The Morality of Adam Smith's Free Market Economics
Our free market economic system depends on the exercise of ethical behavior by corporate officials to provide for the public good. Absent decision making based on ethical values such as honesty, objectivity and integrity, the system cannot be trusted to allocate resources in the best interests of society. The root cause of such problems is the pursuit of self-interests to the exclusion of all others. The financial crisis that started in 2007 resulted in large part from unethical conduct including making home mortgage loans when financial institutions knew (or should have known) that borrowers were not qualified – a fact that was ignored (or overlooked) so that these institutions could earn large fees from closing and other transaction costs. This scandal came on the heels of accounting frauds in the early 2000s at companies such as Enron, WorldCom, Tyco and Health South that shredded billions of dollars of shareholder wealth while top management pay packages at these companies were in the multi-millions.
It is important to remember that Adam Smith connected ethics to economics. Smith came to his philosophy of economic behavior described in The Wealth of Nations through his view of moral behavior espoused in his first book, The Theory of Moral Sentiments. Smith, who is generally regarded to be the founder of free market economics, posited that rational self-interest informed by moral judgments based on fairness and justice would lead to promoting the best interests of society guided by the invisible hand of the marketplace. What is missing from the calculation of recent economic decision making is ethical decision making. We must ask: What are the rights of shareholders and other stakeholders and what are the obligations of CEOs and boards of directors to those parties? How is it in the best interest of shareholders for CEOs to walk away with multi-million severance packages? Perhaps the most glaring example of unfairness is the $130 million package given to Michael Ovitz in 2005, after he was fired as CEO of Walt Disney & Co. by Michael Eisner, the chair of Disney’s board of directors, just fifteen months after being hired. Notwithstanding the fact that the Deleware Chancery Court upheld the legality of the payment, boards need to be held ethically accountable for such actions.
The nature of the present economic crisis illustrates the need for departures from uncontrolled self-dealing for the good of society. Smith had a diagnosis for this: he called such promoters of excessive risk in search of profits "prodigals and projectors,” an appropriate description of many of the promoters of credit swap insurances and sub-prime mortgages in the recent past. Yet, more government regulation is not the answer. Recent efforts at financial regulatory reform may stem the tide in the short-run. However, in the long-run we should expect new and “creative” attempts at financial engineering to benefit the few to the detriment of the many. Unmitigated greed is not what Smith had in mind in writing “Sentiments.” The bottom line is ethical behavior cannot be legislated. It comes from within and a desire to do what is right for society and not to act solely in one’s own self-interests. Greed is NOT a good thing as proclaimed by the character Gordon Gecko in the original movie, Wall Street.