Profits, norms and power

Jesse Norman says companies have a duty not just to obey the law but to follow an ethic of good stewardship. Andrew Lilico and Stephen Pollard disagree. Implicit in this debate is something that should be made explicit - the role of corporate power.

Lilico and Pollard are following the tradition of Milton Friedman, who argued that "the social responsibility of business is to increase its profits."

This principle is an expression of the first theorem of welfare economics - which in turn derives from Adam Smith's invisible hand - which says that rational self-interest will lead to socially optimum outcomes.

However, this is only the case under a particular condition - that companies' economic and political power is limited. Take three examples:

 - Pollution. If we have a Pigovian tax which makes companies pay the social cost of pollution, then a firm will only pollute if the benefits to it of doing so exceed the social cost of the pollution. In this situation, its profit-maximizing strategy will be welfare-enhancing; the value of the goods it produces exceeds the total social cost of them. If however, firms have the political power to ensure that externalities are not priced, then their pursuit of profit would clash with aggregate welfare.

 - Onerous trades. If one party to a bargain is very weak, the other can demand terms which are oppressive, and which third parties might consider unfair. 

 - Taxes. If firms are footloose and workers are not, the burden of taxes will be shifted from firms to workers because firms have the power to avoid them. This might happen through explicit accounting ruses, or through the more subtle route of tax incidence.

Now, here's the thing. When Friedman advocated profit-maximization as a socially optimal strategy, he did so at a time when firms faced countervailing power. In a pre-globalized era of strong unions, they couldn't easily maximize profits by paying lousy wages or offering degrading conditions, and they couldn't so easily dodge taxes. With their power limited, it was at least possible that profit-maximization did increase aggregate welfare. Friedman acknowledged this when he said that firms should "[comform] to the basic rules of the society, both those embodied in law and those embodied in ethical custom."

But things have changed. Firms' bargaining power is now so great that there can be a tension between profit-maximizing and welfare. Maximizing profits now entails ducking taxes, paying wages which are regarded by many as unfair, and producing unpriced externalities such as risk pollution (pdf).This is exacerbated by the fact that "ethical custom", as perceived by capitalists and their apologists, tolerates such behaviour.

There are several possible responses to this:

 - To ignore the role of power . Doing so, I suspect is an example of how beliefs, such as Friedman's, can persist after the conditions in which they were reasonable have disappeared.

- To think that power can be restrained by social norms, as Jesse does.It's a good conservative position, to think that free markets are welfare-enhancing if they operate within a particular moral code.

 - To think legislation is necessary to rein in firms. This is the statist social democratic view.

There is, though, a fourth view - the Marxian one. This says that the tension between profit maximization and welfare hasn't increased simply because of a failure of law and morals, but because of a genuine shift in the balance of class power. Firms now have power and one thing we know about power is that it'll be used. Unless this changes, hopes of reconciling profit maximization with well-being might well prove mistaken. 

Comments

[Anonymous]

With increasing automation, capitalist firms are sowing the seeds of their own destruction unless consumers of their products can be found/created.

Hence firms need to produce consumers, either as an explicit goal or as a by-product,if they are to realise their imputed profit-maximising goals.

The business of business is business, said Friedman. True, perhaps, provided the business of business is also to create un-leveraged demand for its produce.

It's not so catchy, though.

[WNY-WJ]

The statist solution pursued weakly during the New Deal, then strongly from WWII entry into the 1960s, required a collective understanding of interests that is not likely to be forthcoming today. American society is too fractured - whether by design or accident - to allow for collective action.

The results of collective action in WWII - victory and economic recovery - sadly remained ingrained only among the then-living generations. A successful counterrevolution against the lessons learned during this time frame occurred at the earliest opportunity: as the "boomers", with no living memory of the Depression or WWII, began to dominate society.

[Anonymous]

" To think that power can be restrained by social norms, as Jesse does.It's a good conservative position, to think that free markets are welfare-enhancing if they operate within a particular moral code."

Surely, a Marxist riposte to this is that the social norms derive from the economic base and mode of production? If the moral code and social norms are set by capitalists, whose only objective is to accumulate, then the idea that welfare maximising social norms will exist within unbridled capitalism seems fanciful under a Marxist hypothesis

[Errol]

The trouble with presenting a Marxist approach to business is that... it's easily discreditable nonsense.

Marxism is a failed philosophy that cannot exist in the modern world.

The politician is wrong in how they view the role of the company. It is a statist, backward view to leap on a bandwagon of tax and waste.

Companies exist to make money return investment to their owners. A part of this growth is to create jobs. Those simple processes encourage the correct behaviour of the owners. The attempt to penalise business does not work. These are passed on to customers and employees. The only way is to incentivise by considering the sole purpose of what business is for.

[greg]

Companies have too much power for their own good. In the absence of countervailing powers, they are free to drive wages to a minimum, even subsistence levels. While good for each company, this is bad for all companies, since labor is the ultimate market for all production, and driving wages to a minimum destroys that market. It is a failure of composition.

Milton Friedman was simply wrong, See: http://anamecon.blogspot.com/2012/06/milton-friedman-social-responsibility.html and was instrumental in creating a culture of leadership which, by pursuing its narrow self interest and externalizing all costs, is destroying the economy that provides its wealth, and our wealth, also.

Social responsibility merely means including social costs in the corporation’s calculation of profit. In the present of Milton Friedman’s world, social norms are inappropriate for corporations to exercise this restraint, and force of law is required. But corporations have co-opted government, the law is rendered ineffectual in this, and so, until and unless this is remedied, we are all screwed.

[Kate Jackson]

Also, in regards to "moral" constraints on firms - capitalism, as Schumpeter stated so well, has a way of breaking down historical, traditional values. It tends to encourage us to view the world through the lens of a balance sheet - costs and benefits, quantitatively measured. This may be why, for example, big banks feel free to break laws willy nilly, and to pay the fines as a normal part of business operations.

"Morality" under capitalist ideology requires us to accurately measure and account for "externalities" - social costs (as set forth above). SEC fines need to be REAL. And we need to start holding actors responsible for risk, pollution, etc.

[Kate Jackson]

One problem with Friedman's theory is that it presumes that "profits" are earned in the normal sense - a company creates a product for which there is a demand, maybe builds a factory or an office, hires workers. In this way, jobs lost through creative destruction are replaced; the public arguably has its "rational" will fulfilled, and the world keeps churning ever on upwards.

But when profits amount to nothing more than the transfer of value (by exploiting market power, favorable legislation, etc) then it breaks down. E.g., when wage cuts aren't used to fund new investment, but instead used to finance hedge fund takeovers. "Rent seeking," for example. Then capitalism turns into something like a game of monopoly when all the hotels have been built already - we go round and round, trading properties.

When combined with the obliteration of unions, globalization's wage arbitrage, etc., this phenomenon's downward pressure on wages cuts into the consumer demand necessary to encourage new investment. So profits have no where else to go but -- back into the financial markets that exacerbated the problem in the first place.

[Miiockm]

I don't think a business should ever be expected to do anything other than seek profits. This is why regulation is so important.

[Frederic Mari]

My take on this:

http://theredbanker.blogspot.com/2013/07/profit-versus-corporate-social.html