The economics of CSR

Posted: Sep 30, 2006 12:02 AM
The economics of CSR

Economics matters; the Corporate Social Responsibility (CSR) movement obscures basic economic principles by redefining the meaning of a private transaction. Should this redefinition be successful, our economic growth and vitality will suffer. Right now, the prognosis is not good because the Corporate Social Responsibility movement is steadily gaining prominence in the business community. According to an article in the 1/22/04 Economist magazine:

One of the biggest corporate fads of the 1990s - less overpowering, no doubt, than dotcom mania, but also longer-lived - was the flowering of "corporate social responsibility" (CSR). The idea that it is not enough for firms to make money for their owners is one that you might expect to be an article of faith among anti-globalists and eco-warriors. Many bosses now share, or say they share, the same conviction.

This movement is also impacting the business leaders of tomorrow. For instance, a 2004 press release from Ithaca College touts the college “is making sweeping changes in its business school in order to produce leaders who care equally about profits, society and the environment. The practice, which is known as sustainability, or sustainable development, has been adopted by many national governments and a number of leading corporations, but is just now beginning to be taught at the nation's leading business schools.”

Economic theory posits that by pursuing one’s self interest, the greater good can be achieved. As Adam Smith famously noted, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” Free markets work because generally, Smith’s observation provides the optimal social outcome.

CSR proponents argue that this is not the case for modern corporations. They claim that private individuals serve their private interests at the expense of the public interest. The solution, which should come as no surprise, is an elaborate CSR scheme that redefines private interests of corporations to include public concerns. This definition contradicts the very foundations of our free market economy and society, and consequently poses a clear and present danger to the health and vitality of our economy.

Take a recent coalition of unions, consumer associations and church groups in Germany as an example. Their coalition is attacking Corporate Germany because many corporations have not successfully implemented their CSR programs in the countries in which they do business (see the September 26, 2006 issue of the Financial Times). It is important to note that the supposed crime here is not that the companies have not embraced CSR – they have. The crime is apparently that these companies, including DaimlerChrysler, Siemens, and Deutsche Bank, are not adequately providing enough assistance to the local communities in developing countries; nor are they investing adequate resources in micro-finance schemes for small traders.

In short, CSR proponents are arguing that a firm that is solely maximizing its profits and obeying all relevant laws and regulations is deficient because it is imposing costs on the rest of society by not engaging in socially desirable endeavors. Common complaints of the CSR advocates include: too little investment in alternative clean energy; too much environmental degradation (such as deforestation); too little money being devoted to charitable organizations; and/or too few high paying, high benefit jobs (or alternatively too many low paying, low benefit jobs). The CSR prescription for these ills is a type of regulation – regulation via social pressures. In fact, the coalition in Germany wants to limit government contracts to companies with “high social standards”. Presumably, these standards would be defined by the very same CSR activists.

CSR advocates fail to justify the need to influence private transactions especially those actions that diminish its profits. There is no reason to believe that a profit-maximizing company (or individual) would avoid any of the socially responsible activities listed above if it were in their best interests. For instance, when oil is selling at $20 a barrel, few energy companies will invest scarce resources into developing alternative energy sources. To do otherwise would waste valuable resources. When oil is selling at $60 a barrel, the incentives are very different, and many energy companies will invest scarce resources into developing alternative energy sources. There is no market failure in these actions. It is as it should be.

So it is with the investment policies of Daimler Chrysler or Siemens. When a company invests scarce dollars (or euros) in a community, economic growth follows – just look at the hundreds of millions of dollars that states and localities spend to induce corporations to locate facilities in their jurisdiction as evidence to these benefits. To require that private company investments should also include public development investments redefines the basic economic principles that are responsible for the unprecedented welfare gains our economy has produced over the past 300 years. These are the benefits that Adam Smith was describing in his famous quote. They are the best way to ensure prosperity now and in the future – for both private individuals and the broader community.

Definitions matter. CSR sets a dangerous precedent because it redefines basic economic principles creating problems where none exist. The CSR solution to these alleged problems burdens corporations distracting them from their primary roles in society. If widely implemented, CSR programs will sap our economic vitality and make everyone poorer. Both private and public goals will suffer as a result.