Capitalism and free markets have been the focus of withering criticism recently, and for good reason. Even strong proponents of unfettered market action are forced to admit the presumed self-regulating nature of free markets was oversold.
But a better explanation for the failure may lie with the simple behavioral characteristics of markets.
I am not sure if it is the same question or not, but one might also ask: “Does the free market punish moral character?” On balance, the answer is no. Markets tend (but do not guarantee) to reward hard work, calculated risk-taking, applied creativity, amiability and honesty. Competition is the key here: it allows us to find alternatives to doing business with lazy, timorous, unimaginative, rude or dishonest people.
All this assumes that we can see such people coming. Often we can. Most market interactions are repeated, directly or indirectly. I buy something from the same corner shop every day, and it is in neither the shop owner’s nor my own interests to rock the boat. So we smile, chat, perform (very) small favours for each other and do not cheat. My relationship with a Tesco shop attendant is less straightforward, but, although unlikely I will ever see the attendant again, Tesco has an ongoing relationship both with its own employee and with me and does its best to ensure things run smoothly.
When market interactions are not repeated, there is more temptation to cheat. There is a logical reason why holiday guides, estate agents and pension salesmen tend to be regarded with caution.
All this is closer to pub philosophy than science, but some scientific evidence does exist. One suggestive finding comes from a cross-cultural study carried out by three economists and published earlier this year in the journal Science. Simon Gächter, Benedikt Herrmann and Christian Thöni invited subjects in 16 cities across the world to play a “public goods” game, in which players had to choose, repeatedly, between contributing to a pot for the benefit of all or selfishly hoarding their own resources. [More]
Perhaps we have more "one-timer" transactions as the economy globalizes, and hence the creeping dishonesty in markets, or the elaborate abstraction of previously simply exchanges creates strangers even when a long term-relationship exists. Poorly understood transactions like derivatives would seem to be very susceptible to sharp practice.
For whatever reason, it may be more helpful to remember when free markets work well and not expect the same results when we venture outside those parameters.