The three principles of ethical capitalism

by Dr Paul Vorster | Published on 25 February 2019 for The Ethics Institute monthly newsletter

Is ethical capitalism a contradiction in terms? Perhaps, observing the economically unequal society we live in today, one might feel obliged to say ‘yes’. If a system generates such stark disparities in wealth and life prospects for different people, often based entirely on the circumstances of their birth, it would surely by nonsensical to describe that system as ethical. It is instructive, therefore, to pay attention to the moral points that Adam Smith, the ‘Father of Economics’ himself, made about capitalism. Three distinctly ethical principles – prosperity, justice and liberty – were woven into Smith’s famously lucid explanation of the forces shaping what we still call the free market. And it is high time that they were re-emphasised.

South African money "The free market should, by its very character, increase the purchasing power of its citizens over time and thus improve their quality of life."

Adam Smith wrote his epic treatise The Wealth of Nations in 1776 (Smith, 2000). At the time, monarchies and the feudal system were still the status quo in Europe. The first pistons of the Industrial Revolution had just begun to stir, and the French Revolution, which would radically change individual rights and herald the age of democracy and liberty, was still thirteen years away. So, to lay the descriptive groundwork for a capital economic system that is still relevant today was, in short, visionary work.   

The free market, as related by Smith, is an economic system that is based on the mechanics of supply and demand. If there is a demand for something in the market, enterprising individuals or groups can use their skills and knowledge to produce something that meets it. Anyone can participate (indeed, the free-market system encourages participation and equity) and so, if the demand is great enough, more and more producers can supply the same product or service, thus resulting in competition. By necessity, an improvement of the quality of the product or service, and the reduction of its price, will result from these iterative competitive dynamics. The converse is also true. If a good or service is substandard, or an enterprise is considered untrustworthy, consumers will stop utilising it and seek out alternatives from competitors. In this way, free-market competition should stop producers from exploiting consumers and losing their ‘licence to operate’. In essence, the free market should self-correct.

Ideally, competing for price, quality and legitimacy, drives lower costs of production, higher standards of excellence and greater accountability, which is good not only for the producer, but also for the consumer. To use Smith’s famous phrase, the automatic or ‘natural’ interplay between producers, their products and services, and the market, acts as an ‘invisible hand’, constantly recalibrating supply and demand, as well as the morality and trustworthiness of producers.

Obviously, and unfortunately, this is not the state of things as we see them today.   

We have daily evidence in the modern world that producers can exploit the system through, for example, anti-trust monopolies, price-fixing, consumer manipulation, and the constant drive for power, status and wealth at the expense of the poor. This has ironically resulted in a new type of monarchy – which the free market aimed to displace – of the ‘haves’ and the ‘have-nots’. Perhaps Smith’s primary failing was that he placed too much emphasis on the benevolence of producers and too little emphasis on the failings of human nature.

Our own country is a spectacular example. South Africa has the dubious honour of being one of the most unequal economies in the world, where 20% of the population have only a 2.5% share of national income (Keeton, 2014; World Bank, 2019). Why has this happened? Surely Smith’s free market should have allowed more individuals to enrich themselves and participate in the economy? Is it that Smith ignored the selfishness and greed of human nature?

In fact, Smith did anticipate human nature – at least, he tried to. What is interesting, and often forgotten, is that Smith proposed the free market system as a moral philosophy that was supposed to improve the quality of life of everyone in a particular economy (Wells, 2014). Yes, strange as that may sound at first, the free-market system was in fact conceived as a moral philosophy that was supposed to rid the world of the social inequality that stems from economic inequality. However, this moral good of the free market was not inherent, but rather relied on the beneficence of producers in the market and their adherence to three basic principles, namely prosperity, justice, and liberty (cf. Wells, 2014).  

Prosperity

Smith’s notion of the wealth of a nation was characterised by the degree to which an individual citizen has access to goods and services that satisfy his or her wants. Therefore, Smith was quite aware that the wealth of a nation was not only how many rich people or corporations it had, but rather how well wealth was distributed among citizens. In other words, when producers compete fairly and freely, more and more individuals would be able to provide their resources (skills and labour) to produce more and more goods. If enough goods were produced, reducing the demand in the market, the unit cost of products would drop too. Consequently, citizens would eventually have access to goods and services that would have been prohibitively expensive to procure in a non-capitalist economy. Therefore, the free market should, by its very character, increase the purchasing power of its citizens over time and thus improve their quality of life.

Unfortunately, many producers have instead tried to keep the costs of their goods and services high. For example, in South Africa, bread producers colluded to fix the price of this staple foodstuff at a much higher level than it should have been in a free market (Flanagan et al., 2007; Seria, 2007). International examples include the Organization of the Petroleum Exporting Countries (OPEC) that often controls supply to keep prices artificially high, and the Federation of Maple Syrup Producers in Quebec, Canada, that did the same with maple syrup (Edmiston & Hamilton, 2018; Watts, 2019).

Such anti-competitive behaviour, borne of a one-dimensional pursuit of economic growth, exerts an artificial pressure on the ‘natural’ pricing mechanism of the free market, and therefore directly goes against the principle of prosperity envisaged by Smith. It is important to realise that Smith’s idea of prosperity was closely linked with equality; in other words, that an economy based on a free-market system would be mutually beneficial for the producer and consumer.

Justice

Interestingly, Smith anticipated a form of ‘state capture’, and was a believer in social justice. He argued strongly that equity was one of the most important mechanisms of ensuring that everyone has an equal opportunity to benefit from the economic system, not only a few. Writing in his characteristically lyrical way, Smith said that:

To hurt in any degree the interests of any one order of citizens for no other purpose but to promote that of some other, is evidently contrary to that justice and equality of treatment…”

What he meant was that every producer has a moral responsibility to ensure that it shares with those who help produce goods and services what they deserve in a fair and equitable manner. In fact, Smith’s view that a just economic system should bring happiness to as many people as possible has a distinctly utilitarian flavour. Ideally, no one group – neither a producer, nor a government – should ever conspire to short-change a less-powerful group.

Liberty

Smith argued that freedom from constraints, freedom from domination and moral autonomy formed the backbone of the free market. What this means is that the individual can choose how to participate in an economy without intimidation, coercion or by having to adhere to excessive regulation. Smith referred to these as artificial obstacles that limit the degree to which people can get along with their own lives and participate within an economy as they like. In a nutshell, Smith was a champion of economic and thus social self-determination.

This does not mean that Smith was naïve. Indeed, he did motivate for some regulation, but only if such regulation increased the freedom with which people could participate in an economy. For example, Smith argued that the role of governments was to increase the security of a society, and that government-controlled financial institutions should keep interest rates as low as possible to facilitate open and participative business, free from credit exploitation. More importantly, it is the moral responsibility of producers to not artificially exclude others from participating in the economy, and it is the role of certain mandated institutions (such as the Competition Commission in South Africa) to ensure that this does not happen. Having said that, some economic laws and legislation have led to consequences that are decidedly unjust – Apartheid in South Africa is the obvious example of the evils of exclusion, and just about any country that doesn’t rein in the influence of the wealthy on political decision-making opens the door to tax abuse.

In conclusion

Smith’s ideas about the free market anticipated much of the corruption and exploitation currently observed in the capitalist system. It probably isn’t much of a stretch to say that Smith would have been a proponent of the idea that business ethics is about doing what is good for the self (the organisation) and the other (the consumer and employee) in a mutually beneficial manner. Look after the needs of consumers and they will do the same for you. Smith would also probably have been a champion of corporate governance initiatives, such as the King series of reports, and the triple bottom line approach. Smith anticipated many of the problems a free market may throw up, but he intended for such a system to be based on strong moral principles of responsible and ethical business. It is prudent for us to look more closely at Smith’s The Wealth of Nations instead of perpetuating ideas about it that were not intended. A purer form of capitalism as a moral economic philosophy, instead of only an exclusively economic philosophy, is required for economies to return to the principles of prosperity, justice and liberty. 

 

References

Edmiston, J., & Hamilton, G. (2018). The last days of Quebec’s maple syrup rebellion. Retrieved online from https://nationalpost.com/news/canada/the-last-days-of-quebecs-maple-syrup-rebellion

Flanagan, L., Smillie, S., & Tromp, B. (2007). The great bread scandal. Retrieved online from https://www.iol.co.za/news/south-africa/the-great-bread-scandal-378568

Keeton, G. (2014). Inequality in South Africa. Journal of the Helen Suzman Foundation, 74 , 26 – 41.

Smith, A. (2000). The wealth of nations. New York, NY: Modern Library

Seria, N. (2007, November). Tiger Brands admits to bread price fixing, pays fine. Retrieved online from https://www.moneyweb.co.za/archive/tiger-brands-admits-to-bread-pricefixing-pays-fine/

Wells, T. R. (2014). Recovering Adam Smith’s ethical economics. Real-world Economics Review, 68, 90 – 97.

Watts, W. (2018). Opec is neither an oil ‘cartel’ nor a price fixer, insists top official. Retrieved online from https://www.marketwatch.com/story/a-price-fixing-oil-cartel-thats-not-opec-says-opec-secretary-general-2019-02-11?mod=newsviewer_click

World Bank (2019). GINI Index – World Bank estimate. Retrieved online from https://data.worldbank.org/indicator/si.pov.gini?view=map 


Paul circle

 

Dr Paul Vorster is a Research Specialist at The Ethics Institute. He holds a doctorate of Industrial Psychology, which he attained from the University of Johannesburg.