The Vogue of "Social Responsibility"

Monday, September 22, 2014

In September 1970, the late Milton Friedman published a bold manifesto entitled “The Social Responsibility of Business is to Increase its Profits” in the New York Times Magazine, where he argued that businesses do not need to engage in various charitable or public-spirited activities, even those that generally meet with approval from shareholders. The best defense of the Friedman thesis is that any discrete corporate effort to advance collateral ends will not enjoy the unanimous consent of all corporate shareholders, so that the contribution operates like an implicit tax on dissenting shareholders. The better track is for the corporation to make the shareholders rich, so that they in turn can embark on their own charitable operations, without having to bind their fellow shareholders.

Friedman’s overall thesis is subject to several lines of attack. The first difficulty is that no one quite knows what counts as a charitable gift. Thus a corporate giving campaign could easily be regarded as a device to promote corporate good will by establishing a favorable image for the company, created by doing good deeds unrelated to its direct business interests. Virtually any charitable gift could fit into this category, at which point it becomes a business judgment as to whether these expenditures are the best way to woo future employees, suppliers, and customers. The exception, in other words, can swallow the rule. 

The second criticism insists that it is not the job of any economics or law professor to tell corporations how to run their businesses. That decision should reside in each corporation with its distinct shareholders. Nothing prevents a corporate charter from allowing charitable giving. All potential shareholders are then on notice of its powers and prospects, and can buy or sell shares based on whether they share the corporation’s fundamental policy choice. If shareholders think that corporations make better and more informed donors than they do individually, then it is perfectly rational for them to take the risk that some of these corporate gifts will not be to their individual liking. It becomes a question of trading one risk (individual ignorance of the charitable universe) against another (corporate activities gone astray). The market can handle this problem like so many others.

Assuming that corporations have good reasons to engage in charitable giving, the harder question asks how a corporation should best engage in these activities. This issue has been raised as of late in connection with the otherwise technical questions of corporate supply chain management. This esoteric field asks how corporations can best organize their complex chains of supply. The objective of this task is to ensure that the firm gets the right goods in the right quantities to precisely the right place and at the right time, with the right quality for just the right price. This juggling act presents a massive challenge because the system only works well if all of its discrete pieces are in alignment. A single break can stop the entire process. Knowing this, sound chain managers may use procurement strategies that involve multiple chains. 

Additional efficiencies may be added if a firm has long-standing contracts with two or more suppliers so that one can pick up the slack when the other goes down. Further efficiencies can be gained if multiple competitors purchase from the same supplier, where each of them can share the benefits of the lower average costs that can come from larger production runs.  

The success of supply chain management depends on the ability of the firm to assure the quality of its outputs at each point, preferably by direct inspection at the critical stages of the process. Especially when overseas operations are involved, it is virtually impossible for a distant American firm to keep tabs on the conditions internal to the facilities that produce components in its supply chains. Only in rare instances is it cost effective to use direct inspection of foreign facilities to monitor the conditions under which the product is made. 

Unfortunately, government efforts to impose socially responsible regulation in a top-down manner can easily go awry, by limiting the ability of a firm to develop efficient supply chain practices, which might for a whole host of reasons require rapid shift from one supplier to another, perhaps in response to unanticipated regulation from the host state. Diversification of supplies is often the best response to sovereign risk. 

The point here is not that corporations should cease socially-responsible activities, but rather that they should organize them independently of their production efforts. Thus if a corporation wants to show good will to a developing country, either by voluntary choices to improve worker conditions or to make charitable gifts entirely apart from the core business operations, it should be allowed to do just that.  It may well be better, for example, to send aid to local schools than to enter into inefficient agricultural contracts. 

Recent legislative and administrative developments have put this standard supply chain model under serious pressure. New regulatory programs seek to impose on American firms obligations to monitor the labor conditions of their overseas contractors and subcontractors in order to prevent or reduce the likelihood of disasters such as the collapse of the Rana Plaza manufacturing plant in Savar, Bangladesh, where 1,120 were killed when the commercial building collapsed. No one can defend the dangerous construction and maintenance practices that led to the massive loss of life, but it is much more difficult to figure out what should be done to control these behaviors. The ideal social response is for local governments to monitor these practices directly. Properly done, local regulatory efforts should produce net benefits to workers that should offset any wage loss attributable to higher construction and inspection costs, wholly without American involvement at a distance.

Yet the discussion quickly enters the world of second-best regulation, given the total lack of confidence that everyone has in local regulation. Long after Milton Friedman wrote his manifesto, modern business began treating supply chain management as “Imperative for Global Corporations” which generates legal as well as moral obligations. The hard question is how best to design this oversight mechanism. One device, adopted in California’s Transparency in Supply Chains Act of 2010, relies on disclosure that requires all firms doing business in California with over $100 million in world-wide receipts to explain what steps, if any, they have taken to “eradicate slavery and human trafficking from their direct supply chains for tangible goods.”

The difficulties with this system are twofold. First, the term “direct” gives no indication as to how deep down the supply chain a given firm should go to meet this obligation. Second, it is not clear how any firm could conduct the necessary audits and inspections to ensure that remote suppliers comply with these obligations: it is all too easy for products made in a non-compliant plant to be surreptitiously sold through the offices of a compliant firm. 

The good news is that the sole sanction under the California Act is an action for “injunctive relief” brought by the California Attorney General. The bad news is that nothing in this act explains what should be done if the firm overstates its efforts to deter local abuses. Do these deficient disclosures become the basis for actions for fraud and non-disclosure under some separate common law or securities law cause of action that operates outside of this Act? 

Ironically, it is doubtful that any system of mandatory disclosure is needed to deal with this information problem. It is clearly the case that firms who do take effective steps to secure worker welfare in foreign countries can, wholly without regard to the California Act, make voluntary disclosures of their own efforts to improve local working conditions, letting consumers draw whatever inferences seem fit from the silence of their competitors. These firms can bond themselves by indicating the damages they are prepared to pay, and to whom, in the event that their representations prove to be false.

If disclosure measures are of uncertain worth, stronger sanctions, such as those found in the September 2012 Presidential Executive Order “Strengthening Protections Against Trafficking In Persons in Federal Contracts” could turn out to be downright mischievous. The Executive order begins by reaffirming its “zero tolerance” policy with respect not only to sex trafficking, but also “the recruitment, harboring, transportation, provision, or obtaining of a person for labor or services, through the use of force, fraud, or coercion, for the purpose of subjection to involuntary servitude, peonage, debt bondage, or slavery.” The unstated sanction for breach of the Executive Order is the cancellation of present contracts or the inability to acquire future ones. 

The risks of this strategy are substantial. The first danger is that of mission creep, such that “using misleading or fraudulent recruitment practices during the recruitment of employees” could fall within the scope of the order, wholly without regard to sex trafficking or involuntary servitude. The second risk is that the extension of these policies several layers down the supply chain makes departures from the policy virtually inevitable. The United States government does not have the resources to systematically enforce this policy, which makes it ultimately a matter of discretion as to which firms face sanctions and which do not. That selective enforcement of any open-ended obligations does not, as the executive order insists, “increase stability, productivity, and certainty in Federal contracting,” but is likely to have the exact opposite effect on private contracting behavior, by inducing private efforts to have the United States direct its enforcement activities to other firms.

The effort to control abuse overseas by imposing obligations on head contractors to supervise their remote subcontractors is a bit like pushing on a string. The locus of the enforcement action is too far removed from the site of the abuses to do that much good. Indeed, given the obvious inefficiencies associated with both of these enforcement schemes, it is appropriate to ask the public choice question, namely, whether the named beneficiaries of these programs are the actual beneficiaries. 

On that question, there has to be more than a modicum of skepticism. There is little doubt that any legal regime that hits American companies for sins overseas will increase the cost of doing business in those locations. It is hardly clear that these shifts will ultimately benefit the vulnerable workers who are the targeted populations for these measures. Instead, the higher costs could easily lead American firms to abandon foreign markets where the plight of local workers is most desperate, at which point the prime beneficiaries of these programs are the domestic firms for which any inspection, disclosure, or audit obligations are far less onerous. 

It is too soon yet to see how these conflicting forces will play out, but it is at least possible that the actual consequences can imitate those that Benjamin Powell has demonstrated with his alternative history of sweatshops in the global economy. More stringent enforcement drives vulnerable populations underground, improving the position of domestic firms and their higher-paid, and oft-unionized, workers. The law of unintended consequences does not stop at the American border, for the effort to enforce ethical obligations through law could easily hurt the very people they are meant to help.