« Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income | Main | Paul Krugman: Drugs, Devices, and Doctors »

Friday, December 16, 2005

In Trade We Trust

Alan Greenspan sounds a familiar tune on the virtues of free markets. Here, he stresses the importance of implicit contracts in making free markets work. Trust, he says, is a key element in commerce and it is reemerging as an important asset in the global economy as we discover that government alone cannot provide the guarantees that are necessary to ensure integrity in business relationships. Only the market, by punishing the stock values of companies who commit business and financial transgressions, can serve this function:

Remarks by Chairman Alan Greenspan, Acceptance of honorary degree, New York University, New York, New York, December 14, 2005: ...I have had a front-row seat in observing the exceptional growth in world living standards. With all that exposure, it was inevitable that I would gain some useful insights into the role of open and competitive markets in engendering the wealth of nations. ... On average, world standards of living are rising, in large part because of the widening embrace of competitive free markets, especially by populous and growing China and India. ... Open and free markets ... rest not only on voluntary exchange but also on a necessary condition of voluntary exchange: trust in the word of those with whom we do business. To be sure, all market economies require a rule of law to function--laws of contracts, protection of property rights, ... Yet, if even a small fraction of legally binding transactions required adjudication, our court systems would be swamped and immobilized.

In ... virtually all our transactions, ... we rely on the word of those with whom we do business. If we could not do so, goods and services could not be exchanged efficiently. The trillions of dollars of assets that are priced and traded daily in our financial markets before legal confirmation illustrates the critical role of trust. ... Commerce is inhibited if we cannot trust ... commitments. ... This necessary condition for commerce was particularly evident in freewheeling nineteenth-century America, where reputation and trust became valued assets. Throughout much of that century, laissez-faire reigned ..., and caveat emptor was the prevailing prescription for... trading... A reputation for honest dealing was thus particularly valued. ... To be sure, the history of world business is strewn with Fisks, Goulds, and numerous others treading on, or over, the edge of legality. But they were a distinct minority. ...

Over the past half-century, societies have ... partially substituted government financial guarantees and implied certifications of integrity for business reputation. As a consequence, the value of trust so prominent in the nineteenth century seemed by the 1990s to be less necessary. Most analysts believe that the world is better off as a consequence of these governmental protections. But corporate scandals in the United States and elsewhere have clearly shown that the plethora of laws of the past century have not eliminated the less-savory side of human behavior.

We should not be surprised, then, to see a reemergence ... of the value placed by markets on trust and personal reputation in business practice. After the recent revelations of corporate malfeasance, the market punished the stock prices of those corporations whose behavior had cast doubt on the reliability of their reputations. There may be no better antidote for business and financial transgression. ... Our system works fundamentally on trust and individual fair dealing. We need only look around today’s world to appreciate the value of these traits and the consequences of their absence. While market economies have achieved much in this regard, more remains to be done.

Prejudice ... is unworthy of a society built on individual merit. A free-market capitalist system cannot operate effectively unless all participants in the economy have the opportunity to achieve their best. If we succeed in opening up opportunities to everyone, the affluence within our borders will almost surely become more equally distributed. ...

    Posted by on Friday, December 16, 2005 at 12:15 AM in Economics, Fed Speeches | Permalink  TrackBack (0)  Comments (5)


    TrackBack URL for this entry:

    Listed below are links to weblogs that reference In Trade We Trust:


    Feed You can follow this conversation by subscribing to the comment feed for this post.