Monday, 15 March 2010

When is CSR justified?

Tatsiana Parkhimchyk outlines an argument against CSR which I think is mostly right: businesses are here to make an economic profit, not to contribute to social causes:
...the business of business is business.
CSR includes: community health, safety, education...and so on an so forth. My question in this case is quite obvious: aren't all these spheres and activities the primarily concerns of the government? And shouldn't the government take care of their citizens to prevent crime, save the environment and satisfy the basic human needs and desires rather than business?
In principle, yes. The incentives for companies are not to maximise social good - any more than are the incentives for individuals. This is why we appoint governments on our behalf - as a coordination mechanism, to solve the problem that competing individual incentives are sometimes destructive of social benefit. Simplistically put, government's job is to solve the tragedy of the commons and the prisoner's dilemma.

A government with perfect knowledge and correct incentives is, in theory, the best way to maximise total welfare across the population. Much of public choice economics is about how to best meet these two conditions - perfect knowledge and correct incentives are not easy to bring about.

And it's in circumstances where these conditions fail, that there may be a role for CSR after all. If the government (which by its nature, must try to aggregate the preferences of millions of people) does a bad job of understanding the needs of some individuals, other forms of aggregation may be more effective. The management of a company might know their customers, employees or communities better than more remote political representatives. They may therefore be in a better position to provide services that would benefit those people.

That's the knowledge side of the equation. What about incentives? Why would companies have an incentive to accurately meet the needs of communities which are not directly buying a product from them?

As a starting point, we could look at the incentives for governments to meet those needs. Or the incentives of individuals within government to meet those needs. Those are, in conventional economic theory, market incentives. Money, a preference for power, or for the social influence and admiration that comes from a position of responsibility.

The admiration preference could apply in the corporate context too, but is unpredictable and relies on the individual preferences of the firm's managers or owners rather than the intrinsic incentives of the company itself. It's more likely that a company can be incentivised to make a social contribution by taking advantage of the preferences, or information gaps, of people in its community.

There's a parallel again with the government case - governments are partly taking advantage of a preference for reciprocity and sharing between citizens to co-opt them into participating in redistribution (and voting). In the company case, there are a couple of ways in which this could work:

  • In a competitive market, companies seek ways to distinguish their services other than on price. If the company's delivery of social services is productive, buying a slightly more expensive product may be an economically efficient way for consumers to make a social contribution. The company is therefore offering consumers an economy of scale for achieving the consumer's own social objectives.
  • In some markets there is an information asymmetry: companies can't always prove that they're trustworthy, or that their quality is high. Then, they may seek ways of signalling commitment to a marketplace and that they have a reputation at stake. In this case, social contributions serve the same purpose as a bank's traditional marble pillars and gilt edging: showing that the company is willing to sink costs into a market and therefore that they plan to stick around for a while. If the value of trust or perceived quality is high, it can be worthwhile for a company to engage in CSR.
  • Similar competitive and signalling processes may exist in the company's relationship with its employees, instead of with its customers.
  • In the signalling case, the informational benefit is present whether the actual social contribution is large or small. So this works best for big companies which can make a small contribution (relative to their total revenue or profit) but spread the news widely across thousands of employees or customers. The productivity case scales more easily down to small firms.
Thus, in some cases where companies both have the right knowledge, and the right incentives, to carry out CSR, it can be an economically sensible activity. The fact that it's also in the company's self-interest does no harm to the citizen. Indeed, if it were not in the interests of the company, I wouldn't support it.

The macroeconomic question is more complicated: what does it look like to have a society and an economy where social good is sometimes achieved by companies instead of by government? My suspicion is that it will be rare to find a stable situation where firms provide a significant share of social goods - but 5-10% might be expected. Some careful general equilibrium modelling would be needed to learn more about the dynamics of a system like this.

So the following thought of Tatsiana's is close to the mark, but we needn't be quite this cynical:
CSR can create a luring shine around a company, given that all people like when somebody takes care of their needs. But does business really care about the well-being of the general public or CSR is simply a smokescreen or window dressing?
Actually, business doesn't need to care - but it might still make a difference anyway.


codemonkey_uk said...

CSR is quite simply the difference between short term thinking and long term thinking. This is an issue that has bothered me for a while. Why do corporations consider "being green" to be solely a PR operation? The answer is because the shareholders/board do not think long term. A company that cannibalizes it's environment is on a course of self destruction. If a business does not have a sustainable environmental policy, then they do not have a sustainable business plan. A business that nurtures it's customers, nurtures it's business. That so many businesses fail to see this continues to bemuse me.

Leigh Caldwell said...

I'm not sure I agree with that. It's less about short-term versus long-term (though there's some element of that) and more about self versus society.

Normally, the incentives for companies are set up to favour them acting in their own interest and not that of society. In the environmental example you give - let's say the company is extracting natural gas from shale and discarding the effluent into the sea. The firm gets all the benefit of the environmental degradation but only shares a small proportion of the cost (because the cost is to the whole of society). Thus it will pollute more than society would optimally prefer.

It may be completely in the interest of the company (long-term as well as short-term) to act this way, in which case it's very understandable that they'd do so. This is why we need to impose proper pricing and incentives to make sure that it's in the company's interest to do what's also in society's interest. For example, carbon taxes or road pricing - we wouldn't expect companies to voluntarily reduce their carbon emissions without being encouraged or forced to do so by the state.

CSR, I believe, operates only around the margin where these interests haven't been formally aligned by legislation. The company may be able to spot ways to help people which turn out to be in its own interest, and that are beneath the notice of the state.