Saturday, April 15, 2023

Corporate Political Responsibility in a Captured Economy

The social responsibility of business has been debated for years. One point of view follows Milton Friedman’s maxim, “In a free society … there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits.” Others argue for the priority of ESG values, even if they conflict with profit-making. A more pragmatic perspective sees ESG simply as a set of tools that facilitates risk assessment and enhances long-run profitability. 

The political responsibility of corporations has, unfortunately, received much less attention. Friedman himself alluded to political responsibility when he added the proviso that firms must “stay within the rules of the game” by pursuing profit through “open and free competition without deception or fraud.” Unfortunately, he failed to follow up by asking the critical question: In a free society, who makes the rules?

The rules of the game

There is little controversy about the basic rules of the game for free-market capitalism: respect property rights, compete openly and honestly based on price and quality, and follow common-law principles of fraud, nuisance, and negligence. The hot-button disputes over corporate political responsibility pertain not to the basic rules themselves, but to their application to issues that dominate the daily news, like environmental protection, railroad safety, or workers’ rights.

Friedman seemed to posit a sharp division between business and government. Government has the responsibility to impose taxes and spend money for social purposes, such as controlling pollution, subject to free and fair elections and an elaborate system of checks and balances. Businesses are then supposed to follow the law as they find it and leave it to the government to make laws and levy taxes.

Unfortunately, that is not how the world works.

From Friedman to the captured economy

In the real world, corporations do not just mind their own affairs and leave politics to others. Instead, they contribute company funds to political campaigns and political action committees to help elect candidates they like and defeat candidates they don’t like. After legislators are in office, they lobby them, directly or through trade associations, to vote for or against laws that affect their industry. They lobby the executive branch and its regulatory agencies to carry out the laws in ways they like. They bring lawsuits or intervene in actions brought by others to obtain favorable interpretations of the rules from judges. More broadly, they engage in civic discourse through advocacy, philanthropy, social media, and any other channels that grant them reach.

In aiming to enhance profits by shaping the rules of the game, all this corporate political activity suggests a very different division of labor from what Friedman envisioned. Instead, what we see is a game in which businesses do everything in their power to shape rules that maximize their profits, and then make sure those rules are enforced to their own benefit and to the detriment of others. 

This can no longer be called a free market. In fact, there is a name for it: the Captured Economy. In the captured economy, business and government are inextricably intertwined. The powers of government become instruments of corporate enterprise rather than constraints on it. 

Corporate responsibility in a captured economy

The captured economy is anathema to supporters of free markets and constitutional democracy. But what to do about it?

Some reformers aim to create, or recreate, a Friedmanite world in which democratic government makes the rules and business follows them. Some, for example, advocate a constitutional amendment to overturn the 2010 Supreme Court case Citizens United, impose limitations on corporate political spending, and replace it with public financing of political campaigns. However, that approach faces serious obstacles and limitations. 

The obvious political obstacles in today’s polarized America are only part of the story. Even if corporate political spending were limited, it is not the only avenue of corporate political activity. Furthermore, participation in public discourse, funding of nonprofits, and engagement in legislation and regulatory rulemaking cannot simply be cut off. The right to petition the government for redress of grievances is itself, for good reasons, explicitly protected by the Constitution.

Solving the whole problem of corporate political responsibility at a blow is asking too much. A recent initiative by the Erb Institute at the University of Michigan takes a more modest, but crucial, first step by defining exactly what is meant by corporate political responsibility (CPR). 

The Erb CPR principles begin by defining political activity broadly to include not just direct spending but all participation in public political discourse, including actions undertaken indirectly through trade associations and other third parties. They then pose four questions to determine whether specific corporate political activities are compatible with free markets and constitutional democracy:

  • Is the activity legitimate? Does it reflect the company’s views, not those of the individual managers or officers? Does it pressure employees, shareholders, or other stakeholders to engage in political activities they would not voluntarily endorse?
  • Does the activity maintain accountability? Do political activities align with the company’s stated commitments, purposes, values, and goals?
  • Is the activity undertaken responsibly? Are political activities consistent with healthy “rules of the game?” With free and open competition? With minimum adverse impact on stakeholders other than owners? With respect for established science?
  • Are the activities undertaken transparently? Does the company communicate openly and honestly about its political activities, including those of trade associations or other third parties? Does it provide good-faith information and expertise to all levels of government as needed to support informed, effective policymaking?

To ensure that these principles do not remain mere window dressing, companies that publicly subscribe to the principles are required to implement certain observable actions regarding political spending, board involvement, reporting, and transparency.

These principles of legitimacy, accountability, responsibility, and transparency do not require corporate leaders to prioritize the interests of outside stakeholders over their duties to shareholders. They are fully consistent with the principle of shareholder primacy, including the primacy of shareholders in determining the degree to which the corporation should balance profit with ESG values.

What they do require is that corporate leaders not use their political activities to change the rules of the game in ways that encroach on the public interest. That includes the broadest such interests: the maintenance of constitutional democracy, the rule of law, civic freedoms, effective, transparent and accountable civic institutions, and equitable access to civic and political processes.

At first glance, the CPR principles seem very abstract. To make them less so, try applying them to items from the latest news. For example, in February 2023, a Norfolk Southern freight train carrying hazardous materials derailed in East Palestine, Ohio, causing serious health concerns and threatening property values. The railroad’s executive vice president and chief operating officer Paul Duncan was quoted by the Washington Post as having told analysts, prior to the accident, that “operating safely is the right thing for our employees, customers, shareholders and the communities that we serve … even one serious incident is too many.” Yet, as reported by both the Washington Post and the New York Times, Norfolk Southern had vigorously lobbied against federal regulatory efforts to improve rail safety. Were the company’s political activities well-aligned with its stated values and goals? Were they consistent with healthy market “rules of the game” that minimize costs imposed on stakeholders other than owners?

In short, the CRP principles offer a checklist for asking, “Do I want to invest in this company? “Do I want to buy from or sell to it?” “Do I want to spend my own time and resources disputing what it says in public discourse?” 

The bottom line

No set of principles, whether those of the Erb Institute or any other, is going to convert corporate leaders to sainthood. They are, however, a big step forward over the naïve view that corporations can plead “just following the rules of the game” while covertly undertaking political activities that skew those rules in favor of profits for their owners at the expense of broader public interests. 

There is a lot at stake here. Some 80 years ago, Joseph Schumpeter wrote in Capitalism, Socialism, and Democracy that capitalism would destroy itself when the classes that capitalism had made successful turned against that very system of private property and freedom in order to entrench their own power. It is not too far-fetched to see the rise of the captured economy as a step toward that outcome. A world in which corporations make their own rules of the game, concentrating wealth and political power ever more tightly in their own hands, is not one in which either free markets or liberal democracy can survive. Yet, that is the direction in which unchecked corporate political irresponsibility is leading us. It is a slippery slope that only ends badly for all of us.

The Erb CPR principles will be a worthwhile endeavor even if they do nothing more than help guide corporations through the politically charged environment in which we find ourselves today. 

Originally published by ProMarket from the Stigler Center at the University of Chicago Booth School of Business. For republication permission please contact ProMarket . Photo courtesy of Pixabay . 

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