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These days finance, and the dominant trend of economic thinking, act as though they were exempt from all moral interference. The neopositivism that prevails in the financial system sees observation (for example, has the value of the good X risen or fallen?) and prediction (e.g.
what will its value be in the future?) as rational but steers clear of making judgements on these facts such as is it better for the real economy if the price of that good continues to rise? What about the common good?
Many dysfunctions that arise in the financial sector, and sometimes even lead to real crises, are first and foremost the result of a moral crisis.
The 2008 sub-prime crisis showed that it is not enough to have confidence in the market because market action is not purely mechanical or technical. We need to adopt an overall, responsible view regarding the impact of our actions on the common good. All the phases of the finanTrust and Ethics in Finance cial process (savings, loans, investments, and reimbursement) must be guided by ethics and based on civic virtue.
Ethics must be the cornerstone of finance – not vice versa – and must be based on two pillars: respect for human dignity and the moral standards of the natural order. If one or the other is lacking, ethics loses its essential quality, leaving behind only the label. Nowadays we hear about training programmes in business ethics, certification of a company’s social responsibility ethics, ethical investment funds, microfinance, etc.
Though we should applaud all these initiatives, the challenge is still to create a truly moral framework for judging actions, because the adjective “ethical”, used in a generic fashion, may in some cases mask pecuniary interest or injustices that go against the common good (Pope Benedict XVI, 2009).
The word “ethical” must not simply be a label distinguishing those who have a certificate from those who do not. In order to achieve a fraternal commitment that has been freely entered into, true ethics must be prevalent among all players in the financial sector, not just an isolated group among them.
The paradox of trust
Some empirical studies have shown the positive correlation between the degree of trust in a country and its private investment sector, and thus its growth rate (Zak-Knack, 1998).
Trust is very important in all financial transactions, but in the financial sector it becomes a sine qua non condition for it to function, essentially because financial activities are transacted over more than one period of time (Arrow, 1972), which tends to create uncertainty.
In order for the market to achieve mutually beneficial results, individuals must not only agree to the conditions of the contract, they must also trust each other. A frequent problem is that one of the parties breaks this trust, either by drawing up contracts based on asymmetrical inforEthics vs Finance? 305 mation or by breaking a promise. These two forms of betrayal were both clearly illustrated in the 2008 crisis. First, customers were persuaded to accept loans without understanding the enormous risks they were incurring. Second, they then found themselves unable to repay the loan due to a lack of liquid funds.
A curious result is what Fred Hirsh has called the “paradox of affluence”. This happens when, after a period of economic growth based on high levels of trust, excessive rational instrumentalism comes along and undermines it (Ferullo, 2010). Once the level of trust starts to diminish, not only the financial system is affected but also economic growth and social well-being are also affected.
The history of the last century was a clear example of this paradox.
After the Second World War there was widespread economic growth thanks to the financial markets. During the 1980s, capitalism – focused only on profit – seemed triumphant in the old Western economies, Japan and South-East Asia. But in 2008, history suddenly changed. Hand in hand with a food crisis and an oil crisis, the financial crisis arising from the “sub-prime” loans in the United States ended up causing the collapse of the world economy.
What is the solution to this paradox from the financial industry’s point of view? The proponents of the current model claim that the financial markets have worked quite well and that the economy has simply undergone a short-term shock. If we have to blame someone it should be the state, which did not do its job properly, or the selfishness of some isolated groups – as in the greed of Wall Street. Given the “rebound effect”, the economy will get back on its growth track and trust will be reestablished. Consequently, there is no need for any substantial changes.
Even though this point of view may be valid, it is an extremely limited one. If we continue to support the current financial system on the basis of Homo economicus and the monopoly of the free market, we will 306 Trust and Ethics in Finance end up triggering new crises in the future as stated in the “paradox of affluence”.
The challenge is therefore to maintain trust in the long term, even when the market seems to be functioning perfectly and completely securely. I am convinced that in order to maintain sustainable progress there is only one solution: that the financial system and the economy in general, must act on an ethical basis. This implies taking on board means of action other than that of self interest and analysing the way what we do affects not only those who are close to us, but also society and the environment.
The deficiencies of the financial markets prevent us from foreseeing a crisis of confidence within that field of activity. The state can establish an appropriate legal and supervisory framework, but there will always be some “tricky” financier, such as Bernard Madoff, around to defraud others and destroy trust. Long term, acting in an ethical fashion is the most efficient way of not only maintaining trust but also propagating it throughout the whole economic system, while at the same time making an outstanding contribution to growth and the common good.
The challenge of globalisation
Globalisation has changed the rules of the game. Companies relocating their businesses and ever faster international capital flows have resulted in governments losing a certain amount of control over their respective markets.
From a financial point of view, this scenario raises new ethical challenges. As Pope Benedict XVI has said, globalisation brings us together, but does not cause us to act like brothers. Acting without ethical principles has already led to negative consequences, especially for the poorest
countries, and for less well-off individuals. Here are several examples:
• Multinational companies that invest in or withdraw their capital from various countries due to the need to reduce production costs, often Ethics vs Finance? 307 regardless of the impact that this action has on the local economy – unemployment, pollution, etc
• Countries that are overprotective of their advances in the fields of health and food technology, so that emerging countries are denied access to these products and incur unnecessary expenditure
• International financial institutions that recommend to – and impose on – weaker countries reductions in essential social spending so that they are able to meet their loan repayments
• Speculation among ill-informed investors, who follow the herd, and who sell shares, leading to the bankruptcy of companies that they do not even know The globalised financial system may entail negative consequences on a grand scale if it is governed only by the logic of trade and pure profitseeking, and ignores ethical principles such as social solidarity and charity. Finance governed by moral values is more than just an alternative, it becomes a must if we are to attain the common good.
Integrated goals We have already seen that the current capitalist model confers an excessive role on the market in relation to that of the state and civil society bodies. History shows that when one of the three elements gets the upper hand this results in untenable models being set up, as happened with communism and the welfare-state.
A healthy socio-economic organisation demands a subtle balance between its component parts because each of them has its contribution to make to social well-being from its own vantage point. The market achieves efficiency by means of the contract, the state achieves fairness through its redistribution policies, and civil society bodies succeed in strengthening social bonds through charitable donations as an exercise in reciprocity.
308 Trust and Ethics in Finance Even if we suppose that the actions of the financial sector may be guided by ethical principles, globalisation still poses another challenge.
The roles played by the state, the market and civil society bodies should not only be in equilibrium, they must also rethink their ways of working and the scope of their action in order to successfully promote the common good through values such as social solidarity and charity.
Nowadays, the two-step logic – the market produces, then the state distributes – no longer suffices in the pursuit of fairness. Even corporate philanthropy is insufficient since it feeds a syndrome of dependence that contributes very little either to the personal development of those in difficult circumstances or to fraternity in society.
The model we are proposing provides an integrated balance of the three components. The state, the market and civil society bodies must take on board all of society’s objectives as if they were their own. Even though each one has a comparative advantage for attaining efficiency, fairness or fraternity respectively, incorporating the other objectives will help maximise the extent to which they are implemented overall.
where people concern themselves not only with their own self interest but with that of their fellow-citizens and act in a spirit of social solidarity.
We are able to engage in commercial exchange first and foremost because we exist in a community and in certain cases – as with most disadvantaged people – that community requires us to give.
As the “civil” economy preaches, the fruits of the financial market must be everyone’s gain. This is not a matter of giving handouts but of reintegrating into the market people who have fallen into poverty through no fault of their own, and as a result are not in a position to exchange goods or services. This is the concept proposed for example by the winner of the 2006 Nobel Peace Prize, Muhammad Yunus, whose Grameen Bank is the embodiment of this approach.
As well as the contract, financial companies ought therefore to be using the concept of reciprocity. Contracts and gifts both derive from a much older principle, that of reciprocal aid, or reciprocity. Reciprocity is all about “giving” and “taking” in equal measure. In a contract, this equivalence is manifested in the monetary value of the good. When it comes to a gift, the equivalence cannot be measured quantitatively as in the form of a price tag, but through the quality of the response, which may also be conferred on a third party outside the initial relationship.
When it comes to giving and the response to giving no direct comparison can be made. In a contract, agreement on price precedes the transfer of the object. With reciprocity, the transfer is free and precedes the quid pro quo or reciprocal value, which gives rise to an expectation, but does not confer a right. What differentiates giving from aid or philanthropy is that giving requires an equivalent response (Zamagni-Bruni, 2007). But the form of this response is not fixed in advance, which means that the exchange is made on a fragile basis that requires trust.
By turning to reciprocity, financial markets will not only be able to produce material goods; they will also be able to produce the kind of 310 Trust and Ethics in Finance “relationship goods” that characterise the social economy. These goods produce utility, not only because of their objective characteristics, but through their capacity to give pleasure to others. Relationship goods have no price but since they satisfy human needs they still have economic value.
Financial markets should re-create themselves based on the principle of reciprocity, if they wish to strengthen social fraternity. This implies that Pareto optimality is not the only goal worth attaining. The fact that financial companies do pursue objectives other than those of pure profit – contrary to the preaching of economists such as Milton Friedman – means that today we see different types of organisation cohabiting in the financial sector – foundations, charities, community banks, nongovernmental organisations, social enterprises like that of Muhammad Yunus – aimed at making profits, community investment entities, etc.
This is not to suggest that incorporating fairness and fraternity into financial market objectives is a fast, trouble-free process. Nevertheless, it is the only means of making the best possible contribution to the common good.
More efficient CSR
As far as for-profit financial companies are concerned, corporate social responsibility (CSR) is one of the most sophisticated mechanisms accepted by the market as an instrument to serve the common good.
The International Labour Organisation (ILO) defines CSR as a set of actions agreed by companies so that their activities will have a positive impact on society. Through CSR these companies demonstrate the principles and values that govern them, both in their own internal methods and in their relations with other players. CSR is a voluntary initiative that implies commitment to all its stakeholders in the economic, social and environmental fields and demonstrates a respect for ethical values in building the common good.
Ethics vs Finance? 311 Nowadays, hundreds of financial companies worldwide are seeking to achieve this triple goal – socio-economic and environmental. When companies start to envisage objectives other than that of pure profit maximisation this helps them to renounce the two-step logic and take on an approach to their activity that is more distributive and responsible.
Ethics is closely linked to the concept of CSR because CSR is of necessity based on moral values that bind the company to its environment.
However, this necessity carries with it the danger we have described above. Ethics might become dependent on certification or could be used to varnish over nefarious intentions. These false ethics might then become a constant syndrome among all financial institutions, not just a handful, with consequences for society of which we are all well aware.
This should not be regarded as an unduly pessimistic notion, given the excesses created by many companies that have, for example, acted in an ethical way towards the environment but not at all ethically towards their employees.
Another danger we see is that many financial institutions become inefficient when they try to attain the triple socio-economic and environmental objective. By inefficient we mean that financial institutions aiming to satisfy all three objectives are likely to spend enormous resources on positive social and environmental action. But if these same resources had been channelled into other activities, they might have achieved much greater overall socio-economic and environmental benefits.
We constantly observe examples of this inefficiency, such as banks that send their staff to collect rubbish from public parks, teach the rules of the road to drivers, repaint schools, etc. We would not wish to say that these activities are not socially and environmentally useful, merely that the effort made and the resources invested could be better focused on activities that increase the overall socio-environmental impact.
Our criticism is based on our observation of how some financial institutions seem, through their CSR policies, to demonstrate an erroneous 312 Trust and Ethics in Finance vision of the all-powerful market. Even though the market needs to be able to achieve objectives such as socio-environmental goals, this does not mean that at any given moment it is the only or indeed the best mechanism for undertaking such activities.