Follow us on

Free markets must beware creeping breakdown in legitimacy

by Dr Simon Longstaff
02 August 2018
BUSINESS AND PROFESSIONAL ETHICS;
THE ETHICS CENTRE

This article was written for, and first published on the Australian Financial Review

This much we know: a blistering series of scandals has led to a profound loss of trust – not just in Australia but across the developed world. Consequently, the issue of trust has become a hot topic – a new staple item on meeting agendas of cabinets, boards, conferences, etc. However, what if the spotlight being shone on the topic of trust is blinding us so that we fail to see a far greater risk lurking in the shadows – the potential loss of legitimacy?

The Ethics Centre has just published a paper that raises this possibility and sounds a warning that should be heeded by those of us who believe in the virtues of the market economy. We do not argue that trust is unimportant. Instead, we make the case that while individuals and institutions can (and do) survive a loss of trust, they rarely (if ever) survive a loss of legitimacy.
 

"We do not aruge that trust is unimportant. Instead, we make the case that while individuals and institutions can (and do) survive a loss of trust, they rarely (if ever) survive a loss of legitimacy."

At the core of our argument is a simple truth of economics. A reduction in trust can be compensated for by an increase in the "deadweight" costs of surveillance and enforcement. The classic case is the making of agreements. A high trust context can see agreements made on the basis of a low-cost handshake (or its equivalent). Low trust contexts are burdened with the high costs of detailed contracts, enforcement provisions, litigation, etc.

Bearing this in mind, we distinguish between the concepts of trust and legitimacy according to the following definitions:

Legitimacy is a recognised and well-founded right to claim a certain status, role or function.

Trust is a belief that a person or institution will perform their role or function in accordance with its obligations or where not bound by duty, in a predictable manner – often in accordance with its interests.

The less formal distinction is as follows: where low trust can be compensated for by a higher degree of checks and balances (deadweight costs), a loss of legitimacy cannot be compensated for at any cost.

Now, if you accept our argument that there is a difference between trust and legitimacy and that a loss of the latter is usually fatal, it soon becomes clear that some of our institutions are at grave risk. We see the early signs in a number of areas. In politics, it is not only political parties and politicians that risk losing legitimacy – it is the system of representative liberal democracy that is being called into question.

 

As the Lowy Institute has reported, a growing number of younger Australians doubt the capacity of democracy to respond to the challenges of modern life. In economics, there is growing scepticism about the legitimacy of an international economic order based on free trade and the operation of free markets. We see both trends converging in movements (sometimes dismissed and derided as mere populism) that are reshaping the political and economic landscapes in Europe, North America, Central America and at home.

The great risk in this is that each and every part of the political and economic ecosystem becomes tarred by the same brush – with the spiral of decline sucking in all … the good, the bad and the indifferent … without distinction.

For its part, The Ethics Centre has a long history of calling attention to the ethical underpinnings of the free market … recalling that Adam Smith championed markets as the means by which to bring prosperity to all (and not just a few). We (again) make the case for free markets in this latest paper – but go one step further by outlining some core principles that we think should be adopted by corporations if they are to help maintain the legitimacy of the system upon which they ultimately depend.

 

At one level, the headline principles are deceptively simple: respect people, do no harm, be responsible and be transparent and honest. However, rather than simply state self-evident pieties, we have tied these principles back to the underlying concept of free markets as tools for increasing the stock of common good and mechanisms that can only function, as intended, if participants do not lie, cheat or use their power oppressively.
 

"Businesses are struggling to develop enabling connections with communities. Their efforts are embedded in conversations about trust, social licence, shared value and so on."


Businesses are struggling to develop enabling connections with communities. Their efforts are embedded in conversations about trust, social licence, shared value and so on. There are major programs to increase transparency – often as an alternative to trust (which makes transparency unnecessary). We argue that the problem with all of these efforts – well-intentioned as they are – is that they fail to address the larger problem of a system whose parts are progressively undermining the legitimacy of the whole.

The good news is that the unravelling is reversible – that some fairly straightforward measures can be applied … but only if we rediscover the purpose of the free market and the economic actors that it sustains – for the good of all.

 Visit www.trustandlegitimacy.com to download a copy of the Trust, Legitimacy and the Ethical Foundations of the Market Economy report.