The Market for Honesty; D. Lee

And with the market, it's not just a matter of trusting a few people whom we know and care about. Market cooperation depends on our being able to trust large numbers of people, most of whom we will never know. Consider the behavior of business people. If the proverbial man from Mars observed our business activity, he would surely conclude that business people are extraordinarily hon est. For example, they sell precious gems that really are precious to customers who cannot tell the difference between· diamonds and cut glass. They promise not to raise the price of a product once customers commit themselves and make switching to another product cost ly-and they keep the promise. They make good-faith promises that the business they own, but are about to sell, will continue to give their customers good service. The exam ples could be continued indefinitely since honesty and trust are essential for all but the simplest business transactions.

I am not naIve enough to argue that busi ness people are never dishonest. Just like Dwight Lee is Ramsey Professor of Economics and Private Enterprise at the University of Georgia. 45 people in all walks of life, some will cheat, lie, and steal to snatch short-run advantage. But they are not nearly the scoundrels as pre sented in the media and popular entertain ment. According to one study, almost 90 per cent of all business characters on television are portrayed as corrupt. I· In fact, business people can be depended on to act more hon estly than most. This is not because business people are inherently more virtuous than oth ers (though there is no reason to believe they are less virtuous), but because the free mar ket penalizes those who do not provide con sumers with things they value-and con sumers value honesty. The reason the market penalizes dishonesty is obvious at one level. Those who fail to pro vide the quality they promise, and charge for, may profit in the short run, but not in the long run. But even in the short run there are gains from honest dealing, and those who can cred ibly promise to deal honestly can capture some of those gains. So business people are strongly motivated to put themselves in situa tions in which dishonest behavior is quickly penalized. By doing so they are better able to entice customers with assurance of everyday honest dealing.

Committing to Continuity Consider the fear of dishonesty that can arise when it is believed that a business is about to shut down, say, because the propri etor is getting old. Even if such a proprietor has no intention of cheating customers, they 46 THE FREEMAN/IDEASON LIBERTY • FEBRUARY 1999 will have reason to worry without some cred ible assurance of the proprietor's long-run interest in the business. An owner can often provide this assurance by bringing his off spring into the business ("Samson and Sons" or "Delilah and Daughters"). Not surprising ly, research shows that children of single pro prietors are three times more likely to follow in their parents' lines of work than the chil dren of others. Even large corporations, with lives that extend far beyond those of any of their managers, often depend on single pro prietorships to represent and sell their prod ucts. This explains why Caterpillar, for exam ple, has a school on running Caterpillar deal erships for the sons and daughters of the owners of those dealerships.

To consider another example of the impor tance of business continuity in promoting honesty, ask yourself where you would rather shop for an expensive piece of jewelry, a jew elry store with a well-advertised brand name and ornate fixtures, or a sidewalk vendor operating out of a Volkswagen van parked at the curb? What could the store do with its brand name and fixtures ifit went out of busi ness? Not much, and this tells customers that the store has a lot to lose by misrepresenting its merchandise to capture short-run profits. It has made a commitment to staying in busi ness by being honest. Embracing Competition Intel, having received a patent on its 286 microprocessor in the early 1980s, immedi ately gave up its monopoly by licensing a competitive firm to also sell the microproces sor. Why would any company give up a legal monopoly? Because of the importance of honesty. Intel was willing to sell its new microprocessor to computer manufacturers at a reasonable price, and promised to do so. But the manufacturers were afraid that once they committed to using the new microprocessor (making expensive changes in their produc tion process that would be difficult to reverse), Intel could exploit its long-term patent monopoly by raising the price. Intel could make a credible promise that it would maintain competitive prices by giving up its monopoly. Committing itself to honest deal ing was more important to Intel, and more profitable in the long run, than exploiting a monopoly position in the short run.2 Selling and Repairing It is difficult for consumers to determine the quality of automobile repair. They can generally tell if the work eliminated the prob lem: the car starts, the rattle is gone, the oil light is off, and so on. But few people know if the repair shop charged them for only the repairs necessary, or if it charged them for lots of parts and hours of labor when all the mechanic did was tighten a screw. One way repair shops can reduce the payoff from dis honest repair charges is through joint owner ship with the dealership selling the cars being repaired. In this way the dealer makes future car sales largely dependent on honest repair work. Dealerships depend on repeat sales from satisfied customers, and an important factor in how satisfied people are with their car is the cost of upkeep and repairs. The gains a dealership could realize from over charging for repair work would be quickly offset by reductions in car sales.

Automobiles are not the only product for which it is common to find repairs and sales tied together in ways that provide incentives for honest dealing. Many products come with guarantees and warranties entitling the buyer to repairs and replacement of defective parts for a specified period. These guarantees pro vide confidence in the seller's honesty when advertising the quality of his product. Some will always go for the short-run gain through deceit and dishonesty. But the greater the freedom of others to compete with credi ble commitments to honesty, the less dishon esty pays even in the short run. The coopera tion that characterizes the free market would never be possible without the high level of honesty and trust motivated by market com petition. D 1. See Robert Lichter, Linda Lichter, and Stanley Rothman, Watching America (New York: Prentice Hall, 1990), p. 146. 2. Adam M. Brandenburger and Barry J. Nalebuff, Co-opetition (New York: Currency/Doubleday, 1996), pp. 105-106.