When the Economy Needs Morals

The sum total of all the policies in being is a cause of general under-performance. Even if every policy had a positive effect on its own limited target, (which may be too much to hope), there would still be a negative diffuse effect on the economy as a whole due to deviations from the path of least resistance. But that would little by little weigh down activity without most people having much insight into why this should be happening. There will be a frenzied and increasingly desperate piling up of social policy, employment policy, industrial policy, energy policy, transport policy, measures for the young, for the long-term unemployed, for the unskilled, for small business and for any number of other worthy causes. Little or nothing will be achieved.

Those who have followed the history of the French “social model” since its origins after 1975 are familiar with the details of such processes. Italy, Germany and the Scandinavian countries provide similar, albeit less stark, examples, though with one major difference: each, in its own manner has recently at least tried to reverse the process and dismantle part of its towering policy edifice. European countries of the former Soviet bloc have also done some good demolition work. If this dismantling persists and gathers momentum, all may yet be well. The present article deals with the opposite scenario where no dismantling has started, or where it fails to gather momentum.

Generally, the trouble begins with public opinion waking up to the near-absolute primacy of politics over economics that characterises advanced countries since World War II or so. In the 19th century and the first decades of the 20th, public opinion was convinced that there were iron laws no government could transgress without risking catastrophe. Property belonged unconditionally to whom ever held title to it, and could not be violated without the social order collapsing. Budget deficits could not be allowed to persist in peacetime, for printing money meant inflation and the spoliation of small savers. Wages and profits had their own natural levels and could no more be fixed by decree than the weather. These beliefs did not provide complete protection for benign economic equilibrium, but they helped.

Partly as a result of the widespread teaching of vulgarized economics, it came to be understood that none of these iron laws had actually to be respected, except perhaps in the very long run when we are all dead. People saw that everything that was politically feasible or indeed necessary, could be done to the economy without the sky crashing down on them. A democratic government always had the whip hand over business. The freedoms of property and contract could always be curtailed by appeal to the public interest.

The proliferation of policies that seemed a good idea at the time, was to shape the economy to perform as politics dictated. The objective was to establish “social justice” by redistributing the income once the economy has obediently produced it. Policy proliferation and redistribution are the obvious consequences of the primacy of politics. After a lapse of time that is quite short by historical standards, the result is clear. Each policy works to some extent, but their sum total brings overall failure.

At this point, the realization is dawning that, like a sick body saturated with an array of wonderful drugs to which it can no longer respond, the economy will not improve by subjecting it to a further overdose of remedial measures. Above all, historically high unemployment seems to have become chronic. It threatens the whole social order and, more importantly, the political survival of whatever shade of government happens to hold office. Desperate measures are suggested: the “available” work must be shared by ordering everyone to work shorter hours; business must be allowed to hire but forbidden to fire; it must be obliged to invest its profits rather than distribute them to fat cat shareholders; it must also be forbidden to de-localise to lower-cost countries; indirect taxes must be used to penalise imports; the state must pay the wages of young people in their first year of employment; and so forth. Some of these harebrained ideas are actually tried out, but either prove unenforceable or just do not work.

In the last resort, the cry then goes up for more social responsibility, more morals.

In a normally functioning capitalist economy not pulled and pushed off balance by the politics of policies, the need for morals is at a minimum. Most economic agents are called upon to do only what is “incentive-compatible”. This jargon term, regrettably part of the language of economics, means that the butcher and the baker best fulfil their role if they maximise their profit (or otherwise act in their best interest). The exception is the principal-agent relation, such as that between the employer and his employee, the owner and the manager, or the citizen and the state. Such relations are only partly or not at all incentive-compatible and leave a need for supervision and ingenious incentive-creating contracts. Egalitarian arrangements and command economies are both almost totally incentive-incompatible.

Instead of having to rely on morals, a normal capitalist economy works well if, and because, “honesty is the best policy”—namely it pays best. Deviation from the honest norm—shirking, free-riding, short-changing, making shoddy goods, stealing or embezzling—might pay even better, but may trigger legal, economic or social retribution. The best policy is the honest one if the expected present value of retribution is greater than the gain from any dishonest option. (The expected present value of retribution depends on the agent’s subjective probability of being caught, on the pain of the punishment, on how soon it may be suffered, and the rate at which the agent discounts the future. Unsettled social conditions favour the dishonest option, as does slow justice and a high personal discount rate. Dishonest people are believed to discount the future at extravagantly high rates).

Unlike a healthy capitalist economy, the near-bankrupt welfare state requires morals in the strict sense. It asks many of the most decisive economic agents to act against their own interests. Wealthy families or ambitious entrepreneurs must not emigrate to reduce their tax burden—doing so would be a betrayal of solidarity with their fellow countrymen. Top executives must not accept salaries and bonuses that would make them as rich as pop singers or football stars, but should limit their earnings to some moderate multiple of what their workers get. Firms must maintain the payroll and not throw their employees on the dole as long as the company is still profitable; only serious loss could justify laying off defenceless workers. Managers must manage in a “socially responsible” manner and not in the sole interest of the owners. (Interestingly, this demand is made in the name of morals, though if the manager does not run the business in the owners’ sole interest, he is betraying his mandate and is in effect a thief who steals on behalf of “society”).

It is perhaps obvious, but it will do no harm to spell it out, that none of these alleged moral imperatives are pertinent in an economy that runs freely and has not been nearly suffocated by ill-advised attempts to use politics for improving economics. Workers, above all, are not menaced by chronic unemployment which strips them of bargaining power and leaves them to the mercy of a largely imaginary and axe-grinding moral code of economic conduct.