Morality Costs Money

by Professor Jonas Prager

“Honesty is the best policy” suggests not only an ethical norm, but also pragmatic benefits. But it’s certainly not the working rule in economic transactions. Indeed, there’s little difference between consumers and business purchasers; both are fundamentally skeptical and suspicious buyers. This lack of trust, based on both conceptual and experiential grounds, not only reflects poorly on business morality, but also involves significant costs to the economy.

The theoretical grounds for buyer skepticism rise from asymmetrical information, the divergent degrees of knowledge held by the parties in any transaction. Sellers know what they’re selling; buyers do not really know what they are buying. Legal systems recognize this discrepancy, with Jewish and Western legal mandates for seller honesty supplemented by civil and criminal penalties for fraud. The plethora of legislation and court cases devoted to the entire range of misrepresentation issues is clear evidence that seller honesty cannot be taken for granted. In fact, writing and enforcing of such laws is a continuing cost to the economic system.

Confidence-strengthening measures taken by sellers to convince buyers of their integrity and defensive actions engaged in by buyers to protect themselves against less than fully scrupulous vendors normally entail expenses that would be superfluous in a more ethical society. Perhaps the most important evidence of seller probity is the firm’s long-run horizon, demonstrating to the purchasers that short-term cheating is self-defeating. Some economists have explained apparently frivolous marketing expenditures such as expensive showrooms or celebrity endorsements which will be recovered only over the long haul, as credibility-establishing techniques. Similarly, a company paying for an evaluation by a recognized unbiased source – bond and equity rating agencies, for example -hopes thereby to assure purchasers of the seller’s integrity. Sellers also devote resources to and publicize quality control, so that repeat buyers can purchase with confidence without having to subject each transaction to testing.

Buyers, too, protect themselves in a variety of ways. Most indirectly, they support government administrative agencies that apply and enforce quality standards, such as those certifying the honesty of retailer weights and meas-ures or the safety and effectiveness of medicines. Similarly, consumers purchase information from not-for-profit and private agencies who test and report on consumer product and service quality or integrity. (Government and private kashrut certification are obvious examples.) Most important, buyers attempt to make informed decisions, gathering all available information on product performance, vendor reputation, and, when possible, testing the products themselves. Product testing, in fact, is big business for big business, which cannot afford to buy faulty components. After all, producers will ultimately bear responsibility for defective merchandise even when caused by defects in purchased parts. Clearly, such efforts and expenses are not negligible.

Many products and especially services are however, simply not testable, since each purchase is unique. Moreover, most buyers are not only ill-informed, but can never be adequately informed except at prohibitive cost. How truly competent is a physician, an attorney, or a mechanic is something that only peers can judge. Unfortunately, such information is rarely publicly available. Indeed, in the U.S., professionals may violate standards of ethics by offering unfavorable opinions — even when justified – against fellow practitioners. In such cases, the possibility of being discovered and penalized thereafter is remote, and the incentive to perform dishonestly is reinforced. The costs of protection must then rise disproportionally.

No one has yet added together society’s costs from deception and potential misrepresentation. They are found but rarely identified in government budgets, in the financial statements of business firms, and in the practices of consumers. Integrity in selling may be wishful thinking. Yet, it would not only be morally superior, but less expensive for us all.
Dr. Jonas Prager is a Professor at New York University