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The Morality of Markets and the Nature of Competition∗

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The Morality of Markets and the Nature of Competition∗ The Morality of Markets and the Nature of Competition∗ Mathias Dewatripont† Jean Tirole‡ December 18, 2020 Abstract: Does competition undermine ethical behavior when suppliers and stakeholders have social preferences? Under price regulation (health, schools, regulated professions, franchising), a higher price and competitive pressure compromise (boost) ethics when cutting ethical corners increases (reduces) demand. Competitive pressure has no ethical impact when reduced ethics lowers cost and/or with market-determined prices. A more ethical firm com- mands a lower market share under price regulation, but not in a \low-morality market" with market prices. Finally, intense competition induces behavioral convergence among ethical types and/or corporate forms, to the better on the price front and the worse on the ethical front. Keywords: Competition, social preferences, replacement excuse, non-profits, corporate social responsability, strategic complementarities, race to the ethical bottom. JEL numbers: D21, D43, D6, I11, L21. ∗This project has received funding from the European Research Council (ERC) under the European Union's Horizon 2020 research and innovation programme (grant agreement no. 669217 - ERC MARK- LIM). Jean Tirole acknowledges funding from ANR under grant ANR-17-EURE-0010 (Investissements d'Avenir program), and financial support from the Chaire SCOR \Market risks and Value creation". We gratefully acknowledge the comments of participants at a Bonn symposium in honor of Martin Hellwig, the TSE conference on \Markets, Morality and Social Responsibility", the Chicago-LSE \Economics of Social Sector Organizations conference", as well as a seminar at Universit´eLibre de Bruxelles (ECARES and I3h), and of Tim Besley, Aim´eBierdel, Paul-Henri Moisson, Charles P´ebereau and Joel Sobel. †Universit´elibre de Bruxelles (Solvay Brussels School of Economics and Management, ECARES and I3h). ‡Toulouse School of Economics (TSE) and Institute for Advanced Study in Toulouse (IAST). 1 Introduction Does the market obliterate our moral compass? While 18th century thinkers viewed mar- kets as creating trust among otherwise unrelated individuals (Montesquieu's \doux com- merce"), today's public opinion, many social scientists, politicians and religious leaders feel that markets promote unethical behavior. For instance, numerous prominent philoso- phers have warned against the religion of the marketplace, with a variety of viewpoints from the necessity to ban repugnant markets to the stance that a market economy is an unlikely path to a harmonious society.1 Furthermore, recent experimental work demonstrates the power of the \replacement excuse", the idea that if a supplier refuses to engage in an immoral trade, \someone else will". This work echoes widespread narratives used by firms and countries selling weapons to dictatorships or bribing officials to win a contract, by banks selling toxic products or providing short-term incentives to talents they want to attract, by employees ingratiating themselves to their superiors in order to be promoted, by doctors overprescribing opioids, or by professional athletes taking illicit drugs to defeat their competitors.2 Indeed, the replacement excuse has impeccable logic to anyone with a consequentialist bent. On the theoretical front, Dufwenberg et al. (2011) and Sobel (2015) identified conditions under which an economy whose agents have other-regarding preferences delivers the same allocation as if these agents were perfectly selfish, i.e., when perfectly competitive markets destroy any velleity of doing good. This paper takes on board the idea that markets may undermine ethical values by creating alternatives and studies how competition impacts ethical behavior when these conditions are not met. The \nature of competition" in the title of the paper will refer to five attributes that define the suppliers'competitive environmment: (a) market struc- ture (number of firms, product substitutability), (b) price flexibility (whether prices are constrained or market determined), (c) whether cutting ethical corners boosts or reduces demand, (d) rivals' ethical incentives (their ethical preferences and corporate status), and (e) the social responsibility of input suppliers (investors and workers). The situation in which firms lack price flexibility is much more common than one would expect. First, prices may be fixed by a regulatory authority, a private franchisor or a platform. Price inflexibility is a good approximation of many publicly regulated markets (taxis, notaries) and unregulated ones (e.g. apps and franchising environments). Other 1E.g. Anderson (1993), Sandel (2012), Satz (2010), and Walzer (2008). 2Opioid overconsumption illustrates internalities, given the addictive nature of such painkillers. Opi- oids represent both a useful treatment for acute pain (e.g. in case of terminal cancer) but also run the risk of addiction without proven medical benefits in the case of chronic pain (e.g. back pain). Opioid overdoses have been called the worst drug epidemic in the history of the United States (McGreal 2018). The crisis has multiple dimensions, including the role of companies like Purdue Pharma in inducing doc- tors to prescribe their opioid OxyContin. Our paper focuses on doctors' decision when facing patient demands for opioid prescriptions (see Schnell 2019 for a recent assessment of policies aimed at keeping opioid prescriptions in check). 1 prominent industries in which providers receive externally-set prices are education -the price is the value of a voucher-, and health- for which the price is the payment allowed by the Social Security system, Medicare or an HMO-. Second, prices in two-sided markets are often constrained by arbitrage to be non-negative; we will therefore often use the vocabulary \constrained prices" instead of \regulated prices". The framework, developed in Section 2, posits that suppliers play an important role in shaping the morality of markets, in line with Henderson (2020)'s view that managers are key engines for \reimagining capitalism" (we later embody stakeholders' ethical con- cerns as well). The framework accordingly assumes that suppliers are driven by both a profit motive and an ethical concern. \Ethics", though, has a variety of meanings; this paper builds on the familiar social-preferences paradigm. Social preferences imply that suppliers internalize part of their impact on social welfare,3 and that they reflect on what would happen if they did not serve the client, consistent with the evidence on the re- placement excuse. We will use the \moral" or \ethics" terminology in reference to the social-preferences paradigm, although it certainly does not capture the richness of ethical thinking. We later analyze the robustness of our insights to a few alternative ethical criteria. We initially assume that suppliers' moral compass is driven by a disconnect between what is desired by the client and what is good for society. The first possible wedge may be traced to an internality (as is the case when a doctor overprescribes opioids, which is attractive to the client's \current self" but, being addictive, detrimental to her \long-term self"). Second, the disconnect may stem from an externality (as when doctors deliver fake medical certificates to allow their client not to be vaccinated or to take sick leave, or when a firm bribes an official). A third wedge is associated with shrouded attributes,4 as when a supplier misrepresents the product or exploits the client's incorrect prior or inattention. We provide numerous examples of these three wedges between client and social demands. The three wedges are unified within a single framework. The paper thus focuses first on the differential in assessments of quality by customers and a social planner. [Later, it will show how results extend or change when cutting ethical corners does not boost demand but reduces the production cost.] A bit more formally, the oligopolists wage price and non-price competition. Supplier i's demand, Di, depends on her net price, pi − ui, where ui is the gross surplus or quality perceived by consumers, and on the rivals' net prices. The novel aspect is that because of an internality, an externality or a shrouded attribute, the social welfare associated with the transaction, wi = W (ui), is decreasing over the relevant range. We look at the standard model of oligopolistic competition with unit demands, augmented with social preferences: Besides her material 3That economic agents may behave altruistically has received support in experimental economics and is a common assumption in the literature on social responsibility (see e.g. Besley-Ghatak 2018, Broccardo et al 2020, Green-Roth 2020, Hart-Zingales 1997, Landier-Lovo 2020, Oehmke-Opp 2020). 4We borrow the terminology from Gabaix and Laibson (2006)'s work on imperfect competition subject to such attributes. 2 P payoff, supplier i internalizes a fraction αi of social welfare, wiDi + j6=i wjDj. Thus, with P marginal cost c and price pi, her objective function is (pi − c)Di + αi(wiDi + j6=i wjDj). Like other works building on social preferences, we assume that tort law does not provide a perfect Pigovian correction of the wedge between market and society's demands (which is the case for the applications envisioned throughout the paper). This may hold for multiple familiar reasons.5 The imperfect Pigovian taxation leaves scope for an inter- nalization of the wedge by suppliers with social preferences. For notational simplicity, we will ignore such taxation. Section 2 obtains
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