A Toolkit to Rebalance Capitalism

Externalities are the costs of production that a company doesn’t pay for, which are instead passed on to society. An externality might be air or water pollution emitted by a chemical company, or a toxin in our food chain caused by a weed killer that also causes cancer. Often, we only identify these harms after several years, once a cancer epidemic overtakes a community, or all the kids in a school district have lead poisoning. At that point, it’s difficult to make companies pay for the damages, and those companies access expensive lawyers to defend themselves. Frequently these damages occur in low-income communities where people can’t pay for such expensive lawyers. As a result, the local city or county ends up paying, or, in other words, the local taxpayers. But they don’t pay damages to victims, but rather they pay through community level unemployment, uninsured emergency room visits and homeless school kids.

 

These are externalities.

 

Crony Capitalism

Externalities are addressed through regulations requiring companies to follow minimum environmental standards, pay into remediation funds, or at least disclose basic information such as the chemical agents being dumped into our waterways and skies. But when politicians are funded by corporations, and those politicians appoint industry insiders to lead the same regulatory agencies that oversee their companies, then no one is looking out for the public.

 

Milton Friedman, Nobel Prize winning economist, famously stated, "There is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits, so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." For years economists and business leaders deferred to this quote to explain why corporations didn’t need to be socially responsible. Friedman argued that by practicing social responsibility, corporate managers would either tax consumers by raising prices or penalize employees by reducing wages, all in pursuit of a public benefit that government should be providing anyway. In 1970, when Friedman published this article in the New York Times Magazine, it was a time when Republicans and Democrats arguably still served the interests of their human constituents, and perhaps there was reason to believe that the political system would work and that policy would represent the will of the people.

 

Today, we see the two outcomes Friedman warned against: penalizing both employees and consumers. These are not symptoms of corporate social responsibility, but rather corporate greed has held employee wages stagnant while the government has failed to protect the public from the externalities of unfettered resource extraction that have created health epidemics and our environmental crisis.

 

Even Friedman allowed that corporations must play by the rules of the game, meaning not just the law, but also a moral compact of integrity, honesty and not harming one's customers. Hence, while perhaps a company can legally mislead to sell more products, this doesn’t mean it’s playing by the rules of the game. Companies that disobey therefore invite regulation, potentially as innocuous as requiring standardized reporting (what is in that fracking fluid contaminating our water table?) and extending into paying for environmental mitigation or remediation.

 

Information Flows

The dream of free market capitalism assumes that consumers have access to necessary information. Economists draw supply and demand graphs showing the price at which a willing seller and buyer will trade. But how do buyers know the value of a product if they don’t know what’s in the product or how it’s made? Does the consumer have enough information to make an informed purchase? Who’s responsible for making sure that information is available?

 

Today we have at once more information than we can consume, and yet truth is often unclear. Many consumers and investors feel short-changed as we rely on companies to self-report the qualities of their products or their corporate values and operating practices, and the regulations put in place to protect consumers are being rapidly dismantled.

 

Toolkit for Rebalancing Capitalism

Each of us has a role to play as a consumer and investor in this system. It starts with demanding and creating better information – better access, better quality and appropriate levels of detail. Here are several key tools we can use to make this happen.

 

Representative Democracy. In 2010 the Citizens United Supreme Court ruling provided corporations with similar free-speech rights as are extended to humans, and further clarified that unlimited funding into political action committees is protected as free speech. Empowered by this decision, corporate political contributions have increased significantly, and many politicians are now more beholden to their corporate funders than to their human constituents.

 

 Public policy should be determined by democratically elected representatives who uphold the best interests of their human constituents, enabling those constituents to pursue their basic rights to Life, Liberty and the Pursuit of Happiness. One hopes this includes the right to quality, science-based education – free from the threat of mass shootings – access to affordable and reliable healthcare, and the absence of racial or gender profiling, harassment or discrimination. Ultimately this means that we need comprehensive campaign finance reform, clarification that corporations are not people and are not entitled to make unlimited campaign financing contributions, and that human needs must outweigh corporate influence in our elections.

 

Environmental, Social, Governance (ESG) Reporting.

ESG reporting aims to reveal how companies analyze, manage and plan for environmental issues such as carbon and greenhouse gas emissions, water scarcity and plastic waste disposal, social issues related to fair labor standards in the US and beyond, and corporate governance policies. This information on company practices can have long-term impacts on corporate costs, policy exposure risks, and unanticipated controversy, which allows investors to better price a company’s long-term risks and can lead to less share price volatility. ESG reports are also useful to ordinary consumers who want to support companies that align with their values.  

 

ESG reporting is relatively new, and the landscape is noisy, chaotic and full of adolescent exuberance while frequently lacking data-driven, evidence-based analysis, and with limited historical information. While more large companies are voluntarily reporting ESG metrics, others are unable or unwilling to dedicate resources to ESG issues. Meanwhile, a growing industry of third-party data providers compile and sell ESG data, which is used by investors and asset managers to inform their investment strategies. Regardless of who produces and analyzes the data, it is generally prone to subjective bias. Meanwhile, the research is inconclusive about whether companies with high ESG scores corresponds to better share price performance, although popular opinion holds that companies with higher ESG scores have stronger risk management systems in place, and this reduces price volatility and leads to long-term growth.

 

To strengthen ESG reporting, better accounting and pricing systems are needed that quantify externalities and sustainability, and that map quantitative data to ESG scoring systems. The Sustainable Accounting Standards Board (SASB) provides a comprehensive set of voluntary reporting standards and materiality guidance to help companies determine which sustainability standards are most critical to an industry’s financial reporting. The methodology an also map to both standard financial disclosures, and to various ESG reporting tools. This voluntary sustainability reporting provides valuable information to financial analysts seeking quantitative metrics to better value a company’s long-term performance. But this reporting can be technical and potentially esoteric to the general consumer.

 

Other Impact Metrics. While ESG is the primary metric for publicly traded companies, there are a host of metrics to measure sustainable impacts for private companies, philanthropy and public spending. The primary tools in this area are the UN Sustainable Development Goals (SDGs), and the related Principals for Responsible Investing (PRI) and Global Reporting Index (GRI), as well as the Task Force on Climate Related Financial Disclosures (TCFD), and the IRIS+ standards presented by the Global Impact Investing Network.

 

Shareholders. The growth of ESG information is accompanied by increasing shareholder activism. Shareholders themselves are demanding that corporations report on their environmental impact, their achievement of science-based climate outcomes aligned with Paris Accord objectives, their labor practices, and even their campaign contributions. Thus, despite the current abdication of responsibility by government to ensure appropriate riverbanks to guide the flow of free market capitalism, more diverse, informed and activist groups of shareholders are helping palliate our capitalist system. For these reasons, I don’t automatically advocate divesting from low ESG scoring companies, since it can be easier to influence a company from inside the shareholders meeting than as an outsider.