What are we talking about?

By Steven Landsburg

It would help a lot, I think, if we could agree on what we’re talking about.  So let me try to pin down what "creative capitalism" is.  More precisely, let me try to pin down how a CC firm differs from the firms we meet in economics textbooks.

At the textbook firm, all revenue goes to workers and investors.  At the CC firm, some revenue goes to something else.  Where does that revenue come from? The laws of arithmetic admit only four possibilities:

A.  It comes from the workers.

B.  It comes from the investors.

C.  It comes from the consumers.

D.  It comes from nobody, because the CC firm can use labor and capital more efficiently than the textbook firm.

It is quite thoroughly impossible to have a sensible discussion about the prospects for creative capitalism without specifying which of the four possibilities we have in mind.  (Of course we are free to consider all the possibilities in turn.)

Once we specify an assumption, we can draw some conclusions.

By way of illustration, consider assumption A: The workers at the CC firm accept lower wages, presumably because they like knowing that they’re working at a CC firm.  Instead of being paid, say, $10 an hour, the worker gets $8 an hour and $2 goes to some worthy cause. From the firm’s point of view, labor still costs $10 an hour, so the capital-labor ratio, the return to investors, the value of the company stock, etc., is all the same as at the textbook firm.  The advent of CC firms increases the supply of labor (perhaps only slightly) and hence drives down both economy-wide wages and the economy-wide capital-labor ratio (perhaps only slightly).

Assumptions B, C and D each yield other conclusions. Those conclusions might depend on auxiliary assumptions about preferences.  In case D, some auxiliary assumptions are definitely needed to explain where the added efficiency comes from (maybe the gratification of working at a CC firm makes workers more energetic?).

ANY meaningful discussion of what CC will lead to depends on specifying whether we’re in world A, B, C or D (or some combination) and what the auxiliary assumptions are.  If we’re not concrete about that, all we can do is talk past each other.  If we ARE concrete about that, we can settle most of our disagreements with a little bit of math.  (Of course we’ll then have to deal with the meta-disagreements about which assumptions are most plausible.)

All four varieties of CC may be well worthy of discussion, and surely all four discussions can go on simultaneously.  But insofar as specific assertions are made, it would be good to be clear which of the four varieties (and, if relevant, which subvarieties) they’re meant to apply to.

Comments

[ken goldsholl]

You're assuming that being CC has no effect on the company's business: that it doesn't increase sales; that it has no effect on the employees; that it doesn't increase the value of the stock. You're basically saying that how a company allocates its' resources will not affect how the outside world reacts to it. That's an assumption that could only be made in a textbook, and not in the real world, because academics (especially those who believe economics is a science) like to use simple equations with round number solutions to make their point. The world isn't compartmentalized into four worlds.

You are also assuming that operating in a CC mode is going to reduce profits- why is that necessarily so? That's just the prediction of people who never have their predictions measured for accuracy.

We're not in any one of those four worlds, it's just not that simple. Does that mean we can't have this conversation?

[Tracy W]

You're assuming that being CC has no effect on the company's business: that it doesn't increase sales; that it has no effect on the employees; that it doesn't increase the value of the stock.

Ken, I fail to understand your point. Steven Landsburg laid out the four ways being CC could affect the company's business.

If being CC increases sales, then the firm has some more revenue to spend on being CC. This revenue has come from customers. This is Steven's assumption C.

If being CC has an effect on employee, there are two ways it could do this. One is that employees are happy to accept lower ways to work for a firm that is CC. This is Steven's assumption A. The other possibility is that employees work more efficiently for a firm that is CC. This is Steven's assumption D.

If being CC increases the value of the stock then there are two ways it can happen. One is that investors are prepared to pay more for the stock just because the firm is a CC one. This is Steven's assumption C. The other way is that being CC means a firm is more profitable (perhaps because its employees work more efficiently). This is Steven's assumption D.

As far as I can tell, Steven's assumptions A, B, C, and D, exactly cover off all the points you raise. What do you think he is missing?

You are also assuming that operating in a CC mode is going to reduce profits- why is that necessarily so?

Again, Ken, I don't understand you. If we start with Steven's assumption D, that the CC firm is more efficient because it is CC, how do you wind up arguing that operating in a CC mode is going to reduce profits? Surely, if Steven's assumption D is right, profits will at least stay the same, or increase. How do you get from assumption D to profits decreasing?

[ken goldsholl]

Tracy - Landsburg was suggesting that we have to choose one of the four worlds - as if the cost of CC had to be borne by one group. The world doesn't work that way, so suggesting that in order to discuss the viability of CC, we must determine which group of stakeholders is going to "pay" for it, is condenscending ("Okay, children, if you want to be creative, one of you has to pay for it. Now before we talk about being creative, which one of you wants to pay for it?").

That assumes that CC will always cost something. How can that assumption be valid? And if it does have a price, why must it only be paid by one group?

If sales are increased because of a firm's CC, then customers aren't paying for CC - nobody is getting a price increase.

If employees are working more efficiently, they aren't paying for CC, they're not getting an effective pay cut just because they are working harder.

Investors aren't financing the cost of CC (if there is one), because they are paying more for the shares, they are valuing the company higher. Big difference.

Landsburg, to me, is trying to divide and conquer by making each group of consituents unhappy about the prospect of financing CC. This is the same kind of strategy that has worked well in delaying a transition to renewable energy - "it's going to wreck the economy" - that's ridiculous, but people buy it.

[M. Hodak]

ken,

It looks like you didn't actually read the whole post. Landsburg assumed that some of a CC firm's revenues go "someplace else." He also explicitly said regarding the options "or some combination." These are reasonable assumptions. Challenge them if you will, but don't claim that he left them out, or said something that he didn't.

[M. Hodak]

Steve,

To offer a hopefully more rational objection, what you're really saying is that a CC firm is, in essence, adding a second residual claimant. It could be consumers, willing to pay more for a "green" product, or the workers willing to earn less for the chance to do pro bono work, etc. It could even be a segment of investors looking for socially conscious companies, although I have never heard a CSR fund promise lower returns.

In fact, what I tend to hear from CSR supporters is that CSR is really free (your option D), which is consistent with Posner's view of a worker or customer differentiation along the lines of the company's particular CSR mission.

The point that I made in response to Glaeser's post is that as soon as a company takes on a secondary objective beyond maximizing profit in the interest of creating value for one or more stakeholders, they must deal with how well that second objective is also being achieved. The challenge of motivating or rewarding multiple objectives in a way that actually enhances social welfare is my sticking point on this whole concept.

[ken goldsholl]

M.Hodak,

I read the entire useless post. Landsburg said he thinks we should choose between one of the options. Why do we have to choose? His post was unnecessary, we don't have to select one form of "paying" for CC, there is no decision to be made. It's a diversionary tactic to steer the conversation away from what is CC.

Before we have the discussion on who "pays" for CC, we should discuss who pays for basic research that companies like IBM and HP perform. After all, that research (not development, which results in products, but research, which doesn't always yield technology that can be used or products) must be paid for by customers, shareholders, or employees. And things like supporting public radio or TV?

The definition of CC should be discussed, and how best to implement it. There is no way to distribute the financial burden for all possible implementations, as it will vary from firm to firm and project to project.

[Tony Wang]

Ken,

If I understand you correctly, your objection is that CC can lead to firms that will improve sales or have a positive effect on employees or increase the value of their stock. I don't think Landsburg disagrees with you on this point (i.e. you're fighting a shadow of a non-existent argument). If CC improves sales, it could potentially be that consumers are willing to pay both a "charity premium" where the firm is redistributing part of its revenue to some philanthropic purpose, but is also able to command a higher price on the product itself (one example might be Method cleaning products, or organic foods). If CC has a positive effect on employees, it might be because employees are more efficient (in which case D applies) or because employees are willing to sacrifice some amount of pay to work at a CC firm (in which case A applies). But it's entirely possible that consumers are paying enough of a premium that workers can be more satisifed without case D or A applying because the effect of case C (i.e. because consumers are willing to pay the premium and the company makes more of a profit, it just so happens that there is a positive externality to employees).

In the case I just described though, when consumers are willing to pay a premium for a company to engage in charity and the company's profits increase, I think the firm ceases to be truly CC - a traditional profit maximizing firm in the guise of social responsibility would move into this space because of the improved profit margins. In fact, Coca Cola's buyout of Honest Tea, Unilver's buyout of Ben & Jerry's, and Loreal's buyout of Body Shop are great examples of this; although they didn't start the companies that were arguably CC, they bought the companies as part of their profit maximization, making it unnecessary to have a fundamentally different conception of capitalism to accomplish the social objectives these smaller companies sought.

That being said, I personally think there is a case for CC, but it will need to compare the social welfare effects of CC versus the social welfare effects of a P-max firm and that we'll need to find case studies and determine in each case which combination of A, B, C, and/or D factors is at work (although not mentioned explicitly, I think Landburg's model will have to be multivariate since undoubtedly there are probably multiple stakeholders paying for the charity). Ultimately, it would be nice to create a revised version of Arrow and Debreu's general equilibrium analysis model that incorporates charitable giving by firms and would be able to predict at which levels of charity and profit-taking a firm would be maximizing social welfare.

[ken goldsholl]

Tony,

you almost understand me correctly. I don't believe there is a formula that will apply to every company that wants to get creative, nor that we should start the discussion by deciding who will pay for the transition. It's not certain that there will be a cost associated with every firm's implementation of CC - an investment for sure, but not necessarily a cost (i.e., a reduction in profits). What bugs me about Landsburg's post is that he is making the assumption there will be a cost involved, and that is not a valid assumption. He conflates revenues with profits, and I don't understand how an economist can do that.

You are admitting that Landsburg's model will have to be multivariate, which I think means that it won't be just one group paying for the "cost" of CC. Then why waste the time to discuss whether it is A, B, C, or D?

Maybe I missed something, but does CC only involve charitable giving? Does it not have anything to do with how a firm conducts its business? What it sells, who it sells to, how much it charges and pays, whether it is willing to incur additional expense to not pollute, to treat employees fairly? If the question is only should publicly owned corporations make charitable contributions, then it is relatively meaningless question (let the shareholders vote on it). There are so many ways corporation can be creative, by how they design, build, and market their products that add value to society, without a direct contribution. Is that not part of the conversation?

[Tony Wang]

Hi Ken,

Perhaps Landsburg didn't address in detail the possibility of a no-cost option, and upon further reflection, I think it is inconsistent with his framework. By definition, a CC firm is simply a firm that redistributes profits to someone besides workers and investors (which in most cases is some charitable activity, which can be redistribution to a nonprofit or engaging in some kind of business decision that would not normally be done in profit maximizing situations).

Take Walmart for example. Let's assume that it maximizes profit without redistributing profit to someone besides workers and investors. Let's say it donates money to charity (which it does) and engages in environmental initiatives (which it does). In order to distinguish Walmart from CC firms, we say that Walmart's charitable activities are simply PR or Marketing; they're not actually represented as charity since in fact it's probably done as a means to maximizing profit (I consider charity to be sacrificing profit). But if you compare a CC firm with a theoretical profit maximzing firm, there is a difference between how those two firms distribute profits and it becomes readily clear when you juxtapose their business models.

It's interesting that your intuition of what CC means is so different than what we're trying to define here in theoretical economic terms. And to some extent, I agree with part of that intuition - creative capitalism seems to be much more than a differnce in how firms distribute profits (I prefer to use the term social enterprise to describe profit sacrificing firms). For me, creative capitalism means, and I think you might share this intuition, how we can use market forces and new business models to create social change. There is a lot in the profit maximization space (check out d.light - a recent startup trying to distribute solar-powered LED lights as a replacement to kerosene lamps) but there's also a lot in the social enterprise (or what the folks on this blog call CC) space.

However, that being said, the reason why this blog focuses so much on profit sacrificing behavior by firms is because that's how Bill Gates used it in his speech (he talks about creative capitalism as the system in which profits aren't enough to drive goods and services to the very poor). Whether profit maximization behavior that does further those objectives is a part of the conversation is not for me to decide, but ultimately the managers of this blog (but honestly, there are plenty of other blogs that focus on that space - check out nextbillion.net for one).

[Robasse]

I think we have got a good exemple, with orphan diseases.
What is this?
It's a disease that labo. and pharmaceutical firms won't treat because there is no return on investment.
Is that A B C D social responsability?
You know it can be regulated by the states on a B sheme level.

[ken goldsholl]

Tony,

Thanks for the clarification on the concept of CC as discussed here. If it is, in fact, about how corporations should distribute profits for the common good, then it won't be as powerful of an idea as it can be.

I do agree with your idea of CC, and I think your example of the solar LED start-up is only the tip of the iceberg. There is so much that existing (especially large) corporations can do to effect change, but they are limited by their management beliefs. I think the biggest problem is the requirement of every expense or cost to be decided by an estimated return on that investment. It's usually impossible to identify the return on every component of a system, as if they are being sold independently.

The main problem with profit-maximizing firms is that when a firm is designed to maximize profits, there is usually no collateral progress. Health insurance companies are a good example - the for-profit insurers make all of their decisions based on whether it will increase profits or not. They are motivated to get rid of clients who are likely to submit claims, and come up with excuses to deny coverage. They are not designed to offer the best possible policies that will result in the healthiest client, so that doesn't happen. they are designed to be as profitable as possible. This is why the most expensive health care system in the world is one of the least effective.

I am not saying companies shouldn't earn as much profit as possible, just that setting that as the top priority is not the best way to maximize profits. Designing a company to offer the best possible solution for a given price target, will usually result in a very profitable company. My favorite example of this is Apple, they don't define their products to take a certain market share, or price them to be the most popular, but they are easily the most profitable consumer electronics company. They're not designing for maximum profit, rather, they design to make the best product they can sell (and creatively marketing them).

I would rather that CC, instead of being about corporations making charitable contributions, be focused on creative solutions to problems that go un-addressed by traditional capitalism. There are opportunities in every problem, maybe conventional capitalism is capable of exploiting those opportunities.

[Tony Wang]

Hi Robasse,

I think it could potentially be any combination of ABCD. For example, an A situation might be a pharmaceutical company or hospital with socially responsible researchers or doctors, respectively, that has a program where volunteers can contribute to treating orphan diseases (so the charity comes from the workers).

Or maybe it's B where philanthropic investors (the Bill & Melinda Gates Foundation and its Program Related Investment budget comes to mind) provide the capital for an organization that will generate profit (but either 1. does not maximize return or 2. maximizes return but generates below market rates of return, though if 2. it begs the question whether this firm is a CC firm) and is developing a drug that can treat orphan diseases.

A C situation might be some consumer product (maybe something to do with children's toys) that donates proceeds to a charity that does work in this area (One World Health comes to mind).

A D situation might be working on the orphans disease issue within a major pharmaceutical, where employees are extra motivated and are more productive (but don't lose any wages, otherwise it would be an A situation) as to somehow make up for the lack of demand in the orphans disease market (so theoretically, both the supply and demand curves are lower, but the profit surplus is the same).

The challenge will be to figure out which combination yields the most social utility (which becomes increasingly complicated since the variables are most likely not independent; but a good first step would probably be to analyze each variable independently to choose the predominant organizational form among the set ABCD) and the theoretical models within each that will lead to that kind of analysis.

[Tony Wang]

Hi Ken,

I think your points have merit. It's an open question whether focusing on profits behaviorally will actually contribute to maximizing profits as an outcome. Indeed, I've heard entrepreneurs and famous venture capitalists in Silicon Valley argue that the most successful companies didn't seek to maximize profit, but focused on a mission to do something revolutionary (with the not well thought out belief that somehow they would make a lot of money). Perhaps focusing on profit less would somehow increase profits - though it seems a somewhat tenable supposition at best.

Health care is a particularly interesting sector and one that hasn't seen that much innovation (personally, I think it's because of the employer-tied health plans which is why I like McCain's health care proposal to move away from employer-based health care). That being said, I wonder if health care companies didn't worry about maximizing profit so much whether they would be able to innovate on the managerial level and somehow come out with more profit. I think Steve Case of AOL is starting a company in that area (something called Revolution Health or similar) but it's unclear whether something more consumer driven and less insensitive would actually make more profit. In the cases of market failures like this, I think we see the most potential for social enterprises.

But I agree with your overall point - we should be looking for the low-hanging fruit: opportunities that maximize profit and generate a lot of social good. But we've picked a lot of the low-hanging fruit and sometimes it's easier and more effective to invest in CC firms.

---

Here's an interesting theoretical point - if social enterprises addressed market failures where government policy should have been changed, does the impetus for changing government policy decrease? Could social enterprises, by mitigating the very factors it seeks to address, be harming systemic change in a sector?

[ken goldsholl]

Tony,

I have given up on government policy being a tool for positive social change. It can be, and should be, but the political process is so corrupted, I don't believe many politicians place a priority on solving problems. Their top priority is to get re-elected, so everything they do is focused on convincing people to vote for them instead of their opponent. Whether or not social enterprises succeed, the government that people have currently selected will be irrelevant. I guess this makes some people happy, but there's never been any evidence that a great nation can exist without an involved government.

[Jeff Mowatt]

I would say it comes from all of these and more. The employer who pays living wages according to local economic conditions, offers profit sharing and retirement plans, the worker who considers the wage sufficient for his/her needs and the causes rewarding, rather than the maximum available and the investor who expects a fair return on investment rather than that which returns the most. Our business, more to the point, will be human business in which returns are measured past numbers.

it is not rocket science, for instance, to consider a local business running a youth opportunity program, whose activism reduces the probability of one getting mugged while shopping, of the business that invests against disease, or that which creates opportunity in circumstance which otherwise provide a seed bed for terrorism.

This enlightened self-interest, will remain my brand of 'creative capitalism', for people, past numbers.

[Michael F. Martin]

I vote for D, although I will speculate that improving D will also change the current balance of A, B, and C.

Most firms could be managed much, much more efficiently with a more accurate picture of how value is created within the firm available.

We would do more for the economy by improving accounting theory and making more information available to the public by beefing up financial statements than ever we could hope to do with SOX-style corporate governance reform laws.

[Joe Bingham]

ANY meaningful discussion of what CC will lead to depends on specifying whether we’re in world A, B, C or D (or some combination) and what the auxiliary assumptions are.

Ken, did you read this sentence?

You write,

"I read the entire useless post. Landsburg said he thinks we should choose between one of the options. Why do we have to choose? His post was unnecessary, we don't have to select one form of "paying" for CC, there is no decision to be made.

SL writes:

D. It comes from nobody, because the CC firm can use labor and capital more efficiently than the textbook firm.

Ken, did you read this sentence?

You write,

"What bugs me about Landsburg's post is that he is making the assumption there will be a cost involved, and that is not a valid assumption."

Unless I'm missing something, Ken, it seems clear that you didn't carefully read and understand his original post.

[ken]

Yes, I read the whole thing:

"At the textbook firm, all revenue goes to workers and investors. At the CC firm, some revenue goes to something else. Where does that revenue come from? The laws of arithmetic admit only four possibilities:

A. It comes from the workers.

B. It comes from the investors.

C. It comes from the consumers.

D. It comes from nobody, because the CC firm can use labor and capital more efficiently than the textbook firm."

He says "Where does the revenue come from?" I don't see why that question must be answered first.

[Tracy W]

it is not rocket science, for instance, to consider a local business running a youth opportunity program, whose activism reduces the probability of one getting mugged while shopping, of the business that invests against disease, or that which creates opportunity in circumstance which otherwise provide a seed bed for terrorism.

Why not separate the business from the youth opportunity program? Why conflate them? Running a business that does something that makes profits and also runs a youth opportunity program increases the monitoring costs of both the profit-making business and the youth opportunity program. What's the offsetting advantage?

For something that's "not rocket-science" there appears to be an amazing shortage of clear explanations as to what the advantage is of conflating charity and business.

[Tracy W]

He says "Where does the revenue come from?" I don't see why that question must be answered first.

Steven's argument is that we can't have a productive discussion if we are not being explicit about how CCS firms differ from traditional firms, and in particular where we assume that the revenue to fund CCS activities is coming from.

You, if I read you right, are arguing that CCS firms are in fact more productive than traditional firms, (this is the same as Steven L's Assumption D). This leads to different conclusions than if CCS firms pay their investors less returns (Steven L's Assumption B).

Please note, we are only talking about assumptions here. You may be quite right that CCS firms are in fact more productive than traditional firms. However, say that someone is assuming that CCS firms return less to their investors (assumption B). The two of you could easily wind up talking past each other because of different answers to the question of "where is the revenue coming from". If you are both explicit about what you think the answer to this question is the conversation is more likely to be effective.

Of course you don't *have* to agree on where the revenue is coming from. The only things you have to do in this life is pay taxes and die. Stating explicitly that CCS firms are more efficient than traditional firms is likely to lead to a more productive conversation than leaving this up in the air.

[Ken]

Tracy,

No, I am not arguing that CC firms **are** more productive than traditional firms. I am saying that they **can be** more productive, or even less productive, which is why a converstion on who is going to fund CC is meaningless. Just as though there is no guarantee that all purely profitable investments return a profit, there will be no guarantee that all CC corporations will be creative or profitable. We should focus on how to be creative first, and then figure out (in each individual case) how it will get funded. Sometimes it will pay for itself, but let's not delay the experiment by talking about an imaginary one size fits all model.

[Tracy W]

So Ken, what do you mean by a CC firm? How can I distinguish between what you would call a creative firm, and whatever you call a non-creative firm?

[ken goldsholl]

Tracy,

I have the same question as you - what is a CC firm? My definition would be one that is more creative about solving problems than just a single minded goal of maximal profits. I'm not sure that's what this discussion is about, I have seen some comments that imply a CC firm is one that makes charitable contributions.

Capitalism is based on solving problems. You provide a product or service that meets somebody's needs, for less than they can do it themselves, and you can earn income from it. Creative capitalism would be using new management techniques and philosophies to solve problems that don't seem to have an obvious profit component.

[Tony Wang]

Ken,

I think you just admitted that a CC firm is one that makes charitable contributions. Any firm that does not simply maximize profits, must by definition, make charitable contributions (it is engaging in some kind of profit sacrificing behavior).

The reason Landsburg wants to provide this framework is to allow for a clearer conception, at least from the economist's standpoint, where the "charity" is coming from. Even if you're more efficient as a CC firm (assumption D), if you are not maximizing profit, you are engaging in some kind of charitable behavior. Though, it's possible that because of your efficiency, you can make as much profit as the profit maximizing firm, as long as your charity doesn't exceed the efficiency gains of your firm.

Hope this clears things up.

Best,
Tony

[Tracy W]

My definition would be one that is more creative about solving problems than just a single minded goal of maximal profits.

What do you see as the conflict between creative problem-solving and a single-minded goal of maximal profits?