Business Ethics Tom Atchison

Some Notes on Ethics and Free Markets

In his book Capitalism and Freedom, Milton Friedman argues that a free-market society is a good society because the free market (1) promotes freedom of choice and (2) produces an efficient allocation of resources, thereby making capitalist societies much wealthier than other sorts of society. These claims, then, provide the background for his assertion that the only responsibility of business people is to try to maximize profits. Other defenders of "the market order” go farther. To the claims above they add the further claim that the market (3) rewards those who deserve to be rewarded because they have worked hardest (or smartest) to serve the public. Here is a summary of some of the limitations of these claims.

The basic case for the "free market":

The science of economics can demonstrate that a perfectly competitive market will produce certain apparently desirable outcomes. In particular, it can be shown that a competitive market (a market where many suppliers compete for the business of the customers who wish to purchase various goods and services) tends to produce whatever array of goods and services consumers most want, at the lowest possible prices. Competition forces producers to cater to consumers' desires (this is often called "consumer sovereignty") and to produce at the lowest possible cost. The opportunity to make profits gives entrepreneurs a powerful incentive to discover new products and services that will better serve consumers and to seek out ever more efficient methods of producing and distributing those goods and services.

Markets promote freedom, according to their proponents, in several ways. They give consumers the freedom to choose among a wide array of products. They give business people the freedom to manage their assets in whatever way seems best to them, with a minimum of interference from the government. They provide everyone with the freedom to try to start their own business or to change their line of work. When governments control economic resources, the best we can hope for is a (small) voice in a political process that makes decisions democratically. In a free market, we are sovereign over whatever we own (at least ourselves, perhaps much more).

Some limitations of the case

1. Responsible teachers of economics (in my view) make clear that the scientific case for the efficiency of free markets depends on a number of assumptions that are not true. This makes the overall assessment of market efficiency rather problematic.

a. Perfect competition: To show that a market will produce the results sketched above, you have to assume that the market is perfectly competitive. This means that there have to be many producers of any given product, so that no producer has such a large share of the market as to be able to escape the effects of competition and to dictate terms to customers or suppliers. In contemporary industrialized societies, in many industries, this condition may not be satisfied. A few large firms dominate many industries and their size may well enable them to drive more efficient competitors out of business, and to dictate terms, to some extent, to those with whom they do business.

b. Perfect information, perfect rationality: You also have to assume that all the participants in the market economy know what they want, know what the real characteristics are of all the items they could purchase, know of all the opportunities that are available, and make a rational decision to select only those options which best satisfy their preferences. This is manifestly not the case.

c. Fixed preferences: conventional economic theory takes people's preferences as a given. It assumes that, if someone shells out money for a product or service, they are getting something that is worth that much money to them. The possibility that they may have been conned or manipulated into buying something that they don't really want or need is not considered. Many students of our economy have argued that this assumption vastly underestimates the role of advertising in creating the preferences that are then satisfied.

d. No (or low) 'external' costs: 'external' costs are those that are not reflected in the price of a product or service. For example, if a producer can make a product more cheaply by using a method of production that emits pollution, and if there is no regulatory apparatus which forces the polluter to pay for the cost of preventing or cleaning up the pollution, then it is an external cost. The free market does not give anyone an incentive to reduce these costs. But they seriously degrade many people's quality of life.

Once you notice that the technical arguments for the efficiency of the market depend on all these false assumptions, it is hard to know what to conclude. It may be that all these factors added together do not reduce the efficiency of the market all that much. But the abstract part of the science of economics cannot establish that fact (if it is a fact). We have to make a judgment based on what seem to be the actual results of various policies, rather than relying on the 'theorems' of price theory.

2. Another fundamental limitation of the case for the market stems from the narrowness of its definition of 'efficiency'. When economic science proves that the results of market competition are 'efficient', it takes as a given the initial distribution of resources in society. It shows that given the initial distribution of wealth, property, talent, etc. competition will produce results that enable everyone to get the most for their investment of money, effort, etc.. More precisely, it shows that the resulting allocation of goods is such that you cannot make any person better off without making some other person worse off. But it does not show that we could not produce a greater average level of happiness or satisfaction by redistributing those goods. Economic efficiency in this sense is perfectly compatible with widespread poverty, malnourishment, homelessness, etc.

3. Consumer sovereignty suffers from a similar limitation. Producers must respond to the desires of consumers, but only to the extent that those desires are backed up with money (or other economic resources). The more money you have the more 'sovereignty' you exercise. This is reflected in the fact that there may be well-developed markets for luxury goods in societies where people are hungry and homeless.

4. These limitations might not be so troubling if we were persuaded of the claim that people in a market society have generally earned their holdings by giving the public what it wants. But this claim is, at best, half true. Many people work hard; only some reap great rewards. To some extent the difference can be attributed to the intelligence or creativity of the successful. But surely a great deal must also be attributed to luck, social connections, inherited advantages in wealth and education, and so on. Going a little farther, we might wonder why people who happen to have been born with intelligence, creativity, charm, or other socially valuable traits should be regarded as 'deserving' whatever they can get from the market for these 'gifts'.

5. Finally, there is a serious limitation to the 'freedom' offered by a market society, as well. It often goes unnoticed that for every freedom offered by the 'free market' there is a corresponding 'unfreedom'. For example, private ownership of land gives the owners of that land the freedom to do whatever they want with it. But at the same time it deprives everybody else of the freedom to do anything with that land (even to walk on it). Private ownership of a business means that the owners are free to hire and fire their employees at will, or to move their business to another country, etc. But the other side of the coin is that their employees are not free to exercise any control over the assets of the business (or to keep their jobs). Roughly speaking, your freedom, in a free market society, is proportional to the size of your bank account. The actual range of choices facing many people may be pretty limited. (Work at Burger King or go hungry.) It could well be that some other economic system (or some modification of the existing system in the direction of a more equal distribution of wealth or income) would offer most people a wider range of choices. Arguably this would make them more free.