The Social Responsibility of Business is to Increase Profits
Dr. Geoff Lewis a Professor at Melbourne Business School presented the following argument while debating the topic "the social responsibility of business is to increase its profits" at MBS in February 2010.
"It's time to discard the popular belief that corporations must focus first and foremost on maximizing value for shareholders. That idea is inherently, and tragically, flawed."
These are not my words - I am quoting Roger Martin, Dean of the Rotman School, in the January 2010 edition of the Harvard Business Review.
It is gratifying to see that forty years after Friedman's article was published, the debate has moved from Managerial Capitalism to Shareholder Capitalism and now, Roger Martin suggests, to Consumer Capitalism. Just as the emergence of Shareholder Capitalism was spurred by the issues of the day, so too the current debate must be placed in the context of today's concerns.
Friedman argues that the proponents of the social responsibility of business were "preaching socialism." His arguments were, however, set in very different times - before Fukuyama's End of History. Let us be clear, in today's world, this is NOT a capitalism versus socialism debate. We all subscribe to the idea of the free-market economy. The current debate speaks to the nature of capitalism and requires us to acknowledge one of its many wonderful strengths - its dynamic nature; its capacity to change and evolve as society faces new challenges and opportunities.
And so the debate this evening is not about free markets versus the social responsibility of business, it is about how our capitalist system should be responding to the challenges facing our world today.
Read in today's context the title of Friedman's article may appear misleading, for he discusses the social responsibility NOT of business, but of corporate executives. But to be fair, Friedman's article must be placed in context. The article was based on his 1962 book Capitalism and Freedom where, inspired by Hayek, he makes the case for economic freedom as a pre-condition for political freedom. In the article Friedman took on the task of presenting the Chicago free-market ideology to a wider audience in response to Ralph Nader's attempt to get representatives of "the public interest" on the board of General Motors - the so-called "GM crusade". Friedman's article was designed to counter Nader's arguments for government intervention in business.
We need to do two things in this debate - first we need to deal with some of the arguments that Friedman presents in his article. Second, we need to address the actual topic.
Friedman argues that the corporation is an artificial person and can, therefore, only have "artificial responsibilities." "Business" is apparently an even more artificial construct and therefore we are left with just proprietors and corporate executives who can actually be responsible.
Friedman grants that individual proprietors are free to exercise "social responsibility", but because they are far less likely to have monopolistic power they are, apparently, of little concern. And so we are left with corporate executives, who if they were to exercise "social responsibility" could only do so, according to Friedman, by acting against the interests of their employers, the owners of the corporation. In this way Friedman sets up a straw man - the social responsibility of business as a stark choice between the interests of the providers of capital and society.
Friedman argues his case using three examples - lowering price, reducing pollution and providing work for the so-called "hardcore" unemployed. In making these arguments Friedman displays a remarkably unimaginative, one-dimensional view of business. A richer view of the way good businesses operate offers a different perspective. If a business lowers price to provide more buyer surplus hence growing market share and exploiting economies of scale to increase profit, how is that against the interests of the owners? If a business innovates in the area of pollution reduction leading to stricter regulations that drive complacent, short-term profit-maximizing businesses to the wall, is that against the interests of the owners? If a firm develops new HR practices that turn the unemployed into highly productive and motivated employees that make the business internationally competitive, is that against the interests of the owners? I think not.
If we now turn to the actual topic of Friedman's article we need to discuss the role of business in society? Friedman sees "business" as too artificial a construct to ascribe notions of responsibility to, but this evening's audience is, I'm sure, - while avoiding the problems of reification - able to think in terms of business as a central institution in capitalist societies; an institution whose functioning is quite properly the subject of debate.
Certainly we can agree that those managing businesses have an obligation to generate satisfactory returns to shareholders - the people who have provided the risk capital without which the business would not exist - but this is not the reason a business exists. The purpose of business is to create value in society - this value is created through market transactions and the quantum of value is a function of consumers' willingness to pay for the business's goods or services. Costs are incurred in the process of creating value and the value added by the business is the difference between willingness to pay and economic cost.
So businesses have a responsibility, to society, to do two things: to create value and to make a profit. Businesses that capture profits in excess of the value they add are thieves - or in Friedman's terms, self-appointed tax collectors - and businesses that create added value, but do not generate satisfactory returns are charities and, in effect, those managers are stealing - or collecting taxes - from the shareholders.
And so business does indeed bear significant social responsibilities - to create value and, in so doing, make profits. So why do we get caught up in this social responsibility of business debate? Well, the real world is not quite as tidy as the economist's - or even business strategist's - conceptualisation. Empirical evidence shows that businesses frequently - and often for extended periods of time - generate returns below the cost of capital. Failures of corporate governance allow acts of thievery to be perpetrated on the owners. On the other hand, often businesses generate profits in excess of their value added - for example, market power may enable monopoly rents to be extracted at the expense of consumers or suppliers. Neither forms of thievery are sustainable as the GFC demonstrated.
Perhaps more troubling are the problems associated with ‘externalities'. Friedman talks about "reducing pollution", but this is just one more of his straw men - if a business, in the process of creating value, pollutes the environment, surely this cost should be borne by the business. Friedman says as long as it is within the ‘rules' it is okay, but here he is simply conceding to government the very powers he argues against. Profits generated at the expense of environmental or social impacts are ill-gotten gains and they are unsustainable - eventually someone must bear these costs, even if it is our children or grandchildren.
Forty years ago social responsibility may have been seen as acts of corporate "do gooders" - or as Friedman described it, "hypocritical window dressing" - but in today's world we think in terms of sustainability and of business playing a central role in our market-driven society. Friedman ends his article by finally acknowledging that business does have a "social responsibility", that is, to increase profits - I would argue that forty years later this is not enough. The social responsibility of business is to increase its profits, yes, but by fulfilling its central role in society - that of creating value.
