The question for our time is whether or not morality and markets must reach some kind of societal equilibrium for them to be most effective. Some favor regulations as a means of keeping us more honest. Others, like me, are skeptical of such regulations and argue that more often than not, they end up creating perverse incentives and distorting trust.
The latest article up on City Journal by Steven Malanga makes much this point, but looks at the importance of moral fiber in markets. (He also cites CGU Professor Paul Zak.)
Needless to say, this is not what Adam Smith had in mind. Smith laid the groundwork for the economic theories of The Wealth of Nations in his preceding book, The Theory of Moral Sentiments, which traces the evolution of ethics from man’s nature as a social being who feels shame if he does something that he believes a neutral observer would consider improper. Smith proposed that as societies evolve, they form institutions—courts of law, for instance—that reflect and codify these ethical perceptions of individuals, and that these institutions provide the essential backbone of any sophisticated commercial system.
Modern experiments in neuroscience have tended to confirm Smith’s notion that our virtues derive from our empathy for others, though with an important qualification: the ethics of individuals need reinforcement from social institutions and can be undermined by the wrong societal message, as neuroeconomist Paul Zak writes in Moral Markets: The Critical Role of Values in the Economy. When people find themselves bombarded by the wrong message—like the Washington Mutual employees whose supervisors constantly pushed them into riskier and riskier actions—some will resign in disgust, but others will gradually suppress what scientists call the brain’s “other-regarding” behavior and the shame that goes along with it and violate their own ethics.