Markets are moral by default – what about governments?

The German law on corporate due diligence in supply chains, also known as the Sustainable Supply Chain Law, has now been in force for four months. Similar laws in other countries have a longer history. Overall, efforts by Western lawmakers to regulate domestic companies and encourage, if not require, compliance with human rights, labour, and environmental standards along their entire value chain are picking up steam. In the European Union (EU), consideration of a European supply chain directive is moving forward.

Social democratic politicians, in particular, are firmly convinced that companies must be disciplined to ensure that they observe universal human rights along their supply chains. A conference on this topic was recently held in Berlin, and seemed to prove these ideas right. There are reports of companies’ evasive responses, shifting the costs associated with monitoring supply chains to suppliers or consumers, or withdrawing from locations seen as particularly difficult. This seems to affirm those who see a moral deficit in markets and in companies’ general behaviour.

This is a one-sided, and therefore incorrect, perspective. Germany has over one million companies that produce for both the domestic market and for export. They source their inputs from all over the world. Most of them maintain very good relationships with their employees and suppliers. They are very interested in complying with universal human rights, labour, and environmental standards because these align with the owners and managements’ moral beliefs, and because their clientele expect it.

The market is an institution in two senses: First, as a place of encounter and exchange, and second, as a set of rules within which this exchange takes place. It is no more moral or immoral than the market players. They behave as society expects them to. For it is precisely this society that enables them to generate the sales and profits they and their employees need. In the spirit of Adam Smith, one can even speak of market players adapting to the morality of society, at least in the medium to long term. After all, they earn their incomes only if their goods and services meet the quality demands of their customers. In addition, they have their own quality requirements, which encourage them to produce and offer good products. In a prosperous society, good quality increasingly includes the way something is produced.

In principle, this does not require an educating, so to speak nudging, state. Many market players are intrinsically motivated. This intrinsic motivation is strengthened by positive incentives, such as increase sales. However, whether negative extrinsic motivation has the same effect as intrinsic entitlements and profit opportunities cannot be said with certainty. The opposite could also happen. The conference addressed above deals in part with avoidance strategies as a response to negative incentives.

In this respect, in a first-best world where respect for human rights is a matter of course for governments everywhere, it would not be necessary at all to impose regulations on companies to respect human rights along their value chains. It would be in their interest because all employees and customers would want to enforce it. But the world is not perfect. Most governments do not fully respect the human rights and civil liberties of their citizens.

This refusal and the accordingly poor track record in some developing countries and emerging economies has led governments in the West to impose regulations on their internationally active companies, or companies indirectly linked to foreign partners, on how they should enforce respect for human rights along their supply chains. In doing so, they are addressing mostly the wrong actors. It is too much to demand that companies are legally responsible for the misconduct of foreign governments. They lack the power to enforce these rights, unless they are backed by powerful Western governments that impose sanctions. But this is not the default situation in most countries.

This logic is true even if companies are so large that they might be able to prevent misconduct by developing countries’ governments; even small countries are sovereign and can discipline companies. If a government wants to maintain social or environmental standards, it can easily do so.

From the perspective of Western lawmakers, however, it is the easiest way to document their agreement with universal human rights, which might also convince their constituents. Due diligence legislation is also an instrument to maintain the West’s often ineffective and paternalistic development cooperation as well as those restrictive trade policies that disadvantage developing and emerging countries. Activism replaces smart politics here. Instead of opening markets to developing countries’ companies, which may be linked to stricter human rights adherence by developing countries’ governments and even raise the chances that citizens can demand human rights adherence in these countries, Western governments hide behind compliance rules for their companies.

Against this background, the West's supply chain legislation appears very differently. It is possible to conclude that markets and their participants in the West intrinsically act more morally in principle than their governments. Governments implementing due diligence legislation shift responsibility - from “target” governments all over the world to their own private companies - and continue to serve powerful interest groups at home with some dubious trade policies that discriminate against the world's poorest.

Perhaps all those who really want human rights to be respected should get together again and think about more effective and fair instruments.

Andreas Freytag, Professor and Chair of Economic Policy, Friedrich Schiller University, Jena, and Visiting Professor with IIT

The views expressed here are the author(s) alone, and do not represent the views of the Institute for International Trade.

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