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The integral relation of ethics and morality

The historical overview in this paper shows that once upon a time, moral considerations occupied a prominent place in economic studies. However, later, ethics was considered not any longer a legitimate object of serious study in analytical economics. Ethics as such is not part of the core explanation of the efficiency and viability of financial markets.

The utility of models 2 Extensions and modifications of the standard neo-classical framework, as well as New Institutional Economics NIEgo some way in explaining why moral standards are important for the evolution and functioning of financial institutions and markets.

For example, the modern theory of financial contracts is a response to some of the limitations of general equilibrium theory. In the neo-classical general equilibrium framework, economic agents interact only through the price system, while prices convey all relevant information. Institutions function merely as a veil through which markets can see prices.

As a result, existing financial theories such as financial contracting remain largely devoid of moral content. Hence, the link between the full range of moral problems and the viability and efficiency of financial markets cannot be analysed with these models. But also the new institutional the integral relation of ethics and morality is not yet able to explain the central dependency of the viability and efficiency of financial markets on moral standards. The paper concludes with a suggested outline of central questions that a financial theory, with ethics incorporated as a central pillar, should be capable of addressing.

Today, ethics the integral relation of ethics and morality peripheral 4 In the distant past, economists and other social scientists attributed a prominent place to the role of ethics in a market order. Adam Smith highlighted the importance of self-interested behaviour in explaining the wealth of nations but he also noted that this behaviour is part of a complex social fabric based on social habits and moral standards and values.

He went even so far to argue that moral standards constitute the central pillar of the wealth of nations.

The integral relation of ethics and morality

In the prevalent theories of finance, economic agents including intermediaries such as bankers act in a morally neutral fashion. Why do economist ignore ethical concepts? Amartya Sen characterised the nature of modern economics as follows: For example, ethical lapses and greed are at the core of recent business scandals Enron, Parmalat, Tyco, and WorldCom, among others. Moreover, ethical concepts such as justice, honesty and thrift are key in explaining the creation of the wealth of nations.

But why do economists largely ignore ethical concepts? The integral relation of ethics and morality important reason why many economists ignore ethical concepts is that they are very hard to integrate into the prevailing mathematically tractable formal models. The use of these relatively simple models for explaining complex phenomena is both a strength of modern economics and a weakness. The role of founding fathers 8 Neo-classical economic theory is a good example.

The neo-classical framework is a powerful, mathematically rigorous tool for analysing the efficient organisation of economic systems and situations. Within this framework two so-called welfare theorems are derived. The neo-classical description of reality serves as a benchmark model, characterised by zero transaction costs and perfect information. In this framework personal interactions and authority are absent and therefore all behaviour the integral relation of ethics and morality ethically neutral.

Institutions are absent in this perfect decentralisation model. However, on the positive side of the ledger, these simplifications allow powerful demonstrations of the co-ordination function of the price system in a perfectly decentralised setting.

From a historical perspective, the founding fathers of modern finance Harry Markowitz, Paul Samuelson, William Sharpe, Eugene Fama, Merton Miller, Robert Merton, Fisher Black and Myron Scholes, among them developed truly capital ideas that have contributed enormously to a better understanding of the functioning of financial markets, portfolio and risk management and the nature and pricing of risks.

The mathematical expressions of their theoretical frameworks have proved extremely valuable in general. Without these core concepts, modern finance would lack a firm analytical basis. For example, credit derivatives pricing models would not exist.

Indeed, modern financial markets cannot function without the theoretical insights developed by these intellectual pioneers. Thus, an important limitation of these core theories and extensions thereof is that they are largely devoid of moral content.

Integral Ethics

The ethical disconnect in financial theories 10 Although financial theorists have made important progress in analysing the consequences of important classes of incentive problems adverse selection, moral hazard, and principal-agent complicationsthey do not address the full set of ex ante and ex post ethical transgressions to lie, cheat, steal, mislead, obfuscate, distort, and confuse.

An important reason is again the narrow focus on analytically tractable models. In the words of Robert Shiller: Many schools now offer a course in business ethics, and some even try to integrate business ethics into their other courses.

In contrast, moral the integral relation of ethics and morality are of vital importance for understanding the viability and efficiency of markets in general, and financial the integral relation of ethics and morality where confidence is of central importance, in particular. Hayek and the markets 13 The economist Friedrich Hayek presents a penetrating analysis why markets arose spontaneously from certain traditional and largely moral practices.

His analysis is based on the notion of evolutionary ethics. Instead, they are formed as part of a process of unconscious self-organisation of a complex structure or pattern. The invisible hand refers to voluntary co-operation the integral relation of ethics and morality most often we are not aware of it. As competition is not very popular witness the call for protectionism throughout the centuries this would by itself be even more reason to reject an extended order based on the moral and other rules of a market and its invisible the integral relation of ethics and morality.

Since a market order is based on competition and adherence to the rules of the market game, the systemic use of physical violence would lead to its collapse as it implies a rejection of these rules. Markets survive because of a widespread adherence to moral traditions and behaviour. In essence, the viability of our rule-based extended human order is dependent on the morality inherent in our traditions, most of them designed without conscious intention: They are in a separate and unique category: The key insight is that our moral standards like many other aspects of our culture allow us to adapt to new problems, complexities and new circumstances that far exceed our rational capacities.

Therefore moral standards transcend or go beyond or above reason and instinct. The result of human rules 19 The rules of this complex, extended order are not instinctive many are in the form of prohibitions: They are the result of an ethical evolution moving from a small closed society based on inborn instinctual impulses to an extended human order based on learnt traditions often based on religion.

Financial markets that lack integrity will be characterised by relatively high transaction costs and therefore function less efficiently than markets that possess a high degree of honesty and reliability. Uneasiness about the limitations of the neo-classical theory has inspired many authors to seek important extensions or modifications of the standard neo-classical framework. Clearly, analysing the consequences of moral standards and values outside a social behavioural context does not make any sense.

Instead, Sen suggests introducing ethical considerations in economic models by introducing a weaker version of the neo-classical assumption of self-interested behaviour. Amartya Sen distinguishes three dimensions to this strong version of self-interested behaviour 1986, p. Sen suggests that ethical considerations can be introduced by replacing the strong version of self-interest by changing one or more of these dimensions.

Incomplete the integral relation of ethics and morality and asymmetric information 24 Another approach relies on relaxing the perfect or complete informational assumption by analysing situations with asymmetric information or less than perfect information. The modern theory of financial contracting is a prominent example.

This extension of the standard neo-classical model has its the integral relation of ethics and morality in the economics of information and the theory of incomplete contracting. A key insight from the information economics literature is that the existence of asymmetric information between lenders such as banks and borrowers such as entrepreneurs has important consequences for both the structure of financial contracts and financial institutions and market equilibrium.

Quite crucially, the financial system will respond or adapt to the effects of information and agency problems in an endogenous fashion via the emergence of various mechanisms that mitigate the impact of these problems: Incomplete contract models focuses on how control rights i.

Contracts between market participants such as banks, households, brokers, hedge funds, corporations and other businesses, can then be seen as means for limiting friction costs. NIE and transaction cost economics 26 More generally, contracts are institutions that shape human the integral relation of ethics and morality using formal rules e. However, contracts are also supported by a web of informal rules or arrangements such as business codes and market traditions and practices.

Also moral standards are part of this web. The NIE framework focuses on the link between all kinds of financial institutions and transaction costs. Already in 1937 Ronald Coase introduced the idea that there are costs of using the market. Later they became known as transaction costs. Transaction costs are the economic equivalent of friction in physical systems Williamson, 1985, p. Transaction costs can be linked to the imperfect information and information uncertainty consequences of opportunism.

Opportunism is self-interest seeking with cunning or guile. This in turn means that a lowering of moral standards - for example by using unethical business practices on the Internet, large-scale money laundering practices, bribery, etc.

The threat to the integrity of markets causes uncertainty, increases risk the integral relation of ethics and morality raises the cost of capital. The lowering of ethical standards would therefore in particular hamper unlocking the full potential of a globally extended society based on global financial markets.

However, the link between a full range of moral problems and the viability and efficiency of financial markets cannot be analysed with these models.

Integral Esotericism - Part Five

The NIE has in common with modern finance that many important insights are based on analysing the implications of problems related to the availability of information to economic agents.

Nonetheless, NIE and transaction economics has in my view the potential to go a step further in the right direction. Are we operating in the world of Thomas Hobbes or Joseph Butler? How do moral standards allow us to adept to the integral relation of ethics and morality problems and new circumstances such as the emerging global techno-market order and the higher pace of financial innovations?

How does ethics extend the domain of co-ordination to mutual benefit within global finance? In contrast, Joseph Butler rejects the Hobbesian world. In 1726 Bishop Joseph Butler challenged the claim the integral relation of ethics and morality Thomas Hobbes that most co-operation among people is driven by self-interest self-preservation. While Hobbes emphasised self-interest, Butler central doctrine is benevolence.

However, he sees no serious conflict between of self-interest self-love and benevolence Wogaman, 1993, p.


This is very fortunate as main-stream financial theories are largely based on models in which incentives are governed by rational self-interest. On the other hand, modern financial theories are largely devoid of moral content.

For this reason Shiller seems to reject the world of Hobbes: That said, the view of the world that one gets in a modern business curriculum can lead to an ethical disconnect.

Michel Foucault: Ethics

The courses often encourage a view of human nature that does not inspire high-mindedness. Consider financial theory, the cornerstone of modern business education. The mathematical theory that has developed over the decades has proved extremely valuable in general. But when it comes to individuals, the theory runs into some problems.

This means that people are expected to be totally selfish, constantly calculating their own advantage, with no thought of others. If the premise is that everyone would steal the silverware if he knew he could get away with it, and if we spend the entire semester developing the implications of this assumption, then it is hard to know where to begin to talk about ethics. Most people are prepared to be willing to make small sacrifices for other the integral relation of ethics and morality beings, including total strangers.