Corporation 2020 and the Free Market Fallacy

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Corporate lobbying and crony capitalism have left the American economy and society in a dysfunctional and broken state, argues Pavan Sukhdev in "Corporation 2020".
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Pavan Sukhdev lays out not only why business-as-usual will continue unless we are prepared for a major overhaul but also takes a look at the free market fallacy.

From arbitrage trading and foreign direct-investment to crony capitalism, Pavan Sukhdev lays out not only why business-as-usual will continue unless we are prepared for a major overhaul but also takes a look at the free market fallacyCorporation 2020 (Island Press, 2012) presents new approaches to measuring the true costs of business and the corporation’s obligation to society.

Today’s corporation is something of an anachronism, the result of a long history of development which began in ancient India and Rome, continued in medieval Europe, and culminated in nineteenth-century America and England. However, most of the development of today’s corporation happened during an eventful century beginning in the early 1820s and lasting until early in the twentieth century. These hundred years achieved limitations on shareholder liability, established corporate personhood, and unshackled the corporation’s operations from restrictions on time, place, and purpose, enabling the corporation to engage in any business, anywhere, for as long as its shareholders desired. These hundred years also freed the corporation from social purpose, and established the primacy of profits as the corporation’s raison d’etre. A landmark judgment in the United States (Dodge v. Ford, 1919) affirmed that the purpose of the corporation was indeed its own self-interest. By 1920, therefore, the corporate form had crystallized as the corporation we recognize today, and for the purposes of this book, I shall refer to today’s corporate entity as “Corporation 1920.”

The key drivers of Corporation 1920’s success are demand creation and expansion, product innovation, and low-cost production. It is characterized by its multinational presence, as well as its success at employing large-scale and international “price arbitrage” in every aspect of its operations. It arbitrages raw-material costs by sourcing cheaply from resource-rich, ill-governed developing countries in Africa and Asia, or from Australia. It arbitrages labor costs by hiring labor cheaply from populous developing countries in Asia to expand its manufacturing capacities. It arbitrages foreign direct-investment benefits from source countries, and investment subsidies from development-hungry destination countries keen to grow their manufacturing and services sectors. Last, but not least, it arbitrages demand from rich consumer markets (particularly Western demand for branded consumer goods) by branding and selling goods at hefty premiums that translate to substantial profit margins.

As technology is forever evolving, the successful corporation needs to grow turnover at a rate fast enough to cover the costs of product obsolescence (through technological innovation and rapidly changing products–as we see with cars, cell phones, and laptops). Indeed, the most successful corporate models (such as Apple) actually build obsolescence into their product and marketing strategies. The successful corporation also needs to grow volume to counter competitive losses of margins (such as air travel in real terms, microchips, etc.). Corporation 1920’s basic mantra is “more is better.” It needs and feeds that other central mantra of today’s dominant economic model, “GDP growth.”

Corporation 1920 has four defining characteristics. First, determined pursuit of size and scale in order to achieve market dominance. Second, aggressive lobbying for regulatory and competitive advantages. Third, the extensive use of advertising, largely unhindered by ethical considerations, in order to influence consumer demand and, often, to create entirely new demand by playing on human insecurities and “turning wants into needs” which can only be satisfied by new products. And finally, aggressive use of borrowed funds to “leverage” the investment that shareholders have made in their corporation.

Leverage, advertising, and lobbying often combine to drive size, thus creating positive feedback loops. Size, in turn, creates cost efficiencies and economies of scale which can deliver more competitive pricing that, in turn, leads to more sales. In the corporate quest for growth, even without the excess, misuse, or abuse that so often attends lobbying, advertising, and leverage, the collateral damage inflicted by corporations on society is not small. This damage typically leads to three exclusions: the exclusion of small- and medium-sized companies through lack of access to leverage; the exclusion of poor consumers from public alternatives to manufactured and marketed private goods; and the exclusion of competing new products (especially clean-tech or green alternatives) by means of a corporate stranglehold on media and distribution networks.

In his book The Corporation, Joel Bakan presents today’s corporation as a psychopath–devoid of moral compass, relentless in the pursuit of power and profits, an “externalizing machine.” Not all commentators are as damning of today’s corporation, but several have taken issue with the corporation’s focus on shareholder interests to the exclusion of other stakeholders, with its enormous and growing environmental and social cost externalities, and with its tendency toward unethical conduct (including bribery, inducement, lobbying by connected parties, irresponsible advertising, and public misrepresentation, among a long list of scandals). All this is justified to achieve business advantage and higher short-term returns.

It is a moot point whether or not the average corporation shows more than the average human tendency for unethical behavior. There is no study that argues that corporations transact to higher ethical standardsthan individuals. On the contrary, there are mountains of evidence of the distancing or subjugation of individuals’ normal moral compass when they act on behalf of their soulless corporate employers. Whistle-blowers in many industries have been effective precisely because they are the exception and not the norm. They are mostly people who at some stage in their working lives have become unable to bear the disjointedness of their personal response from their professional response to situations that require an ethical stance.

Elinor Ostrom, winner of the 2009 Nobel Prize in Economics for her work on the significance of community-based management of common-pool resources (CPRs), in conversation described the Corporation as a CPR owned by a community of shareholders. But it does not appear to be managed even to their advantage, given the long-term and reputational costs of most corporate misconduct. Hence, perhaps Corporation 1920 might be best described as a dysfunctional CPR. This is particularly worrisome when one considers that the archetype of today’s corporation operates across dozens of national boundaries, through thousands of employees and hundreds of suppliers, and serving perhaps millions of people as their customers. Should there be any roomfor dysfunctionality at all in the design of the corporation?

Tilting the Field 

Corporate proponents of a green economy, low-carbon growth, and other economic recipes that target the goals of sustainable development are often frustrated by market-entry barriers and hostile economic policies, unhelpful laws and taxes, and perverse subsidies. Public policies, public investment, taxes, subsidies, and laws are sometimes collectively referred to as “enabling conditions” that could, if properly calibrated, provide fertile ground for “green” business strategies to take root. Instead, they usually face market barriers put up by large incumbents, they are confronted with consumer resistance to greener products, and they experience the frustrating power of enormous subsidies supporting the opposite economic model–the incumbent “business-as-usual” model, or so-called brown economy. For example, fossil-fuel subsidies add up to an estimated US $650 billion per year globally, or about 1 percent of global GDP. Subsidies for fisheries–mainly ocean fisheries–represent almost a third of the total value of fish caught in the oceans. Agricultural subsidies worldwide are over a tenth of total agricultural output. It is hardly surprising, therefore, that renewable energy, sustainable fishery, and ecologically friendly agriculture have a hard time competing with their brown economy alternatives. Country after country provides examples of tax exemptions, import duties, export incentives, and a plethora of subsidies that favor a status-quo brown economy. The question begs to be asked: How did the playing field in so many sectors of the economy get so tilted, and how did corporations manage to achieve such outcomes?

A globally tilted playing field with around $1 trillion per annum in subsidies favoring a business-as-usual model over greener alternatives is, by definition, anything but a free market. Ironically however, an almost religious fervor for free markets has become the cornerstone of the public narrative told by corporations and amplified through advertising campaigns, PR firms, lobbyists, and even shareholders. For example, US corporations activate shareholders across multiple voting districts to flood the offices of Congressional representatives with phone calls decrying “legislation against the free market.”

But the free market they seek to preserve is most often the status-quo market, and their large spending to lobby politicians is fundamentally a reflection of the value that the status quo represents to their bottom lines. Indeed, managing the regulatory landscape is among the most cost-efficient ways by which a corporation can sustain its dominance. Corporate lobbying is a pervasive and potent tool to interact with the regulatory process in a way that tilts the playing field further in their favor, or alternatively, prevents change in the status quo. Often, such change might have helped to foster a healthier balance among private risks, private gains, public risks, and public interests.

Although lobbying is part of the operational toolkit for almost all large companies, it is particularly important for those operating in realms of public trust, including oil, gas, coal, and other extractive industries. And as it happens, these corporations are also among the world’s corporate behemoths: of the world’s ten most profitable companies, four sell energy products and three base their global operations in the United States.

It is not difficult to see why lobbying is such an attractive proposition for corporations seeking market dominance and profits, whether through new competitive advantage or by preserving the status quo. But why does lobbying deliver its punch with such apparent ease into the political world? No doubt party political funding matters, and (in some countries more than others) corruption in politics and government adds to the success of lobbyists. But that is not the case in every nation. Checks and balances are quite strong in most democracies, and the risks of exposure are real and politically costly–and yet, in every capital city from Washington to Wellington, corporate lobbying and influence is visible and successful.

The most pervasive reason for the ease with which corporate lobbying reaches into political decision making is that the corporation today is the most important and pervasive institution in political economy. The private sector delivers nearly 60 percent of GDP worldwide, employs 70 percent of workers, and corporate taxes comprise a significant slice of government revenues. In other words, the report card for today’s politicians and their “grades” on the subjects of GDP growth, employment, and deficit management are largely written by corporations. Small wonder, therefore, that politicians today are so beholden to the corporation, or that they are constantly looking over their shoulders to check if this or that policy change might harm the profitability of some business sector. The last thing they want is that voters see a “failing” grade on their report card, which would prevent them from getting another term. Small wonder, too, that “crony capitalism,” the cozy relationship of mutual favors between businessmen and government officials, is so ubiquitous, no matter whether we look at Latin America in the pre-crisis 1970s, or at Asia pre-crisis in 1997, or the United States pre-crisis in 2007. The revolving door between the US Treasury and Wall Street was just the crowning refinement of this crony capitalism and it has had a deep impact on the financial and economic history of our times, especially the financial crisis of 2008 and the economic recession that followed.

Corporation 2020 

Tellus Institute’s “Corporation 20/20” is an international, multi-stakeholder initiative that seeks to develop and disseminate a vision and pathway for the twenty-first-century corporation in which social purpose moves from the periphery to the heart of the organization. In a 2007 position paper “Corporate Design: The Missing Business and Public Policy Issue of Our Time,” the authors remark that “business leaders operate today inside a corporate design largely inherited from the nineteenth century, with ownership and governing structures put in place during the horse and buggy era.” The report sees the challenge of creating a new kind of corporation as “the design challenge of the twenty-first century.”

This book reflects many of the concerns raised by the Corporation 20/20 project, and it proposes a composite solution to the problem of corporate design. Corporation 2020 argues that endogenous changes will not suffice, notwithstanding exceptional leadership from some corporations, and that exogenous changes with the collaboration of governments, businesses, media, and civil society will be required to make a new design arise from the old. It contends that a safe timeline for these changes (taxation reforms, leverage limits, externalities disclosure, and advertising standards) to be introduced into policy frameworks and business practices is probably the next ten years, rather than the next fifty or a hundred years. A new DNA of the corporation must begin to make its presence felt in the global economy by 2020, by which time we shall be dangerously close to many planetary limits or will have actually exceeded them. The 2050 or 2100 scenarios that are still reflected in UN climate negotiations and economic literature on the subject are too far off to be of any relevance. This is why the new corporation is termed “Corporation 2020” in this book. And there is an increasing convergence of opinion that vision, action, and timelines must converge; “20/20” and “2020” are therefore two sides of the same coin.

The New DNA That Business Needs 

This book makes the case that Corporation 1920 has had its day. What attributes does today’s corporation need to evolve in order to secure not only the corporate form but also the future of mankind on our only home, Planet Earth? What kind of corporate agent, in other words, do society and the economy need today if they are to forge an “economy of permanence,” also known as a green economy or a sustaining economy, one which increases human well-being, increases social equity, decreases environmental risks, and decreases ecological scarcities?

A new DNA for the corporation needs to have numerous strands, but our focus will be the four key strands that are likely to make the most difference: corporate goal alignment with society, the corporation as community, the corporation as institute, and the corporation as a capital factory. As early as the early 1900s, Henry Ford was aligning his company’s goals with society: he wanted every American farmer and his wife to have mobility and he wanted the farmer to grow his own fuel–ethanol from corn, fruit, or almost any biomass. Natura in Brazil prides itself on a community which is anchored in the company’s relationship with over a million housewives who sell the Natura “story” and through that sell their cosmetics and personal products. Infosys in India has built the largest corporate university ever, and trains over thirty thousand young software professionals every year–in fact, Infosys is as much a training institute as it is a corporation. Creating social capital (like Natura) and human capital (like Infosys) are activities that are very valuable to society at large–not just to the company. In Japan, more than fifty large corporations maintain natural forests as their contribution to the society where they do business. It is the thesis of this book that such activities will make the corporation of the future a veritable “capital factory”–not just creating one line or category of capital (financial profit) but a whole array of capitals (physical, social, human, and natural), and not just for itself, but also (in the form of positive externalities) for society at large. This behavior at the “micro” level will make way for a very different world at the “macro” level, the world of Corporation 2020.

We are not compelled to live with the risks and costs of Corporation 1920 as the main agent of our economy and the most significant institution of our times. We can instead collaborate to create an environment for the success of a new species of corporation. Corporations, like biological species in a dynamic environment, respond to external stimuli which, in their case, include policies and prices. They adapt and evolve, with the strongest and fittest surviving over time. Changing external conditions such that the input costs of natural and social resources converge with their true value to society would enable a Darwinian process by which corporations most able to adapt in this efficient environment would survive and facilitate the creation of more such businesses. In the long run, therefore, the social benefits and social costs of corporations’ activities would be reflected in their accounts as much as possible, thus realigning the corporations’ profits with society’s gains.

Excerpted with permission from Corporation 2020: Transforming Business for Tomorrow’s World by Pavan Sukhdev and published by Island Press, 2012.

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