Markets in everything - internalizing expenses due to misconduct as the cost of doing business

Since the disastrous oil spill from its Deepwater Horizon oil rig in April 2010, British Petroleum (BP) has apparently spent nearly $30 bn in clean up costs, civil damage claims, and restitution to businesses and residents along the Gulf of Mexico. The incident, which involved a spillage of 200 million gallons of oil, resulted in the death of 11 workers and a massive environmental disaster. However, despite the huge price tag of the oil spill, $30 bn and climbing, BP's commercials appear unaffected. It collected more than $375 billion in 2011, pocketing $26 billion in profits.

While criminal prosecution charges were framed against the executives of BP and its contractors, nobody has been prosecuted till date for these damages. This has important moral hazard implications. Though BP has been involved in similar safety failures earlier, when they paid huge fines, they have moved on without addressing the underlying safety related issues. In fact, as Times writes, "without personal accountability, the fines become just another cost of doing business".

Much the same story can be said about the several cases of financial market irregularities, bordering on criminal misconduct, that played a major role in blowing the sub-prime mortgage securitization bubble. Several financial institutions, including its leading lights, have been found guilty of practices that involved making money by betting against their own clients. These firms peddled unsuspecting clients securities that they themselves were betting against (say, shorting). They made money from fees as well as being the counterparty in the trade.

In most of these cases, the financial institutions have settled the malpractice suits and even the criminal prosecution by making huge compensation and fine payments. However, not one top executive has been convicted on criminal misconduct. Most of these institutions have weathered the worst of the sub-prime meltdown, paid their fines, and are back to making profits by indulging in the same practices. They have come to see the fines as another "cost of doing the business".

In his best selling book, Predictably Irrational, Dan Ariely has written about the changed behaviour of parents when a kindergarten moved from a regime of mandatory pick-up as soon as school closes to a regime that charged for additional hour spent beyond the school hours. They found that in the former regime parents generally came to pick-up their children within time, whereas parents preferred to pay and pick up their children at their convenience. He argued that in the first regime, social norms kept parents from tardiness in pick-ups. However, in the second regime, introduction of a penalty increased tardiness. A fine becomes the price (pdf here) of the violation or deviation. The same motivations lie beneath the moral hazard described in the first two examples.

Such trends are not confined to high-finance and business, but pervasive in modern-day lives. Old-fashioned virtues of equality (of people standing in a que to access a service) have given way to opportunity-cost driven conventions (rich people pay to access the service out of turn). The implications of this gradual shift have been far-reaching and is surely a major contributor to the widespread widening of inequality across societies. It is obvious that there is a slippery slope associated with these trends. Traditional mores slowly get replaced with market-based morality, with all its attendant consequences.

In this context, Michael Sandel's new book, What Money Can't Buy: The Moral Limits of Markets, provides an excellent perspective on how pricing human behaviour and responses runs the risk of crowding out other values. Jonathan Last has an excellent review of the book, where he writes,

Today you can purchase your way out of waiting in line for rides at many amusement parks. There are express lanes that allow us to buy our way out of traffic. Many schools now "incentivize" performance, paying students if they read books or do well in school; some schools now sell ads on children's report cards. Cities routinely sell advertising space on public property, ranging from parks and municipal buildings to police cars. In each of these cases, long-held ideas about inherent worth and common ownership have been displaced by the simple morality of the market. 

He quotes Sandel's assessment of market driven morality,

Markets don't only allocate goods, they also express and promote certain attitudes toward the goods being exchanged... When we decide that certain goods may be bought and sold, we decide, at least implicitly, that it is appropriate to treat them as commodities. 

Prof Sandel raises questions about the effect of such marketization on democracy itself,  

At a time of rising inequality, the marketization of everything means that people of affluence and people of modest means lead increasingly separate lives. We live and work and shop and play in different places. Our children go to different schools. You might call it the skyboxification of American life. It's not good for democracy, nor is it a satisfying way to live. Democracy does not require perfect equality, but it does require that citizens share in a common life. What matters is that people of different backgrounds and social positions encounter one another, and bump up against one another, in the course of everyday life. For this is how we learn to negotiate and abide our differences, and how we come to care for the common good.

The issues raised by Prof Sandel have enromous significance for our society today. If the creeping influence of markets and its touchstone of utility maximization crowds-out individual values and social norms, then we are not far from an age where man would move from being a "social" to a "monetary" animal. Its aggregate consequences would be far from benign.

Votes would be bought and sold, criminals would purchase their way out of jails, college seats would be auctioned off, policy decisions would be purchased based on donations made to parliamentarians and ministers, and so on. Further, it would be no longer anathema to let the poor suffer or even die for lack of access to medical care, or keep lowering taxes on the rich, or provide tax concessions to businesses while loathing welfare subsidies to the indigent, and so on.