v1n1: Jaworski on Heath

“Moving Beyond Market Failure: When the Failure is Government’s” by Peter Jaworski

http://doi.org/10.12747/bejr2013.01.01

A COMMENT ON Joseph Heath (2006), “Business Ethics Without Stakeholders,” Bus Ethics Q 16(4): 533–557.

Abstract: Joseph Heath lumps in rent seeking with cartelization, taking advantage of information asymmetries, seeking a monopoly position, and so on, as all instances of behaviour that can lead to market failures in his market failures approach to business ethics. The problem is that rent and rent seeking, when they fail to deliver socially desirable outcomes, are instances of government failure. I try to argue that this is so, offer an amendment to Heath’s approach, and then explain why accurately describing the failure matters.

To download the full PDF, click here: Jaworski on Heath.


Update! Now see also Heath’s reply to Jaworski.


16 Comments on “v1n1: Jaworski on Heath”

  1. OK, I’ll get the discussion going!

    Peter, I worry that there’s a false dichotomy here between market failure and government failure. Why can’t a single situation embody both? When governments enact protectionist measures, can’t we reasonably describe that as a) a government failure that results (or can result) in b) a market failure?

    And so, as a normative matter for business, can’t Heath say that businesses ought not foster government failure as a way of creating (or in a way that risks) market failure?

  2. rob phillips says:

    First let me say congratulations to Chris and Alexei on the new journal. Excellent idea! Consider yourselves Tweeted and followed.

    Now for a few remarks on the Heath paper. Or, more accurately, a list of readings and a general query about what effect they have on Heath’s arguments.

    First, how does Heath’s approach compare or relate to the “implicit morality of the market” arguments in Christopher McMahon, “Morality and the Invisible Hand,” Philosophy & Public Affairs, Vol. 10, No. 3 (Summer, 1981), pp. 247-277 and the related Daniel R. Gilbert, Jr. “Corporate Strategy and Ethics,” Journal of Business Ethics, Vol. 5, No. 2 (Apr., 1986), pp. 137-150? There may be some useful interplay to be had between the papers.

    Next, Lynn Stout lays waste to the dogma of shareholder wealth maximization in her (helpfully brief) The Shareholder Value Myth. Do her arguments against the idea that shareholder wealth maximization is codified in corporate law damage Heath’s claims? Or, perhaps the implicit morality arguments remain intact, but their strength relative to stakeholder theory is diminished.

    And on that note (and unapologetically self-servingly), several of the shortcomings Heath attributes to stakeholder theory are addressed in my own BEQ articles starting in 1997 and most completely addressed in my 2003 book, Stakeholder Theory and Organizational Ethics. If some intrepid reviewer would like to talk about anything I’ve said there, I would be most eager to engage with that conversation.

    –rp

    • Thanks, Rob.

      I can only speak to part of your comment. I don’t think Lynn Stout’s argument really touches Heath, since his is a moral argument not a legal one. Nothing in it relies on a legal standard of shareholder primacy. It’s about the preconditions required for markets to work well, and the way those preconditions should be understood as the ‘implicit morality of the market.’ (Yes, Heath shares that term with McMahon, but I can’t recall if Heath actually discusses McMahon in any detail in his pieces on market failure.)

      • rob phillips says:

        I appreciate Heath’s (and McMahon’s and Gilbert’s) arguments very much. As I do van Oosterhout el al.’s similar arguments in 2006 Academy of Management. There is an interesting discussion to be had comparing “implicit morality” arguments to a robust version of stakeholder theory (i.e., not the “multi-fiduciary” version).

        I’m tempted to agree with you when you say, “Nothing in it relies on a legal standard of shareholder primacy.” (Heath, 2006: 541 – “Thus in order to see managerial obligations toward shareholders as genuine moral obligations, one cannot merely point to their fiduciary status”)

        But what then are we to make of the references to (supposed) legal duties to shareholders? For example:

        p. 548 – “In particular, the downgrading of shareholder claims creates an enormous tension with corporate law, which remains very much committed to the idea that shareholder have a special status within the firm, and that managers owe them fiduciary duties.”

        fn17 – “This should be interpreted as a positive (i.e., factual) claim about the structure of corporate law.”

        p. 538 – “As a result, there is a set of fiduciary principles governing the relationship between managers and shareholders. Because the fiduciary relationship imposes upon managers a very broad “duty of loyalty” and “duty of care” toward shareholders concepts with explicit moral overtones this particular relationship might be thought to serve as a natural point of departure for the development of a theory of business ethics (in the same way that duties toward the patient form the core of professional ethics for doctors, duties toward the client the core of professional ethics for lawyers, etc.). Yet despite the fact that moral obligations towards shareholders are such a striking feature of the managerial role, in the business ethics literature they are the subject of considerable controversy, and are often downplayed or dismissed. (Marjorie Kelly, the editor of Business Ethics magazine, set the tone for one end of this discussion with the title of her article,” Why All the Fuss About Stockholders?”). There are several reasons for this relative neglect of the shareholders some worse than others.

        p. 539 – “Thus a very robust theory of business ethics could be developed based simply on the injunction to respect the spirit of this judgment, along with the fiduciary obligations that it outlines toward shareholders”

        etc.

        It seems that these passages are either intended to impute some relevant baseline or default position that competing theories must overcome or they are just gratuitously incorrect and do not bear on the arguments. Reverting to a principle of interpretive generosity, I will rely on the former. But in that case, we have to conclude that Heath’s interpretation of corporate law does play at least some role in the arguments. And if so, this role is one of mistake in light of Stout’s sustained and compelling critique.

        In any case, I re-issue my request (challenge?) that some intrepid reader engage in a more comprehensively informed discussion of the relative merits of stakeholder theory vs. implicit morality theories.

  3. Chris: I see no reason why some situation could not embody both government and market failures. What we need to do, however, is to clearly distinguish the bit of inefficiency attributable to market institutions, and the bit attributable to regulation or intervention.

    Since rent-seeking, tariffs, and quotas (the examples in Heath) are clearly the sorts of things that governments do, whenever they generate (additional?) inefficiencies it is appropriate to call the bit of inefficiency generated by those regulations or policies as government failures.

    When we describe something as a government failure, we are saying that a regulation or intervention distorts the market leading to a socially inefficient outcome. When we describe something as a market failure, we are saying that the institutions of the market *free of intervention* lead to a socially inefficient outcome. Strictly speaking, for any particular bit of inefficiency, it can only be a result of government or market failure, but not both. Maybe this would be more obvious to more of us if it was called a “free market failure,” rather than just as a “market failure.”

    So, a “bad” intervention can lead to inefficiencies in the market for cars. But an inefficiency in the market for cars does not a market failure make. It only counts as a market failure if the institutions of the market led to the inefficiency, without intervention. This is because the strict and technical meaning of “market failure” is dependent on an idealized model of a market free of government intervention (This might be helpful: http://www.economicsonline.co.uk/Market_failures/Types_of_market_failure.html).

    I suppose it might be more obvious if we referred to it as a “free market failure” rather than just as a “market failure.”

  4. Peter: Better, I think, than appealing to a technical economics definition to make your point is to observe that, in terms like ‘market failure’ and ‘government failure’, the adjectives are causal (rather than, say, locational) modifiers. Thus, a market failure is an inefficiency caused by market forces; a government failure is an inefficiency caused by legislative or administrative rule making. That seems to be the spirit in which you offer your criticism of Heath: by calling tariffs, price floors, and so forth ‘market failures’ he makes (or, at least, invites his reader to infer that he is making) a causal attribution error – attributing to market forces what is the handiwork of government functionaries. A big part of public policymaking is making causal attributions. If, as Heath (implicitly) and Norman (explicitly) suggest, business people ought to guide their actions by norms informing good public policymaking, it would seem to follow that business people must be careful in making causal attributions about the inefficiencies they are called upon to avert (or, at least, avoid exploiting).

    • Alexei, that helps. But we need to think in terms of causal chains, don’t we? When companies (market actors) lobby government to, say, raise barriers to entry, it looks like government is merely part of a causal chain, an instrument in what is in many ways a market story. I’m happy to caul that a government failure (too), but it fits fine with Heath’s story, since it involves market actors working to render markets less competitive and hence (per hypothesis) less efficient.

    • Thanks, Alexei. I agree that that is a much better way of putting the point.

      • The distinction Alexei points to is useful, but I’m not sure it’s anything like canonical. Bator (1958) for example is considered a key source on this topic, yet he explicitly refers to “failure by enforcement” as one category of market failures. So the term “market failure” needn’t refer to failures caused by market forces. (Or has Bator’s usage been superseded?)

        • For those interested: Francis M. Bator (1958) “Anatomy of Market Failure” Q J Econ, 72(3).

        • I don’t offer that account because it’s canonical. I offer it because it’s (i) a reasonable reconstruction of what Peter is saying and (ii) the sense in which most non-economists use terms like ‘market failure’ and ‘government failure’ – how ever economists may use them.

          That said, I believe appeals to market/government failure are attempts to put a (social) scientific veneer on what are, at bottom, statements about value. Heath calls business firms lobbying for, e.g., tariffs ‘market failure’ because, in his (basically technocratic) worldview, but for the distortive effects of self-seeking business people, efficient public administration would prevail. Jaworski calls the same thing ‘government failure’ because, in his (Virginia public choice-inflected) worldview, but for the distortive effects of self-seeking elected officials, efficient markets would prevail. Like both of them, I have views on the matter. (Mine are closer to Jaworski’s.) Unlike both of them, I don’t think a superior grasp of (social) science underwrites my view.

          • Alexei: I think it is true that the concepts “government failure” and “market failure” have come to be used as kinds of criticism. But in my Comment, that is not the intention. Recognizing that regulations and interventions by the government can result in an inefficient outcome does not mean that any particular or actual policy leads to an inefficient outcome. That is, I think, a separate discussion. Anyone with any view about what the ultimate cause of social inefficiency really is (whether it’s the greed of market actors, or the self-seekingness of political or public actors) should be willing to accept the theoretical distinction that I’ve made in my piece as a friendly amendment to Heath’s market failure approach.

            When Heath writes about quotas and tariffs as causing inefficiency, we need to recognize that, in that case, it would count as a government failure. Whether or not any particular quota or tariff does this is a matter of controversy. The distinction that I draw is a distinction that people with a basically technocratic worldview should be willing to adopt, because it does not commit them to any further views about what is better. It only commits them to the claim that “when the government causes inefficiency, it is a government failure.” That commitment is hardly the sort of thing that underwrites laissez-faire (or any view about what institutions we should endorse). It is only when we say of any real-world policy that it is an instance of government- or market failure that we begin to make the kind of judgment you suggest. In my comment, I say nothing of any real-world policies. So it is perfectly all right for someone to say, “when the government causes inefficiencies, that is government failure. But we have never been witness to government failure, since the root cause of all inefficiency is one or another market institution.”

  5. Adam says:

    (2 cents from an economist)

    Bator was writing before there was a concept of government failure. Peter and Alexei are closer to the post-1960′s economists’ use of the terminology*–which, as Alexei correctly notes, are just value judgments. Nonetheless, they are value judgments that have some sort of causal inference embedded in them.

    What makes a failure to be “market-” or “government-” is the RULES that generate the inefficiency. If, e.g., the rules of private property fail to internalize a cost, then there is a market failure. If the ability of government to restrict competition creates the inefficiency, then it is a government failure.

    The problem with the “causal chain” argument is this: every relevant causal chain is going to involve both causal forces. If you go back in time far enough any government policy will have been historically influenced by an interaction under market rules, e.g., a prospective politician buys a copy of Marx that influences his later policy beliefs.

    Would it be a market failure if firms failed to lobby against an inefficient policy? Would it be government failure if public schooling didn’t instill an anti-rent-seeking ethos? If we’re talking in terms of causal chains then all failures are just “social failures,” neither market nor government. For the distinction to be serviceable at all, it needs to be about what rule proximately causes the divergence of private cost and social cost. I have my own problems with it but Peter appears to be using the distinction more properly.

    *There is a use–idiosyncratic as far as I know–that describes all failures of individual rationality to add up to group rationality as “market failures.” That is, the author explicitly disavows that market institutions have to be present, and instead wants to use “market failure” as synonymous with “inefficiency.” Then it becomes a theoretical and empirical question as to whether government creates more market failure than it alleviates. The economist in question is David Friedman, who thinks “market failure” is a good reason not to have any government at all. I mention this only because it is amusing and obviously an unhelpful use of language.

    • Adam:

      Thanks, that’s very helpful. (The little I’ve read on MF is maddeningly vague. Lots of examples, but few explanations of necessary and sufficient conditions. And if you read classics like Bator, you end up missing modern consensus, such as it is. Suggested readings would be welcome!)

      What you say about causal chains is of course correct, but it’s not really a “problem” I think. Heath is admonishing businesses not to engage in certain kinds of behaviours. (Actually *exactly* what he’s admonishing them to do is ambiguous, which is something I’m currently working on.) But regardless of precisely what Heath means, it would likely map just fine onto the normal moral distinction between acts and omissions, namely that duties to avoid certain behaviours are typically taken as being more important than duties to actively do good. The ontological question of whether a particular instance is “really” a case of government failure or market failure is more or less moot.

  6. John says:

    While I very sympathetic to Peter’s criticism there’s an aspect that is missed. Not having access to the article being critiqued I’m not sure if Heath is thinking along these lines or not.

    I would argue that within large corporations there is still opportunity for various forms of rent-seeking behaviors related to the producer surplus that most large corporations enjoy; these funds represent a pool of money that is not market allocated but will be distributed by the governing body of the corporation. I suspect all are familiar with the potential problem of shifting private consumption, indirectly achieved, into corporate costs.

    The questions is do such rent-seeking behaviors belong to the market or to government? It’s not nearly as clear as when on points to trade protections or favorable tax policies, or even outright grants of monopoly with a very accommodating regulator. Still, I’m a bit hard pressed to lay the blame here on government.

    True, one might suggest that it’s a government failure to enforce property rights and the extravagant art on the walls of the corporate headquarters should be returned to shareholders. But personally I would prefer those types of disputes be settled through both shareholder actions and common law processes rather than regulatory and statutory approaches. So to me these would fall more into the market’s lap than government’s lap.

    The question then becomes what systemic impacts will such internal rent-seeking behaviors have? I suspect it’s difficult to tell because one needs to really be able to measure the true corporate culture (which is a critical institution within a modern market society) and not merely the published policies they have written down.

    • John: In the piece by Heath, and in a longer article that I’ve written on this that is currently under review, we both use rent-seeking in a sort of peculiar way. We both — this is, at least, my interpretation of Heath — mean to refer only to instances of trying to seek private gain over cost (including opportunity cost) through government institutions.

      There is, in my opinion, no very good definition of rent-seeking on offer. Buchanan and others offer question-begging definitions, that include the (empirical) outcome of the behaviour (social waste) as part of the definition of rent-seeking. Of course, that renders all of the work by economists that purport to find socially efficient and non-wasteful instances of rent-seeking mere conceptual confusion.

      I’m currently doing my best to come up with a non-question-begging definition of rent-seeking that would capture not just cases where people seek changes in the regulatory framework or some other special treatment at the hands of government as rent-seeking, but would also include the case you suggest, and other cases (like Buchanan’s example of a family fighting over an inheritance). The criteria for a good definition would allow us to identify rent-seeking ex ante, before we discover that there is any social waste or gain. It would then be a genuinely empirical question whether or not some particular instance of rent-seeking is or is not socially wasteful.


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