Market Economy, Prisoner’s Dilemma, and Accountants
Adam Smith, John Nash & The Dilemma of Trust
The market economic theory is well known across the world. Adam Smith, the author of The Wealth of Nations, said that if everyone works for themselves to maximize their own profit, society will most effectively and efficiently create wealth through the invisible hand. For example, when each baker works to produce the best bread to win the competition against other bakers, society will have the best quality bread at the lowest possible price as a result of the competition. Before Adam Smith’s work, the dominating perception was that people were supposed to work to serve God, the king, or the great cause.
The message that people’s behavior of maximizing their own benefits would eventually lead to society’s maximum prosperity was shocking news and a breakthrough concept at that time. Over the last 200 years, many countries that followed the market economy as their central economic policy have created more wealth than other countries that pursued other economic models.
1. The Prisoner’s Dilemma: Why the Invisible Hand Breaks Down
However, we have also observed that the market economy can also create many social problems. For example, what happens to the losers if the winners take all the benefits? Do they lose everything? In fact, we also need losers to survive and for them to be able to participate in the next round of competition. Therefore, the winners should share the spoils with the losers to maximize society’s long-term benefits. The competition must continue to keep the market productive. We want to encourage winners enough to continue their hard work, but we also don’t want losers to lose motivation and want them to survive for the next competition. The market economy is expected to be a long-term, almost endless repetitive game.
There is another theory that the market economy does not guarantee the maximum benefits for society. The Nobel Laureate John Nash introduced the “Prisoner’s Dilemma” in his famous game theory. When one party is not sure that the other party will keep to the rules in the competition, each party’s decision to maximize their own benefits does not guarantee the best results for society.
Suppose competitors have no trust that their counterparts will follow certain rules established by the authorities. In that case, competitors will not make a decision that will produce win-win results (the first-best solution). They will make decisions that create less than maximum benefits but are more guaranteed results for themselves (the second-best solution) at the expense of the competitors’ trust.
In other words, if you are not sure that the counterparts will keep to the rules agreed upon by rule makers, everyone in the competition will end up making the second-best decisions. As a result, society in aggregate will suffer the cost of not making the first best results. In this situation, the invisible hand will not function as well as predicted by Adam Smith.
2. Corruption, Social Contract & The Three OECD Typologies
For Adam Smith’s competition to produce its best results for society, everyone in the market should believe that every participant will observe the rules. In this context, the government has a role in establishing the rules that every participant should follow. As Thomas Hobbes argued in his social contract theory, the state should be responsible for maintaining order and establishing trust among constituents that everyone will observe the rules.
A corrupted government means a government that destroys social trust. According to the OECD definition, there are three types of corruption:
Occurs between low-level (frontline) government officials and civil petitioners. Petty corruption is the easiest to detect and punish, but its aggregate macroeconomic effects are comparatively limited.
Occurs between high-level government officials and particular persons or enterprises. Includes granting privileges to participate in state projects (such as airports or highways) without fair and proper competition.
Includes launching a less urgent state project over the most urgent one, or mislocating bridges/airports to curry constituent favors. Causes the most severe societal damage but is extraordinarily difficult and costly to legally prove.
“Grand Corruption includes granting a specific individual or an organization the privilege to participate in a state project, such as the construction of an airport or highway, without going through a fair and proper competition.”
Even though constituents of a society know that political corruption occurs, they can’t do anything about the crime because it is too risky and costly to prove its existence. Where political and grand corruption occurs without punishment, the government’s efforts to detect and punish petty corruption only cause cynicism in society. In this environment, society does not trust the government’s genuine efforts to keep rules and order for the market to function well. Therefore, the market mechanism is not guaranteed to produce the first-best results.
“It is not about accounting – it is about improving people’s lives by holding governments to account to deliver on their obligations without hiding the facts about who will pay for them.”
An empirical examination of the perceived levels of the Corruption Perceptions Index (CPI) published by Transparency International (TI) against the rank of GDP per capita across market economies reveals an overall correlation of 79%1. It demonstrates that the more corrupted an economy is, the less effective the market mechanism is at generating societal wealth.
3. Citizenship in Leadership & The Limits of State Machinery
Governments have a certain responsibility to set up rules and ensure all participants follow them. But as Peter Drucker observed in Post-Capitalist Society, the government’s role is very limited and inefficient in a modern, complicated, fast-moving society. Leaders and individuals equipped with citizenship are essential to build and maintain market trust.
Citizenship means that people – especially leaders – let the public interest take precedence over individual interest when personal interest conflicts with the public cause. Individuals can maximize their own benefits as long as it promotes the public interest or causes no harm. For corporations, this citizenship is manifested as corporate social responsibility (CSR).
4. Accountants Should Play a Key Role to Build Trust & AI Reality
When AlphaGo won one-sidedly against world champions in 2015 and 2016, many predicted accounting would be among the first professions replaced by Artificial Intelligence. Over the past decade, that prediction has proven completely false. Rather than being replaced, the profession has embraced technology to alleviate routine, lower-value tasks and transitioned toward strategic value creation.
“Artificial Intelligence will not replace human creativity yet and it certainly can’t deploy ethics, judgement or professional skepticism. In the era of Artificial Intelligence, professional accountants become more essential and valuable constituents in the market economy.”
IFAC comprises 172 members and associates across 129 countries and jurisdictions, representing approximately 2.5 million professional accountants in public practice, education, government service, industry, and commerce.
The Crucial Role of PAIBs (Professional Accountants in Business) & IESBA Code Part 2:
Among the 2.5 million accountants globally, more than 60% work in business and the public sector (PAIBs). They shoulder direct institutional responsibility for cultivating societal trust, yet their contributions are often less visible than those of external auditors.
The International Ethics Standards Board for Accountants (IESBA) issued the International Code of Ethics, where Part 2 is explicitly dedicated to PAIBs. Unfortunately, most PAIBs remain unaware of Part 2, and many countries fail to translate it into local languages. To remain indispensable, PAIBs must champion public confidence, uphold professional responsibilities, and safeguard the public interest.
5. Conclusion: Accountants as Moral Linchpins of the Economy
The market economy is based on the premise that participants act with integrity by observing rules and putting the public interest before maximum private benefits. Although the government is the designated agent responsible for establishing trust in the market, society’s leaders are getting to play a more critical role in upholding that trust.
Professional accountants, who have the code of ethics to observe, are still essential in the era of Artificial Intelligence for the market economy. As they stand for the public interest when the organization is in conflict with the public interest, they will be a key element to lead the market economy to be successful. ■■■
Two Accounting Qualifications with One Study Pathway
The CA Masters pathway allows students who undertake a Master of Professional Accounting in select universities in Australia or New Zealand to complete the CA Program modules in the final year of their degree – with no extra tuition fees, study, or certification. Learn more about the CA Masters pathway at the CA ANZ Stand at WCOA 2022.
“At the end, you graduate with a Master’s degree from a leading university and an internationally recognised qualification from one of the leading professional bodies in the world.”
“... be recognised in different countries without further loss of time or further qualifications required.”