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Thursday, October 21, 2010

The Social Responsibility of Business is to Increase its Profits and More! Revisiting Milton Friedman Forty Years Later

My apologies to faithful readers, as you may have seen some of this before. I wrote this piece in hopes that the New York Times would celebrate the 40th anniversary of Milton Friedman's piece and run it in their magazine.  I've since given up hope.

by R. Todd Johnson

The businessmen believe that they are defending free enterprise when they declaim that business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are–or would be if they or anyone else took them seriously–preaching pure and unadulterated socialism.
Quote from Milton Friedman, September 13, 1970, The New York Times Magazine, “The Social Responsibility of Business is to Increase its Profits.”
Forty years after the publication of Milton Friedman’s still oft-cited piece in The New York Times Magazine, the epic battle continues around whether businesses should produce positive social results other than jobs and wealth. And yet, as we approach the end of a tumultuous decade – when markets and economies have fallen, when Soviet and Chinese communism have given way, more or less, to market economies, when social entrepreneurship shows signs of success, when the gap between the world’s richest and the world’s poorest has continued to widen, when strong, vibrant middle classes have begun emerging in Brazil, Russia, India and China, and when demand has sharpened the focus on a future of resource constraints – the prevailing attitude of American free-market capitalism remains that corporations should exist primarily or even solely for wealth creation.

One thing has changed, however. Today, passionate capitalists ask more and more often, “Why can’t a corporation do business, for good?” Why does a free-market, capitalist system of economics seem so inept at providing for the long-term good of shareholders, as well as the long-term good of the planet and its inhabitants, and why doesn’t it seem to be helping in the hard places of the world, where nearly half of the world’s population is living on less than $2 per day?

Given the 40th anniversary of Milton Friedman’s piece last month, it seems appropriate that we stop and ask: “What have we learned over the past 40 years?” “What would Milton Friedman say if he were writing a similar piece today?” and “Has our thinking (and would his thinking have) changed as a result of the last 40 years of experience?”

Corporate Social Responsibility: A Brief History

Today’s concept of a “social entrepreneur” may seem new in the world of American business. Yet, even the term “corporate social responsibility” (or sometimes “CSR”), that emerged with a vengeance on the business scene forty years ago, was itself preceded by an ancient history reflecting concerns around the impact of business on people and the planet. For example, nearly 5,000 years ago, societies had commercial logging operations as well as laws to protect forests. The Hammurabi code developed in 1700 B.C. required that builders, innkeepers or farmers be put to death if their negligence caused the deaths of others, or resulted in a major inconvenience to local citizens.

In some ways, these examples foreshadowed today’s CSR ideals of pursuing wealth creation without harming the planet or its inhabitants. The point is to acknowledge the longstanding societal policy decision that business owes a responsibility for a greater good – as a quasi-citizen of society – to living within a set of prescribed norms that would be enforced by government. This prescribed normative behavior, acknowledged by Friedman himself as necessary, seems reasonable given that American society has granted business great freedom (perhaps greater freedom than anywhere else in the world) to pursue its wealth creation ends as a quasi-citizen, with the Supreme Court recently going so far as viewing businesses as a “person,” entitled to the protection of the Bill of Rights and its Constitutional right to free speech through unlimited expenditures in political campaigns.

The industrial revolution brought into sharp relief the impact of business on the lives of individuals and the environment, often with direct consequences, giving rise to an environment of greater regulation, where workers, air, water, land and animals were all the objects of protection. The industrial revolution also gave rise to an attitude of “corporate paternalism” in the late nineteenth and early twentieth centuries, resulting in wealthy industrialists dedicating some of their wealth to support philanthropic ventures. These sentiments flourished in the writings of capitalists like Andrew Carnegie, founder of U.S. Steel, who believed that in order for capitalism to work, the “elite” class must practice charity and exercise good stewardship. To him, capitalism regularly failed the “have not’s” of society, so the rich, through institutions such as churches or community groups, were required to do so. Carnegie went even further, advocating that the wealthy consider themselves stewards of their property “in trust” for the rest of society.

In some respects, Friedman’s piece reflects this same mentality when he ends by saying “there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game,” thereby providing the most money to the individual shareholder to exercise their individual right to be charitable and “do good.” Although no one denies the great value resulting from charity, the real question is whether this reflects the greatest aspirational goal for business – making some people wealthy beyond description in order that they may provide for the rest of society. And even if we conceded this to be the highest aspiration, shouldn’t we stop and ask periodically, “How is business doing?”

By the 1920’s, discussions about the social responsibilities of business had evolved into what we can recognize today as the beginning of a modern CSR movement. In 1929, the Dean of Harvard Business School, Wallace B. Donham, commented in an address delivered at Northwestern University:

Business started long centuries before the dawn of history, but business as we now know it is new – new in its broadening scope, new in its social significance. Business has not learned how to handle these changes, nor does it recognize the magnitude of its responsibilities for the future of civilization.

Perhaps never before, as in this past decade, have these words carried so much relevance for so many. Enron, WorldCom, banks and other financial institutions that are “too big to fail,” climate change, the rapid growth of human trafficking around the world (directed not only at lucrative sex trafficking, but also cheap labor for growing global supply chains), child soldiers in areas of conflict that strangely coincide with maps of growing water resource constraint, the loss of lives in mining disasters both in America and China, oil spills of catastrophic dimensions in the Gulf of Mexico and in China, and the list goes on – all these experiences of the past decade conspire to give Donham’s voice the prescient ring of truth 80 years later.

The Failure of the Enforcement Model

Many argue that the disasters of the past decade point to a need for bigger and better regulations and tougher enforcement of the rules on the books. This proscriptive approach to creating better business behavior has been tried for more than 80 years and compelling arguments can be made that it has failed miserably. Just look at our system of regulations, where we’ve spent billions of dollars regulating and enforcing, yet still end up with disasters taking a toll on human life and the environment.

Why does this continue to happen?

Business schools typically teach future business leaders the concept of “capture theory” – the idea that regulators, over time, become the captives of the regulated. This theory suggests that regulated businesses influence, more than any person or group, the selection of the regulators, the drafting of legislation, the drafting of regulations and, through lobbying and election spending, the budget allocation for enforcement. Thus, the proscriptive approach often produces a “dive to the bottom,” setting up a lowest common denominator of acceptable behavior and a mindset of minimal compliance as normative, rather than creating aspirational goals for business to achieve. As a by-product, we encourage an adversarial system, both of rulemaking and of enforcement between business and other stakeholders, resulting in litigation where short-term compromises of reformed behavior, coupled with big payouts to plaintiffs, plaintiff classes and plaintiff lawyers, often result in little systemic change.

In this respect, it seems useful to understand how we might create a corporate model that encourages some aspirational behavior beyond “lawsuit avoidance.” What if directors were not so risk averse and were not so regularly advised by the most risk averse creature known to man – the staple at board meetings – a lawyer? What if directors felt they would be rewarded for encouraging innovation in a company – innovation that focused on long-term benefits – even if that innovation failed to produce short-term monetary returns, because it lived up to the stated purpose of the company?

The Failure of Binary Thinking

Unfortunately, entrepreneurs setting up companies and seeking to apply the lessons of the past and implement a new code of aspirational behavior for the future of their business are left choosing from among the same bad choices that existed forty years ago. Until recently, available corporate forms left entrepreneurs with an “either – or” calculus: either adopt a corporate form that maximizes doing well (wealth creation), or adopt a corporate form that maximizes doing good (most often, the so-called “non-profit”). In Milton Friedman’s words:

In a free enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. Of course, in some cases his employers may have a different objective. A group of persons might establish a corporation for an eleemosynary purpose–for example, a hospital or a school. The manager of such a corporation will not have money profit as his objective but the rendering of certain services.

This separation of doing well from doing good represents the great legacy of corporate paternalistic public policy decisions, embodied in the federal tax code designed originally to give tax benefits to the rich who participated in Carnegie’s charity and stewardship ideals. Today, after more than 100 years of experience, we can all see (and hopefully admit) that this binary thinking for business models often produces unhealthy and unintended consequences, both at the local and global levels.

Unintended Consequences and Externalized Costs

At the local level, binary thinking leaves the start-up entrepreneur with two possible forms of capital to access – the $1 million investment or the $10,000 charitable contribution. I remember my first meeting seven years ago with John Sage, founder of Pura Vida Coffee – a fair trade, shade grown, organic coffee company that gives back to the coffee growing regions of the world – when he described his efforts to obtain funding from sophisticated private investors. By his account, investors were all focused either on their “return on investment,” or the social impact and leverage of their charitable donation. As John put it, “when I explain the possibility that in Pura Vida their money might do both – offering a possible return on investment, while also providing funding for at-risk children in coffee growing regions of the world – they respond by saying simply ‘you’re making my head hurt,’ and then move on to the next item on their desk.”

As a result, the entrepreneur is forced into accepting an investment, allowing for scale and the hiring of professionals, but risking the mission of impact in favor of profit, solely or primarily, in order to satisfy an expected return on investment. Or, the entrepreneur can make the scale and the speed of the undertaking secondary goals to the consistency of mission by establishing a non-profit.

The binary thinking of corporate paternalism also presents a dangerous dynamic globally, resulting from the export of our special brand of capitalism. Traditionally, Americans are known for two remarkable qualities: our entrepreneurial spirit and our heart for helping the poor, the disadvantaged, the hungry, and those in distress (whether as a result of disaster or conflict). And yet, the bifurcation of our organizational structures leaves much of the world with a view that we are hypocrites.

In her recent book, The Economics of Integrity, journalist Anna Bernasek reviews the value of integrity in business. Speaking clearly about how our economy is built on trust, she attempts to measure how businesses that build trust and integrity have brands, products, services and financial results that distinguish them from competitors. Unfortunately, her list of examples is relatively small, and the companies noted seem to be the exceptions, rather than the rule.

Perhaps we shouldn’t be surprised that more businesses don’t pursue the blended values of doing well and doing good. Our lack of a corporate form that encourages both values, results in the exportation of an entrepreneurship that most often reflects the value that “greed is good,” and equally often creates devastating results in the harvesting of natural resources and minerals, the utilization of cheap labor, the sale of goods in the developing world that cause physical harm, and the manufacture of goods in places with limited or lax environmental laws, all in the name of reducing expense and increasing margin. That, after all, is the greatest social responsibility of business.

Then, when disaster strikes, the biggest and best non-governmental organizations (many of which are U.S.-based, founded and funded) go to work spreading the goodwill of the American people. Unfortunately, these efforts are often spent cleaning up the negative results, indirect consequences or failures of businesses, resulting in reinforcement of the view that Americans are hypocrites.

Even worse, this goodwill often comes at the expense of business opportunities for local people in the developing world.

Outside of direct relief aid and some of the amazing health and education research and development, much of what is done in the developing world through non-profits and non-governmental organizations (or NGO’s), could actually be accomplished through a business model, even if it would be harder to obtain investment funding. Instead, someone begins selling tax subsidized and donor subsidized water pumps in Africa. They could sell the pumps for a profit, without a tax subsidy or donor subsidy, but funds are easier to raise through tax deductible donations rather than through the rigors of proving out the business model for investment dollars. Selling the pumps through a non-profit has the positive result of increased deployment of inexpensive water moving technology in the developing world to aid rural farmers, but the negative results of both killing markets for future indigenous entrepreneurs attempting to sell water pumps at a profit and locking potentially valuable distribution channels into non-profit organizations making it difficult for use by for-profit organizations.

Even worse is the buy-one, give-one or “BOGO” model that has become increasingly popular for companies here in the United States seeking the halo effect of helping places like Africa. Whether it’s shoes, flashlights or computers, in Africa you can find numerous retail products produced by U.S. companies (often in Asia), where the purchase price paid by a U.S. consumer includes the cost of donating a second such product to Africa.

“What’s wrong with that,” you might ask? On the surface, nothing.

Take shoes, for example. Africans need shoes. In fact, shoes are critical to issues of health, nutrition, education, healthy pregnancies and much more. Child malnutrition continues to afflict most children in Africa who take in too few calories and burn too many (often fetching fuel or water) for healthy growth and the mental stimulation required for an adequate education. And when young women are malnourished, their under-developed bodies often lead to complicated pregnancies and, in the worst cases, to still-born deliveries after three days of labor and fistulas that leave the women childless, incontinent, and ostracized by a community and family that does not understand.

So how does that have anything to do with shoes?

Let’s take a look at one country – Ethiopia – and let’s assume that you could provide the approximately 60 million rural Ethiopians who are living on less than $2 per day with the appropriate levels of nutrition for healthy development, but no shoes. In all likelihood, those Ethiopians would still be malnourished, and under-developed due to the prevalence of worms and other parasites, all of which could be treated with medications, but that would continue to recur if rural Ethiopians walk around barefoot stepping in animal droppings.

So it’s clear – shoes are important in rural Ethiopia.

Now comes the real issue: Should shoes be donated by Western companies, or should they be produced in Ethiopia and sold locally?

This is where the BOGO model, although well intentioned, appears to be hindering long-term, sustainable solutions for Africa. As long as rural Africans might potentially receive free shoes donated by a U.S. shoe company, why would they want to pay for shoes? And, as long as rural Africans are unwilling to pay for shoes, how can local African shoemakers hope to have a flourishing local business?

And that’s before we ever get to the biggest issue facing the African entrepreneur.

Last year, while in Addis Ababa, I visited with my friend Sammy, an Ethiopian entrepreneur. Interested in how his new SMS content platform business was going, I asked Sammy about his greatest challenge. His answer was simply, “The NGO economy.” Sammy noted what should have been intuitive to me after my many trips to Africa: Africans are naturally entrepreneurial – many have been making something from nothing all their lives, just to stay alive. But what Sammy said next rocked my world.

“Africans don’t see a reward, other than survival, from being entrepreneurial. Specifically, they do not view entrepreneurship as a means for lifting themselves out of poverty. Rather, what they learn at a very early age is that they can make good money, if they learn to speak English well and then maybe, just maybe, they can get a job driving for an NGO. In a few years, if they play their cards right, they might be able to land an NGO job as a project manager and even advance further.”

Sammy’s point was simply this. As a struggling businessman creating new start-ups in Africa, he could not compete with what NGO’s were paying for some of the best and brightest. And even worse, he said, “by the time the NGO’s are done with them, there isn’t an ounce of entrepreneur left.”

These examples should leave us asking questions, such as:

• Are we concentrating too much funding to philanthropies that are killing places like Africa?

• Why can’t we build for-profit enterprises designed to produce a reasonable or even dramatic return for investors, while at the same time producing a flourishing of human life and the environment, and maybe even help in some of the hard places in the world?

• Why can’t ventures in the form of for-profit corporations be funded to scale and compete for the best and brightest, without a risk of losing a mission that might include a flourishing of people and the planet?

• Why is it that the blending of the values of caring for people, caring for the planet and achieving profitability, seems so hard for entrepreneurs choosing a for-profit model?

• Can anything be done within the existing corporate and finance frameworks to change that dynamic?”

And, most relevant to this article,

• What would Milton Friedman say?

Milton Friedman’s View: Shareholder Democracy or Utilitarianism

As the Ayn Rand acolyte and objectivist, Roger Donway has noted, there are only one of two ways to understand Milton Friedman’s views on social responsibility: either he was an advocate of shareholder empowerment and democracy, or he held a utilitarian view of corporations and the deployment of investment capital.

The first view suggests that corporate executives are only expressions of a bounden duty to “shareholder-bosses [who have a] right to be self-interested money-grubbers, desiring only ‘to make as much money as possible while conforming to the basic rules of society’?” If this is correct, then those advocating greater shareholder rights to remove directors or access proxy statements with proposals regarding corporate conduct would seem to have a friend in Friedman.

In which case, what happens when the shareholders and investors want to both create wealth and ensure that those efforts involve no negative impact on people or the planet? Even better, what happens when those goals become more aspirational, such as a corporation whose investors desire that their management both makes money and helps people and the planet to flourish? As we note below, these goals are difficult to accomplish with the corporate forms available today, but it would seem from Milton Friedman’s point of view, such a corporate purpose should be permitted and, in fact, encouraged, when that is what the shareholders desire.

In the alternative to Friedman’s own words, Donway argues that Friedman backed away from this view of listening to shareholders in later years and instead began justifying corporate profit-seeking (to the exclusion of other social responsibilities) on the basis of utilitarianism. In Donway’s words:

The perspective of “social responsibility” looks upon a free-market system not as the social expression of individual rights, but as the means by which society organizes the use of “its” resources so that they are employed in the most valuable way — “valuable,” presumably, in accordance with some utilitarian standard. Within this system, shareholders are, yes, justified in pursuing the maximization of their wealth (through the work of their servant-executives). But they are so justified only because their pursuit of profit happens to be a means employed by society for the general, collective good. In effect, society is employing “its” selfish shareholders to make certain that society’s goods are deployed in the most efficient and value-producing manner. That, according to Friedman, is the overarching justification for the selfish behavior of those who participate in business.

Assuming for a moment that Donway’s perspective on Friedman’s view is correct, then one might rightly ask why Donway’s calculus of “value” applies to only one societal resource – monetary wealth – when costs to other societal resources (such as the environment and the health and well-being of individuals, both of which impact societal wealth creation either directly or indirectly) have long been seen as costs externalized in our present system. Instead, it seems quite plausible that someone deploying this utilitarian equation might rather propose achievement of a blended or integrated set of values, especially where shareholders, investors and entrepreneurs are collectively seeking aspirational goals of building businesses that optimize the creation of wealth and the flourishing of individuals and the planet. In fact, these collective aspirational pursuits by society could well reflect a rational collective decision to choose deployment of capital to achieve these blended values, as the most effective, value-producing means for capital investment.

Time for the “For-Benefit” Corporate Model

When I was younger, my father repeated a Winston Churchill quote that I paraphrase here:

“If you’re not liberal when you are young, you have no heart.

But if you’re not conservative when you are older, you have no brains.”

Even though that line still begs a chuckle today, as I’ve gotten older, I’ve come to realize that it is really a great lie.

Why?

Because it allows lines between “smart” and “stupid,” and between “good” and “bad” to be drawn between us, rather than through each one of us individually. The lie of the quote permits me to place you on one side of the line or the other, and helps me avoid responsibility for what I do that is “stupid” and “bad.”

Basically, Churchill’s line lacks integrity. It’s cute, yes, but it doesn’t really help me understand the truth.

The same is true today of the pervasive idea that a corporation can either “do good” or “do well.” The idea simply lacks integrity. When we separate doing well and doing good, in a person, an organization or a corporation, the completeness or “whole” no longer exists – there is a lack of integrity, in the traditional sense of the word’s meaning.

Take U.S. tax policy, for example, that rewards entities for “doing good” with deductions and tax exemptions. Corporate philanthropy (up to 10% of profits), expenditures on research and development, and employee health care, among others, all receive tax deductions as a result of public policy decisions designed to encourage that behavior.

Even further, so-called “non-profits” represent another corporate form, this time for maximizing “doing good,” rather than creating wealth. Thus, for-profit corporations “do well” by creating private wealth, and non-profits “do good” by creating other social benefits. This binary thinking of doing good versus doing well produces two systems that can be represented simplistically on an x-axis/y-axis as follows:

where the $ sign represents the highest point on the axis for creating private wealth (doing well), and the ♥ represents the highest point on axis for creating a social benefit (doing good). Our figure shows that a classic “for-profit” entity (typically a subchapter C corporation or a limited liability company) scores high on the doing well axis, but near the bottom of doing good, whereas a non-profit or tax-exempt corporation scores the opposite: high on doing good, but near the bottom for doing well.

Of course, that last statement is overly broad. Corporations have long undertaken corporate philanthropy; supporting the arts, education and contributing to programs to alleviate the conditions of poverty. But corporate philanthropy does not represent the universe of ways in which corporations have a positive social impact. Companies employ people, produce efficiencies in the use of capital, improve lives, help alleviate poverty and starvation, not to mention create wealth (both for executives at the top of a corporation, but also workers holding equity in IRA’s, mutual funds and pension funds). Yet even further than all this, CSR programs are entering their third decade of wide-spread adoption, with more and more positive measurable impact on communities, extreme poverty, and reducing negative stress on the planet and the environment.

In the world of philanthropy, daily stories in the media profile social entrepreneurs seeking to employ business models on behalf of non-profit corporations. Earned income strategies, corporate efficiency, market analyses have permeated nearly every major non-profit, moving them up the scale of earning more. Non-profit donors are asking tougher and tougher questions about ways to achieve scale, ways to measure impact, and ways to ensure that investments result in leverage.

Interestingly, this movement of for-profits toward doing good, in addition to doing well for their shareholders, and the movement of non-profits toward doing well, in addition to doing good, does not represent the result of some grand orchestration. Rather, in a very real sense, the behavior of each organizational type has been, and continues to be, a movement towards the natural point of integrity, or wholeness and completeness – in the upper right-hand corner of the earlier diagram.

And yet, both forms have their limitations.

For example, corporate philanthropy is limited – because tax policy only rewards a deduction for up to 10% of corporate profits donated to philanthropy. But would directors find protection under the rubric of the business judgment rule if they decided to give away 50% of corporate profits to help at-risk children in the developing world? Certainly, at some point, directors find themselves exposed to arguments of wasting corporate assets. Thus, the law has a barrier on how much good a typical for-profit corporation can undertake, at least in terms of giving away profit. So too, most states limit special purposes that corporations may undertake, if it creates a trade-off to the primacy of maximizing returns for shareholders.

Likewise, capitalistic strategies of earned income have their limits for non-profits. The typical charity may earn profit to support charitable activities, even income unrelated to their charitable mission, so long as they pay taxes on the income. But at some point, the earned-income strategies of a non-profit threaten a test of “substantial relatedness” to their charitable mission, so that too much earned income could jeopardize its charitable status. This, in turn, limits efforts for non-profits to achieve sustainable models and forces them back into the fundraising circuit annually.

And yet, one look at the diagram above, begs the question: “Why not create an entity unfettered by the “for profit” and “non-profit” rules, thereby establishing corporations for broader benefits, or what I like to refer to as “for-benefit corporations”? Permitting a form that allows the entrepreneur to build an organization that aims directly for the “for-benefit” sector represents the shortest distance between two points.

Unfortunately, until recently, no system existed that brought integrity to the corporate organizational form.

This year, both Maryland and Vermont have adopted laws and California is considering similar legislation allowing corporations focusing on profitability, to also elaborate purposes such as creating a flourishing environment for the people working for the corporation and for other constituents, such as the community in which the corporation does business, as well as the planet.

Imagine: Businesses seeking profit and the well-being of the planet and its people. People, planet, profit. It may seem idealistic to many, but there are companies already achieving some success without the “for-benefit” corporate form. The time has come to give these like-minded entrepreneurs and investors a corporate form that actually works towards their blended value pursuits.

For those concerned that directors and management might hide poor economic performance behind corporate purposes where results are harder to measure, all three of the statutory options require transparency far beyond anything previously on the books, thereby permitting far greater opportunity for investors and consumers alike to weed out the “green-washers” – those companies who are determined to spend time, money and effort on good marketing, rather than on really doing good.

Likewise, the statutes do not permit companies to opt-in or to opt-out of the “for-benefit” form without shareholder approval, typically at a supermajority level. Thus, businesses adopting this form will have an explicit understanding between shareholders and management that transcends the model of the traditional selfish shareholder.

Contrary to Milton Friedman’s fears that such a pursuit could only occur at the government’s behest, thereby representing a form of socialism – or government control of the means of production – these statutes create a voluntary framework by permitting entrepreneurs and investors to opt-in to the “for-benefit” corporate form, rather than forcing it on anyone. Ultimately, this means that the markets will determine, over time, whether such a form is viable. Either businesses adopting this form will attract capital, or they won’t.

I think Milton Friedman would be proud of such a free market approach.


R. Todd Johnson is a partner at the law firm of Jones Day, where he heads their Renewable Energy and Sustainability Practice. He co-chairs a working group in California that drafted Senate Bill 1463 and is seeking the implementation of “for-benefit” corporate laws in other states. The views expressed in this column are solely Mr. Johnson’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.


© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are excerpted, in part, from a forthcoming book by R. Todd Johnson, titled “Business for Good” and are the property of R. Todd Johnson and may not be otherwise used or reprinted without his express permission.

Monday, September 13, 2010

Revisiting Milton Friedman's Thinking, 40 Years Later

Today is the 40th anniversary of Milton Friedman's oft-cited piece in the New York Times Magazine, titled "The Social Responsibility of Business is to Increase its Profits." Over the coming week or so, we plan to review the thinking contained in this article and some of the other writings of Dr. Friedman, particularly within the context of whether a corporation can do "Business for Good."

But for today, let's just remember what Dr. Friedman wrote 40 years ago (reprinted here in its entirety, as it appeared on that Sunday, 40 years ago):

The Social Responsibility of Business is to Increase its Profits

by Milton Friedman


The New York Times Magazine, September 13, 1970. Copyright @ 1970 by The New York Times Company.

When I hear businessmen speak eloquently about the “social responsibilities of business in a free-enterprise system,” I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free enterprise when they declaim that business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers. In fact they are–or would be if they or anyone else took them seriously–preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.

The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. What does it mean to say that “business” has responsibilities? Only people can have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but “business” as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom.

Presumably, the individuals who are to be responsible are businessmen, which means individual proprietors or corporate executives. Most of the discussion of social responsibility is directed at corporations, so in what follows I shall mostly neglect the individual proprietors and speak of corporate executives.

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. Of course, in some cases his employers may have a different objective. A group of persons might establish a corporation for an eleemosynary purpose–for example, a hospital or a school. The manager of such a corporation will not have money profit as his objective but the rendering of certain services.

In either case, the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them.

Needless to say, this does not mean that it is easy to judge how well he is performing his task. But at least the criterion of performance is straightforward, and the persons among whom a voluntary contractual arrangement exists are clearly defined.

Of course, the corporate executive is also a person in his own right. As a person, he may have many other responsibilities that he recognizes or assumes voluntarily–to his family, his conscience, his feelings of charity, his church, his clubs, his city, his country. He may feel impelled by these responsibilities to devote part of his income to causes he regards as worthy, to refuse to work for particular corporations, even to leave his job, for example, to join his country’s armed forces. If we wish, we may refer to some of these responsibilities as “social responsibilities.” But in these respects he is acting as a principal, not an agent; he is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are “social responsibilities,” they are the social responsibilities of individuals, not of business.

What does it mean to say that the corporate executive has a “social responsibility” in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers. For example, that he is to refrain from increasing the price of the product in order to contribute to the social objective of preventing inflation, even though a price increase would be in the best interests of the corporation. Or that he is to make expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment. Or that, at the expense of corporate profits, he is to hire “hardcore” unemployed instead of better qualified available workmen to contribute to the social objective of reducing poverty.

In each of these cases, the corporate executive would be spending someone else’s money for a general social interest. Insofar as his actions in accord with his “social responsibility” reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers’ money. Insofar as his actions lower the wages of some employees, he is spending their money.

The stockholders or the customers or the employees could separately spend their own money on the particular action if they wished to do so. The executive is exercising a distinct “social responsibility,” rather than serving as an agent of the stockholders or the customers or the employees, only if he spends the money in a different way than they would have spent it.

But if he does this, he is in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other.

This process raises political questions on two levels: principle and consequences. On the level of political principle, the imposition of taxes and the expenditure of tax proceeds are governmental functions. We have established elaborate constitutional, parliamentary and judicial provisions to control these functions, to assure that taxes are imposed so far as possible in accordance with the preferences and desires of the public–after all, “taxation without representation” was one of the battle cries of the American Revolution. We have a system of checks and balances to separate the legislative function of imposing taxes and enacting expenditures from the executive function of collecting taxes and administering expenditure programs and from the judicial function of mediating disputes and interpreting the law.

Here the businessman–self-selected or appointed directly or indirectly by stockholders– is to be simultaneously legislator, executive and, jurist. He is to decide whom to tax by how much and for what purpose, and he is to spend the proceeds–all this guided only by general exhortations from on high to restrain inflation, improve the environment, fight poverty and so on and on.

The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is an agent serving the interests of his principal. This justification disappears when the corporate executive imposes taxes and spends the proceeds for “social” purposes. He becomes in effect a public employee, a civil servant, even though he remains in name an employee of a private enterprise. On grounds of political principle, it is intolerable that such civil servants–insofar as their actions in the name of social responsibility are real and not just window-dressing–should be selected as they are now. If they are to be civil servants, then they must be elected through a political process. If they are to impose taxes and make expenditures to foster “social” objectives, then political machinery must be set up to make the assessment of taxes and to determine through a political process the objectives to be served.

This is the basic reason why the doctrine of “social responsibility” involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce resources to alternative uses.

On the grounds of consequences, can the corporate executive in fact discharge his alleged “social responsibilities?” On the other hand, suppose he could get away with spending the stockholders’ or customers’ or employees’ money. How is he to know how to spend it? He is told that he must contribute to fighting inflation. How is he to know what action of his will contribute to that end? He is presumably an expert in running his company–in producing a product or selling it or financing it. But nothing about his selection makes him an expert on inflation. Will his holding down the price of his product reduce inflationary pressure? Or, by leaving more spending power in the hands of his customers, simply divert it elsewhere? Or, by forcing him to produce less because of the lower price, will it simply contribute to shortages? Even if he could answer these questions, how much cost is he justified in imposing on his stockholders, customers and employees for this social purpose? What is his appropriate share and what is the appropriate share of others?

And, whether he wants to or not, can he get away with spending his stockholders’, customers’ or employees’ money? Will not the stockholders fire him? (Either the present ones or those who take over when his actions in the name of social responsibility have reduced the corporation’s profits and the price of its stock.) His customers and his employees can desert him for other producers and employers less scrupulous in exercising their social responsibilities.

This facet of “social responsibility” doctrine is brought into sharp relief when the doctrine is used to justify wage restraint by trade unions. The conflict of interest is naked and clear when union officials are asked to subordinate the interest of their members to some more general purpose. If the union officials try to enforce wage restraint, the consequence is likely to be wildcat strikes, rank-and-file revolts and the emergence of strong competitors for their jobs. We thus have the ironic phenomenon that union leaders–at least in the U.S.–have objected to Government interference with the market far more consistently and courageously than have business leaders.

The difficulty of exercising “social responsibility” illustrates, of course, the great virtue of private competitive enterprise–it forces people to be responsible for their own actions and makes it difficult for them to “exploit” other people for either selfish or unselfish purposes. They can do good–but only at their own expense.

Many a reader who has followed the argument this far may be tempted to remonstrate that it is all well and good to speak of Government’s having the responsibility to impose taxes and determine expenditures for such “social” purposes as controlling pollution or training the hard-core unemployed, but that the problems are too urgent to wait on the slow course of political processes, that the exercise of social responsibility by businessmen is a quicker and surer way to solve pressing current problems.

Aside from the question of fact–I share Adam Smith’s skepticism about the benefits that can be expected from “those who affected to trade for the public good”–this argument must be rejected on grounds of principle. What it amounts to is an assertion that those who favor the taxes and expenditures in question have failed to persuade a majority of their fellow citizens to be of like mind and that they are seeking to attain by undemocratic procedures what they cannot attain by democratic procedures. In a free society, it is hard for “evil” people to do “evil,” especially since one man’s good is another’s evil.

I have, for simplicity, concentrated on the special case of the corporate executive, except only for the brief digression on trade unions. But precisely the same argument applies to the newer phenomenon of calling upon stockholders to require corporations to exercise social responsibility (the recent G.M crusade for example). In most of these cases, what is in effect involved is some stockholders trying to get other stockholders (or customers or employees) to contribute against their will to “social” causes favored by the activists. Insofar as they succeed, they are again imposing taxes and spending the proceeds.

The situation of the individual proprietor is somewhat different. If he acts to reduce the returns of his enterprise in order to exercise his “social responsibility,” he is spending his own money, not someone else’s. If he wishes to spend his money on such purposes, that is his right, and I cannot see that there is any objection to his doing so. In the process, he, too, may impose costs on employees and customers. However, because he is far less likely than a large corporation or union to have monopolistic power, any such side effects will tend to be minor.

Of course, in practice the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions.

To illustrate, it may well be in the long run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects. Or it may be that, given the laws about the deductibility of corporate charitable contributions, the stockholders can contribute more to charities they favor by having the corporation make the gift than by doing it themselves, since they can in that way contribute an amount that would otherwise have been paid as corporate taxes.

In each of these–and many similar–cases, there is a strong temptation to rationalize these actions as an exercise of “social responsibility.” In the present climate of opinion, with its wide spread aversion to “capitalism,” “profits,” the “soulless corporation” and so on, this is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.

It would be inconsistent of me to call on corporate executives to refrain from this hypocritical window-dressing because it harms the foundations of a free society. That would be to call on them to exercise a “social responsibility”! If our institutions, and the attitudes of the public make it in their self-interest to cloak their actions in this way, I cannot summon much indignation to denounce them. At the same time, I can express admiration for those individual proprietors or owners of closely held corporations or stockholders of more broadly held corporations who disdain such tactics as approaching fraud.

Whether blameworthy or not, the use of the cloak of social responsibility, and the nonsense spoken in its name by influential and prestigious businessmen, does clearly harm the foundations of a free society. I have been impressed time and again by the schizophrenic character of many businessmen. They are capable of being extremely farsighted and clearheaded in matters that are internal to their businesses. They are incredibly shortsighted and muddleheaded in matters that are outside their businesses but affect the possible survival of business in general. This shortsightedness is strikingly exemplified in the calls from many businessmen for wage and price guidelines or controls or income policies. There is nothing that could do more in a brief period to destroy a market system and replace it by a centrally controlled system than effective governmental control of prices and wages.

The shortsightedness is also exemplified in speeches by businessmen on social responsibility. This may gain them kudos in the short run. But it helps to strengthen the already too prevalent view that the pursuit of profits is wicked and immoral and must be curbed and controlled by external forces. Once this view is adopted, the external forces that curb the market will not be the social consciences, however highly developed, of the pontificating executives; it will be the iron fist of Government bureaucrats. Here, as with price and wage controls, businessmen seem to me to reveal a suicidal impulse.

The political principle that underlies the market mechanism is unanimity. In an ideal free market resting on private property, no individual can coerce any other, all cooperation is voluntary, all parties to such cooperation benefit or they need not participate. There are no values, no “social” responsibilities in any sense other than the shared values and responsibilities of individuals. Society is a collection of individuals and of the various groups they voluntarily form.

The political principle that underlies the political mechanism is conformity. The individual must serve a more general social interest–whether that be determined by a church or a dictator or a majority. The individual may have a vote and say in what is to be done, but if he is overruled, he must conform. It is appropriate for some to require others to contribute to a general social purpose whether they wish to or not.

Unfortunately, unanimity is not always feasible. There are some respects in which conformity appears unavoidable, so I do not see how one can avoid the use of the political mechanism altogether.

But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”


*Todd is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely Todd’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.

© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.

Thursday, September 2, 2010

New Corporate Forms

2010 will likely be remembered as the year in which states began looking at their powers in chartering companies in a new light. And for the entrepreneur looking for the opportunity to blend the values of doing well and doing good, this is very good news indeed.

First, a little reminder. As I've said before, we must move past the idea that organizational structures are "either" about maximizing value for shareholders, "or" they are about having a positive social impact. This "either-or" calculus is damaging in so many ways, but that's for another post.

Second, we need to take on board what is and isn't wrong with our current organizational structures. As I've noted before, the binary thinking of the structural choices force entrepreneurs to choose, and drive binary thinking that leaves investors thinking in terms, either of a $1 million investment or the $10,000 charitable contribution. I remember my first meeting seven years ago with John Sage, founder of Pura Vida Coffee – a fair trade, shade grown, organic coffee company that gives back to the coffee growing regions of the world – when he described his efforts to obtain funding from sophisticated private investors. By his account, investors were all focused either on their “return on investment,” or the social impact and leverage of their charitable donation. As John put it, “when I explain the possibility that in Pura Vida their money might do both – offering a possible return on investment, while also providing funding for at-risk children in coffee growing regions of the world – they respond by saying simply ‘you’re making my head hurt,’ and then move on to the next item on their desk.”

Even further, corporations that have long undertaken corporate philanthropy; supporting the arts, education and contributing to programs to alleviate the conditions of poverty, also produce a positive social impact by employing people, producing efficiencies in the use of capital, improving lives, helping alleviate poverty and starvation, not to mention creating wealth (both for executives at the top of a corporation, but also workers holding equity in IRA’s, mutual funds and pension funds), but they are still limited. Even CSR programs that are entering their third decade of wide-spread adoption, with more and more positive measurable impact on communities, extreme poverty, and reducing negative stress on the planet and the environment, still represent a very small portion of the total corporate activity.

Perhaps an example would help. First, the idea of limits on corporate philanthropy exists, in some respects, because tax policy only rewards a deduction for up to 10% of corporate profits donated to philanthropy. But the law places other limits as well. Would directors find protection under the rubric of the business judgment rule if they decided to give away 50% of corporate profits to help at-risk children in the developing world? Certainly, at some point, directors find themselves exposed to arguments of wasting corporate assets. Thus, the law has a barrier on how much good a typical for-profit corporation can undertake, at least in terms of giving away profit. So too, most states limit special purposes that corporations may undertake, if it creates a trade-off to the primacy of maximizing returns for shareholders.

And yet, “Why not create an entity unfettered by the “for profit” and “non-profit” rules, thereby permitting the establishment of corporations for broader benefits, or what I like to refer to as “for-benefit corporations”? Unfortunately, until recently, no system existed that brought integrity to the corporate organizational form.

This year, both Maryland and Vermont adopted laws, and California is considering similar legislation allowing corporations focusing on profitability, to also elaborate purposes such as creating a flourishing environment for the people working for the corporation and for other constituents, such as the community in which the corporation does business, as well as the planet.

Imagine: Businesses seeking profit and the well-being of the planet and its people. People, planet, profit. It may seem idealistic to many, but there are companies already achieving some success without the “for-benefit” corporate form. The time has come to give these like-minded entrepreneurs and investors a corporate form that actually works towards their blended value pursuits.

For those concerned that directors and management might hide poor economic performance behind corporate purposes where results are harder to measure, all three of the statutory options require transparency far beyond anything previously on the books, thereby permitting far greater opportunity for investors and consumers alike to weed out the “green-washers” – those companies who are determined to spend time and effort on great marketing, rather than on really doing good.

Likewise, the statutes do not permit companies to opt-in or to opt-out of the “for-benefit” form without shareholder approval, typically at a supermajority level. Thus, businesses adopting this form will have an explicit understanding between shareholders and management that transcends the model of the traditional selfish shareholder.

In my next posts, I plan to review each statute and then provide a comparison of all three.  Stay tuned!


*Todd Johnson is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely his personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.

© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.

Wednesday, August 11, 2010

Reflections from Ethiopia: Is Philanthropy Killing Africa? (Part II)

by R. Todd Johnson

When I posted this question several weeks ago, I never anticipated it would touch a nerve.  Now I'm receiving comments here, here, here and (of course) right here. Not surprisingly, the responses span the spectrum.

One commenter noted, "That philanthropy is harmful to Africa should by now be a given for anyone who’s heard the Hippos vs Cheetahs pitch from George Ayittey," referring to Ayittey's entertaining (and convicting) TED Talk.

And yet, on another site, Christine seems to note nearly the opposite, when she states,
"First of all, I think the issue of saving lives has to be addressed first, and trying to make life bearable for those who have the least in this life, and how can you sit around and debate this issue, when the human toll is so great? It must be along with the efforts of the government of the host countries to improve the plight of their country that NGOs will be able to step aside and consider entrepreneurial initiatives as more important."
So one suggests that the idea of philanthropy killing Africa is obvious, and another asks "what are the alternatives?" Both comments note a common theme: the impact of corrupt, dishonest or wasteful African governments.

I've stated before that I'm no African expert, but it doesn't take an expert to realize there are significant problems with the way U.S. and Western aid gets spent in developing countries. And it only takes one story of planeloads of dollars being flown out of a developing country for unknown destinations (most probably Swiss bank accounts) to bolster the idea that aid is wasteful.  But let's take a slightly deeper look at the issue (just because I hate to settle for simple answers), relying on the place in Africa I know best -- Ethiopia.


What is Our Responsibility?

For starters, I'd like to acknowledge the important question that is often overlooked regarding Western aid to developing countries: "Does it make sense to require a minimum standard of behavior governmentally and economically regarding principles of freedom, democracy, and a marketplace concept of private ownership and the "rule of law?" Put another way, should the United States and other democratic countries of the Western world provide assistance to countries run by repressive regimes?

As you might guess, this isn't the first time someone has asked this question, so I won't try to reinvent the wheel. The concerns of both sides, as they relate to Ethiopia, are well elaborated in the back and forth between Helen Epstein and Ken Ohashi in pieces published in the New York Review of Books this past spring. The only thing I would add to their dialogue - and the thing that often goes missing from these discussions - is the question of "how do we define 'good' and 'right' when we are making moral decisions between 'good' and 'bad' and 'right' and 'wrong.' Both Ms. Epstein and Mr. Ohashi have implied assumptions about what is 'good' and what is 'bad,' and what is 'right' and what is 'wrong,' without ever putting those assumptions to the test of stating them and letting others critique.

Examples will help.

Ms. Epstein clearly would posit that aid to a repressive regime is bad or wrong. Why, is not difficult to infer - if the regime is repressive, stifling individual freedom and creativity, then providing it assistance condones the repression. But what if people are dying and lives could be saved by providing aid? Then, the humanitarian issue faces both ways and difficult decisions need to be made.

Mr. Ohashi would posit, on the other hand, that aid should be divorced from the political issue, because over time, the will of people to be creative, independent and free, will overcome political repression, particularly if they can live healthy and strong lives. But what if strong, healthy people are being jailed and killed for no reason other than their political opposition?

And how do we decide what to do in these circumstances?

Perhaps the answer is our government aid, and how it is administered.


Is US Aid a Good Thing?

Both Ms. Epstein and Mr. Ohashi imply that aid is good and right (at least under certain circumstances).

That's the assumption I'd like to consider more carefully.

[Now, just because I've started down the path of asking this question, please don't assume I'm against international aid. And don't send me comments reminding me of the 2.8 billion people who are living on less than $2 US Dollars per day, of the 11,000 children dying each day from hunger and hunger-related illnesses, or of the 124 million children living in the world today without parents, orphaned by HIV/AIDS and other preventable diseases. I've been there, remember? Our family supports some of these kids and has helped in some of these communities. But it seems worthy to me, in part because of what I've seen, to consider more deeply how we can positively impact these issues with sustainable solutions. So . . . ]

Let's look at some facts.*

1. When we talk about foreign aid, we need to make distinctions. Much of our aid to the developing world is designed to help address dire crises. Thus, for example, due largely to the significant and important U.S. funding to fight HIV/AIDS in Africa, health program areas received 59% of USAID/State-managed assistance for Africa in 2008 and received 67% under the 2010 budget.

But attending to the crises by providing funding for basic needs, such as health, food assistance in times of drought, and water and sanitation, is hardly a sustainable model for development, particularly if the goal is to help people "learn to fish." And perhaps more importantly, people are still open to gross exploitation if they only have their basic needs met, but have no hope of educational opportunity and economic opportunity.

Put another way, if we want to pursue a goal of helping people help themselves in the developing world, then we need to consider both how to provide for their basic needs, and how to give them the hope of economic and educational opportunity.



2. In most of the developing world, the economic opportunity that is most likely to impact the "poorest of the poor" positively, is agricultural development assistance. In Ethiopia, for example, a country of 80 million people, nearly 60 million people live and die based upon their own agricultural efforts in the rural lands away from the country's cities. For the most part, these rural famers have no wells or even water supplies, other than what their wives and daughters can carry on their backs. Without water supplies, they have no interest in drip irrigation and other means of watering their crops, other than the seasonal rains.  Thus, they are more dependant on Mother Nature than you or I could possibily imagine.

So how are we helping?

During 2005-2008, U.S. agricultural development assistance for sub-Saharan Africa grew significantly, from an estimated $657 million in 2005 to $1.1 billion in 2008, when all bilateral and multilateral channels are considered. These increases are significant and important. However, even with projected increases in 2009 and 2010, U.S. agriculture funding for Africa remains a relatively small fraction of U.S. assistance globally and within Africa, and continues to lag far behind health funding. In 2008, agriculture programming for Africa was 0.8% of global U.S. foreign assistance and 3% of the U.S. assistance for Africa managed by USAID and the State Department. Even with significant increases in 2010, agriculture programming for Africa is just 1.8% of global U.S. overseas development assistance and less than 10% of assistance for Africa.

Thus, we are spending only a small fraction of our aid on programs that would appear to directly impact economic opportunity for the majority of people.

3.  How does our agricultural assistance occur?

Much can be discerned simply by understanding the appropriations mechanism.

For example, the $2.5 billion in annual food assistance authorized most recently by Congress, occurred in the 2008 farm bill.  And although the new farm bill adds promotion of food security and support of sound environmental practices to the objectives of commodity donations, the basic impetus of this aid is use of US agricultural production, NOT assisting other countries with their own agricultural production. That's why the basic program is called "commodity donation." In fact, it has been estimated by some researchers that nearly 85% of the USAID budget in this area is earmarked for specific expenditures, primarily food expenditures from US producers.

So, we spend additional sums on food assistance, but it is a small fraction of what we spend in international aid, and mostly it seems to be earmarked to help US agriculture companies.

So someone needs to ask the question, are we really helping Africa help itself, or are we helping ourselves, at the expense of African farmers?

 
 
*  Information in this section of my post has been gathered from multiple sources, including testimony before Congress by folks such as Julie Howard, Executive Director of Partnership to Cut Hunger and Poverty in Africa.

*Todd is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely Todd’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.

© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.

Tuesday, July 20, 2010

Reflections from Ethiopia: Is Philanthropy Killing Africa?

by R. Todd Johnson

My latest post on Law For Change -- Legal Resources (http://www.lawforchange.org/)

I just returned from my seventh trip to Ethiopia and I've been back in the United States for less than 48 hours. After only 120 days spent in Africa, I'm hardly an expert on anything that is happening or has happened there. And yet, I have a few impressions that seem worth sharing, particularly around how business can assist in the elimination of extreme poverty.

While there, I saw some incredibly encouraging relationships and budding opportunities for sustainable business models.  For example, products from Stanford's Extreme Affordability course are selling and creating business opportunities for local entrepreneurs. These include the d.light, the Mighty Mitad and, most recently, a budding joint relationship for the production of manual well drilling equipment for rural well drilling businesses targeted for vocational school graduates.

Unfortunately, these are small and isolated examples of business opportunities (outside of the rural staple of subsistence farming and the urban staple of selling retail necessities). More often, instead, I bump into those places where well-intentioned philanthropy produces a long-term, unintended negative consequence. The following are a few examples.

BOGO Should Be A NoGo!

The "Buy-One, Give-One" (or "BOGO") model has become increasingly popular for companies here in the United States, particularly for places like Africa which, over the past decade, has become the "cause du jour." Whether it's shoes, flashlights or computers, you can find many retail products that are produced by U.S. companies (often in Asia) where the purchase price paid by a U.S. consumer includes the cost of sending a second such product to Africa.

"What's wrong with that," you might ask?

On the surface, nothing.

Take shoes, for example. Africans need shoes. In fact, shoes are critical to issues of health, nutrition, education, healthy pregnancies and much more. Take the critical issue of child malnutrition in Ethiopia. Most children there take in too few calories for healthy growth and for healthy education. And when women are malnourished, their under-developed bodies often lead to complicated pregnancies and, in the worst cases, to still-born deliveries after three days of labor and fistulas that leave them incontinent.

So how does that have anything to do with shoes?

Well, let's assume that you could provide the approximately 60 million rural Ethiopians who are living on less than $2 per day with the appropriate levels of nutrition for healthy development, but not shoes. Well, in all likelihood, those Ethiopians would still be under-developed due to the prevalence of worms and other parasites, all of which could be treated with medications, but that would continue to recur if they walk around barefoot through rural areas stepping in animal droppings.

So it's clear -- shoes are important in rural Africa.

Now comes the real issue: Should shoes be donated by Western companies, or should they be produced in country and sold?

This is where the BOGO model, while well-intentioned, appears to me to be hurting a long-term, sustainable solution for Africa.

First, as long as rural Africans have an opportunity to potentially receive free shoes donated by a U.S. shoe company, why would they want to pay for shoes? Second, as long as rural Africans are unwilling to pay for shoes, how can local African shoemakers hope to have a flourishing local business?

The NGO Economy Is Killing Entrepreneurship

Let's face it, we've drifted far afield from the original concept of “charity.” Rather, as a matter of public policy, we instead seem fixated on the idea of tax subsidies for the rich with our tax deductibility system. The result shouldn't surprise us: over time, while philanthropy increases (measured as total aggregate of dollars donated in the form of tax deductible contributions), the world's gap between the rich and the extremely poor grows.

"So what," you might ask? I mean, after all, wouldn't the gap just be much, much worse if there weren't philanthropic dollars flowing to Africa, encouraged by tax deductibility? Just because some people save their charitable giving for museums or building naming rights, doesn't mean that African AIDS orphans would receive more funding if we drew the tax deductibility line closer to charity.

And you would be right, as far as that argument goes. But arguing that we shouldn't be using our tax policy to encourage wealth redistribution doesn't deal with the real learning to be gained from a look at our tax policy, namely that it creates incredible dysfunction of unintended consequences in the developing world by encouraging too much money to Africa in the form of charity and not enough in the form of investment dollars for the creation of businesses.

Outside of direct relief aid and some of the amazing health and education research and development, much (perhaps most) of what is done in the developing world through non-profits and NGO's, could actually be accomplished through a business model, even if it would be harder to raise investment funding. Instead, someone begins selling tax subsidized and donor subsidized water pumps in Africa, because it is easier to raise the funding through tax deductible donations rather than through the rigors of proving out the business model for investment dollars, with the great result of increased deployment of inexpensive water moving technology in the developing world to aid rural farmers, but the negative results of (1) killing the market for future indigenous entrepreneurs attempting to sell water pumps at a profit and (2) locking a potentially valuable distribution channel in a non-profit, making it difficult for other for-profits to use.

And that’s before we ever get to the biggest issue facing the African entrepreneur.

Last year, while in Addis Ababa, I visited with my friend Sammy, an Ethiopian entrepreneur. Interested in how his new venture was going, I've long since learned that if you want the straight scoop from an entrepreneur, you don't ask "how are you doing." They are simply too optimistic to ever provide a meaningful answer. Instead, I asked Sammy about his greatest challenge in his new SMS content platform business. His two word answer? The "NGO economy."

Sammy noted what should have been intuitive to me after so many trips to Africa, that Africans are naturally entrepreneurial -- many have been making something from nothing all their lives, just to stay alive. But what Sammy said next rocked my world.

"Africans don't see a reward system in place for being entrepreneurial. In fact, they view it as a matter of survival, not an opportunity to lift themselves out of poverty. Rather, what they learn at a very early age, is that in order to make good money, they should learn to speak English incredibly well and then maybe, just maybe, they can get a job driving for an NGO. In a few years, if they play their cards right, they might be able to land an NGO job as a project manager and even advance further."

Sammy's point was simply this. As a struggling businessman creating new start-ups, he could not compete with what NGO's were paying for some of the best and brightest. And even worse, he said, "by the time the NGO's are done with them, there isn't an ounce of entrepreneur left."

Add to that, the typical underpaying of talent in the developed world, creating non-sustainable NGO economies in the developing world, and the brain drain that NGO’s create by attracting the best and the brightest away from business to work for NGO’s, you can begin to see some of the dysfunctions that arise from our philanthropic dollars.

And so, it seems right to ask the question:

Is philanthropy killing Africa?

I'd love to know your thoughts.

*Todd is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely Todd’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.

© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.

Wednesday, June 23, 2010

Integrity and the Problem with Binary Thinking

My latest post on Law For Change - Legal Resources ("LawforChange.org")

by R. Todd Johnson



When I was younger, my father used the oft-cited Winston Churchill quote that I paraphrase here:

“If you’re not liberal when you are young, you have no heart.
If you’re not conservative when you are older, you have no brains.”
That line still begs a chuckle today. (And I learned a long time ago that it’s no laugh-line unless it includes some truth.)

But honestly, as I’ve gotten older, I’ve come to realize that this is really a great lie.

Why?

Because it allows us to draw the line between “smart” and “stupid,” and between “good” and “bad” between us, rather than through us. In fact, if I can put you on one side of the line or the other, then it helps me avoid my responsibility of realizing that I am sometimes “smart” and sometimes “stupid,” sometimes “good” and sometimes “bad.”

Basically, Churchill’s line lacks integrity. It’s cute, yes. But what is really does is make me think of youthful idealism as though it were stupidity, and older practicality, as if it were evil, and it allows me to ignore the older idealists, and the selfishness often present in youth.

The same is true today of the pervasive idea that you can either “do good” or you can “do well.” The idea simply lacks integrity.

Put another way, when doing well and doing good are separated, in a person, an organization or a corporation, the completeness or “whole” does not exist -- there is a lack of integrity.

Let’s take a deeper dive into what I mean.

Take our U.S. tax policy, for example, that rewards entities for “doing good” with deductions and tax exemptions. Corporate philanthropy (up to 10% of profits), expenditures on research and development, and employee health care, among others, all receive tax deductions as a result of public policy decisions designed to encourage that behavior.

Even further, so-called “non-profits” represent another corporate form, this time for maximizing “doing good,” rather than creating wealth. Thus, for-profit corporations “do well” (i.e., create private wealth) and non-profits “do good” (i.e., create social benefit). This binary thinking (doing good vs. doing well) produces two systems that can be represented on an x-axis/y-axis as follows:



where the $ sign represents the highest point on the axis for creating private wealth (i.e., doing well), and the ♥ represents the highest point on axis for creating a social good (i.e., doing good).

This figure shows that a classic “for-profit” entity (typically a subchapter C corporation or an limited liability company) scores high on the “doing well” axis, but near the bottom of “doing good,” whereas a non-profit or tax exempt corporation scores the opposite (i.e., high on “doing good”, but near the bottom for “doing well”).

Of course, that last statement is overly broad. Corporations have long undertaken corporate philanthropy, supporting the arts, education and contributing to programs to alleviate the conditions of poverty. But corporate philanthropy does not represent the universe of ways in which corporations have a positive social impact. Companies employ people, produce efficiencies, improve lives, help avoid poverty and starvation, not to mention creating wealth (not only for executives on the top of a corporation, but also workers holding equity in IRA’s, mutual funds and pension funds). Yet even further than all this, corporate social responsibility programs are entering their third decade of wide-spread adoption, with more and more measurable impact on communities, extreme poverty, and reducing negative stress on the planet and the environment.

On the other side, daily press stories profile social entrepreneurs seeking to employ business models on behalf of non-profit corporations. Earned income strategies, corporate efficiency, market analyses have permeated nearly every major non-profit, moving them up the scale of earning more. Non-profit donors are asking tougher and tougher questions about ways to achieve scale, ways to measure impact, and ways to ensure that investments result in leverage.

Interestingly, this movement of for-profits toward doing good (in addition to doing well for their shareholders) and the movement of non-profits toward doing well (in addition to doing good) is not being orchestrated. Rather, in some very real sense, the behavior of each organizational type has been, and continues to be, to move towards the fully integrated spot – the spot of integrity, or wholeness and completeness -- in the upper right-hand corner of the earlier diagram.



And yet, both forms have their limitations.

For example, corporate philanthropy is limited – because tax policy only rewards a deduction for up to 10% of corporate profits donated to philanthropy. But would directors find protection under the rubric of the business judgment rule if they decided to give away 50% of corporate profits? Certainly, at some point, directors find themselves exposed to arguments of wasting corporate assets. Thus, the law has a barrier on how much good a typical for-profit corporation can undertake, at least in terms of giving away profit. So too, most states limit special purposes that corporations may undertake, if it creates a trade-off to the primacy of maximizing returns for shareholders.

Likewise, capitalistic strategies of earned income strategies have their limits for non-profits. The typical organization qualified under Section 501 of the Internal Revenue Code, may earn profit to support charitable activities (even income unrelated to their charitable mission), so long as they pay taxes on the income. But at some point, the earned-income strategies of a non-profit threaten a test of “substantial relatedness” to their charitable mission, so that too much earned income could jeopardize its charitable status.

And yet, one look at the diagrams above, begs the question: “Why not create an entity unfettered by the “for profit” and “non-profit” rules, thereby establishing corporations for broader benefits (or what I like to refer to as “for-benefit corporations”)?1 Permitting a form that allows the entrepreneur to build an organization that aims directly for the “for-benefit” sector represents the shortest distance between two points, right? I mean, can you think of anyone with more than a fifth grade education who would look at the diagram above and, seeking to build an entity in the “for-benefit” sector, would chose to first build a typical for-profit or non-profit corporation, and then move towards the “for-benefit sector?” Of course not!

Yet, the tax code, state statutes for incorporating, case law surrounding the dictates of fiduciary duty, and other forces dictate binary thinking when evaluating the proper type of entity for accomplishing objectives – if you want to do well (i.e., create wealth), then you form a for-profit corporation, and if you want to do good (i.e., create a social benefit), then you form a non-profit. In each case, the result is something less than perfect, particularly for the social entrepreneur who is determined to create a different type of corporation – one that can both do well and do good at the same time.

The Problem with Binary Thinking

Until recently, available corporate forms left entrepreneurs with a simple “either – or” equation. You either adopt a corporate form that maximizes the possibility of doing well, or adopt a corporate form that maximizes doing good. This has been the great legacy of our public policy decisions.

Personally, I find such a binary choice unhealthy, both at the local and at a global level.

At the local level, binary thinking leaves entrepreneurs with one of two possible buckets of capital to choose from – the multi-trillions of dollars moving through our public capital markets daily (and the many trillions more in private capital behind that), or the $900 billion in public and private foundations. As John Sage, the founder of Pura Vida Coffee (an organic, shade-grown, fair trade coffee company that gives back a significant portion of its profits to help at-risk children in the coffee growing regions of the world), once put it,

When I meet with private investors about investing in Pura Vida they focus on one of two things – the ROI of their investment dollars OR the social impact and leverage of their charitable donation. They seek either to invest $1 million, or donate $10,000. When I offer that their money will do both and begin explaining Pura Vida’s model, they respond by saying simply ‘you’re making my head hurt,’ and move on to the next item on their desk.

When investors think in this manner, entrepreneurs are left with only two types of cars to build – one that has a very small tank for gas where they are the driver and have control over the destination, and one with a very large tank for gas that could even become self-filling, where they may drive for a time, but where ultimately, the “professionals” will take over and drive for scale.

Let’s say the first car –the philanthropic model – has a one gallon tank of gas. That car will absolutely make it across the country, but progress will be slow and will involve excess time and energy as the driver regularly leaves the freeway in search of gas stations for refueling. The second car – the classic corporate model – will certainly make better time in speeding across the country with its million gallon tank of gas. (In fact, the gasoline engine is powering a monster battery that allows the car to begin generating its own electric power, to the point where it might ultimately become self-sustaining.) But along the way, this speedster may run over a few things, including the spirit of the entrepreneur and her social mission, in favor of a professional (someone more accustomed to high-speed travel) seeking “scale” and “leverage.”

This typifies the social entrepreneur’s dilemma – accept an investment of $1 million or a donation of $10,000. Scale quickly, with the ability to cover long distances, but risk that others – the professionals – may take over and redirect the mission in favor of profit solely or primarily. Or, make the scale and the speed secondary goals to consistency of the mission.

Other issues immediately follow. Compensation, for example, tends to vary widely between the two types of corporations as a result of the available financial resources. “For profits” have the advantage of the million gallon tank for gas, meaning that paying for the best and brightest is not only feasible, but expected. By contrast, with the significantly smaller tank of gas, the executive director of the philanthropy is practically expected to accept lower pay. After all, their corporation is doing good. Why should they make good money too? Too often, this satirical idea turns into the tyranny of doing good. Many times I’ve heard the head of a philanthropy or social venture explain that their labor costs are simply lower because they don’t have to pay as much for people to come and work for them, because they are doing good.

But there are implications far beyond the individual corporation and its employees.

Globally, the U.S. people are known around the world for two primary and remarkable assets – assets that the rest of the world seeks to replicate. First, the entrepreneurial spirit of Americans is widely respected and held in awe, both here and abroad. Second, the heart of Americans for helping the poor, the disadvantaged, the hungry, and those in distress (whether through natural disaster or conflict) is unparalleled.

So what’s the problem, you may ask?

Well, the two assets don’t work together on an integrated basis, or to borrow Jed Emerson’s concept, they don’t work to achieve an optimized blended value. We export our entrepreneurial spirit through our corporate form, emphasizing the idea that making money is the greatest good of a company, all the time creating devastating results in the harvesting of natural resources, minerals, cheap labor, and regularly selling goods that people in the developing world don’t need, or worse yet, that cause physical harm. All this is done in the name of capitalism. Then, when disaster strikes, the biggest and best non-governmental organizations (many of which are U.S.-based, founded or funded) with great corporate donations (from some small percentage of profits) go to work spreading the goodwill of the American people.

We don’t see the need for integration of our “doing well” with our “doing good,” but can we blame the world outside for their cynicism? With one had we take and with the other hand we give. What the rest of the world sees is hypocrisy.

What I see is a lack of integrity – the state of being whole, entire, or undiminished; a sound, unimpaired or perfect condition.

I’m not talking about morality. I’m talking about working to create a “complete” form of doing business. Doing good and doing well through the same organization should be the aspirational goal of every entrepreneur, every investor, every philanthropist and even the government. In many respects, our national security and our future may depend upon it.

But even if that’s too idealistic to hope for, why wouldn’t that form exist for those who want to pursue the “for-benefit” model?

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1 The term “for-benefit corporation” is used throughout to describe the type of entity distinct from the typical “for-profit” and “non-profit” models of a corporation. These are entities are built to optimize private wealth innurement (doing well) and social benefit (doing good). “For-Benefit Corporation” is a trademarked term of the Fourth Sector Network, which ascribes a different meaning.



*Todd is a partner at the law firm of Jones Day, where he founded their Silicon Valley Office and runs their Renewable Energy and Sustainability Practice. The views expressed in this column are solely Todd’s personal views, not the views of Jones Day or its clients, and the information provided as to his affiliation with Jones Day is solely for purposes of identification and may not and should not be construed to imply endorsement or even support by Jones Day of the views expressed herein.



© R. Todd Johnson, 2010. The thoughts, ideas and words expressed in this column are the property of R. Todd Johnson and may not be otherwise used or reprinted without express permission from Todd.