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The Free-Market Solution to Ethical Problems

For well over two years now, we have been wringing our hands about ways to make businesspeople act more ethically. We’ve tried criminal prosecution. Legislative action. Public opprobrium.

Enough. We have missed the obvious. As with many of civilization’s most intractable problems, there is a very simple answer: the free market.

Our problem is that we have been framing the problem in terms of “ethics,” “morality,” “justice,” and other subjective concepts. A dollar is a dollar is a dollar, but one person’s morality is not another person’s morality. Pinning down morality is like trying to nail Jell-O to the wall. What is morality? What is Jell-O? Even if you know, you still can’t nail it to the wall, and therein lies the problem.

We need a new approach that re-conceptualizes “ethics” in terms of the hard, bottom-line reality of the 21st century. How do we do this?

If we could x-ray an “unethical action” – peer through all the superficial talk about equity and fairness and righteousness – and expose its inner structure, we would recognize it for what it is: an externality.

The ordinary course of business produces unethical behavior, just as the ordinary operation of a factory produces pollution. With fuel comes smog. With omelettes come broken eggs. And with value-maximized shareholders come defrauded employees.

Pollution is the best model for the “problem” of unethical behavior. Now, we could all jump up and down and flap our arms around and shout, “Hey, pollution is evil! Let’s put the polluters in cages!” But this would not accomplish much.

A better option is to nestle ourselves in the gentle grip of the invisible hand. With pollution, we have learned an important lesson: The best way to deal with externalities is to create a market for them.

Pollution “permits” have been designed, which allow businesses to trade for the right to pollute. In this way, we regulate pollution without crushing businesses that need pollution to exist, such as acid rain manufacturers.

Once we have recognized the parallel to pollution, the answer is clear. It is foolish to pretend that we can wave our Anti-Whammy Wand and make unethical behavior disappear. We must accept it and ration it. In short, we must create tradable permits for unethical behavior.

We can call the program “Permits for the Suspension of Ethics” (PSEs). The PSEs could be printed on special paper, with holograms or disappearing ink, to prevent counterfeiting. PSEs would be available via Airborne Express or, in the event of an emergency, by fax. Unfortunately, holograms do not transmit well over the fax, which could create concerns about authenticity. This issue will need to be explored before the roll-out begins.

The operational issues are trivial, though, relative to the enormous gains that society could realize. How much anguish could have been avoided if Arthur Anderson had traded for the right to shred its incriminating documents? How many jobs would have been saved?

What if Enron could have indefinitely concealed its off-balance-sheet dealings? Think of the revenue society could have generated from such permits. With this money, how many kids could we have kept off crack?

Through the magic of the free market, the businesses with the greatest need to act unethically could do so. Businesses who choose to act ethically could sell their excess PSEs for a profit. Translation: Ethical businessmen win, unethical businessmen win, and society wins. Crack loses.

Questions will arise. How will we know what kinds of behavior require a PSE? The line between “unethical” and “tough-minded” can be hazy indeed. For example, if a CEO wants to raid his employees’ pension fund, does he need a PSE? Look, it’s a gray area.

All of the sudden, we’re back to the problem of defining “ethics.” But, once again, the free market provides an answer. There is a word for what we do when something is too hard to do ourselves: outsource. We will outsource the definitional aspects of ethics to experts in the industry, such as William Bennett and Dr. Phil.

Another common question people have about PSEs is: What happens if someone uses a PSE unethically? For example, imagine that a businessperson purchases a PSE to use for firing the audit committee, but then uses it instead for something much worse, such as allowing the formation of a union. What can be done?

One option is to make the misuse of PSEs a crime. There is some irony, though, in looking for a “big-government” solution to a free-market problem. A better proposal, suggested by leading economists, is to create Meta-PSEs, or tradable permits that can be bought to authorize the unethical use of PSEs.

No doubt people will want to quibble about questions such as these. The bottom line, though, is that if you oppose the PSE program, you are encouraging black-market unethical behavior. If you want fraud and corruption to breed in dark alleys, then by all means, shout down PSEs. We should invite bad ethics into the light. “Come in, little fella. We want to keep an eye on you.”

Our society faces a fork in the road. One path leads to ethical witch hunts, irrationality, and crack. The other leads to economics, efficiency, and nestling in the gentle hand. It’s our choice to make.

Reprinted from 3.1.04

March 7, 2005
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