Joseph Heath, Morality, Competition, and the Firm: The Market Failures Approach to Business Ethics, Oxford University Press, 2014        

 Jason Brennan
Georgetown University
Washington, DC, USA            

Until Joseph Heath came along, philosophical business ethics was in a bad way. To the extent it’s still in a bad way, perhaps it’s because Heath has had insufficient influence.

Before Heath, much of the debate in the field was between two major theories—stockholder and stakeholder theory. Both of these theories are either false, or vacuous and empty, depending on the interpretation. Heath has to some degree rescued the field by providing what is perhaps the only good general theory of business ethics, which Heath calls the Market Failures Approach. (To be clear, there is some good casuistical work in business ethics, but the Market Failures Approach is perhaps the only good general theory of business ethics.) Morality, Competition, and the Firm contains updated versions of ten of Heath’s previously published essays on the Market Failures Approach, along with three new essays.

To see the value of Heath’s work, one needs to understand what came before it. Stockholder theory claims that since a corporation’s capital belongs to the stockholders, managers in a corporation have a fiduciary duty to promote stockholders’ expressed interests. Many people, both defenders and critics of the theory, misunderstood this as meaning that managers should do whatever it takes to maximize profit, so long as they don’t break the law. On this misinterpretation, stockholder theory seems false. But, more accurately, stockholder theory says that managers should pursue stockholder interests, provided they do not violate their other, pre-existing obligations, whatever those might be. Just as my lawyer does not lose her pre-existing duties when I become her client—she cannot, for instance, dump toxins in the ocean in order to keep me out of jail—so stockholder theory says that manager must pursue stockholder interests, but only after first observing whatever duties people have. The problem—the reason stockholder theory is empty—is that it offers no account of what these prior duties are. But that’s what we need a theory of business ethics to do.

Stakeholder theory—perhaps the dominant theory of business ethics—is worse. Stakeholder theory claims that when making decisions, managers should take into account and properly balance the interests of all affected parties affected by their decisions, i.e., all “stakeholders”. This includes employees, suppliers, customers, local and national governments, and, well, everybody. The question, of course, is what counts as “properly balancing” all “legitimate interests,” in particular, how one ought to balance conflicts of interest both between and within stakeholder groups. Rather than trying to put meat on stakeholder theory’s bones, R. Edward Freeman and other stakeholder theorists instead assured everyone that the theory really is vacuous. In a recent book outlining the “state of the art” of stakeholder theory, Freeman and his co-authors explain that all stakeholder theory says is that we should “pay attention” to affected interests (Freeman et al. 2010, 9), and, further, even stockholder theory turns out simply to be an instance of stakeholder theory (Freeman et al. 2010, 24). (After all, it’s a theory about how to properly balance legitimate interests.) Instead, the point of stakeholder theory is to “creat[e] compelling stories” or “tell better stories” that help managers create value (Freeman et al. 2010, 216). In Freeman’s defense, at least the final theory cannot possibly admit of any counterexamples, since it does not say anything.

Heath’s Market Failures Approach begins by reflecting on what markets are for. Consider that interpersonal morality is highly demanding. People are wary of businesses and capitalism in part because it seems that many of the norms of the market are lax or less demanding than those of normal interpersonal morality. As Heath puts it, this is a feature, not a bug, of capitalism. Markets are a kind of “staged competition” among firms, producers, suppliers, workers, and consumers (4). In market institutions, it’s reasonable to relax the normal interpersonal rules—including norms about fairness or equality—because doing so results in spectacular gains for everyone. We are all (even the poorest of us) vastly better off with markets than without them, but for markets to make us much better off, we cannot require competing businesses to treat each other the way we expect family members to treat each other.

Instead, the ethics of the market is a kind of adversarial ethics, like the ethics of sports. It’s a set of rules designed to constrain or shape how competitors compete, with the goal being that competition leads to Pareto-efficient gains for everyone involved. (A situation is Pareto-efficient just in case it is impossible to make one person better off without making someone else worse off.) Market competition tends to discipline firms to act in publically beneficial ways. (This is Adam Smith’s invisible hand.) Government regulations are needed to correct some market failures. (This is the visible fist of government.) But market and government regulation are not enough to make the system work well; we need morality as well. David Gauthier had argued that a perfectly efficient market would (and even should) be a morality-free zone (Gauthier 1986, 83-112); Heath agrees, but responds that since real-world markets are not perfectly efficient, we need morality to help rectify their deficiencies. Thus the label the “Market Failures Approach”: the morality of the market is meant to correct inefficiencies in the market. For that reason, whatever norms Heath’s theoretical framework leads to depend in large part on empirical issues, such as to what extent real-world markets fail, and to what extent various norms, when widely followed, can lead to Pareto-optimal results.

For Heath, competing market agents are not themselves supposed to aim for Pareto-optimal results. Instead, “achieve Pareto-optimality” is a rule of recognition by which the moral norms of the market are derived. In the same way, the point of staging a baseball competition is to have fun, but players on the field are not bound by a rule of trying to maximize the fun. Instead, fun results from the players following properly designed rules (Rawls 1955).

As Heath summarizes, “…in cases where the explicit rules governing the competition are insufficient to ensure the class of favored outcomes, economic actors should respect the spirit of these rules and refrain from pursuing strategies that run contrary to the point of the competition” (4). Most market norms are thus norms of good sportsmanship. Competitors ought to follow good regulations, ought not lie and cheat, ought not exploit market failures, and should not try to game the rules by engaging in rent seeking behavior.

Indeed, in the current era of crony capitalism, this may be one of the biggest problems with business ethics. The government’s power to regulate the market for the common good is also the power to regulate it on behalf of special interests. Once government begins regulating markets, corporations, unions, and other special interests lobby to control the rules for their own benefit, at the expense of society at large. Economists call this “rent seeking”, which refers to non-voting, non-criminal activities that individuals or firms engage in with the purpose of either changing the laws or regulations, or how the laws and regulations are administered, for the purpose of securing a benefit. A firm engages in rent seeking when it seeks to gain an economic privilege or advantage from governmental manipulation of the market environment (Mueller 2003, 333-334). In fact, rent seeking is extensive in most economies, accounting for massive amounts of deadweight loss.

But this point brings up a possible weakness in Heath’s framework. Suppose no other business has yet induced regulators to rig the market for their own benefit at the expense of the competitors. Heath’s theory implies, plausibly, that it would be wrong to then seek a rent. But now suppose most competitors are already engaged in rent seeking. They are already cheating. If your firm does not cheat as well, you will go out of business, lose your capital, and, let’s say, be destitute. In that case, it’s plausible to say that one might be justified in engaging in defensive rent seeking. By analogy, if a student in a curved class is the first to cheat, he does something wrong, but if he cheats as a response to everyone else cheating, and moreover, the professor helping them cheat, it’s not so obviously wrong. In that case, the student (or the firm) is in a sense restoring itself to the outcomes it should have had under a proper system of cooperation. It’s not clear to me how the Market Failures Approach handles such cases. What are the moral rules regulating how players respond to other players and the umpires themselves breaking the moral rules?

In the end, Morality, Competition, and the Firm is a rich anthology. It’s a tour-de-force of political economy, corporate governance, and business ethics. It contains powerful critiques of virtue ethics and the misuse of moral psychology by other business ethicists. It is valuable reading for anyone interested narrowly in business ethics, but also more broadly in political philosophy or the intersection of politics, philosophy, and economics.

Jason Brennan
Georgetown University
Washington, DC, USA

REFERENCES

Freeman, R. Edward, Jeffrey S. Harrison, Andrew C. Wicks, Bidhan L. Parmar, and Simone de Colle, 2010. Stakeholder Theory: The State of the Art. New York: Cambridge University Press.

Gauthier, David. 1986. Morals by Agreement. New York: Oxford University Press.

Mueller, Dennis C. 2003. Public Choice III. New York: Cambridge University Press.

Rawls, John. 1955. “Two Concepts of Rules.” The Philosophical Review 64: 3-32.