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The Flaws of the Market Failure Approach

The theories of business ethics that are deemed appropriate have evolved over the last decades. People are often quick to assume that business ethics is an oxymoron, but without knowing and understanding the main ideologies, they are unaware of the thought process of companies. In 1993, Andrew Stark wrote a controversial piece in the Harvard Business Review titled, “What’s the Matter with Business Ethics?”. He argued that conventional business ethics was “largely irrelevant for most managers,” because it failed to offer them any “practical” advice. “Moral philosophy,” he argued, “tends to value altruism, the idea that an individual should do good because it is right or will benefit others, not because the individual will benefit from it.” As a result, business ethicists have had too little to say about “the potential conflict between ethics and interests,” and in particular, how managers should handle such conflicts when they arise. (Stark 1993). The three main business ethics views are the shareholder view, the stakeholder view, and the market failures approach. Although the market failures approach has been accepted by some as the most appropriate theory of the three, there are flaws in the theory. It fails by focusing too much on pareto efficiency and consumer preferences while not determining whether the actions and preferences are morally correct. Additionally, it fails by not focusing on the non-economical impacts of the actions, such as not taking into account the environmentalist viewpoint in his methodology.

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First, I will discuss the ideas of the market failures approach and where the ideas stem from. I’ll present Joseph Heath’s arguments and how he presents they work in a market. Then, I will explain how the market failures approach fails in two fronts: satisfying consumer preferences to achieve pareto efficiency while not considering whether those preferences are ethical themselves and not taking into account the non-economical impacts of actions, such as the long-term impacts to the environment.

The market failures approach was introduced by Joseph Heath in 2004. His approach stemmed from the failures of the shareholder view, where Milton Friedman famously shared his belief that the only fiduciary duty of a business is providing its shareholders the greatest amount of value by accumulating as much profit as possible. The ideas of shareholder view have seldomly been explained as a good code of ethics and rather used in situations where groups are justifying (or mostly apologizing for) irresponsible behavior. Heath tries to explain how managers should make decisions when they are met at a crossroad, such as if they should reduce wages of employees or increase the prices of products. Heath believes that the market is a staged competition that promotes Pareto efficiency. The explicit rules that govern the competition are inadequate to take advantage of and receive favored outcomes. Thus, the parties involved should respect the nature of market failures and refrain from pursuing actions that oppose the theory.

Heath uses the example of how in the judiciary system, lawyers are obligated to advance the interests of or defend their client regardless of their client’s actions. For example, there are lawyers who are defending mass murderers. Lawyers are met at a crossroads of doing their obligation of fighting for their client, even if it is defending a mass-murderer, and not fighting for justice in the trial. Heath believes what justifies this behavior is the idea that the lawyers on each side of a trial are being operated within an institution but with differentiated roles. The best outcome is the product of the two lawyers’ interaction who are either vigorously prosecuting their opposition or defending their clients. Heath states how the business manager and defense lawyer have very similar roles. The manager seeks to maximize profits in the same way that a defense lawyer defends a client who is accused of mass murder because the adversarial trial system as a whole is taken to be the most effective form of institutional arrangement to fulfill its appointed purpose. The basis of profit is to provide competitive prices for consumers and suppliers. The competition is what determines prices of goods, and thus the market will determine the appropriate prices. This idea stems from Adam Smith’s “invisible hand theorem” where outcomes in perfectly competitive markets end up in the best interests of the consumers and producers (pareto efficiency); it is not possible to improve your condition without worsening someone else’s condition. For example, as firms lower their prices by undercutting their competitor, their competitor reacts and creates a bidding war until the margins are so thin that profits can’t be made. With that being said, as the role of business managers have increased, the “invisible hand” has lost its way, as individual motives of managers have changed the effectiveness of the theory. For Heath, however, the market must provide perfect competition to effectively carry out or else it will experience “market failure”.

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Although the approach makes sense in some aspects, the market failure approach fails on a variety of fronts. Firstly, Heath describes the market failures approach to finding pareto efficiency as strictly economical. This is inherently wrong in business ethics, as people need to take into consideration non-economical values. For example, he uses the example of a company not being socially responsible with respect to the environment if they were to factor in the cost of market failure. Environmentalist would argue that people have the responsibility of preserving resources in our environment for future generations. Companies that emit greenhouse gases may pay a tax associated with it, but how are future generations being compensated for the potential problematic environment or scarcity of resources that they must live under?

Heath stresses the idea of making sure consumer benefits are satisfied in the most optimal way. His approach of social benefit fails to cover public health. Heath believes that “if all companies fully internalized all costs, and charged consumers the full price that the production of their goods imposed upon society, that it would be impossible to make the case for any further ‘social responsibility’ with respect to the environment” (Heath 2004). For example, in the gas industry workers are often exposed to various types of chemicals that are detrimental to their health. In Heath’s eyes, if there are no market failures, where workers were notified of the risks of the chemicals, and the workers were paid for taking on those risks then it would align with his approach of a ‘pareto optimal outcome”. Workers would have “voluntarily” chosen to assume the risk as worth it for their increase in salary that makes up for the inefficiency, and consumer preferences would be satisfied. There is a set monetary value for human lives, and if there exists a risk of a worker dying, the workers are aware and compensated for the risk which follows his logic. Obviously, there is a flaw to this belief system, as the market value of a human life is not necessarily its “true” value in that a human life cannot be represented truly in a monetary way. People can’t go out and buy a new identical person with the amount of money that a “human life is worth”. Furthermore, his idea of the “right amount” of pollution based on consumer preferences fails. The environment is not strictly made up of consumer preferences. The well being of the environment includes preserving resources for the future which are not determined by managers nor consumer preferences. An environmentalist in this situation would not consider a tax on corporations as being sufficient for the impacts that those companies are making for the long-term being of the planet.

Secondly, his approach of market failures in business ethics is too limited in that it focuses too much on consumer preferences, while not considering whether the actions are indeed ethical or not. For example, a market for babies or sex could be efficient, but those markets violate basic human principles. There exists sex tours of the Mediterranean that are completely staffed by prostitutes (in countries where it is legal). Obviously, this is inhuman in which the basic human principles are being overtaken by the consumer preferences which are at stake. Focusing too much on consumer preferences is not efficient, especially in small and/or illegal markets. People in smaller markets tend to have preferences that are not ethical themselves. For example, in a market for drugs, the consumer’s preferences would want, we assume, as strong dosage of drugs that they can get, even if this means more harmful effects to their health. The market failure approach would want to satisfy the customer’s preferences even though it results in further harm to their bodies. The market even fails to consider whether the market itself is ethical and legal. Simply, Heath’s approach does not take into consideration of whether the action being done is right or wrong. Rather, his viewpoint focuses on the end-result. If there are inefficiencies in the market caused by market externalities, Heath would intervene to reach pareto efficiency. However, if the markets of selling babies and sex trade were pareto efficient, Heath would accept the market with his viewpoint.

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Although Joseph Heath’s market failures approach tries to find solutions to imperfections in the shareholder view, there exists many flaws within the view itself. Its over-emphasis in finding pareto efficiency and satisfying consumer preference refrains the viewpoint from determining whether the actual consumer preferences are ethical. It seems that Heath is less worried about the market place and whether it is unjust and cares more about whether the market is running efficiently and that there are no market failures. Furthermore, his approach to business ethics fails to take into account non-economical values. It seems that Heath has adopted the dangerous ideology that social problems are strictly economical and that business ethics conceivably diminishes the perceived importance of noneconomic values. In the case of a business’ social responsibilities to the environment, Heath is incorrect in not taking into account the environmentalist viewpoint. Heath states that a business should not be expected of providing more social responsibility than internalizing costs and including the price of market failures. However, the social responsibility of preserving resources and giving future generations a rich environment is valued significantly more than the companies having to pay for their market failures.

Works Cited

  1. Stark A (1993), “What’s the Matter With Business Ethics,” Harvard Business Review (May/June, 1993): 38-48.
  2. Heath J. (2004) A Market Failures Approach to Business Ethics. In: Hodgson B. (eds) The Invisible Hand and the Common Good. Studies in Economic Ethics and Philosophy. Springer, Berlin, Heidelberg

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The Flaws of the Market Failure Approach
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Artscolumbia
The theories of business ethics that are deemed appropriate have evolved over the last decades. People are often quick to assume that business ethics is an oxymoron, but without knowing and understanding the main ideologies, they are unaware of the thought process of companies. In 1993, Andrew Stark wrote a controversial piece in the Harvard Business Review titled, “What’s the Matter with Business Ethics?”. He argued that conventional business ethics was “largely irrelevant for most mana
2021-07-22 14:12:05
The Flaws of the Market Failure Approach
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