One of the big criticisms of free market economics is that markets are driven by greed. “Why would you want to allow markets to set the price of [health care, wages, basic housing, food, education, etc.],” the argument goes, “when that means subjecting a basic humanitarian necessity of the dictates of unfettered greed?” I think this represents a basic misunderstanding of how markets work, and I’m going to try to address that in this post — though I approach the attempt with some trepidation given the difficulties of the subject matter and the limits of the medium.
I’m going to start by conceding a point which those making the assertion I describe above may consider to prove their case: The economic view of market dynamics tends to view individual actors within a market as value maximizing agents. In other words, a market consists of a number of actors each trying to get the most possible value for the least possible expense.
Doesn’t this mean that markets are driven by greed? Don’t we need to encourage people to be something other than value maximizing agents?
Well, certainly, there is much more to life than what you can buy and sell,
so people should never reduce themselves to <i>nothing but</i> value maximizing agents. However I’m going to attempt to argue that markets based on individual value maximization are not necessarily merely exercises in greed.
There are two things which must, I think, be kept in mind here. First of all, we do not all value things equally. And secondly, a market involves all sides of every transaction trying to maximize value.
The first of these points is key because the different values which we place on things result in the motivation for trade. Say that I enjoy doing carpentry while a buddy of mine enjoys doing car work. It would make sense for me to help my buddy with building book shelves and installing wood floors, while he would help me when my car needs work, because the work of doing carpentry has a higher “cost” to him than it does to me. (I enjoy it, and he doesn’t. Plus I perhaps have more skills than he does, so I get it done faster and better as well.)
Since I get enjoyment from doing carpentry (and find it easy) I would not be willing to pay someone much to do it for me. But since my friend doesn’t enjoy it, he would pay significantly more in order to avoid having to do the work himself. When we specialize and exchange, we both get increased value from the transaction. In essence, by exchanging what we don’t want for what we do want, we create value. Is either one of us being greedy in this exchange? No. Indeed, you could argue that we’re both helping each other, even though we are also both maximizing value for ourselves.
Let’s try this with an example which is more often seen as showing greed. I bought a coat yesterday for $69 (50% off) which was, according to its tag, made in Vietnam. I’d long delayed buying a coat, even though the last one I bought (nine years ago) was pretty seriously worn out, because I was put off by the expense of the coats I was seeing. If you grit your teeth and jog fast from your car to the building you’re headed for, you can get by a long time in Central Texas without a coat, and the thought that the $150-$250 that many of the coats I was seeing cost would feed our family for a week or two, or buy winter clothes for all the kids, or cover car repairs, or any of another of other items on the list of household expenses. Now, if the wages for coat makers in Vietnam were such that it was impossible to buy a coat for less than $300, I certainly would not begrudge them a better lifestyle, however I almost certainly would have continued wearing my shabby old coat and dashing about in shirtsleeves and put off buying the coat for another year. And that decision of mine (and of others like me) would mean that there would be a reduction in the demand for coats. Which in turn would impact those who make coats.
The current cost of coats thus represents a balance. I want to cover other household expenses before my own needs. Coat sellers want to sell more coats and grow their business. Coat makers want higher wages. Unemployed Vietnamese workers living near coat factories want jobs, and are willing to get them by offering to work for slightly less than others who are already skilled in coat making. All of these demands are weighed and balanced through millions of individual transactions in the coat market. And everyone gets as much of what they value as possible given the demands of everyone else.
Some of the people involved in this complex interweave of desires may indeed be profoundly greedy, but in a sense, it doesn’t matter. Whether they are greedy or simply trying to take care of their families by balancing the many demands upon them, the result is a balance between the demands of everyone involved.
The idea behind markets is that given that hundreds, thousands, or millions of people are often involved in a complex economic supply chain, it’s far easier and more efficient (and thus in the long run, better for all involved) if to a great extent prices are negotiated through free exchange of goods and labor rather than through seeing prices or wages where they “ought” to be — because given a sufficiently complex situation the sum of the knowledge of all the individual actors involved is much greater than the understanding of any given regulator could possibly be.
Still, isn’t it a problem to have a market full of people thinking only of their own profits? Wouldn’t it be better to have community organizations whose whole purpose is to benefit everyone involved?
A couple weeks ago I had an extended conversation with someone over whether credit unions were morally superior to banks. His argument essentially was, “The express purpose of a credit union is to provide value for its members, to whom it is directly accountable. A bank, on the other hand, is accountable to its stockholders, so it is always going to put the interests of its customers second to profit.”
If this were the case, it seems to me, then people would invariably keep their money at credit unions, buy their food at co-ops, etc. Because while a credit union and a bank have different business and ownership models, the services they provide are pretty much the same: They loan money in return for interest, and they pay interest out to depositors.
People with savings will naturally want to get the most interest that they can without sacrificing the security of their savings, so they will check around at a couple of different banks and/or credit unions and put their money in the most advantageous place. Similarly, borrowers will shop around for the lowest possible interest rate.
If the community-owned model of credit unions always provided greater value to depositors and borrowers, then they would get all the business and banks be left on the sidelines. And yet, we know that this is not the case. Why not?
I think that more than anything else it boils down to incentive. A bank is constantly incented to stretch itself in order to both win more customers by offering high interest to depositors and low interest to borrowers, and also to make those bets pay off in order to make money for the stock holders and bonuses for the employees. As such, the management and employees at a for-profit bank are strongly incented to take good risks, avoid bad risks, and find new ways to make that extra basis point of profit. (A basis point is 1/100th of a percent, and it’s the sort of thing that a lot of work is put into making when you deal with consumer financing.)
The community owned, not-for-profit enterprise, on the other hand, is primarily incented towards stability. At this particular moment in history, when a lot of banks recently made bad bets based on poor forecasting, focusing on stability definitely has its upside. However, because a community owned enterprise is incented towards stability while a for-profit enterprise is incented towards risk and innovation, the result is that a for-profit enterprise will often provide goods and services at similar <i>or lower</i> cost than a not-for-profit, while at the same time paying out a small operating profit to its owners. By providing people with the incentive of additional gain, for-profit enterprises encourage the creation of more value than communally owned enterprises.
One final example: Let us consider two grocery stores in a small neighborhood. One of them is a community owned co-op. As a member, you are a part owner and you help elect the governing board which sets policies and hires employees. Any reductions in costs are handed back to the members in the form of lower prices. The other is a family owned grocery, and that family keeps all the profits which are made.
Both the co-op and the grocery will only have customers if they provide good groceries at low prices. Sure you could label the grocer as being motivated by “greed” in everything he does, because if he find that he can price cereal $0.05 higher per box he gets to keep the money — or if he’s able to buy honey directly from a local bee-keeper he gets to pocket the 5% markup that a distributor would have taken.
And yet, in order to make his family money, he needs to provide customers with good products at low prices. While his business model may be centered around making a profit, if he doesn’t do just as good of job of meeting the food co-op’s mission of “Provide the community with good food at great prices while maintaining a warm, personal atmosphere” he won’t have customers and won’t make a profit. So while you could argue that his ultimate incentive is to make a profit, the only way he can achieve that goal is to give himself the personal goal of providing the community with good food at great prices.
Meanwhile, the fact that he directly benefits his family when he finds a way to save $1000 here in cost negotiations and make $500 there where the competitive environment allows him to raise prices incents the grocer to work harder and take more calculated risks than the managers of a community owned food co-op would be. After all, a $2000 increase in monthly profits might mean a great deal to a family grocery store, but in a food co-op that $2000 would be spread out across the monthly food budgets of hundreds of families in small savings on each item until it became impossible to notice.
Because ownership assigns the benefits gained from cost savings, increased efficiency, demand generation and optimal pricing to a small enough number of people for them to have a compelling interest in putting a lot of work into improving those numbers, for-profit enterprises can succeed in producing more value for more people, and have just as much incentive to keep their customers’ interests at heart as not-for-profit “community owned” enterprises.
I agree that the pursuit of self-interest is not itself an act of greed, but I would still say that greed matters a great deal for markets. Pursuing self-interest may not corrupt, but the habit of greed does, and its corruptive effects will be felt in the market. The greedy man will seek his own interests at the expense of others, by causing harm to others if that harm helps him in a cost-benefit analysis. Situations can be made where workers are coerced into working for sub-standard wages. Customers can be convinced through advertising to pursue the fulfillment of false needs, things that may actually be spiritually or physically harmful for them. I don’t see that the market itself provides sufficient incentives to check the ill effects of greed. Rather, I think that for a free market to work well, to be really free, it has to function in a society ordered by moral frameworks that encourage people to pursue the good.
I think that for a free market to work well, to be really free, it has to function in a society ordered by moral frameworks that encourage people to pursue the good.
Quite true, although ditching markets in favor of heavy command-and-control approaches does not solve the problem of sin, either. Was it James Madison who made the remark about our Constitution being suitable only for a moral people? The same is true of free markets. That’s why we don’t really have 100% free markets; we have a mixed solution.
The economist in me would also add that we don’t need to be entirely fuzzy about deciding if/when free markets are a good thing. There are very strong theoretical models that suggest how markets can fail. Asymmetric information, public goods, principal/agent problems, externalities, etc. All of these market failures remind us that not all markets can satisfy the conditions for an efficient competitive equilibrium. The only question that remains is, How often are these failures present?
Ditto to j-c. A profit-making organization is only as good- or bad- as those within it. Particularly those at top of food chain. True of any Girl Scout troop, corner bakery, humongous bureaucracy. Simply a smokescreen for the eternal Capitalism vs. Socialism debate. Say we communicate on fancy computers hooked up to loads of internet sites. Not likely they could be developed at USDA. Or that fancy cell phone surgically attached to you. Your local Motor Vehicles office is not a hothouse for these technological developments. Of course we have the laff-riot issues involving the current governor of Illinois. Of course it was Michael Dukakis who noted the Greek proverb that the fish stinks from the head. Twas ever thus.
Do you live in Chicago’s Hyde Park or what? That exact same scenario of grocers played out in Hyde Park. The Co-op is completely gone (hurrah!), while the family owned Hyde Park Produce just moved into the Co-op’s smallest location (more than doubling its size). The family owned location provided decent to pleasant service and average to above-average products for the expected local grocery store, while the Co-op in its considerably larger main location provided terrible service, average to below-average products and no significant difference in price.
A profit-making organization is only as good- or bad- as those within it. Particularly those at top of food chain.
Indeed, good point. I think that a free market tends to reward good people running businesses well (with well being defined as: in the way that their customers want them to) but it certainly doesn’t make people good!
Also ditto on Kyle’s point about the necessity of virtue for free institutions to work. Though I’d add: free institutions tend at least to reward virtue, while command-control institutions often do the opposite.
And of course to J. Christian’s point, there are certain circumstances where a market isn’t really free and equal, in which case the attempt to act like it is can run into problems.
And no, Cheryl, I’ve actually never been to Chicago. Though we do have our share of “community run” organizations here in Austin, the blue spot in the heart of Texas.
One of the things that I think is important to look at in the question of greed versus honest profit is the worth of the job. DC brought up good points in the carpenter/mechanic example he gave, but there’s a flip side to it. Suppose I’m offering a general service (say, computer repair and virus-cleaning) to people, and I charge a much lower rate than my competitors but barely eek by on my earnings. If I then raise my prices and earn more money, that’s not necessarily greed, but getting a more accurate reflection of the value of my work. We had some discussions a while ago about just wages, and the concept applies here, as well. If I, as a private practitioner, raise my rates, one could try to argue that it is simply greed and I’m price gouging; but on the other hand, the raised rates could simply be me ensuring I receive a just wage for my work.
The greedy man will seek his own interests at the expense of others, by causing harm to others if that harm helps him in a cost-benefit analysis.
The greedy man will do this if he can get away with it. Most people, I think, greatly overestimate the degree to which he can get away with it in a market setting.
A profit-making organization is only as good- or bad- as those within it.
I disagree. Obviously the people that make up a profit-making organization (or any other type of organization) matter a great deal. But they aren’t the whole story. The “rules of the game” also tend to matter quite a lot.
Great post and great comments. As an ex-distributist convert to free markets, I think that the biggest problem is that “anti-capitalists” frame the argument incorrectly. They rely on undefined terms. They also overlook opportunity costs. Maybe there are trade-offs in the market system. But there are trade-offs in anything in life, and the market offers the most choices and minimizes adverse impacts. As blackadderiv noted, socialists tend to exaggerate the potential for exploitation within a market/rule of law system. They ignore the egregious political, moral and economic exploitation under a controlled economy, as I saw when in the former Eastern bloc in the early 90s.
As a practical matter, no organization can consistently operate at a loss, and hitting the break even point exactly is almost impossible, so all organizations (even ostensible “nonprofits”) seek to make a profit. It’s the only thing a wise manager can do: try to make sure that revenues exceed costs. Your pastor in your local parish probably thinks this way, too.
Another thing we can add to the list of market failures is missing markets. Sometimes there’s a bad outcome because we don’t have a market for something — like information or risk — that might make us better off. Think of credit rating agencies, for example, and the informational role they play in finance. Missing markets aren’t something that government can typically supply; they’re often an innovation that makes other markets more competitive and efficient.