TRUST ME :

Moral Character and Proper Incentives : A free enterprise system depends upon more than just greedy rent seekers. (Citizens for a Sound Economy , July 9, 2002)

Moral character is a necessary pre-condition to the development of a functioning, prospering economic system based on the concept of “gains from trade.” Self-interested actors will not engage in a transaction with an individual that he or she does not trust. To bind individuals to promises and establish trust between actors who do not know each other well enough to risk millions of dollars, the law of contracts has developed to legally bind parties to the performance of their promises.

Yet for contract law to work properly, it requires a widely accepted and practiced standard of moral behavior. When one party breaches his obligations, the widely accepted assumption must be that the individual will pay his prescribed penalty. An individual who signs a contract with no intention of fulfilling his obligations is committing fraud. If fraud is a widely accepted practice, contract law is dysfunctional.

That is why the recent corporate accounting scandals are so bothersome and why the market has reacted swiftly with such brutal efficiency. Bad actors committed fraud so pervasively that the market is now worried about the basic moral character of the individuals in the system ? and that’s a huge problem.

Patrick Ruffini sent this very fine essay, which points out one of the most misunderstood aspects of capitalism, its dependence on a stringent and universal morality. For freedom to function generally it requires that behavior be fairly predictable. Since humans are notoriously unpredictable, it requires that they have internalized a moral code which will in most cases override their personal desires and their natural tendency towards wholly selfish behavior.
Posted by Orrin Judd at August 9, 2002 11:20 AM