Creative Capitalism

I think the conversation going on at the Creative Capitalism blog is interesting. I was pleased to be asked to join in.

Bill Gates put a lot of emphasis on “recognition” as a “market-based incentive.” I think that’s worth examining closely. Many contributors has argued about whether it’s legitimate for a company’s managers to divert resources to social ends – with Steven Landsburg, and the spirit of Milton Friedman, at the heart of the debate. But there’s another question here: would this work? Will the quest for a good corporate name actually provoke the behaviour we’d like to see?

By Tim Harford

In his Davos speech, Bill Gates sketched out several ways in which capitalism might better serve the poor.

One is that corporations should just get smarter at finding profit opportunities “at the bottom of the pyramid.” No harm in that, but at Michael Kinsley and Warren Buffet both point out in their discussion, we’d expect most of the available market opportunities to be filled already.

Another is that governments should take a role in providing incentives to help the poor. One direct way to do that is to establish prizes or quasi-prizes for companies that develop vaccines for diseases of the poor. (I discussed that development in a feature for the Financial Times magazine in January.) Another is to use aid money to purchase services for the poor – so-called “output-based aid.” And there are other possibilities too, although the example Gates gives, of rewarding philanthropic pharmaceutical firms with priority drug approval on another product, raises more questions about the waste involved in the US drug approval system than about creative capitalism.

But Gates put most emphasis on “recognition” as a “market-based incentive.” I think that’s worth examining closely. Many contributors has argued about whether it’s legitimate for a company’s managers to divert resources to social ends – with Steven Landsburg, and the spirit of Milton Friedman, at the heart of the debate. But there’s another question here: would this work? Will the quest for a good corporate name actually provoke the behaviour we’d like to see?

I am not sure. Think about how the quest for recognition might work as a “market-based incentive.” Corporations would hope that by doing good things, or avoiding bad behaviour, they’d win loyalty from employees, business from customers and suppliers, or cheaper funding from socially responsible investors. If the cost of doing the right thing is less than the reputational benefit, well, that’s a successful market-based incentive to be a good corporate citizen.

Great. But when would it work?

First, firms must be long-lasting and patient enough to make the investment in good behaviour up front, in anticipation of a reputational reward.

Second, the rewards for good behaviour or punishments for bad behaviour must be easy to inflict. It is easy to boycott a particular brand of gasoline or to buy a cool RED product. It is a bigger deal to resign from a company on ethical grounds.

Third, it must be easy to spot good behaviour and bad behaviour. Firms must realise that their actions really will have consequences for their reputation, consequences that can’t be duplicated with a nice advertising campaign.

Fourth, the company’s potential reputation must be worth more than the expense of doing the right thing.

Recognition works as a market-based incentive when these four conditions are met, and I’m just not convinced that that will happen often enough.

Think about successful reputational campaigns and you start to realise how exceptional they are. Following bad publicity about sweatshops, Nike is now regarded by many as a leader on labour standards. But Nike, which is basically a marketing outfit, finds it fairly cheap to respect these standards and very beneficial to do so. What have less prominent sportswear brands been doing? Who cares? Nike put resources into setting up collaborative bodies for responsible behaviour, but many less famous competitors declined to join. So this is a “recognition” incentive which has been a success only in a very narrow way.

Product RED is a terrific idea, but again, cheap to implement and reliant on a few very brand-conscious firms, for whom recognition is very important.

Contrast such efforts with the mid-1990s campaign to get Shell out of Nigeria, then run by the dictator Sani Abacha. Shell cares about recognition, for sure, but no reputational damage was ever likely to outweigh the cost of halting oil production in Nigeria. It is no surprise that Shell stayed and took the bad publicity on the chin.

Other companies who produce commodities, intermediate goods or non-branded products – memory chips, copper, rice – are unlikely to be seriously affected by reputational concerns.

My final worry about recognition is that we do not always recognise behaviour that will truly help the poor. A simple example: a friend of mine recently bought shoes made in Italy rather than shoes made in Romania, specifically because she was worried (in a rather vague way) about encouraging sweatshop labour. That’s a valid concern, but clumsily expressed. I worry that most of us, being simple human beings, will also clumsily express our desires to make the world a better place, as shareholders, customers or employees. If I’m right, recognition will be an even blunter tool.

I share with Bill Gates the conviction that capitalism has a huge role to play in helping the poor. But I am not convinced that the recognition mechanism is what will make that happen.

I wrote a longer (but still brief) note on this subject with Michael Klein, Chief Economist of the International Finance Corporation. The note is available here.

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