Friday, September 03, 2010

The case against corporate social responsibility (part 1)

Aneel Karnani offers a rather pedestrian analysis in The Case Against Corporate Social Responsibility. He doesn't actually make much of a case against corporate social responsibility in general; the article does not live up to the lede:
Can companies do well by doing good? Yes—sometimes.

But the idea that companies have a responsibility to act in the public interest and will profit from doing so is fundamentally flawed.
He observes that corporations can and probably should act in their own self-interest, and corporations will therefore act in socially responsible ways only if such action is somehow in their own self-interest.

As Dr. Karnani notes,
Very simply, in cases where private profits and public interests are aligned, the idea of corporate social responsibility is irrelevant: Companies that simply do everything they can to boost profits will end up increasing social welfare. In circumstances in which profits and social welfare are in direct opposition, an appeal to corporate social responsibility will almost always be ineffective, because executives are unlikely to act voluntarily in the public interest and against shareholder interests.
The key here is that corporate executives are unlikely to act voluntarily. Truly voluntary corporate or executive social responsibility (when conflicting with short or medium term material self-interest) is not just unlikely, it's almost impossible. Absent some higher-level incentives, a firm (or its executives) that sacrifices profits for some general good when other firms are free to sacrifice a general good for profits will be selected against in the short term.
Executives are hired to maximize profits; that is their responsibility to their company's shareholders. Even if executives wanted to forgo some profit to benefit society, they could expect to lose their jobs if they tried—and be replaced by managers who would restore profit as the top priority.

The general good is a good like any other, and there's a production-possibility frontier between the production of privately profitable goods and competing general goods. (There is no production-possibility frontier — there is no underlying trade-off — between private profits and general goods that result directly from those profits.) The overall social task is to find the optimal point on the production-possibility frontier. If we consider only profits, the "optimal" point is to maximize profits while completely ignoring competing general good: the opportunity cost of ignoring the general good is, on this measure, zero. If we want a more sophisticated economic analysis, we have to somehow account for the opportunity cost of foregoing a profit-competing general good, so we can compare it to the opportunity costs of foregoing not just profits but also profit-compatible general goods (which would also be measured as zero considering only profits).

Dr. Karnani correctly argues that the costs of foregoing a general good have to explicitly imposed on companies as actual monetary costs. More importantly, these costs have to be imposed more-or-less universally, even on those companies that would otherwise not voluntarily take the general good into account.
So how can that balance best be struck?

The ultimate solution is government regulation. Its greatest appeal is that it is binding. Government has the power to enforce regulation. No need to rely on anyone's best intentions.
Absent binding government regulation, the trade-off between profit and general good is a prisoner's dilemma game. While we might all be better off if every firm's best intentions were to give weight to the general good, any individual firm is better off (measured exclusively by profit) if they ignore the general good. If all other firms are sacrificing profit for the general good, then each individual firm would not only enjoy the general good afforded by other firms' behavior but would also have an advantage if they ignore the general good for larger profit (thus attracting more capital) or reducing prices (thus attracting more market share). If no other firm is doing so, then a firm not only places itself at a disadvantage by sacrificing profits for a general good but also fails to realize any benefit from the general good. The dominant strategy is therefore to sacrifice the general good, even if optimizing the balance between profit and public good were Pareto efficient on some larger measure.

Dr. Karnani also endorses less formal ways of incentivizing corporations and corporate executives to act in socially responsible ways. He mentions the Rainforest Action Network favorably; the organization does not merely encourage social responsibility, it imposes actual costs on firms which do not act responsibly. As the article quotes from from the Rainforest Action Network's website,
Our campaigns leverage public opinion and consumer pressure to turn the public stigma of environmental destruction into a business nightmare for any American company that refuses to adopt responsible environmental policies.
Because private campaigns do not have the authority afforded by the full democratic, governmental process, however, these campaigns will typically be less effective than true regulation.

The main thrust of the article is the correct but rather obvious position that a moral standard that does not differentiate or respond to differential compliance is no moral standard at all; it is simply irrelevant and ineffective. However, this observation does not at all support the claim that these sorts of irrelevant "moral" standards are actively dangerous:
The danger is that a focus on social responsibility will delay or discourage more-effective measures to enhance social welfare in those cases where profits and the public good are at odds. As society looks to companies to address these problems, the real solutions may be ignored.
The best example noted in the article is "greenwashing", where companies claim to be acting in an environmentally sound way, but are not taking any effective environmental action. But it's hard to see the actual danger of such a response. As Hamlet mentioned, "Assume a virtue if you have it not," and many effective moral standards have begun with first insisting only that people (and institutions) give lip service to some moral standard. Such a measure seems to do nothing but increase popular support and the public consensus for actually enforcing values; how can you be against enforcing a value to which you publicly adhere?

Additionally, this article suggests a deeper tangent: Is government regulation — and the general imposition of costs not related to immediate profit — ever justified? I'll address this question in my next post.

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