Dr. Norbert Walter, Chief economist of Deutsche Bank Group, on the Austrian Alps.

"The Market Economy, Ethics and Morals - - How Values Build Trust in the Economy,"is the title of a book written by Norbert Walter, the chief economist of Deutsche Bank Group, which was recently published in Germany.

In four chapters, the author details the rules and values that an economic order requires to remain functional and guarantee a society with equality of opportunity. He pays special attention to the financial crisis and the conclusions to be drawn from it for ethics and morals. He asserts that only a functioning system of order and the reestablishment of morals can guarantee acceptance of the market economy.

Walter says that over 250 years ago Adam Smith set out his thoughts on economic systems in his first great work “The Theory of Moral Sentiments.” In it the professor of moral philosophy expounded why a competitive economic order ultimately delivers good outcomes. According to Smith, it is self-love that drives human behaviour. It incites human activity, but it can also degenerate and develop in an extremely egocentric fashion.

Smith also observed that there is a type of self-love that is inclined to become laziness. In order to fully utilise the dynamism of self-love we must therefore have ideas about how to prevent, or at least constrain, its excesses. The first control mechanism mentioned by Smith was fellow-feeling. Our self-love is immediately and spontaneously constrained when we look into the eyes of those to whom we do wrong out of self-love. But the bigger societies become - - the further they grow apart, the more anonymous and more complex everything gets - - the more apparent it becomes that sympathy and brotherly love are not sufficient to keep self-love in check.

In this case Smith recommends a second filter for preventing excesses: ethics. Ethics provide societal answers to questions like “which is the done thing and which is not.” However, Walter says ethics admittedly only exist where there is reasonable agreement about the rules concerning an issue because there is a certain degree of homogeneity within that particular society.

However, Smith observed that due to obvious heterogeneity of societies this second filter is also insufficient to constrain self-love. He therefore proposed the establishment of state institutions to make laws, set up courts and create a police force - -  i.e. a legal system. A binding legal framework, including a liberal system of property rights  - with liability obligations and efficient rules for competition - - form the foundations for economic activity. The market economy’s division of labour does, however, require something extra to operate smoothly: the actions of all participants have to be transparent and reliable, and there has to be faith in this reliability. To put it another way, the economy - - just like all other areas of society - - has to have an ethos that is put into practice and there has to be trust.

Walter says the financial market crisis has shown how important trust is in particular for the functioning of markets and especially of highly complex modern financial markets. Although it appears a logical conclusion for so many people, the financial market crisis should not be misused as evidence of the demise of the market economy. There is no doubt that the financial markets and many protagonists have failed in the crisis, but this failure goes hand in hand with the failure of the state as well.

In the international financial markets there are many rules and laws that are components of a good market economy which during recent years were not established or were not enforced. And there was a lack of vigilant state control which could have recognised this and taken corrective action. The acceptance of the market economy can, however, only be ensured over the long term if people see that the state is not powerless in the face of business and the financial markets but that it remains capable of exercising its necessary control function. This now needs to be reestablished, Dr. Walter says.

He says this is the only way that we can endow the financial system with a reliable, international architecture. The G-20 Conference in Pittsburgh last showed that the international community takes this task seriously. People need to be presented with a solution that is definitely neither emotional nor short-sighted: it may be tempting to resort to populism and pander to base instincts, but such an approach is counterproductive.

The economist says the international economic crisis reflects a deficit of values. It shows how important trust is for markets and their ability to function -- especially for the highly complex modern financial markets. The market requires a sustainable framework of rules and regulation, and it needs morals. When many critics condemn the shareholder value principle and the excessive power of the financial markets as being amoral, they are in fact referring to the market economy and its mechanisms. They regard the developments of recent years as confirming their reservations concerning markets. However, instead of apportioning blame by calling the entire system into question critics should realise that first of all, a market system does have to be established. It was the absence of intangible values that led to distortions and excesses.

Society has to establish its morals; the family is the ultimate fabric for this. Adherence to values cannot, however, be created and enforced by the state, as advocated by many of those who are now professing their faith in the power of state. The job of the state now has to be to put in place the necessary regulations and ensure their long-term viability. It is time for the “arbiter” to resume its original, limited role and allow the competition between the market participants. The state as owner and market agent has to exit.

Adam Smith's most famous book was "The Wealth of Nations," which was published in 1776.

While Smith identified the importance of individual self-interest, contrary to what some critics have claimed, his emphasis was that you serve your own self-interest by serving the self-interest of others, in the context of a community.

SEE Finfacts article Jan 2006: Philosopher-economist Adam Smith : A patron for 21st century trade unionism?