Was Milton Friedman Right After All?
We need to protect the market capitalist system, our common pasture
I read the article, “What is shared value and why is it important for Mexico?” by my friend and colleague, Alvaro de Garay with a great deal of interest. Alvaro has made an important contribution in demonstrating the value of shared value. For firms that adopt it, the benefits of shared value are important: they improve competitive performance as they contribute to social well-being and they improve firms’ social license to operate. They also attract talent and capital to the great social and environmental challenges that Mexico faces. The vision that Alvaro proposes is especially important in these days of the coronavirus crisis. Firms can make a difference in these difficult days.
Asking the hard questions
Nevertheless, among the many important things I have learned from Alvaro is the necessity of asking the hard questions. It is not new to say that good management practices include seeking and taking actions that contribute to a societal goal when these also benefit shareholders. Creating shared value should be a beacon for all companies. Milton Friedman recognizes this in his frequently cited, but seldom read article, “The Social Responsibility of Business is to Increase its Profits.”
The hard questions are:
- What do we do when a social good cannot be attained without sacrificing shareholder return? While it is often the case that the two are positively correlated, meeting society’s future challenges will at times require actions that do not correspond with shareholder interests.
- Who should decide? Friedman argues, and I agree with him, that firms may choose to sacrifice profit for a social good, but this decision belongs to the owners of the firm as represented by the board, not to management.
- Will the actions of a few forward-looking companies committed to shared value be sufficient to address the critical problems we face today? How do we create a system where the vast majority of companies, not just a select few companies, adopt shared value?
The role of government
For shared value to succeed, stringent, well-designed regulations are fundamental. As James Madison, a founding father of the United States wrote in the Federalist Papers, “if all men were angels, governments would not be needed.” Stringent, well-designed regulations increase the benefits of shared value for companies that take social and environmental concerns seriously. In the absence of regulations, firms not committed to shared value will seek to gain a competitive advantage at the expense of society. Friedman argues that it is the role of government is to protect the public interest and to establish a level playing field where firms can compete fairly.
Unfortunately, today in the United States and Mexico governments are dismantling or failing to enforce social and environmental regulations. Last year’s Madrid meetings to develop implementing mechanisms for the Paris Climate Accords failed as formerly important advocates of the Paris Accords, including the United States, Brazil and Australia, opposed it. In Mexico, meanwhile the Lopez Obrador administration has made fossil fuel development a centerpiece of its economic program.
Too often, firms commit publicly to lofty goals but welcome de-regulation or do little to implement those goals. Clearly, some regulations are poorly designed and need to be changed, but firms seldom advocate for the sensible, stringent government regulation that will be essential to addressing today’s and tomorrow’s social and environmental challenges. If ever there has been an initiative that deserves broad corporate support, it is the Paris Climate Accords. Nevertheless, prior to the Madrid meetings, 84 CEO’s of major corporations singed a Joint Labor Union and CEO Statement on the Paris Agreement” opposing U.S. withdrawal from the Paris Accords. Only 15 of the 181 signatories of the widely applauded, Business Roundtable Statement on the Purpose of the Corporation, were among the signers. According to Science Based Targets, a consortium of the UN Global Compact and leading environmental think tanks, only 21 of the Business Roundtable Statement signatories have taken the obvious first step—to establish or be in the process of establishing goals to reduce greenhouse gas emissions.
Firms focused on short term profits also threaten those that take shared value seriously. As described in Harvard Business School case study, “Battle for the soul of capitalism: Unilever and the Kraft Heinz takeover bid,” Kraft Heinz Foods (KHF), owned by 3G Capital an investment group known for its focus on cost reduction and short term value creation, saw Unilever as an attractive hostile takeover. Generally, Unilever is considered the world’s leading sustainability-focused firm. KHF saw the hostile takeover as an opportunity to squeeze short term profit out of the long-term sustainability investments that Unilever had made. Ultimately, Unilever barely resisted the takeover attempt, but other firms may not be as able or as fortunate as Unilever was.
We need to protect the market capitalist system, our common pasture
In 1968 in The Tragedy of the Commons Garrett Hardin described a common pasture as a metaphor for the primacy of the parochial interests over the public interest. Hardin argued that (in contrast to Adam Smith’s invisible hand) there are cases, epitomized by a common pasture, in which the private interest and the public interest diverge. In the common pasture, individual herdsmen brought their cows to graze on a commonly owned pasture. At first, the commons could support all the cows and the initial herdsmen who brought their cows to the commons prospered. As other herdsmen saw the success of their neighbors, they too brought their cows to the commons and overgrazing ensued; ultimately, they depleted the commons on which they all depended.
The legitimacy of the market capitalist system is the commons on which all firms depemd. Firms and society benefit if the system is widely seen as a legitimate and fair way to allocate society’s resources. Like the commons, the market capitalist system can be depleted if it is not cared for. State capitalism and populism are waiting in the wings should market capitalism fail.
In 2008 Harvard Business School (HBS) commissioned a study, published as Capitalism at Risk in 2011, to look at the future of market capitalism. The study was intended to reset how the HBS teaches future generations of students. It looked at ten “disruptors”-- powerful financial forces and the absence in transparency of the financial system, protectionism, inequality and populism, migration, environmental degradation, failure of the rule of law, public health and education, the rise of state capitalism, radical movements terrorism and war, the threat of pandemics, inadequacy of institutions--were undermining the foundations of market capitalism
Capitalism at Risk, reached a startling conclusion coming from a bastion of market capitalism
“…if it (the market capitalist system) continues to function in the next 25 years as it has in the past 25, we are in for a violent ride or, worse, a serious breakdown in the system itself.”
We are nine years into the 25 years that the authors of Capitalism at Risk projected as the timeframe to change how capitalism functions (coincidentally, also the year Michael Porter Mark Kramer published Creating Shared Value). Unfortunately, the data do not bear out the proposition that Capitalism at Risk and “Creating Shared Value” would make a difference. My recent study, Mexico Facing the Future, suggests, moreover, that without action these conditions will exacerbate.
We can expect more questions of whether public and private institutions did enough to prepare for and respond to the coronavirus crisis. Both must demonstrate that they are prepared to grapple with the hard questions.
How do we address two extremely difficult questions?
We face two extremely difficult questions:
- “What do we do when government does not take its appropriate role in representing the needs of society?” and
- What do we do when the actions we are taking prove to be insufficient?”
Absent a strong regulatory underpinning, shared value does not work for all but a very few companies. The competitive playing field will be tilted in favor of companies that are focused on short term value creation, and/or are willing to capitalize on socially deleterious business opportunities. To address these questions, I suggest three specific actions for the private sector:
- Eliminate greenwashing. To maintain credibility with stakeholders, when firms declare they adhere to concepts like shared value and corporate social responsibility, we must insist that they do it in a manner that is well documented, material and significant,
- Insist that the institutions of government function as they should. Government regulations must be stringent, forward looking and enforced. The role of government must be to establish rules that benefit all of society, not just a few favored groups. They should be developed with industry input, but this input must be to make them effective, not to dilute them or to lobby for favored treatment.
- Establish rules for private sector self-governance. Elinor Ostrom won the 2009 Nobel Prize in econmics for her work on economic self-governance. In her book, Governing the Commons she suggests principles for successful self-governance. These include bottom up rules established by the participants in a self-governance system themselves, an external authority established by the participants to monitor and verify compliance with the rules, impose graduated sanctions and mechanisms to renew the rules as circumstances change.
In 1985, led by the Canadian Chemical Manufacturing Industry, the global chemical industry designed the Responsible Care program in the wake of the 1984 Bhopal disaster. While not perfect (no system is), the Responsible Care program established a set of required behaviors for chemical industry association members that changed the image and management of chemical industries worldwide. If we are to ensure that shared value is a widely adopted concept that truly contributes value to shareholders and society and builds the legitimacy of the market capitalist system, a program modeled on Responsible Care may be the best option we have.
I wrote the above when the full implications of the coronavirus crisis were not yet apparent. In the United States community transmission of the disease was in its early stages and in Mexico most cases were still associated with foreign travel. Today the United States has by far the most cases in the world and the peak number of cases is still weeks away. Mexico is just entering the community transmission phase. Some suggest warm weather may mitigate the full impact of COVID-19. If it follows the pattern of other nations, it will be at the height of the crisis in a few weeks. I suggest that the crisis can be an opportunity to learn and renew a commitment to serve society. I another article I examine the response to the coronavirus in greater depth.
