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National Affairs

 

The Dangers of Quasi-Capitalism

January 07, 2013

By Howard Husock

In the aftermath of the 2008 financial crisis, America has largely been spared a full ideological assault on the legitimacy of capitalism. While past economic and financial calamities have produced vocal anti-capitalist movements—and though the antics of Occupy Wall Street have generated headlines—principled, substance-based critiques of the essential elements of a free-market system have not materialized. That such criticisms have been blunted is surely related to the dismal experience of anti-capitalist regimes: As a result of the failure of socialism in the 20th century, many have come around to the belief that there is simply no viable alternative to an economic system rooted in the basic principles of free markets. Such widespread acceptance, even if only the result of all other possibilities having been exhausted, would seem to offer comfort to those concerned about capitalism’s future.

But that comfort would be too easily taken. While critics of capitalism may have resigned themselves to its endurance, they have not given up trying to eradicate its perceived flaws. In doing so, they have launched a movement that, in seeking to address these flaws, risks changing the essential character of the market economy. This movement does not seek to dismantle the foundations of capitalism, but rather to transform its goals and basic purpose by proposing new, alternative corporate forms that might best be called "quasi-capitalist." There is a variety of such forms, but they have in common a key underlying assumption: that firms neither motivated nor measured purely by financial profit will be more effective than traditional profit-driven corporations in creating benefits for society at large.

The quasi-capitalist "movement"—really a series of philosophically related but independent initiatives — is premised on the notion that today’s business structures serve an overly narrow purpose, with the benefits accruing primarily (or even exclusively) to private individuals and interests. If our economy is to work to the advantage of the general public, the reasoning goes, businesses must instead pursue what is known as a "triple bottom line." It is not enough for firms to be judged merely by returns for investors: They must also meet specific social goals such as safeguarding the environment or improving the lots of disadvantaged populations. Under the quasi-capitalist ideal, producing all three kinds of benefits—economic, environmental, and social — would replace the traditional balance sheet as the measure of corporate success. Indeed, profits would be justified only insofar as they served as means to the realization of the broader social good.

Recent years have seen the development of different organizations and mechanisms to advance the "triple bottom line." Some — such as the simple donation of corporate profits to social causes—are relatively innocuous-seeming and in keeping with the longstanding tradition of corporate community philanthropy. Others represent a more radical break. These include pressure on companies—exerted by self-appointed arbiters of right-thinking—to demonstrate "corporate social responsibility." Still others—principally "hybrid businesses" and "benefit corporations"—establish alternative corporate forms that pose a direct challenge to traditional free-market, for-profit structures. By implication, they are a threat as well to the private philanthropy that business profits have historically fueled.

The most damaging outgrowth of the new quasi-capitalism, however, may be the degree to which it lends credence to the notion that the traditional model of private enterprise produces no benefits to society at large. As researchers Julie Battilana, Matthew Lee, John Walker, and Cheryl Dorsey argued in the Summer 2012 issue of the Stanford Social Innovation Review, hybrid businesses represent a "blend of social value creation and commercial revenue," providing "products and services that, when consumed, produce social value." The obvious implication is that the traditional commercial model does not produce such social benefits, and so should be replaced by one that does.

But the experience of societies with robustly capitalist systems belies this assertion. From scientific and technological innovation and medical advances to widespread employment, generous philanthropy, and higher standards of living across all income groups, economies oriented around profit do in fact create "social value." To the extent that we seek to change the defined purposes of the corporate structures central to a free-market economy and to replace them with untested alternatives, we risk undermining the broad benefits that capitalism can be shown to provide. It is therefore worth examining the rise of quasi-capitalism—the alternative corporate forms and practices it seeks to spread, as well as the thinking that animates it—in order to better understand the threat it poses to America’s economy and society.

PROFIT-DIVERSION CAPITALISM

Critiques of the social ills caused by capitalism are, of course, far from novel. But the idea of marrying the revenue that profit-making businesses earn to the needs of social causes is a relatively recent variation, traceable to a few specific figures and their ideas.

One is William Drayton, the one-time federal environmental official who, in 1980, founded Ashoka: Innovators for the Public. The organization was predicated on the idea that society’s most pressing needs might be best addressed not by governments or businesses, but by a cohort of so-called "social entrepreneurs." Ashoka supports these entrepreneurs through (among other efforts) seed funding for non-profits; the group has developed a broad reach, supporting some 3,000 "fellows" in 70 countries since its launch. It has also widely popularized the term "social entrepreneur": That label is now taken to mean not only people who establish and lead non-profit service organizations and advocacy groups (the definition I have used in my own work on the subject), but also those who push for-profit companies to work with non-profits in order to benefit the poor. (The underlying assumption, naturally, is that for-profit firms would otherwise neglect this population.) Drayton’s labeling is key: By describing people who facilitate public benefits as "social entrepreneurs," he implies that traditional entrepreneurs are self-interested or even anti-social.

Another key figure in the evolution of quasi-capitalism is John Elkington, founder of the British environmentalist consulting firm Sustainability and author of a 1994 paper in which he coined the term "triple bottom line." In that paper, Elkington put forward the idea that the traditional profit-loss bottom line should be augmented with two others: a "people’s account" and a "planet account." The idea was meant to be transformative, wholly reframing the way business had been understood and practiced for centuries. As Elkington explained in his contribution to the 2004 book The Triple Bottom Line: Does it All Add Up?:

In the simplest terms, the [Triple Bottom Line] agenda focuses corporations not just on the economic value that they add, but also on the environmental and social value that they add—or destroy.

With its dependence on seven closely linked revolutions, the sustainable capitalism transition will be one of the most complex our species has ever had to negotiate. As we move into the third millennium, we are embarking on a global cultural revolution. Business, much more than governments or non-governmental organizations (NGOs), will be in the driving seat. Paradoxically, this will not make the transition any easier for business people. For many it will prove grueling, if not impossible.

Today, the far-reaching quasi-capitalist vision expressed by Drayton and Elkington manifests itself in different forms, the most limited of which is commonly termed "profit-donation capitalism." It might as well be called "profit-diversion capitalism": Firms practicing profit-donation capitalism simply redirect capital from private interests to public ones, donating surplus revenues to organizations offering the social benefits that traditional businesses are assumed to be incapable of providing.

At a superficial level, profit-diversion capitalism resembles the most common form of "corporate citizenship"—corporate philanthropy. Both practices involve companies using their profits for some public purpose. At the smaller end of the scale, this might involve a local bank underwriting a concert series in the park or a grocery store sponsoring a Little League team. For larger corporations, the scale of such "citizenship" can be enormous: The Chronicle of Philanthropy has reported that, in 2011, 13 companies donated more than $100 million each (of these firms, the largest contributor was Walmart, which donated $342.4 million). Such donations may just be cynical marketing ploys; they may also be rooted in the communitarian assumption that businesses have an interest in fostering healthy communities. Whatever the motive, this "corporate citizenship" funnels enormous revenues to organizations like the Red Cross, United Way, Salvation Army, and local schools every year. Indeed, according to Giving USA, overall 2011 corporate philanthropic donations of all kinds totaled $14.55 billion.

But it would be a great mistake to confuse this corporate giving with profit-diversion capitalism. Like all philanthropy, corporate giving is the collateral benefit of the traditional, for-profit business model. Profit-diversion capitalism, on the other hand, represents a different model entirely. It is premised on the basic assumption underlying quasi-capitalism: that businesses produce broad social benefits only if they support organizations that explicitly assert public interests as their raisons d’être.

The distinction is clarified by looking at the best exemplars of profit-diversion capitalism: the handful of firms that pledge to donate not some but all profits to charitable causes. One example is NIKA, a bottled-water company based in La Jolla, California. In 2009, NIKA pledged to donate "100% of our profits to support clean water projects in areas lacking access to clean water" in countries like Sri Lanka, Kenya, Ethiopia, and Ecuador. The aim, according to the firm, was to express a commitment both to "ending the cycle of poverty" and to encouraging "smart consumerism."

The most famous example is surely Newman’s Own, the food-products company founded in 1982 by the late actor Paul Newman and writer A. E. Hotchner. In 30 years of selling sauces, snacks, beverages, and salad dressings, the company claims to have donated more than $330 million to thousands of charities (the most prominent of which is a camp Newman founded for children suffering from cancer and other serious illnesses). Newman’s Own certainly sees itself as occupying corporate America’s moral high ground: Newman and Hotchner co-wrote a memoir tellingly titled Shameless Exploitation in Pursuit of the Common Good.

Though Newman’s Own is a familiar and celebrated business model, few companies have climbed aboard the "100% donation" bandwagon. Still, there are reasons to be concerned about even this sort of quasi-capitalism. While a firm like Newman’s Own may increase charitable donations, the company does little more than allow consumers to use a foodstuffs manufacturer as a charitable-giving proxy—a poor substitute for both traditional philanthropy and traditional capitalism. In the case of traditional philanthropy, after all, donors can give their money directly to organizations that they know share their priorities, values, and interests. And in the case of traditional capitalism, profits are returned to investors, who can exercise similar control over the direction of their surplus dollars. Profit-donation capitalism allows for neither: Both a firm’s customers and its investors forgo some amount of money they would otherwise control, simply trusting that it will eventually make its way to some good cause.

Furthermore, it is not difficult to see how the work of serving as a de facto charitable foundation might not be done well by a company fundamentally dedicated to other purposes—like bottling water—or how it might distract from and come at the expense of the company’s profit-generating activities. The model of profit-donation capitalism thus risks undermining the nimbleness and efficiency of both straightforward charity and for-profit capitalism.

Nor is the profit-donation model enough for people ambitiously seeking to launch a wholesale revolution in socially responsible capitalism. It has not attracted large legions of followers. It does not require whole new ways of doing business. Newman’s Own has, for instance, neither called for nor implemented changes in the manufacture or distribution of salad dressing to make its production more socially or environmentally beneficial. For changes of this sort, activists have turned elsewhere: to the movement for so-called corporate social responsibility.

CORPORATE SOCIAL RESPONSIBILITY

The push for corporate social responsibility (CSR) represents a much more far-reaching effort to overhaul the everyday operation of business. It seeks not merely to redirect the fruits of capitalism, but to fundamentally transform its practices and processes. This movement thus stands to have a much greater effect on the character of our free-market system, and so poses a much greater threat to the innovation and prosperity that system has tended to provide.

The fundamental premise of the CSR movement is the belief that corporations should adhere to a variety of performance standards adopted not for their effects on productivity or income, but because they are inherently worthy moral goals. These standards could include paying "living wages" to employees or vendors in a firm’s supply chain or offsetting the carbon emissions yielded during a firm’s production process. The assumption, again, is that unless a company explicitly incorporates social or environmental concerns into its way of doing business, that company will not create benefits for the public at large.

The definition provided by the Corporate Social Responsibility Initiative at the Harvard Kennedy School’s Center for Business and Government sums up well how this particular form of quasi-capitalism is understood and how it operates:

Corporate social responsibility encompasses not only what companies do with their profits, but also how they make them. It goes beyond philanthropy and compliance and addresses how companies manage their economic, social, and environmental impacts, as well as their relationships in all key spheres of influence: the workplace, the marketplace, the supply chain, the community, and the public policy realm....[T]hroughout the industrialized world and in many developing countries there has been a sharp escalation in the social roles corporations are expected to play. Companies are facing new demands to engage in public-private partnerships and are under growing pressure to be accountable not only to shareholders, but also to stakeholders such as employees, consumers, suppliers, local communities, policymakers, and society-at-large.

The approach articulated by Harvard has been some three decades in the making. One of the earliest episodes in its development came in the 1970s, when activists launched an international boycott against the Nestlé corporation. By promoting the use of its infant-formula products as a substitute for breastfeeding, the critics claimed, Nestlé was directly responsible for sickness and death in poor countries without sanitary water supplies (needed to make the formula). In 1974, the organization War on Want published a pamphlet titled "The Baby Killer" in an effort to expose Nestlé’s alleged wrongdoings; the ensuing campaign led to World Health Assembly restrictions on the promotion and marketing of formula. To this day, Nestlé faces CSR pressure over its alleged failure to practice business ethically. As recently as 2011, 19 NGOs boycotted a Nestlé competition — which would have awarded half a million dollars for, as one report put it, "outstanding innovation in water, nutrition, or rural development projects"—because of the company’s marketing of baby formula in Laos.

It wasn’t until the early 1990s, however, that the CSR model really gained prominence. The case of Nike brought demands for socially minded business practices to the fore after widespread protests against labor practices in the company’s supply chain. (Critics alleged that the shoe maker used sweatshops in countries like China, Indonesia, and Vietnam.) By 2005, the Economist, in an extended special report on CSR, would write that "over the past 10 years or so, corporate social responsibility has blossomed as an idea....CSR commands the attention of executives everywhere...and especially that of the managers of multi-national companies headquartered in Europe or the United States."

So it was that Coca-Cola—as a major user of fresh water—came to collaborate with environmental organizations to conserve freshwater river basins. General Electric launched its "Ecomagination" campaign, emphasizing its use of renewable energy and efforts to reduce carbon emissions. Starbucks initiated what it called C.A.F.E. standards, aimed at supporting the "sustainable" production of coffee. Novo Nordisk, a Danish company that manufactures insulin, went so far as to include the idea of the triple bottom line in its corporate articles of association.

One of the foremost exemplars of CSR is Ben & Jerry’s ice cream, which trumpets a supply chain built around "family farmers," "caring dairy," and "cage-free eggs." The firm uses environmentally friendly hydrocarbon freezers and recycled packaging; on its web site, it explains: "We continue to devise and pursue plans to reduce our greenhouse gas emissions to respond to the challenge of climate change, which is real, which, in our opinion, humans are clearly creating, and which isn’t going away anytime soon." As co-founder Ben Cohen explained in a 1995 Los Angeles Times article: "At Ben and Jerry’s...we see ourselves as somewhat a social service agency and somewhat an ice cream company." The company even publishes an annual "Social and Environmental Assessment Report" to evaluate how well it is upholding its "social mission goals."

Today, virtually no major firm can afford not to have some demonstrated commitment to CSR. This, in turn, has spawned an extensive management literature and related university centers at a host of business schools. Indeed, the Aspen Institute provides a list of what it calls the "Top 10 business schools," ranked for "integrating Corporate Social Responsibility" into their curricula.

CSR has become so fashionable, and indeed so expected, that champions of quasi-capitalism have developed several certifications to help companies prove they are truly committed to a triple bottom line. One thinks here of the Fair Trade certification regime, which avers, through its branding, that products such as coffee, tea, and fruit have been grown in environmentally "sustainable" ways (not, for instance, through slash-and-burn agriculture) and that their producers have been paid a "living wage" (often above market). Many CSR certifications are environmental, such as the near-ubiquitous LEED labels identifying that business takes place in "green buildings." Others focus on human resources, such as Social Accountability International’s SA8000 standard. That label, according to the organization, attests that a firm’s "management system supports sustainable implementation of the principles of SA8000: child labor, forced and compulsory labor, health and safety, freedom of association and right to collective bargaining, discrimination, disciplinary practices, working hours, remuneration."

Complementing this certification of business practices is a group of self-proclaimed socially responsible investment funds — which, one could argue, exist as unofficial enforcers of CSR. As Congressional Quarterly has put it, such institutions "[combine] financial goals with the aim of improving society through stock screening, shareholder activism and other methods." These funds certainly avoid owning stock in firms that are widely viewed as producing goods of questionable or negative value, such as tobacco products. But they also use the proxy-motion process to influence corporate behavior at a wide range of major firms—by, for instance, using shareholder power to limit executive compensation or to champion specific environmental objectives.

One such fund is Walden Asset Management, which describes itself as "the socially responsive investment division of Boston Trust & Investment Management Company." Walden has been an active enforcer of CSR at the companies in which it invests, targeting a diverse array of Fortune 200 firms. In 2006, for instance, the fund filed a shareholder resolution with Coca-Cola effectively accusing the company of hypocrisy regarding the environment. Walden’s resolution acknowledged that "Coca-Cola Company has repeatedly emphasized its commitment to environmental leadership," but blamed the company for the fact that "the majority of Coca-Cola beverage containers in the U.S. continues to be landfilled, incinerated or littered, thereby contributing to environmental pollution, and reducing the U.S. supply of recycled plastic." As a solution, Walden requested that Coca-Cola’s board of directors "review the efficacy of its container recycling program and prepare a report to shareholders...on a recycling strategy that includes a publicly stated, quantitative goal for enhanced rates of beverage container recovery in the U.S."

In 2012, Walden joined with a large group of mainline Protestant organizations and Catholic religious orders to file a shareholder resolution calling on ExxonMobil to incorporate "greenhouse gas reduction goals" into its operations. And it urged the Walt Disney Company and Johnson & Johnson to permit shareholders "say on pay" — in other words, to review executive compensation to ensure that it is not too great in relation to the pay earned by lower-level employees. Walden’s other targeted firms include household names like UPS, Pepsi, IBM, and General Electric, as well as financial behemoths like Goldman Sachs. (A helpful database of such proxy motions may be found at proxymonitor.org.)

One particularly revealing Walden motion was filed in 2007 with Home Depot. Though Walden’s aim was to achieve a desired social practice — increased hiring of racial minorities—Walden framed its CSR pressure campaign as an effort to increase profitability. Citing settlements reached with the federal Equal Employment Opportunity Commission over alleged employee discrimination, Walden called on Home Depot to seek a more "diverse" work force. The premise was that, because American customers are increasingly diverse, a representative work force would be more likely to anticipate and respond effectively to consumer demand.

Walden’s activism, and the Home Depot case in particular, highlight some of the dangers of the CSR movement. To begin, CSR is often pushed as an inevitable requirement of doing business in an age of socially conscious investors and consumers (as Walden argued about Home Depot’s "diversity" problem). Companies invest significant resources in CSR compliance — both in altering their business practices and in obtaining the various proofs of their good-heartedness—on the notion that the public will be more inclined to invest in them or buy their products because the company is seen as sharing their values.

But as David Vogel of the University of California, Berkeley, has argued, this argument is "misinformed." There is little evidence to link companies’ CSR records with the returns they offer investors; "for most firms, most of the time, CSR is largely irrelevant to their financial performance," Vogel explains. The same is true, Vogel argues, of socially responsible investment funds (like Walden), whose long-term performance "has been no better, or worse, than those of funds that use other criteria to predict future shareholder value." Consumption decisions, he notes, are still made overwhelmingly on the basis of price, convenience, and quality. Even for those consumers who represent the "niche" for ethical products, a company’s true CSR record can be difficult to ascertain: Merck distributes a drug to cure river-blindness free of charge, but withholds information about the safety of Vioxx. "The belief that corporate responsibility ’pays’ is a seductive one: Who would not want to live in a world in which corporate virtue is rewarded and corporate irresponsibility punished?" Vogel argued in an article for Forbes. "Unfortunately, the evidence for these rewards and punishment is rather weak."

The incident between Walden and Home Depot also illustrates how CSR is often imposed from without, through pressuring mechanisms (like proxy motions) and the threat of embarrassment. Companies may be forced to change their practices to implement policies that reflect outside activists’ beliefs, but not the firms’. And to the extent that companies design their business practices to avoid bad publicity rather than to generate returns for shareholders, they are likely to be distracted from their core purposes and are unlikely to be using their resources as efficiently as possible. Even when firms do consciously desire to build their businesses around CSR practices, those practices can hinder profitability and growth. As the 1995 Los Angeles Times article about Ben & Jerry’s noted, when the firm wanted to expand, its various CSR commitments imposed major obstacles to additional production and distribution. And in order to attract a new CEO capable of managing "the daily machinations of a $150 million company [that] had grown too complex" for its founder to run, the Ben & Jerry’s board had to abandon the celebrated seven-to-one salary cap, sacrificing "values" to reality.

The Home Depot case also shows how the CSR regime can be used to layer restrictions on corporate functions atop existing laws and regulations—a sort of hyper-regulation of corporate activity. Recall that Home Depot had already settled with the EEOC when Walden launched its proxy motion: The fund was calling on the building-supplies company to take additional steps toward a "diverse" work force beyond those required by the terms of the settlements. In this sense, Walden was serving as an extra-regulatory enforcement arm of government.

This is one of the primary threats posed by the CSR apparatus: that it allows critics of traditional capitalism to impose their ideal regulatory regimes without having to enact them through our well-established lawmaking processes. One of the most dangerous instruments for imposing such added burdens is the United Nations, which has developed a keen interest in CSR. The U.N. has in fact sought to codify corporate social responsibility in its "Global Compact," through which more than 7,000 corporate signatories in 145 countries have pledged to uphold "universal principles in the areas of human rights, labor, environment and anti-corruption" while aiming "to mainstream these...principles in business."

The Global Compact’s web site takes pains to stress that participation is purely voluntary, and companies may withdraw as they please (though companies failing to "communicate progress for two years in a row are de-listed and the Global Compact publishes their name"). In this sense, participating firms consent to follow extra rules and regulations not necessarily required by the laws of their own countries. But this isn’t to say that the United Nations doesn’t want more. In 2011, the U.N.’s special representative for business and human rights released "guiding principles" for how businesses and states can "[take] practical steps to address business impacts on the human rights of individuals." Among the suggestions were calls for states to more aggressively monitor and regulate the overseas business activities of corporations "domiciled" within their borders to ensure that the firms adhere to the U.N.’s preferred CSR standards. As the document noted, "States should not assume that businesses invariably prefer, or benefit from, State inaction, and they should consider a smart mix of measures — national and international, mandatory and voluntary—to foster business respect for human rights." The U.N.’s statements and activity point to how today’s largely informal CSR apparatus — the various international guidelines, compacts, pressure campaigns, and unofficial enforcement mechanisms — might easily result in binding regulations on global business.

To be sure, there are some serious arguments in favor of compelling firms to abide by the standards of CSR. They are particularly relevant in the context of weak states, where even rudimentary regulatory standards might not exist or be enforced, or where such basic regulation might be subverted by corruption. It is certainly possible that industrial operations in weak or corrupt states can produce what economists call negative externalities—air pollution, water contamination, human-rights abuses—and that the pressure of an international CSR organization might help matters. But this is clearly not the situation in the United States and in other advanced industrial economies, where CSR is, in effect, seeking to bypass the give-and-take of the political process (through which the compromises of regulations’ costs and benefits are sorted out).

It should be no surprise, moreover, that prominent, brand-name firms tend to support CSR demands. These firms are not only more vulnerable to public pressure because of their prominence: They are also in a better position to afford the expense of adhering to extra-legal operating standards. The spread of CSR demands thus puts large, established firms at a competitive advantage over smaller start-ups. In this way, quasi-capitalism lays the groundwork for concentration and barriers to entry, sapping the dynamism of true capitalism. It is one of many ways in which those who seek to cleanse our free-enterprise system of its perceived stains risk throwing the baby out with the bathwater.

BENEFIT CORPORATIONS

As greatly as the corporate social responsibility movement threatens to change our system of free enterprise, it still doesn’t go far enough for people who seek a different version of capitalism entirely. Or, as Clive Crook put it in the Economist in 2005, CSR advocates are, despite their ostensible success, "oddly enough...disappointed. They are starting to suspect that they have been conned....When commercial interests and the broader social welfare collide, profit comes first." So it is that the push has continued for a version of capitalism in which social benefit is realized not through ongoing struggle with a system seen as providing primarily private benefits, but rather as the explicit core goal of enterprise. To put it another way, a corporation’s producing chiefly social, rather than private, benefits would no longer be the exception, but rather the rule.

One model of this alternative capitalism is the "hybrid business." As Nardia Haigh and Andrew Hoffman describe them in an article for Organizational Dynamics,

Hybrid organizations can exist on either side of the for-profit/non-profit divide; blurring this boundary by adopting social and environmental missions like nonprofits, but generating income to accomplish their mission like for-profits. Hybrids are built on the assertion that neither traditional for-profit or nonprofit models adequately address the social and environmental problems we currently face. Entrepreneurs of hybrids seek to build viable organizations and markets to address specific social and environmental issues.

Hybrids can thus take a variety of forms. It is easiest to understand them, however, as non-profits that attract philanthropic funds while also earning significant revenues by operating businesses that are themselves predicated on social purposes (like environmental improvement or lifting up the poor). The quintessential incubator of such organizations is the Roberts Enterprise Development Fund, launched in 1997 by George Roberts, the billionaire co-founder of the pioneer leveraged-buyout firm Kohlberg Kravis Roberts & Co. Based in San Francisco, REDF describes itself as "provid[ing] equity-like grants and business assistance to a portfolio of nonprofits in California to start and expand social enterprises." Its well-known Juma Ventures, for instance, hires low-income Bay Area youths to work at concession stands at the city’s sports stadiums, selling products manufactured by CSR-minded firms (Ben & Jerry’s ice cream, Tully’s Coffee, Tazo Tea). It funds similar enterprises in fields such as landscaping and the retrofitting of buildings to meet environmental goals, employing disadvantaged youth or those with a history of mental illness.

The model of the hybrid organizations supported by REDF has spread. In New York, for example, Hot Bread Kitchen hires poor, immigrant women to bake and sell artisanal breads; the Doe Fund employs ex-offenders to staff a business that recycles used cooking oil from restaurants. To some extent, these hybrid organizations are new versions of what used to be called "sheltered workshops" — such as those that employed developmentally disabled people in making and selling handicrafts. As non-profits, they can be viewed as essentially philanthropic enterprises.

But they are not to be confused with a far more ambitious and alarming hybrid form, combining an ostensible for-profit model with social causes. The main vehicle for this more aggressive form of quasi-capitalism has been dubbed the Benefit Corporation, also known as the B Corp. The Philadelphia-based organization B Lab—a 501(c)3 that certifies B Corps—describes the firms this way: "B Corps are a diverse community with one unifying goal....We support entrepreneurs who use business as a force for good" (emphasis added). To be certified as such, benefit corporations must not only "create a material positive impact on society and the environment" but effectively accept a redefinition of profit—specifically to "expand fiduciary duty to require consideration of the interests of workers, community and the environment." A flow chart in the B Lab’s 2012 annual report explains the B Corps’ quadruple bottom line: Offering Quality Jobs, Building Strong Communities, Championing Healthy Environments, and Alleviating Poverty.

It would be a mistake to view B Lab and its supporters as a fringe movement. Two of the organization’s founders (Jay Coen Gilbert and Bart Houlahan) built and sold AND 1, a major basketball footwear and apparel business, before founding B Lab. B Lab, in turn, has attracted financial support well beyond the founders’, including grants greater than a million dollars each from the Rockefeller Foundation, Deloitte LLP, the Prudential Foundation, and federal taxpayers (through the U.S. Agency for International Development). Other prominent supporters include the Robert Wood Johnson and Annie E. Casey foundations. And the philosophy of "social enterprise" animating B Lab seems likely to spread: It has been embraced by U.S. business schools, including (among others) Harvard, Berkeley, and New York University, which include benefit corporations in their high-profile business-plan competitions.

According to the B Lab, there are now 650 firms that have already secured B Corp certification; they collect $4.7 billion in revenues in 19 countries. One of the more prominent B Corps is the long-established apparel maker Patagonia, which, according to its mission statement, seeks "to build the best product, cause no unnecessary harm, and use business to inspire and implement solutions to the environmental crisis." Most B Corps, however, are small start-ups — often traditional small businesses augmented with a "green" goal. Examples include gDiapers, Green Building Services, Piedmont Biofuels, and Guayaki Sustainable Rainforest Products.

The B Corp movement could be dismissed as little more than a marketing posture if its advocates didn’t aim to overhaul the entire capitalist system — to lead "a global movement to redefine success in business," as B Lab puts it. To this end, a major aim of the B Lab is to enshrine the benefit corporation as a new corporate form recognized by law in all 50 states. The B Lab’s web site features a map titled "Creating a New Kind of Corporation for a New Economy," which tracks the status of benefit-corporation legislation in each state. Model legislation developed by a major corporate law firm—Drinker Biddle & Reath — has been passed into law in 11 states, including California and New York.

The legislation envisions more than some sort of general seal of approval. Rather, it offers (its drafters hope) important legal advantages and protections for these new quasi-capitalist enterprises. As William H. Clark, Jr., and Larry Vranka note in their white paper "The Need and Rationale for the Benefit Corporation: Why It is the Legal Form That Best Addresses the Needs of Social Entrepreneurs, Investors, and, Ultimately, the Public," the benefit-corporation designation, once awarded by a state, "serves to protect against the presumption that the financial interests of the corporation take precedence over the public benefit purposes, which maximizes the benefit corporation’s flexibility in corporate decision-making." This implies significant protection against shareholder suits, hostile takeovers, and other investor actions based on traditional concerns about profitability and the judgment and acumen of firm executives. As the B Lab rightly puts it, these are apparently "little things" that are actually "game changers" in how corporate activity is conducted, and to what ends.

Perhaps most notable, however, is the elaborate questionnaire-based scoring system developed to assess the performance of B Corps. The "B Impact Assessment" form scrutinizes every aspect of a business enterprise’s goals and operations, divided among five major areas (governance, workers, community, environment, and "socially and environmentally-focused business models"). Questions posed to respondents include not only whether the firm’s leaders have "clear statements of your mission, its goals, and the change you seek," but whether they offer "quantifiable results from your mission (e.g., lbs of carbon offset)." The section on employees inquires not only about compensation—the survey asks, "Is an hourly living wage paid to all full-time, part-time, and temporary workers?" and notes that this criterion is "heavily-weighted" in developing the firm’s final numerical score — but also about the presence of an employee ownership plan.

In effect, the assessment is an elaborate list of what B Lab considers best practices: labor policies that include flex-time work schedules and job sharing; products and services that "address an economic inequality," "[preserve] the environment," or "improve health"; attention to supplier and employee diversity (the assessment asks, "What [percentage] of workers resides in low-income communities?"); and ownership patterns implicitly critical of the multi-national firm ("Is the majority...of the company’s ownership located locally to at least two-thirds of your workforce?"). No detail is too small when considering whether a firm provides social benefit, including its use of low-flow toilets. And if all this might be taken to imply an alignment with at least some protectionist and organized-labor interests, it should not surprise that the questionnaire inquires as to whether the firm is a member of such organizations as the Fair Labor Association or International Labor Association.

While currently used to provide a seal of approval for niche firms, this B Lab evaluation system could foreshadow a regulatory schema that might, should the opportunity arise, be applied across businesses more broadly. The implications would be vast: Such regulation would, crucially, allow firms to hide inefficiency behind service to good causes. Indeed, it would tend to render moot the price signals that not only drive efficiency but also serve to allocate societal resources more broadly. In short, it implies just what B Lab — and its well-heeled philanthropic supporters—promise: "a new sector of the economy that will redefine success in business."

The worry, of course, is that this redefinition will not be confined to its own corner. And that worry is justified, in no small part because of the tendency of the quasi-capitalist model to claim the moral high ground and demonize traditional business. As the B Lab explains in its 2012 report, "B Corps demonstrate that we can create a both/and economy — not just an either/or economy." In other words, traditional capitalism is deficient: Under the existing system, a firm may produce either profit or social benefit — but these are mutually exclusive, and so entrepreneurs cannot provide both. The B Corp — both its existence and philosophy—is a stinging indictment of that system.

In addition to concerns about how quasi-capitalism undermines the perceived legitimacy of traditional capitalism, there are also reasons to worry about its practical effects on the broader economy. Recall that we have already seen models of regulation-driven capital allocation based on the sort of social-justice criteria embedded in the hybrid or B Corp models. The Community Reinvestment Act, for instance, requires banks to invest in low-income geographic areas or to extend credit to disadvantaged households. People can argue whether the CRA played a significant role in precipitating the housing bubble and the 2008 financial crisis. What is not open to question, however, is that regulators issue banks’ CRA ratings (crucial to determining whether the banks can expand or merge) based not on the performance of such loans, but on the volume of them. Put another way, the CRA sees using corporate resources to extend credit to the poor as an end in itself, regardless of financial viability. The same was true (on a much larger scale) of the affordable-housing mandates of Fannie Mae and Freddie Mac.

Benefit corporations must also be seen as a threat to traditional philanthropy. Indeed, the same must be said of quasi-capitalism more broadly: Profit-donation firms embed philanthropy in consumer purchase, diverting revenue and reducing the money available to traditional service groups seeking public support. Corporate social-responsibility demands divert funds from those corporate community-citizenship projects not tied to flavor-of-the-month crusades.

And the diktats that come with B Corp status imply that certain business approaches—for instance, the use of low-volume toilets—are moral goods, inherent to the pro-social form of capitalism. In reality, however, these practices may well represent more costly approaches to the production and purchase of goods or services, or even to personnel policies (as in the case of a firm that must pay above-market wages, or that cannot lay off an underperforming worker, because of the terms of its triple bottom line). Of course, the quasi-capitalist movement exists to encourage firms to sacrifice profit in the name of the environmental and social goals favored by activists. But if firms did not forgo these profits, they would instead be able to direct them to the full range of philanthropic ideas and causes.

Ultimately, it is the profit flowing from successful businesses that allows for the combination of revenue, discretion, and creativity that makes possible philanthropic feats like those of Rockefeller, Carnegie, and Gates. Profit-donation firms, CSR campaigns, hybrid businesses, and benefit corporations thus exist at the expense of the traditional charitable sector—which affords donors infinitely more choices than the narrowly defined aims of B Lab, and which has a much longer and more demonstrable track record of success.

IN DEFENSE OF TRADITIONAL CAPITALISM

Pointing out the inherent pitfalls of the quasi-capitalist approach is necessary in order to debunk it, but not sufficient. Those who would defend traditional capitalism must also address this new movement’s central assumption: that traditional capitalism is an anti-social activity predicated on private gain at public expense.

This defense must of course begin with Adam Smith. In oft-quoted lines from The Wealth of Nations, Smith clearly described (and championed) a system of enterprise and commerce that served broad social needs without anyone’s self-consciously setting out to do so: "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest," he wrote. "We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages." In a less well-known passage, Smith addressed the issues engaged by the quasi-capitalists even more directly. In discussing the business owner, he wrote: "By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it."

Defending against the encroachment of quasi-capitalism requires more than theory, of course. There are important points to be drawn from history as well. The rise of quasi-capitalism demonstrates the extent to which the general increase in living standards since the advent of the modern market economy is very much taken for granted as a natural and inevitable state of affairs. But as Yeshiva University’s James Otteson has observed, the benefits of capitalism are a departure from historical norms. In his essay "An Audacious Promise: The Moral Basis for Capitalism," Otteson writes,

Since 1800, the world’s population has increased sixfold; yet despite this enormous increase, real income per person has increased approximately 16-fold. That is a truly amazing achievement. In America, the increase is even more dramatic: in 1800, the total population in America was 5.3 million, life expectancy was 39, and the real gross domestic product per capita was $1,343 (in 2010 dollars); in 2011, our population was 308 million, our life expectancy was 78, and our GDP per capita was $48,800. Thus even while the population increased 58-fold, our life expectancy doubled, and our GDP per capita increased almost 36-fold. Such growth is unprecedented in the history of humankind. Considering that worldwide per-capita real income for the previous 99.9 percent of human existence averaged consistently around $1 per day, that is extraordinary.

What explains it? It would seem that it is due principally to the complex of institutions usually included under the term "capitalism," since the main thing that changed between 200 years ago and the previous 100,000 years of human history was the introduction and embrace of so-called capitalist institutions—particularly, private property and markets. One central promise of capitalism has been that it will lead to increasing material prosperity. It seems fair to say that this promise, at least, has been fulfilled beyond anyone’s wildest imagination.

Yet as impressive as they are, even these broad descriptions of increased general wealth and diminished poverty do not adequately rebut the claims of the quasi-capitalists. This is partly because quasi-capitalism is rooted in the specific: It seeks to advance very particular causes (such as reduced carbon outputs) or serve very particular populations (low-income immigrant women) using methods and practices that the quasi-capitalists themselves codify and strictly monitor.

But traditional capitalism has its own specific stories to tell. Consider, for instance, the 2007 analysis by University of California, Los Angeles, economist Robert Jensen (then at Harvard) of the introduction of cell phones to the fishing industry in the Indian coastal state of Kerala. Historically, the fishermen catching sardines in the Arabian Sea faced a conundrum: They had no way to know at which of many commercial ports their competitors had already sold their catch, and thus no way to know where they might get the best price. Indeed, they often had no way to know where to sell their catch at all before it spoiled: Between 5% and 8% of the catch was typically wasted.

But in his paper "The Digital Provide," Jensen found that the simple introduction of cell phones—technology developed in the robust for-profit sector, and distributed through traditional commercial channels—changed the situation dramatically. Armed with mobile phones, fishermen could call ahead to ports and determine where their catches would fetch the best prices, thereby increasing their incomes and avoiding waste of environmental resources. As Jensen explained it, "Using microlevel survey data, we show that the adoption of mobile phones by fishermen and wholesalers was associated with a dramatic reduction in price dispersion, the complete elimination of waste, and near-perfect adherence to the Law of One Price. Both consumer and producer welfare increased." The Kerala example illustrates, in other words, how traditional capitalism is capable of producing profits and social and environmental benefits, contrary to the quasi-capitalists’ claims.

The Economist looked at Jensen’s findings in the context of work by the London Business School’s Leonard Waverman, who in 2005 found that (as the Economist put it) "an extra 10 mobile phones per 100 people in a typical developing country leads to an additional 0.59 percentage points of growth in GDP per person." Moreover, the article explained, these social benefits are provided not in spite of traditional capitalism, but because of traditional capitalism—and only because of traditional capitalism. The profit motive is what makes these gains possible. "Mobile-phone networks are built by private companies, not governments or charities, and are economically self-sustaining," the Economist noted, citing Jensen. "Mobile operators build and run them because they make a profit doing so, and fishermen, carpenters and porters are willing to pay for the service because it increases their profits. The resulting welfare gains are indicated by the profitability of both the operators and their customers, [Jensen] suggests. All governments have to do is issue licenses to operators, establish a clear and transparent regulatory framework and then wait for the phones to work their economic magic." Absent from the discussion was any reference to multiple stakeholders and bottom lines, or alternative criteria for assessing how the practices of mobile-phone companies help underserved populations. The benefit to all parties involved can be clearly measured by one data point: profit.

The Kerala example is revealing, but one does not have to seek out exotic locales in developing nations for similar case studies. In another example involving mobile technology, George Mason University’s Thomas Hazlett used the fifth anniversary of the launch of Apple’s iPhone to examine the device’s impact. He noted how popular it had become and how lucrative the phone had been for Apple: While the company sells just 9% of all cell phones, it garners 73% of the industry’s profits, and Apple’s market capitalization has vastly increased since the iPhone first went on sale.

But Hazlett also pointed out the iPhone’s benefits to small tech developers, for whom (as he wrote in the Wall Street Journal) it is "opening fantastic opportunities." He went on to explain: "Downloads from the proprietary Apple App Store reached 30 billion this year, with 650,000 applications available. Independent software developers who create those apps are feasting in the Apple ecosystem. They receive 70% of store revenues, so their share is more than $5 billion thus far." This doesn’t even take account of the gains enjoyed by users of those applications—to spend less time in traffic and get to meetings on time, or to take photographs of a factory the firm wants to rent and send them to a partner overseas to get his opinion and hear his concerns while the facility visit is still taking place. It is daunting to even begin to consider the social benefits Steve Jobs created—without explicitly aiming to (as the quasi-capitalists would require), and all while pursuing profits.

CAPITALISM’S UNCONSCIOUS GOOD

There was once a time when business leaders themselves were willing to assert unabashedly that their enterprises led to social benefit, as Andrew Carnegie did in "The Gospel of Wealth." Today sensibilities have changed, and few executives are willing to follow in Carnegie’s footsteps. But by failing to stand up for our existing system of free enterprise, these executives do a disservice to more than themselves, their companies, and their shareholders. They fail to appreciate the lessons taught by both Adam Smith and the story of the fishing industry in Kerala: that a great deal of social good can be realized "unconsciously" through traditional capitalism and that, in many cases, the scale of these social and environmental benefits cannot be matched by any organization not driven by the pursuit of profit.

This is not to say that there are no new ideas about business and social benefit worth considering. For example, writing in the Financial Times, Alexander Friedman, the chief investment officer at UBS, and Patty Stonesifer, a former Gates Foundation CEO, have proposed that investment advisors and financial institutions routinely guide clients to allocate 0.1% of their assets to philanthropy—and to identify high-performing social programs to which to direct such funds. They estimate that this approach would increase philanthropic giving by some $100 billion annually. "The financial intermediary," they write, "would make philanthropy as easy for clients as buying a share of stock or investing in a mutual fund." It’s a well-conceived proposal that, in effect, relies on an in-kind contribution of a firm’s time and expertise—in keeping with the tradition of corporate community contributions.

The key here—and for any proposal that might seek to direct financial resources to organizations undertaking good works—is a recognition that business and philanthropy are essentially distinct. Confusing and confounding their goals risks undermining the efficacy of both. Quasi-capitalists are right that markets cannot meet all needs — especially the needs of individuals who lack the skills and habits to participate in those markets. They are profoundly wrong, however, to assert that the fruits of private enterprise are solely private, and that traditional capitalism meets no social needs at all.

Our system of free enterprise has, over the years, evolved to produce broad prosperity and high standards of living unimaginable for most of human history. Should the quasi-capitalists succeed in undermining or supplanting the structures that have made those benefits possible, they will surely harm the very people and causes they claim to help—not to mention the rest of society. Quasi-capitalism thus presents a very real threat to our innovative economy and dynamic way of life. We fail to take it seriously at our own peril.

Original Source: http://www.nationalaffairs.com/publications/detail/the-dangers-of-quasi-capitalism

 

 
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