Morality and Markets

5. November 2012 by Joachim Goldberg

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I was so impressed by a lecture on the fascinating subject of ‘Economics and Ethics’ by Julian Nida-Rümelin, a former German culture minister and currently professor of philosophy and political theory at the Ludwig-Maximillian University in Munich, I literally ran out and bought the book. Nida-Rümelin’s newest publication, entitled The Optimisation Trap[1], deals with the philosophy of a human economy. Despite being engrossed by the lecture and the book, there was an element in both that alienated me somewhat, namely his insistence on describing economic rationality in a way that allied it with the notion of homo œonomicus, the rational agent of classical economics. One has to question whether one can even begin to discuss the relationship between economics and ethics if the starting point is the outdated notion that an individual has economic preferences whose utilities can be optimised.

 

The author Herbert Simon, who coined the phrase ‘bounded rationality’, made clear that in practice economic optimisers often do not know what their preferences are, let alone are able to evaluate the consequences of all of the available alternatives. This is not only because our perception of gains and losses is starkly different from their economic value – we typically weigh the latter twice as heavily as the former – but also because it is very difficult for us, in the present, to imagine how quickly we adapt to positive and negative outcomes in the future. As a result, it is no simple task to evaluate how much lasting perceived utility our choices will bring. In short, all of the lessons of behavioural finance were missing from the discussion. Even when I challenged him on this point, I received the polite, but ultimately unsatisfactory response that he was not oblivious to the research in behavioural economics. Still, I could not help the impression that the human psyche had not been taken into account.

The message in the lecture was that market capitalism’s unstoppable pursuit of efficiency and optimality, was not only irresponsible but also the cause of the global financial crisis. The professor went on to establish that communication was essential for economic success, and that adequate communication required a strict adherence to norms such as truth, trust and dependability. These, I thought to myself, are virtues that not everyone seemed to have. I dwelled at that moment on Leon Festinger’s theory of cognitive dissonance, which revealed that even honest people can, despite themselves, be found guilty of selective perception. That information that is congruent with their decisions is often elaborated upon, expanded, and redistributed. In contrast, we have a tendency to undermine, discredit, or ignore altogether information that is incongruent with our pre-existing beliefs. This means there is hardly any objective or strictly truthful communication. To use an example employed by Nida-Rümelin: If a woman asks a friend whether she should leave her husband, the advice given will be strongly influenced by the precedents of the friend. If the friend has left her own husband, the advice is likely to be that the woman does the same. If, on the other hand, the friend went to great lengths to keep her relationship intact, the advice is more likely to be to fight for the marriage. In both cases, ‘truths’ are being communicated, but it is difficult to see how two contradictory recommendations could both result in economic optima. A similar situation occurs in the financial market. The owner of an asset will almost invariably see more value in his own holding than in any other alternative. The decision to recommend it to another investor would not violate the norms of truth or trust in the asset-holders eyes, but it could nonetheless be wrong. As more people hold the asset, new norms can develop, which result in herding behaviour, and ultimately in bubbles. Seen in this way, economic agents are able to have ‘friends’ during particular market phases, something Nida-Rümelin rules out.

I do agree with the professor’s insistence that economic markets are not completely without morals.  This is because markets are not populated by homines œconomici – who are indeed devoid of any sense of morality – but by agents composed of flesh and blood, whose complex motives cannot be reduced to a simple profit or loss equation. And, if we are going to speak about the ethics of ordinary people, then we should not forget that their habitudes and values are also subject to the adaptation processes I mentioned earlier. We get used to money and to comfort, which means that in order to maintain any perception of well-being we have to see our wealth increase – a bonus that is lower than the previous year’s will be seen as a disappointment. This is the origin of greed. Adaptation is also at work with events we see as negative. One needs only to watch the excellent film Dogville by Lars von Trier for a graphic illustration of such processes at work. As long as the change is sufficiently gradual, people are able to become progressively cruel even while maintaining their moral self-perception intact. When the moral reference point drifts imperceptibly, even honest people can slip into criminal behaviour without ever having the impression that a line has been ´crossed. This too was undoubtedly a contributing factor to the financial crisis that the philosophy of human economics should not overlook.



[1] Translation of the German title, ‘ Die Optimierungsfalle

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