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The Economy of Trust

What can the world of religion and ethics contribute to economics?

The market has deficiencies of a kind for which ethics is a remedy. For example, the world is really filled with private information. There is inside information on products and in contracts. In these situations, there is a very strong possibility of one person using this information to take advantage of the other. If this happens frequently, a market may not exist at all because the buyers know that they don't know certain things, and that the sellers can exploit them. Therefore, it's not so much that there are potential unfair gains, but that such uncertainties about private information can make the market inefficient. In fact, if the problem is pronounced, the market may not exist at all. This is a situation that is studied particularly in insurance contracts; when the person insured may have private information about dangers unknown to the insurer, there is said to be “moral hazard” or “adverse selection,” phrases in the last forty years that have been imported into economic analysis from insurance literature.

There are various ways of handling these cases. One of them is the existence of morality. It turns out that to a considerable extent, people spontaneously do avoid taking excessive advantage of their inside information, their private information. Part of it is an understanding that even though I would gain by cheating, it would bring down the market if everybody did it. Of course, there can be a problem if one person says, “Well, if I did it, nobody will notice.” But then, if each person feels the same way the whole thing breaks down. Part of this behavior, though, is morality—the person doesn't cheat because he thinks it's the wrong thing to do. To get markets that work, you have to keep the other person from trying to cheat you at every moment. So morality is closely related to the workings of the market.

The other point, of course, is that people do have aims in life, and not just the grand achievement of material gains. They're concerned about others. This concern is the result of moral codes, which are developed and adopted through religion or through inculcation by other ethical sources. Certainly family relationships are marked by sacrifice. People are engaged in these relationships, and therefore, they devote their energies to acquire goods, not for the purpose of using them themselves, but for others.

So there are two aspects to this relationship. One relates to deep concern for others, and therefore touches upon the ends of economic activity. The other relates to the means of economic activity—the market. Morality plays a functional role in the operation of the economic system.

Could it be argued that a certain amount of virtue of a basic kind—being honest, honoring contracts, providing accurate information—is required for a market to work? Is it a danger that prosperity can sometimes weaken those virtues? To become prosperous you need to be virtuous, but then does prosperity erode the foundations of virtue?

I don't know if it's so much prosperity as the prospect of prosperity that's dangerous. When you see a large potential personal gain, you may tend to feel that your virtue stands in the way. Now there is always the question of whether you can get away with something or can cut corners. You may find the pursuit of the material goods becomes an end in itself. But if you're a chess nut, you can also be a fanatic about playing chess in a way that gets in the way of doing good deeds.

Beyond a certain point, material goods can be symbols of success, but they can't really improve your life very much. Yet somehow these things have a way of becoming necessities. This is a real phenomenon. A number of psychologists and economists influenced by them have been arguing that happiness, whatever it may mean, is all relative to a previous standard of living. Relatively speaking, if you ask people, what they need to be thoroughly happy or how much income they need to really be thoroughly satisfied in an economic sense, they will typically answer 20 percent more than they've got now.

So while it's hard to define these terms and some economists don't like to make comparisons to which they can't give definite meaning, the typical thing you find is that rich people are happy and poor people not all that much less happy. If you compare countries, the average happiness in poor countries is the same as that in rich countries. (I'm not talking about extremely poor countries.)

One of the most striking things to me is some surveys [that measure happiness] that were done in Japan every few years, and, if I remember the dates, the answers in 1958 to 1988 were roughly the same. If you draw the curves relating happiness to income, you could not tell them apart. Now that was one of the most rapid periods of economic growth any country has ever experienced. They were pursuing material goods very, very vigorously. The pursuit of material goods may have very little to do with satisfaction.

On the other hand, divorce shows up as a big negative factor in measuring happiness. Material possessions play a role in happiness, I think, but it's just a role.

The danger of excessive reliance on the market, excessive perception of the market, is that it will obscure these other, clearly more fundamental courses of happiness or unhappiness. If you spend all your time at this instead of building up your relationships, there can be a real price to pay.

A temptation of any academic discipline—especially in the social sciences, but also in the natural sciences—is to explain more than the discipline is competent to do. Are there areas of economics today that you think are overstepping its limits? And then, to what degree does the world of metaphysics, philosophy, and theology point out that there are areas beyond the market, beyond economic analysis?

Well, I think you're asking two quite different questions. One is the use of economic explanations for things that you think of as part of other social science fields. It's true that economists do have something to say about other fields. Here the problem is that you get one-sided views—namely the economic perspective alone. You are not getting irrelevant statements; they are not meaningless statements, but just one-sided or incomplete. For example, some of the claims of economics about motivation, if correct, are applicable in other fields, and that was already pointed out when the utility theories were being developed in the 1880's and 1890's.

We see, by the way, that today psychology is invading economics—the whole field of behavioral economics. I believe that sociology should play more of a role in economics than it does. The way people behave in economics is partly influenced by how other people behave. It's easy to point out examples, but it's not so easy to construct a broad theory.

You raise a different question when you ask if things like metaphysics, theology, and moral philosophy play a role. Now you're coming to the question of the realm of value versus the realm of description. It's clear there are value questions of how one “ought to act” that are not going to be answered by a description of how people do it. Economics is not going to answer that question because it can't answer it. It's just a logically different thing.

We draw on religious sources about how one should act. We used to have, in the Middle Ages, very elaborate regulations of commerce—what was permissible commercial behavior and what is not permissible commercial behavior—derived from the laws on usury, the apparent prohibition on interest, [etc.] And the same thing is happening in Islamic law now, according to things I've read. There is the so-called Islamic banking, which claims not to charge interest—but does, as had happened in the Christian world also.

Does social analysis today neglect the question of the intermediate, private charity collective action through churches, through families—these kinds of transactions that are not strictly speaking private and not for state?

I don't want to say this is a void field, but I think the tendency when anyone thinks of a policy is that either individuals should do it for themselves or the state should do it. I'm struck by the fact that there are a number of situations where the policy expert doesn't understand that there are other institutions. There are many cases where these other institutions are probably superior, because the state has constraints on its actions, even the ideal state, leaving aside corruption and things like that. The state has to treat people in some uniform way. You don't want the state to start making too many distinctions or the potential for corruption or unfairness arises. So you have rules. Well, these rules tend to be broad and not very applicable to particulars. They don't take account of the individual case. In a way, you don't want them to, but that means that their effectiveness is reduced and something more flexible can be achieved by using intermediate institutions.

For instance, we have such institutions for distributing resources—what we call charitable groups. But such institutions also exist for agitation to bring matters to the public concern, changing people's values. I think the church is playing this major role in dissemination of these values and judgments and forming a focal point for them.

Your Jewish faith has a rich tradition of moral consideration, both moral philosophy and moral theology, and a very sophisticated Biblical vision of what the economic life of the Chosen People would look like. For someone who is at the very peak of his field in economics, what lessons have you picked up from nearly twenty years of frequent contact with Christians, and particularly Catholics, thinking about these things?

Well, I've been really concerned about ethical questions for a long time. I generally try to write things I feel sure about. As I get older, I'm a little more speculative and start to stimulate other people to think more about it. I think one of the critical things is the idea of what's called tzedakah , loosely translated as charity. It's the idea of responsibility for the welfare of others. Of course, then the problem comes, how do you institutionalize that? How do you get people to take these general beliefs and translate them into their own actions? And that's why collective actions of all levels play a role.

Like most economists, I find the market a very powerful instrument for achieving efficiency. We're not wasting things. We're not wasting resources. So whatever gets there, gets there. Nevertheless, there are a lot of limitations. For instance, there are intrinsic limitations like the kinds I sketched out earlier because of the existence of private information.

Religion calls for a sense of responsibility to the other, which the market, in principle, doesn't have. In fact, the markets do have it because they need fairness and efficiency to some extent. Yet the logic of markets means that such considerations have to be modeled as totally self-regarding, and people are not totally self-regarding. It's helpful to model them in that way, I'm not going to deny that; but it's not the set of values by which you want to live. Those values have to come from elsewhere, and this is what is emphasized by Christian and Jewish thought about the economy.