company and instead becomes a debt - and this is true, not only for the risky sub-prime mortgages you should never have underwritten, not only for all the sub-prime mortgages, but for every one of the mortgages on your books.

The problem is not one of failed regulation: it is a problem of failed self-control. If enough people without mortgages are greedy and enough insurance brokers are greedy and enough insurance companies are greedy, you will create a bubble, and the bubble will eventually burst.

This is the nature of markets: the value of an item is whatever you can sell it for. If everyone believes the price will go up, the price will go up... for a long time. It makes no difference whether you are talking about morgages or tulips or South Sea investments, as soon as the market believes that something will go up in value, it will go up in value and you will get a bubble, and sooner or later the bubble will burst.

Interestingly, Wikipedia notes that "The cause of bubbles is a puzzle to science... To date, there is no widely accepted theory to explain their occurrence." (External link - Economic Bubble Economic Bubble) I suggest that this may be because economists generally fail to see the moral framework underlying the activities they describe, and hence fail to spot the problems caused when it breaks down.

In conclusion

I have talked about the problems caused by unfettered greed and a lack of self-control, but I believe a case can equally be made for problems being caused by a lack of the other key virtues. Businesses and markets need kindness and generosity, just as much as they need investment and workers.

The other obvious point is that these virtues cannot be derived from the activities which need them. A business may need its workers to be honest, but you cannot make a worker honest 'because the business requires it'! Economics may tell you whether you can afford to build a skyscraper, but it cannot tell you that you should build a skyscraper in order to provide work for unemployed men.

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Copyright © 2008 Paul Hazelden was last updated 10 August 2008
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