Ding-dong. In the left corner we have the great champion Adam Smith, assisted by his charming assistant Deirdre McCloskey. In the right-hand corner his vile challenger Bernard Mandeville, accompanied by leftist groups shouting ‘boo!’

The fight can begin. Mandeville opens with a direct right on Smith’s chin, who immediately goes down. We are not talking about a boxing match, but about a philosophical struggle in which Bernard Mandeville held a song of praise for self-interest with his extremely provocative fable of the bees. Acting in the interests of others was, according to him, suspicious, vain or ultimately explainable by self-interest.

Adam Smith fundamentally disagreed with Mandeville and attacked him in sharp words. Smith was a follower of Aristotle and believed that people strive to be virtuous. He acknowledged that Mandeville was right that much (especially economic) acts spring from some form of self-interest, but in Smith’s dictionary that does not imply egoism. Proper behavior finds a balance between self-interest and the interests of others.

The tragedy

The tragedy is that later in history Smith and Mandeville were lumped together. The first because he was assumed to believe in the invisible hand and as a result became the involuntary ‘founder’ of naked capitalism. The second because he was assumed to have shown that markets are fundamentally provoking bad behavior, or worse: only function properly when people behave badly.

Because of this charade, hundreds of years later we still do not know whether markets are intrinsically beneficial or not. On the one hand we see that the capitalist system has not only generated enormous prosperity, but are also able to reduce poverty more effectively than other systems. So it cannot be that bad. On the other hand the financial crisis shows us the bizarre shadow side of the system.

The cardinal virtues

In the Moral markets project a large number of Dutch scholars are trying to develop a better answer to the question of the conditions under which markets are or are not virtuous. The four cardinal virtues of Aristotle are always a good starting point for such endeavors.

One can, for example, claim that markets lead to caution (Prudentia). If people take risks with their own money and do not operate sufficiently carefully this leads to bankruptcy. The lack of the possibility of bankruptcy in a non-market environment often leads to less virtuous actions. It is also evident that courage (Fortitudo) is necessary for entrepreneurship. Things can, after all, also go wrong on the market and then you will have to suffer the consequences. That requires courage. It is no coincidence that risk-averse people often end up working in the public sector.

Self-control (Temperantia) is also required because taking too many risks leads to accidents. Justice (Justitia), finally, also applies to markets. If an entrepreneur is acting unfairly vice versa his employees, suppliers or customers, he may get away with it for a while, but eventually is likely to get caught. Mandeville’s world is not based on empirical observations and is philosophically shallow. The market is not fundamentally a matter of vices. In fact, virtues are needed to make markets work well.

This, of course, does not demonstrate yet that a reverse causality also applies. Do markets also lead to virtuous behavior? That is more difficult to say. But as long as success in the market place at least partly depends on virtues, as described above, everyone has an incentive to behave properly. The most successful entrepreneur is then the one who works best with customers, has the best relationships with suppliers, colleagues and employees, and is willing to take risks – but not too much. Long live the market!

The tension

Has our question been answered? At a general level, yes. The market (as an abstract institution) is virtuous and even stimulates virtuous behavior. Societies where the market is suppressed do not flourish, as recently became painfully clear by the disaster in Venezuela. The leftist movement must lick its wounds.

But there is still some uncomfortable tension. If it is true that markets are good, why do we see so many counterexamples? Greedy capitalists who get away with persistent cheating, income disparities which in some countries take on surreal and even disruptive proportions, and companies that systematically cross the line with child labor, weapons or environmental pollution. We cannot dismiss this as unfortunate incidents or collateral damage. Is it not actually the rightist movement that needs to ponder over its sins?

The conditions

The solution of the puzzle lies in the conditionality of the market that provokes virtuous behavior. As long as success in a market is depending on virtues, everyone has an incentive to behave properly. In theory, and in practice as well, this is often the case – but equally often it is not. In a technical sense a market continues to operate if these conditions are not met. Supply and demand come together and a price is determined, but the outcome is not all puppies and sunshine.

Suppose it pays to make clothes using child labor. The clothes are cheaper as a result, the consumer is not aware of it – or does not want to know – and the government chooses to ignore it. Likewise with cheap meat from the bio-industry or environmental pollution. This changes the story significantly. Proper conduct is being punished by consumers and it is precisely the villains who earn the most money. The market fails in a moral sense, not because supply and demand do not come together, but because underlying public values (such as environmental protection or animal welfare) are not sufficiently guaranteed.

The same is true for the wrongs in the financial world revealed during the crisis. If it pays to gamble with other people’s money and losses can be deferred to society, pious stories about virtues should go out of the window.

The balance

Markets are only virtuous to the extent that societies make them so. This requires a well-functioning government that protects values that are not naturally priced (such as child rights or sustainability). But it also requires that markets are embedded in society more broadly.

Markets are not virtuous in isolation from other social forces. A judicial power is required that protects property; A democratic system that controls the government; A competition authority that monitors whether there is sufficient competition; A free press acting as watchdog; Social cohesion that contributes to a collective moral compass. Only then can the market be virtuous and encourage virtuous behavior in its participants.

The market as an institution is not so much immoral as a-moral. It can be a vehicle for both virtuous and vicious behavior, depending on the conditions that apply. The French diplomat and philosopher Joseph de Maistre (1753-1821) once said: “Every nation has the government it deserves” (Toute nation a le government qu’elle mérite). We now have a new version: Each country gets the market it deserves, virtuous or not.