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The London School of Economics and Political Science: Department of Philosophy, Logic and Scientific Method Is the Perfectly Competitive Market a Morally Free Zone? Dana Andreicut Word Count: 7,000 MSc Economics and Philosophy 2010/2011 Table of Contents 1 Introduction................................................................................................................. 2 2 Morals by Agreement ................................................................................................. 4 2.1 Gauthier’s Thesis ................................................................................................... 4 2.2 Background Assumptions ...................................................................................... 6 2.2.a) Pareto Efficiency ........................................................................................... 6 2.2.b) Welfare Economics and Market Failure ....................................................... 7 2.2.c) The Initial Endowments ................................................................................. 8 2.3 The Perfect Market as a Morally Free Zone ........................................................ 10 3 A Critical Analysis .................................................................................................... 14 3.1 Pecuniary Externalities ........................................................................................ 14 3.2 The Limits of the Market ..................................................................................... 19 3.3 Voluntary Market Participation ........................................................................... 21 3.4 Multiple Equilibria............................................................................................... 25 4 Pareto Optimality...................................................................................................... 28 5 Concluding Remarks ................................................................................................ 31 Bibliography .................................................................................................................. 33 1 1 Introduction Economics often treats the perfectly competitive market as a space in which moral judgement is not necessary. The efficiency of markets culminates in the achievement of optimality, a state in which often divergent interests are elegantly reconciled by the invisible hand. Going back to Adam Smith, economics endorses the view that individual pursuit of self-interest ensures a maximum gain for each participant to market activity.1 In the realm of free market economics, morality appears to be superfluous. In chapter four of Morals by Agreement (1986), David Gauthier puts forward the idea that free market activity, in the absence of market failures, brings about optimal outcomes for the participating individuals. He goes on to argue that a perfectly competitive market (PCM henceforth) is a morally free zone. This paper will critically assess Gauthier’s claim. It will challenge his view and show that his argument is problematic. Furthermore, it will suggest that his reliance on Pareto optimality, for the assessment of the moral neutrality of an outcome, is inadequate. This paper will proceed as follows. Section 2 will begin by discussing Gauthier’s overall aims in Morals by Agreement. The latter part of the section will provide the background assumptions that Gauthier is using in his analysis. It will then proceed with the author’s depiction of the PCM. Section 3 will offer a critical analysis of the argument, by presenting four objections against Gauthier’s thesis: the existence of pecuniary externalities, the limits of the market, the voluntary nature of market participation and the possibility of multiple equilibria. 1 Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, ed. Kathryn Sutherland, (Oxford: Oxford University Press, 1998), p. 22 2 The paper will then analyse whether Pareto efficiency is a necessary and sufficient condition for the moral neutrality of a market outcome. This will be done in Section 4, which will argue that multiple equilibria question the sufficiency of Pareto efficiency. Its necessity in turn is challenged by the existence of pecuniary externalities and involuntary exchange. Two further points will be raised to strengthen this argument. The paper will conclude that Pareto efficient allocations are often not neutral and that the PCM is not a morally free zone. 3 2 Morals by Agreement Before analyzing the PCM and the morally free zone, it is important to understand how these concepts fit into Gauthier’s overall aims in Morals by Agreement. 2.1 Gauthier’s Thesis Gauthier sets out to derive morality from rationality. He believes that an individual is acting rationally if and only if she pursues “her greatest interest or benefit.”2 She does this by maximizing her utility in line with her preferences, “whatever the content of those preferences.”3 In his derivation of morality, Gauthier provides a contractarian account of why it can be rational to control the pursuit of one’s self interest. According to contractarianism, moral norms acquire a normative force from a contract or mutual agreement between individuals.4 These norms are artificial5 moral constraints to the pursuit of self-interest.6 They are necessary because the pursuit of one’s self-interest often leads to suboptimal outcomes, such as prisoners’ dilemmas or market failures. Prisoners’ dilemmas occur when individual utility maximization results in outcomes 2 David Gauthier, Morals by Agreement (Oxford: Clarendon Press, 1986), p. 7 David Gauthier, ‘Morals by Agreement – Reply to Wolfram-,’ Philosophical Books, Vol. 28, No. 3 (1987), p.135 4 Ann Cudd, ‘Contractarianism,’ The Stanford Encyclopedia of Philosophy, ed. Edward N. Zalta, http://plato.stanford.edu/archives/fall2008/entries/contractarianism/ Accessed on 16/07/2010. 5 Peter Danielson, ‘ The Visible Hand of Morality,’ Canadian Journal of Philosophy, Vol. 18, No. 2 (1988), p.358 6 David Gauthier, ‘Morals by Agreement – Reply to Wolfram-,’ Philosophical Books, Vol. 28, No. 3 (1987), p. 138 3 4 that leave all parties worse off than they would have been had they cooperated.7 Market failures will be addressed in more detail in Section 2.2.b). If it were possible for individuals to come together and bargain about the terms of their interaction, Gauthier suggests that they would agree to enforce moral constraints.8 Starting out with rights over their body and mind, individuals gradually acquire rights to material goods, provided they abide by what he calls the Lockean Proviso. The Proviso prohibits making oneself better off by making someone else worse off. It also establishes the initial endowments that the parties bring to the bargain.9 The principle which is to guide the bargaining process is that of ‘minimax relative concession.’ According to it, the distribution that comes about as a result of cooperation should minimize “the largest relative concession made by any of the parties to the cooperative enterprise.”10 The optimal outcome is achieved when the parties have made concessions that are equal to each other.11 While moral constraints are necessary in the presence of market failures and prisoners’ dilemmas, there is one space where they are not required. This is the perfectly competitive market. The PCM is defined by the absence of externalities and public goods, perfect information, certainty and price taking behaviour. In this realm, 7 Dan W. Brock, ‘Critical Notices,’ Philosophy and Phenomenological Research, Vol. 49, No. 1 (1988), pp. 157-158 8 David Gauthier, ‘Morals by Agreement – Reply to Wolfram-,’ Philosophical Books, Vol. 28, No. 3 (1987), p.136 9 David Gauthier, Morals by Agreement, (Oxford: Clarendon Press, 1986), p. 205 10 Ibid., p.158 11 Jean Hampton, ‘Can We Agree on Morals?’ Canadian Journal of Philosophy, Vol. 18, No. 2 (1988), p.333 5 utility maximizing action leads to Pareto efficient allocations.12 Because the allocations are efficient and are achieved through free exchange, Gauthier concludes that the PCM is a morally free zone. 2.2 Background Assumptions To get a better grasp of Gauthier’s argument, it is useful to consider some of the background assumptions that he is working with. These are Pareto efficiency, the tools of welfare economics and the initial endowments. 2.2.a) Pareto Efficiency The author uses the notion of Pareto optimality as formulated in microeconomics. “A feasible allocation x is a weakly Pareto efficient allocation if there is no feasible allocation x’ such that all agents strictly prefer x’ to x. A feasible allocation x is a strongly Pareto efficient allocation if there is no feasible allocation x’ such that all agents weakly prefer x’ to x, and some agent strictly prefers x’ to x.”13 Strong Pareto efficiency implies weak Pareto efficiency. For the purpose of Gauthier’s argument, it is not necessary to distinguish between weak and strong efficiency. I will therefore use Pareto efficiency (or Pareto optimality) to describe an outcome in which the only way to make someone better off involves making someone else worse off. 12 Dan W. Brock, ‘Critical Notices,’ Philosophy and Phenomenological Research, Vol. 49, No. 1 (1988), p. 158 13 Hal R. Varian, Microeconomic Analysis (New York: W.W. Norton & Company, 1992), p. 323 6 2.2.b) Welfare Economics and Market Failure Gauthier is also relying on the First Fundamental Theorem of Welfare Economics. This states that any competitive equilibrium is Pareto efficient.14 Figure 1 illustrates such an efficient allocation. It depicts a simple economy with two consumption goods and two individuals (A and B), with well-behaved indifference curves. The latter are convex and differentiable, guaranteeing an interior solution to the utility maximization problem. The point of tangency (E) between the indifference curves constitutes the competitive equilibrium, which is Pareto efficient. Figure 1: Good 2, Mr. A OB Good 1, Mr. B E Good 1, Mr. A OA Good 2, Mr. B When market failures occur, the competitive equilibrium is no longer efficient.15 This can happen in the presence of externalities. Externalities represent “the imposition of noncompensated harms or benefits on parties who are not primary participants in 14 Wyn Morgan, Michael Katz and Harvey Rosen, Microeconomics (Berkshire: McGraw Hill Education, 2006), p. 433 15 Jean Hampton, ‘Can We Agree on Morals?’ Canadian Journal of Philosophy, Vol. 18, No. 2 (1988), p.334 7 exchange.”16 An example is a cement producer who pollutes the air around his factory by emitting CO2. Another cause of market failure is the existence of public goods. These are commodities whose consumption is non-rival. Non-rivalry implies that consumption of a unit by one individual does not preclude the consumption of the same unit by another person.17 Clean air and national defence are well-known examples of such goods. Failures also occur if individuals or firms do not act as price takers (for instance, if a firm can set prices)18 or when there is asymmetric information, which involves one party to the market exchange being better informed than the other.19 2.2.c) The Initial Endowments The initial endowments are taken as given by the market. However, Gauthier stresses that the fairness of these endowments is important and he explains how they come about. Prior to the emergence of the market, people are in a state of nature. This state is defined by Gauthier as one where there are no moral or political constraints, and in which individuals “advance whatever seems best to” them.20 At this point, people possess rights over their mental and physical capacities only. They begin from an initial bargaining position that is non-coercive and which comes under the scope of the 16 James M. Buchanan, ‘The Gauthier Enterprise’, Social Philosophy and Policy, Vol.5, No. 2 (1988), p. 90 17 Wyn Morgan, Michael Katz and Harvey Rosen, Microeconomics (Berkshire: McGraw Hill Education, 2006), pp.674-657 18 Ibid., p. 442 19 Ibid., p. 443 20 David Gauthier, ‘Moral Artifice,’ Canadian Journal of Philosophy, Vol. 18, No. 2, (1988), p. 388 8 Lockean Proviso. The Proviso only allows worsening someone’s situation if “this is necessary to avoid worsening one’s own position.”21 The worsening and bettering of someone’s position need to be judged relative to the situation this person would be in, if another participant to the exchange were not present. Consider an example. You are walking past a river and see someone drowning in it. If you do not save that person, you are failing to better their position. This is not prohibited by the Proviso. If you however pushed that person into the river yourself, and then do not save her, you are violating the Proviso.22 People gradually move from owning their mental and physical capacities to owning material goods. This is made possible by the first appropriator, who Gauthier calls Eve. She encloses a piece of land, which can be of any size provided she does not leave others worse off than they would have been in her absence.23 Gauthier argues that Eve’s action determines others to start appropriating as well. This enables a more efficient use of resources. Thus, even though she acts out of a desire to better her own position, Eve does others a favour by commencing the process of appropriation. Eve benefits most from the process, as she takes the best portion of the common resources. Despite this however, she leaves others at least as well off as they were before appropriation began. Therefore “advantage is not taken, but equality is not assured.”24 21 David Gauthier, Morals by Agreement, (Oxford: Clarendon Press, 1986), p. 203 Ibid., p. 204 23 Ibid., p. 205 24 Ibid., p. 217 22 9 2.3 The Perfect Market as a Morally Free Zone We can now turn to Gauthier’s argument for the PCM. In this space, each individual, while having in mind her own gain, ends up promoting the interest of society.25 The PCM presupposes the absence of force and fraud26 and has the following defining features: 1. Individuals choose their actions by taking the actions of other individuals as given. 2. They have complete information and make their decisions under certainty. 3. They derive utility from consumption and have diminishing marginal utility from it (each additional unit of consumption gives them less utility than the previous unit). 27 4. All products and factors of production are privately owned. Private consumption has two components: private goods and mutual unconcern. The latter implies that individuals do not have an interest in the interests of those they exchange with.28 5. Externalities and public goods are ruled out. Prices are determined by the market and are taken by the individuals as given.29 6. Each individual is defined by his utility function and factor endowments, which determine their preferences and capacities.30 25 Ibid., p. 89 Ibid., p. 85 27 Ibid., p. 85 28 Ibid., p. 87 29 Ibid., p. 88 30 Ibid., p. 86 26 10 7. There is an initial allocation of endowments, which is taken by the market as given.31 Having defined the PCM, Gauthier argues that “the presupposition of free activity is independently necessary”32 before he can conclude that the market is morally neutral. Gauthier illustrates this by means of an analogy focused on Robinson Crusoe. While alone on her island, Crusoe can direct her capacities to the service of her preferences. She can stop her efforts when she foresees that the costs incurred will be greater than the benefits.33 The PCM gives individuals in the market a freedom equal to that of Robinson Crusoe, while offering them the benefits of “exchange and the division of labour-and also, in the long run,” those of investment.34 Individuals bring their fairly acquired endowments to the market. These initial conditions fall under the scope of the Lockean Proviso.35 Just as Crusoe enjoys the full benefits of her labour, similarly the parties to market interaction also receive a marginal product that is equal to their marginal contribution.36 The market provides an improvement on the no trade baseline, while ensuring that individuals engage in voluntary activity. Given the previous seven assumptions and the free nature of market exchange, Gauthier concludes that the market reaches an equilibrium state.37 Each individual is able to choose his optimal consumption bundle, given the prices on the PCM, his preferences and his endowment. Furthermore, the competitive equilibrium that emerges 31 Ibid., p. 94 Ibid., p.90 33 Ibid., p. 90 34 Ibid., p. 90 35 Ibid., p. 205 36 Ibid., p. 91 37 Ibid., p. 89 32 11 is Pareto efficient. Gauthier argues that while many outcomes can be Pareto efficient, “the actual one” that comes about is given by the initial factor endowments.38 He is thus suggesting that the there is a unique Pareto optimal outcome. Gauthier interprets laissez-faire economics as stating that the coincidence of equilibrium and optimality, resulting from free activity, serves as a justification of each person’s pursuit of their own interest. The outcome is efficient and gives each individual a marginal benefit equal to their marginal contribution. Interfering with the actions of individuals implies preventing the optimal outcome from coming about, hence leaving some individual better off at the expense of another.39 While defenders of laissez faire economics may argue that a Pareto optimal outcome is morally right, Gauthier states that morality plays in fact no role in the PCM. Morality would be “a constraint on the individual pursuit of utility.”40 This constraint is unnecessary, since the market outcome is already optimal. Gauthier concludes that the traditional moralist has no tasks to fulfil.41 Gauthier appears to be suggesting a narrow view of morality. He believes that moral judgement is not necessary if we are dealing with a Pareto optimal outcome, which came about through free exchange in the PCM. Moral judgements are only appropriate when some individuals are harmed for the gain of others. His notion of ‘harming others’ however is very specific, as harm is only inflicted when Pareto inefficiencies arise. 38 Ibid., p. 94 Ibid., p. 93 40 Ibid., p. 93 41 Ibid., p. 91 39 12 To conclude this section, let us consider a summary of Gauthier’s argument for the moral neutrality of the PCM. This will allow us to see where the points of contention lie and how they affect the final conclusion that the author draws. 1. The PCM is defined as above. 2. Individuals engage in free and voluntary activity, assuming that: a) Initial endowments are fair. b) The market makes them better-off relative to the no trade baseline. 3. Given points 1 and 2, the market moves to an equilibrium condition. 4. By the First Fundamental Theorem of Welfare Economics, the competitive equilibrium is Pareto efficient. 5. The Pareto efficient outcome is unique. 6. If an allocation is Pareto efficient, this implies that it is morally neutral, as individuals get a marginal benefit equal to their marginal contribution. Given points 1 to 6, Gauthier is now able to draw the following conclusion: The Pareto efficient outcome is a result of the market process and therefore not contingent, but necessary. The social planner has no choices to make, hence the PCM is morally free. 13 3 A Critical Analysis In what follows, this paper will proceed by considering four objections to Gauthier’s claim. These will target specific points and omissions in his argument and will render his conclusion that the market is a morally free zone questionable. 3.1 Pecuniary Externalities The first objection argues that there is a certain category of externalities, which economic theory legitimately disregards, but which morality should be concerned with, even in the PCM. The objection thus targets assumption 6, as it questions the moral neutrality of Pareto efficient outcomes. Economic theory classifies externalities into two categories: non-pecuniary and pecuniary. Non-pecuniary externalities directly have an impact on either the utility function or the production function of a party that does not participate in the exchange in question. An example of non-pecuniary externalities is that of CO2 emissions. Pecuniary externalities on the other hand arise from actions that affect third parties and come about when the terms of trade or prices change.42 Consider the economic intuition behind this. Take a scenario in which two firms interact in the market. Firm 1’s production function is given below43: q1 = f ( x1 , y1 ,...; q2 , x2 , y2 ,...) 42 James M. Buchanan, ‘The Gauthier Enterprise,’ Social Philosophy and Policy, Vol.5, No. 2 (1988), p. 91 43 Randall G. Holcombe and Russell S. Sobel, ‘Public Policy toward Pecuniary Externalities’, Public Finance Review, Vol. 29, No.4 (2001), p. 306 14 In the above, qi represents the level of output of firm i, and x and y represent the inputs used in the production process. A non-pecuniary externality is said to arise when firm 2’s actions have an impact on the physical output of firm 1, while holding the input level of firm 1 constant.44 More specifically, firm 2’s actions directly affect the production function of firm 1, in the sense that either q2, x2 or y2 impact q1. Now consider firm 1’s profit function, defined as the difference between its total revenues and its total costs: π 1 = g (q1, x1 , y1 ,...; q2 , x2 , y2 ,...) Profits are a function of output choices, which in turn depend on the inputs, x and y. The profits of firm 1 do not only depend on its own decisions, but also on the inputs used by firm 2 and on its output decisions. Pecuniary externalities can directly affect the firm’s profits. If the actions of firm 2, through its choice of either q2, x2 or y2, affect π1, then we are dealing with a pecuniary externality. This happens because the profits of firm 1 (π1) are affected, while its production function (q1), is not.45 Disregarding pecuniary externalities is the engine of what Schumpeter called the process of ‘creative destruction’. The term captures the nature of the market system: for economic progress and growth to ensue, sometimes old industries will suffer and jobs will go out of existence.46 Competition inevitably brings along pecuniary externalities.47 Moreover, it is precisely the freedom of new firms to enter an industry 44 Ibid., p. 306 Ibid., p. 306 46 Joseph A. Schumpeter, Capitalism, Socialism and Democracy (London: Routledge, 1992), p. 83 47 Randall G. Holcombe and Russell S. Sobel, ‘Public Policy toward Pecuniary Externalities’, Public Finance Review, Vol. 29, No.4 (2001), p. 309 45 15 and impose pecuniary externalities on old firms that makes it possible for efficiency to arise in competitive markets.48 Gauthier assumes that the PCM is dynamic. While discussing utilitarianism, he argues that the market is constantly changing, as “technology is not static, and market competition accelerates its growth.”49 Pecuniary externalities can therefore arise in the PCM. Since harm only occurs in the presence of Pareto inefficiencies, pecuniary externalities do not harm individuals, according to Gauthier’s understanding. Pecuniary externalities are not only prominent in interactions between firms, but can also impact the everyday lives of individuals. Hausman illustrates this with the example of a hand weaver, who produces cloth.50 One day power looms are invented and stream-powered weaving factories become available. The hand weaver’s labour is rendered valueless, even though no non-pecuniary externality occurred.51 Despite the fact that the weaver loses his job, the PCM should automatically redirect him to a new position. However, even if he obtains a new job, can we conclude that the weaver is indeed not made worse off as a result of this change? His consumption may be lower under the new job, even though he is still receiving a marginal benefit equal to his marginal contribution. Let us consider this in more detail. If all Gauthier is concerned with is maintaining the identity between an individual’s marginal contribution to the market and his marginal benefit (‘the merit principle’ henceforth), pecuniary externalities do not create any problems for his argument. Two issues arise at this point. On the one hand, we could argue that the merit 48 Ibid., p. 305 David Gauthier, Morals by Agreement (Oxford: Clarendon Press, 1986), p. 91 50 Daniel M. Hausman, ‘When Jack and Jill Make a Deal,’ University of Wisconsin-Madison Website, http://philosophy.wisc.edu/hausman/papers/jack-and-jill.htm, Accessed on 20/12/2010 51 Ibid. 49 16 principle is legitimate, provided initial endowments are fair. The fairness of the endowments will be addressed in the Section 3.3. On the other hand, we can challenge whether giving individuals a marginal benefit equal to their marginal contribution is a good principle to begin with, even granting fair starting points. Let us focus on the second point. The argument for the merit principle appears to be rooted in libertarianism, even though Gauthier chooses not to use this label. Libertarianism accepts negative rights, such as the right to life, liberty, and property, which only imply “noninterference with the possessor of these rights.”52 These are consistent with giving individuals a benefit equal to their contribution. Positive rights, which include rights to food, housing and healthcare, among others, are rejected. The argument against them suggests that their provision can infringe someone’s liberty. This is the classic libertarian argument against taxes, which are levied “under a coercive threat.”53 A core idea underpinning libertarianism is that human beings are naturally capable of “autonomous self-direction.”54 From this, it is inferred that one should not interfere with people’s liberty in any way. A similar argument appears to legitimise the merit principle. Autonomous self-direction enables individuals to contribute to the market. This should result in a benefit at least equal to that contribution. Interfering with this outcome implies tampering with individual liberty. It is not entirely clear that the conclusion of non-interference follows from the premise of a natural capacity for autonomy.55 The fact that individuals possess a natural 52 Richard Hudelson, Modern Political Philosophy (London: M.E. Sharpe, 1999), p.97 Ibid., p. 97 54 Ibid., p. 103 55 Ibid., p. 103 53 17 capacity for something does not establish that capacity as desirable. This in turn suggests that the claims of libertarianism are not unambiguously established. To see why the merit principle is also problematic, consider the following example. After falling ill, an individual in the PCM is unable to contribute to the market. According to Gauthier, since his marginal contribution is now zero, his marginal benefit should also be zero. Should we allow this individual to starve? This seems to be a serious moral issue. We may wish to impose moral constraints on the utility maximizing actions of individuals in this society, if this can prevent such an outcome. This hints at a need for redistribution, which implies a transfer of resources by some means, such as taxation.56 This solution however goes against Gauthier’s narrow view of morality. If we accept that the merit principle has a weak foundation, we could question whether Gauthier can push aside the moral significance of pecuniary externalities. Gauthier has to argue that when the weaver obtains a new job, he deserves his new wage. This might be acceptable. However, what if the weaver’s new wage only allows him to live below subsistence level? This could be in line with his new contribution to the market, but still one could question whether the weaver deserves this. Whatever the answer to this question is, it does not change the fact that the question is a moral one. 56 Christian Barry, ‘Redistribution,’ The Stanford Encyclopedia of Philosophy, ed. Edward N. Zalta, http://plato.stanford.edu/archives/fall2011/entries/redistribution/ Accessed on 16/07/2010. 18 3.2 The Limits of the Market A discussion of what goods can be sold is essential to the definition of the PCM. The second objection aims to reveal a gap in Gauthier’s argument. The author merely argues that the realm of the PCM is the zone of private goods. He does not however clarify what goods belong to this category. The choice of which commodities one can trade is a moral one and requires prior ethical deliberation, as will be highlighted by the following discussion. This will be also used as a starting point for the argument of Section 3.3, which will illustrate how, by commodifying everything, the PCM may coerce people into involuntary exchanges. Defining a commodity is difficult. Commodification implies that a certain good can be bought and sold.57 The commodification of children, the sale of blood and organs, as well as that of sexual services, are all highly contentious issues.58 Whether the market system is an appropriate mechanism for these goods has been widely debated. Sandel puts forward two arguments against commodification, namely corruption and coercion. The argument from corruption holds that certain goods are incompatible with market exchange59 and suggests that it matters where one draws the limits of markets. Coercion involves people being forced by circumstances, such as poverty, into agreeing to sell things that they normally would not sell.60 57 Margaret Jane Radin, ‘Market-Inalienability,’ Harvard Law Review, Vol. 100, No. 8 (1987), p. 1859 Ibid., pp. 1856-1857 59 Michael J. Sandel, ‘What Money Can’t Buy: The Moral Limits of Markets,’ The Tanner Lectures on Human Values (Delivered at Brasenose College, Oxford, May 1998), www.tannerlectures.utah.edu/lectures/documents/sandel00.pdf, Accessed on 10/03/2011, p. 94 60 Ibid., p. 94 58 19 Sandel’s points are illustrated by the case of surrogate motherhood. A surrogate mother is a woman who receives monetary compensation for bearing a child for other individuals and who gives up her parental rights.61 The main worry is that surrogate motherhood can corrupt certain moral goods, such as pregnancy or parenthood.62 Contract pregnancy can furthermore be argued to turn both children, as well as women’s labour, into commodities, thus undermining important values such as the autonomy of women and parental love.63 Returning to the coercion worry, women may feel forced, due to poverty, to become surrogate mothers. Sandel illustrates this by means of an example from the imperfect market. In India, a baby is delivered to a British couple every 48 hours. This enables a financially beneficial transaction for the surrogate mother. Sandel hints at the possibility that women may in fact be forced by circumstances to accept a contract pregnancy.64 By choosing not to address the debate about the limits of the market, Gauthier disregards an important ethical discussion. The outcome in the PCM may be optimal from the Pareto point of view, yet it may still conceal troubling moral issues that are not being addressed. This can only be resolved by providing a clear definition of what a commodity is. 61 Elizabeth Anderson, Value in Ethics and Economics (Cambridge, Massachusetts: Harvard University Press, 1993), p. 168 62 Michael J. Sandel, ‘What Money Can’t Buy: The Moral Limits of Markets,’ The Tanner Lectures on Human Values (Delivered at Brasenose College, Oxford, May 1998), www.tannerlectures.utah.edu/lectures/documents/sandel00.pdf, Accessed on 10/03/2011, p. 100 63 Elizabeth Anderson, Value in Ethics and Economics (Cambridge, Massachusetts: Harvard University Press, 1993), p. 168 64 Michael J. Sandel, ‘Morality in Politics,’ (Lecture 2, the Reith Lectures, delivered for BBC Radio 4, June 16th, 2009), Market Design, http://marketdesigner.blogspot.com/2009/06/michael-sandel-onmarkets-and-morals.html, Accessed on 11/07/2011 20 3.3 Voluntary Market Participation The assumption that market participation is voluntary is crucial for Gauthier’s argument. To what extent one’s participation in the market is entirely free is debatable however. The third objection targets assumption 2, according to which market exchange is voluntary. It aims to make two points. It will first argue that Gauthier’s definition of fairness, in the context of initial endowments, is debatable, thus challenging assumption 2a), which states that initial conditions are fair. It will then go on to suggest that even if we grant this fairness, the PCM may still bring about coercive trade. Both points will question the voluntary nature of exchange. Hausman addresses the voluntariness of market exchange and argues that one can be seen as voluntarily engaged in market relations if one had the choice of participating in the market in the first place. “Since this is not a real option,” Hausman writes, an individual’s “decision to participate in markets seems little more voluntary than is his decision to hand over his wallet to an armed robber.”65 It is difficult to endorse Hausman’s definition however. One could argue that while there is little choice involved in the case of theft, one can at least freely choose the extent of one’s participation in the market. There are different degrees of involvement and if one does not like the idea of market exchange, one can minimize the number of one’s market interactions. While it is not entirely clear whether we could escape market interactions in reality, Gauthier’s argument is not theoretically threatened by this criticism. His thesis however relies heavily on the appropriate initial conditions. In what follows, I will 65 Daniel M. Hausman, ‘When Jack and Jill Make a Deal,’ University of Wisconsin-Madison Website, http://philosophy.wisc.edu/hausman/papers/jack-and-jill.htm, Accessed on 20/12/2010 21 argue that these conditions could be unfair. I will then suggest that even if we grant their fairness, they may still be insufficient in order to prevent coercive exchanges on the PCM. According to Gauthier, an initial endowment is fair if it comes about without violation of the Lockean Proviso. He acknowledges the fact that the more talented will end up benefiting more from appropriation, but argues against any redistribution. He suggests that “one’s natural capacities determine what one gets, given one’s circumstances, in a condition of solitude. One’s natural capacities are what one brings […] to market […] interaction. Why should a principle determine impartially how persons are to benefit in interaction except by taking into account how they would or could benefit apart from their interaction?”66 This statement is problematic. The initial endowments are compatible not only with huge inequalities in resources, but also with major discrepancies in talents.67 This could render their fairness disputable. Gauthier’s notion of fairness, just like his notion of morality, appears to be very narrow. Additionally, Gauthier’s argument rests on the crucial assumption that there is no significant difference between solitary existence and market interaction and that the only change occasioned by the transition from the one to the other is given by improved trade between the parties. Doesn’t this trade also bring along the possibility of redistribution? Gauthier’s claim that the two states of affairs are similar is debatable. These worries question the fairness of the endowments. 66 67 David Gauthier, Morals by Agreement (Oxford: Clarendon Press, 1986), p.220 Ibid., p.220 22 Gauthier does not find the presence of inequalities troubling and believes that the market can protect individuals from certain differentially unfavourable exchanges, which arise due to a lack of better options.68 An example of this could be Man Friday selling himself into slavery to Crusoe. Gauthier suggests that the market rules these interactions out, as Man Friday would no longer benefit to the extent of his contribution.69 His argument is not entirely compelling though. While Gauthier believes that, given his starting points, the PCM cannot lead to involuntary exchanges, the following discussion will illustrate that there are exchanges from which the PCM cannot protect individuals. Thus, even if we grant Gauthier the fairness assumption and the analogy between solitary existence and market exchange, a problem still remains. This problem arises if we accept that certain goods should not be commodified. If individuals find themselves in financial difficulties and decide to trade these goods, the PCM will allow it. Exchange of this type can be perceived to be involuntary. An example will clarify this point. Consider Gauthier’s discussion of Eve’s initial appropriation once more. As was discussed in Section 1, her appropriation indirectly makes other individuals better off, as they can now make more efficient use of resources.70 However this does not mean that everyone will be as well off as Eve. Huge inequalities may still arise. What Gauthier believes however is that people will still be better off than in a no trade scenario.71 68 Ibid., p.97 Ibid., p.97 70 Ibid., p. 205 71 Ibid., p. 205 69 23 Now imagine that Eve is extremely rich, following fair appropriation of the common resources. Adam however finds himself in financial difficulties, yet this situation came about without the violation of the Proviso. Assume that this happened because Eve was one of the first appropriators, while Adam was one of the last. Additionally, Eve is naturally more talented than Adam. As Adam needs to provide for his family, he sees no route out of his problem other than selling his kidney to Eve, who needs a transplant. They carry out the exchange and Adam receives monetary compensation. Gauthier would argue that this is a voluntary exchange. Both parties started out from fair initial conditions and Adam was willing to engage in this exchange. Suppose one believes that kidneys should not be traded, but that the market allows one to commodify everything. Then the initial endowments, as depicted by Gauthier, by offering Adam minimal financial resources, can determine him to sell his kidney. In this sense, the initial endowments are not constraining market exchange sufficiently, even though they fall under the scope of the Lockean Proviso. While being fair along Gauthier’s lines, they do not provide individuals with sufficient resources to prevent them from selling morally contentious goods, such as organs. Gauthier would have to argue that the exchange remains voluntary nonetheless. This is problematic however. If financial difficulties can lead individuals to sell morally contentious goods, then these transactions should be seen as involuntary. The above discussion hints at a more general idea that goes beyond the commodification of organs. No matter where one draws the line with respect to commodification, provided there exists at least one good that should not be traded, then 24 involuntary exchange can arise in the PCM. This is due to the fact that the initial positions are compatible with severe inequalities and limited resources. Therefore they do not constrain the transactions enough. At this point, Gauthier could do one of two things. He could provide an argument about which commodities can be traded. This would rule out certain exchanges straight away and the PCM would not coerce trade anymore. This would however impose a moral constraint on market activity. Alternatively, he could provide the participants to market exchange with starting points that make it impossible for coercive transactions to take place. To do so, he would have to guarantee a minimum level of subsistence for all individuals. The Lockean Proviso cannot ensure such an initial endowment. 3.4 Multiple Equilibria The fourth objection targets point 5, which states that the Pareto efficient outcome, which emerges from a given set of initial endowments, is unique. According to general equilibrium theory, the set of Pareto efficient allocations of an economy form its contract curve. By definition, any point on the contract curve is Pareto efficient.72 Usually, if we take the initial endowments as given, we have a unique general equilibrium, which also corresponds to a unique Pareto efficient point. 72 Wyn Morgan, Michael Katz and Harvey Rosen, Microeconomics (Berkshire: McGraw Hill Education, 2006), p.425 25 As Hausman suggested however, the competitive equilibria need not be unique in a PCM.73 In general equilibrium theory, multiple equilibria usually arise if one starts out from different endowments. However, multiple equilibria can arise even if one keeps initial endowments fixed. This can also occur in Gauthier’s PCM. The presence of wealth effects (an increase in spending that comes along with an increase in perceived wealth) can lead to the emergence of multiple equilibria. Two effects arise when the price of a good changes. On the one hand, “the relative attractiveness of various commodities changes” (the substitution effect), on the other, “the wealth distribution of individual agents is altered” (the income effect).74 The two can offset or reinforce each other, making it possible for more than one set of prices to represent an equilibrium.75 Bergstrom et al. illustrate the possibility of multiple equilibria by means of a simple two consumer, two goods economy. The two consumers used in their model have quasi-linear utility functions. This implies that individuals derive linear utility from one of the goods, while the utility from the second good comes in a different functional form, such as a logarithm or an exponential function. The two utility functions are given below:76 U1 ( x, y ) = x + f1 ( y ) U 2 ( x, y ) = f 2 ( x ) + y 73 Daniel M. Hausman, ‘Are Markets Morally Free Zones?’ Philosophy and Public Affairs, Vol. 18, No. 4 (1989), p. 327 74 iReference.ca, ‘General Equilibrium Theory’, Online Reference Site and Encyclopedia, http://www.ireference.ca/search/General%20equilibrium%20theory/, Accessed on 01/08/2011 75 Ibid. 76 Theodore C. Bergstrom, Ken-Ichi Shimomura, Takehiko Yamato, ‘Simple Economies with Multiple Equilibria,’ The B.E. Journal of Theoretical Economics, Vol. 9, Issue 1 (2009), p.2 26 Functions f1(y) and f2(x) are concave, continuous and differentiable.77 Bergstrom et al. assume that each consumer starts out with an endowment of only one good, namely of the good from which they derive linear utility. There are strong income effects acting in the opposite direction of the substitution effects for each of the consumers. This interaction results in an aggregate excess demand function “increasing in price over part of its domain.”78 Excess demand is defined as the difference between a consumer’s endowment and her demand for the specific good. This particular interaction between income and substitution effects makes it possible for multiple equilibria to arise. The findings of Bergstrom et al. can be used to support the objection against Gauthier’s argument. Since there is no reason to assume that an exchange economy will always have a unique equilibrium point, the natural question then arises: which equilibrium do we choose? Different equilibria may favour different groups of individuals, while all equilibria will be Pareto efficient. An answer along Gauthier’s lines can be given to this objection. Since all outcomes are Pareto efficient, and assuming the initial endowments were fair, it does not matter which outcome is chosen. Judging by Gauthier’s standard, they are equally good. So it could be claimed that we are going beyond Gauthier’s narrow view of morality if we advocate the use of a mechanism by which to choose an outcome. Nonetheless, the objection raises an important point, as it challenges the sufficiency of Pareto optimality. The principle may not be able to serve the important role that Gauthier ascribes to it. We will return to this point in the next section. 77 78 Ibid., p.2 Ibid., p.1 27 4 Pareto Optimality The objections raised by multiple equilibria, pecuniary externalities and voluntary exchange also target the notion of Pareto optimality. This notion is crucial for Gauthier’s argument and represents the baseline by which he assesses the moral neutrality of outcomes. This section will use the prior objections, together with two additional arguments, in order to show that Pareto efficiency is neither necessary, nor sufficient for moral neutrality. Let us first consider the sufficiency of Pareto optimality. The multiple equilibria objection raised the point that one may be confronted with more than one Pareto efficient outcome. Thus in the absence of an additional mechanism, one has no standards by which to choose the appropriate outcome. If one believes that the choice of the final allocation matters, then Pareto efficiency needs to be supplemented by some other principle. Consider now whether Pareto efficiency is necessary for a morally neutral outcome. The necessity of the principle has been questioned by the pecuniary externalities and voluntary exchange objections. The pecuniary externalities objection showed that if Pareto efficiency relies on the merit principle, it is not obvious that the outcome given by the market is morally neutral. Furthermore, involuntary exchanges can also result in outcomes that are Pareto efficient from the point of view of the market. This however, does not make them morally acceptable. In what follows, I will present two further arguments against the necessity of Pareto optimality. The first argument aims to question the view that Pareto optimality is a requirement of rationality. The claim is that “rational individuals necessarily consent to 28 a Pareto improvement.”79 But this need not be the case. Consider the following dynamic interaction between agents A and B. At move M1, they move from state 1 to state 2. As a result, A makes a gain, while B is just as well off as before. Future moves M2 and M3 follow. If B’s potential gains from subsequent moves such as M2 and M3 “will be lessened due to the fact that B did not gain in M1 while A did, then the rational strategy for B may be to refuse to consent to M1.”80 Hence it is not immediately obvious why Pareto optimality is a necessary requirement of rationality. Secondly, the necessity of the principle has been contested due to its disregard of inequality. From the point of view of Pareto efficiency, it can be optimal that individual A owns all the resources in society, while individual B owns nothing. The only way to redistribute resources would be to take away some of A’s endowment and give it to B. Removing even an infinitesimally small amount of A’s endowment would make A worse off, and the Pareto criterion would disallow this. If we find this outcome troubling, we may ask whether the principle is necessary to begin with. This lack of concern for equality however is completely in line with Gauthier’s argument. He suggests that “the rich man may feast on caviar and champagne, while the poor woman starves at his gate. And she may not even take the crumbs from his table, if that would deprive him of his pleasure in feeding them to his birds.”81 Unless one can show that the Lockean Proviso or the minimax relative concession principle were violated at some point, Gauthier cannot condemn the outcome. 79 Allen Buchanan, Ethics, Efficiency and the Market (Oxford: Clarendon Press, 1985), p. 12 Ibid, p. 13 81 David Gauthier, Morals by Agreement (Oxford: Clarendon Press, 1986), p. 218 80 29 Gauthier furthermore argues that “equality is not a fundamental concern in our theory […] Since no one is in a position to take advantage of any other person, pure market inequalities no more reflect unfairness than do inequalities among isolated, noninteracting individuals.”82 This point has been challenged earlier, when it was argued that we may have reasons to perceive a significant difference between solitary existence and social interaction. Sen suggests that the underlying disregard for inequality exhibited by Pareto optimality does require justification.83 He acknowledges that the mere fact that equality is valued in society, does not establish it as a supreme value. Nonetheless, going from valuing equality above other concerns to not valuing it at all, as appears to be the case if we fully rely on Pareto optimality, requires some explanation.84 Sen makes a valid point. If the market outcome is to remain morally free, Gauthier needs to give an argument of why inequalities are morally neutral. As has been argued so far in this paper, there may be many instances in which the PCM delivers an outcome, which while Pareto efficient, is far from morally neutral, if by moral neutrality one understands more than Pareto optimality. The outcome may still be morally neutral along Gauthier’s lines. The real question is however whether we can accept such a narrow view of morality, or whether we want to go beyond Pareto optimality, when assessing the outcomes delivered by the market. The Pareto principle appears to be neither necessary, nor sufficient for this purpose. 82 Ibid., p. 270 Amartya Sen, ‘The Moral Standing of the Market,’ Social Philosophy and Policy, Vol. 2, (1985), p.10 84 Ibid., pp.12-13 83 30 5 Concluding Remarks In Morals by Agreement, Gauthier attempts to offer a contractarian account of morality, deriving the latter from rationality. Gauthier argues that the PCM is a morally free zone, and that only when market failures arise, is morality required to constrain the actions of utility maximizing individuals. Free market activity leads to the emergence of Pareto efficient allocations, which Gauthier believes are morally neutral. This paper sought to show that the PCM need not be morally free. Sections 1 and 2 presented Gauthier’s overall aims and his depiction of the PCM. Section 3 raised four objections against Gauthier’s argument. Firstly, we considered pecuniary externalities. This objection led to a discussion of whether individuals should be paid their marginal contribution to the market. We concluded that the merit principle is problematic and that pecuniary externalities bring up important moral issues. We then looked at the limits of the market, and argued that Gauthier chooses not to provide an account of what a commodity is. This has significant implications. Not only do the limits of the market raise a moral question that needs to be discussed, but they also have implications for the voluntariness of market exchange. This worry was addressed by the third objection, which raised two points. The first point suggested that the fairness of the initial conditions is not as straightforward as Gauthier deems it to be and concluded that unfair starting points can lead to involuntary exchanges. The second point argued that even if we grant the fairness that Gauthier ascribes to the initial endowments, these conditions do not constrain market exchange in an appropriate way, making it possible for the PCM to allow involuntary trade. 31 Gauthier furthermore disregards the possibility that the market may deliver multiple Pareto optimal outcomes, and that the choice of an outcome may have important moral implications. The objection from multiple equilibria targeted both the uniqueness of Pareto optimal points, as well as the sufficiency of Pareto efficiency. In Section 4, we questioned the necessity and sufficiency of Pareto optimality. This worry was endorsed by the multiple equilibria, pecuniary externalities and voluntary exchange objections. Two more arguments were then presented to illustrate the necessity worry. We thus argued that the principle is not a requirement of rationality and that it can tolerate significant inequalities. Even though it is not immediately obvious why equality should matter, if Gauthier wants to disregard it, he needs to provide a compelling argument of why inequality is not important. The discussion of Section 4 thus challenged the overall function of Pareto optimality. Putting this worry together with the objections of Section 3, we may conclude that the PCM is not a morally free zone. This paper did not only aim to show that Gauthier’s argument is problematic. It had the broader purpose of illustrating how ethics inevitably comes into play in economics, even in the realm of the PCM. Morality cannot be dismissed so easily and moral constraints are necessary even in idealized conditions. 32 Bibliography Anderson, Elizabeth. Value in Ethics and Economics. 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