A Response to the Gates Foundation Memo

By Steven Landsburg

I have no idea what the authors of this memo are trying to say, and neither, I am pretty sure, do they.

First bullet point: This isn't about changing capitalism. Second bullet point: Creative capitalism is an effort to get more companies involved in work that reduces inequity. Oh--so maybe it is about changing capitalism. Firms either do or do not seek to maximize profits to the exclusion of other goals. Add more goals and you've changed capitalism.

By way of diverting attention from this glaring inconsistency, the authors say that under CC, firms will continue to maximize profit; they'll just do a better job of it by finding new ways to serve the poor. Well, it's true that most firms have room to improve. They overlook opportunities to serve the poor and they overlook opportunities to serve the rich. Is CC a call for more diligence about the former but not the latter? Or a call for more diligence all around?

If CC is just about diligence in the pursuit of profit, then every disgruntled shareholder at every corporate annual meeting is a creative capitalist. If it's about diligence with respect to some opportunities more than others, then it's a diversion from profit maximization.

So which is it? I can't tell, and reading the memo doesn't help. All I find are platitudes like: Businesses can seek more effective ways to use existing market incentives...to reduce inequities and serve the poor. So when firms face conflicting incentives, is this or is this not a call to weight some of those incentives disproprtionately (and therefore, implicitly, to dilute the goal of profit maximization)? That's a yes or no question. Why isn't it answered here? It looks like the authors want to pretend that the answer is both yes and no.

And on and on it goes. Businesses, we're told, can do all kinds of cool things, like tapping profitable but previously unrecognized markets that serve the poor. Well, tapping profitable but previously unrecognized markets that serve the poor can be a great strategy for profit-maximization. So can tapping profitable but previously unrecognized markets that serve the rich. Being more attuned to the former than the latter means, again, diluting the goal of profit maximization. But the authors say they don't want to dilute that goal. So once again, what do they want?

Well, they want businesses to produce products that serve the poor, and they want businesses to support social causes. These, they say, are the "two general ways" for businesses to serve the poor. But this overlooks the primary way that businesses serve the poor: By making them more productive, or, in the vernacular, by creating jobs for them. The best thing Nike can do for third-worlders is not to provide them with low-cost sneakers; it's to employ them in making high-cost sneakers for rich westerners.

By the way: Why all the emphasis on things that corporations can start doing instead of on things corporations can stop doing? Would it be an example of CC if Archer Daniel Midland stopped lobbying for sugar quotas? We should talk about whether this sort of "negative CC" gets you more or less bang for the buck than the "positive CC" being envisioned here. My guess is that if corporations are willing to forgo profit in the pursuit of greater social good, then they can do far far more good by laying off their demands for subsidies and protection than by anything being envisioned here.

Next, the memo asks, Why shouldn't companies just try to maximize profits and let their shareholders donate the cash as they see fit? A fair question. I recently had my roof redone. I could have given my roofer an extra $1000 and instructed him to make a $1000 charitable contribution, but that seems like a very ineffective way to be charitable. I don't want corporate executives choosing my charities any more than I want my roofer choosing my charities. Why can't shareholders simply direct the corporation to maximize profit and then contribute a share of their earnings to charity?

By way of an answer, the authors offer a total of two bulleted examples, at least one of which is patently absurd: A consumer who wants to support farmers in the developing world might find that buying fair trade products is the best way to...support that goal.

Well, yes, I suppose that a consumer with a passionate desire to raise the wages of coffee farmers (as opposed to sugar farmers or sheepherders or urban indigents) might accomplish his goal by purchasing fair trade coffee. But I both hope and expect that very few consumers are burdened with such a bizarrely crabbed sort of altruism.

Never mind the fact that "fair trade" seems to be a euphemism for the enforcement of monopsony power (enriching some producers by pricing others out of the marketplace); this isn't the place to get into that debate. But this much is directly to the point: Lots of people feel a moral obligation to help poor people in general. No sane person feels a moral obligation to help poor coffee farmers in particular. So the "creative capitalism" solution serves a non-existent goal---and this was one of the best two examples the authors could come up with!

In fact, the whole fair trade thing is an excellent illustration of creative capitalism gone insane. You can pay an inflated price for your coffee and put a farmer out of work, or you can buy ordinary coffee, contribute to CARE, and feed a starving child. Please oh please don't trick people into thinking the former is a good deed.

The memo concludes with the hope of unlocking new potential for capitalism to bring people out of poverty. This point cannot be overemphasized: Capitalism has brought most of the world out of poverty, and nothing else has ever brought any substantial number of people out of poverty. Ever. (If there's a counterexample I'm unaware of, I hope someone will tell me.)

Most of the world's poor are poor because they live under confiscatory governments. It's not enough to ask how to provide them with goods or with incomes; we've also got to ask how to prevent those goods or incomes from being confiscated. If we don't address that, I fear we'll accomplish very little. And I'm not sure I see how anything in this memo contributes to that problem.

Finally: There's been much talk here about what governments, businesses and philanthropists can do to help. Given the contributor list on this project, it might be useful to ask what intellectuals and journalists can do. My answer: We, perhaps in conjunction with governments, businesses, and philanthropists, can remind people of where wealth comes from, of how wealth without capitalism is a fantasy, and of how this translates into concrete policy questions. Undermining the anti-sweatshop movement would be an excellent place to start.

Comments

[Steve Saker]

If your criticism of CC is valid, then I am curious about your answers to a few related questions:

First, is there such a thing as a "good corporate citizen", a company that can be valued by a measure other than its straightforward profit-making capacity?

Second, if the answer is "yes", then must this "good behavior" necessarily be at the expense of the shareholder, or is there any possibility of having one's cake & eating it?

Finally, is it rational to care about constituencies other than shareholders? Specifically, if "bad behavior", short of outright illegality, maximises profits at the expense of customers, or employees, are we always to assume that the market will take care of the bad corporate behavior?

[Amitav]

Prof. Landsburg is correct that intellectuals and journalists must stop apologizing for capitalism, and must continue to urge more freedom (human and market) everywhere. Meanwhile, we live in a world of trade barriers and bad government, which bears very little resemblance to the world of Econ I. Companies often operates around the cracks and niches of repressive or counterproductive market policies; there are few perfect markets and profit-maximizing decisions are not always simple and obvious. We can’t wish these realities away, and companies operating in such conditions must make strategic decisions that are risky and uncertain. It’s perfectly legitimate for such companies to make decisions that are both in their immediate self-interest and socially beneficial (i.e., in the company’s long-term self-interest), particularly in the poorest and least-free markets in the world. I laid out some potential scenarios in my reader submission (take 4) and comments, and there are probably other scenarios as well.

It’s also a false dichotomy that companies that explore opportunities to serve poor customers dilute their opportunities to serve the rich. In developing countries, rich customers are the most visible and obvious. Company owners and managers are most likely to be rich customers themselves, and to understand the profit potential of that market segment very well. Prof. Prahalad has demonstrated that mass market profit potential exists in developing countries, but it requires a commitment to specialized innovation. This might not be right for all companies, but it shouldn’t prevent managers from exploring such non-obvious options. Companies evaluate new business strategies and make trade-offs among them every day; I don’t see why examining opportunities in a poor market segment should be deemed so outrageous.

Like Prof. Landsburg, I am skeptical of “fair trade” practices, especially in lieu of more free trade generally. I don’t view “creative capitalism” as a substitute for good old-fashioned free markets; I certainly don’t see why companies operating solely in rich countries should go out of their way to help people in the poorest parts of the world. But companies that do operate in poor countries can benefit from a thorough understanding of creative capitalism as a means to improve their business. Formalizing these practices (as with all business practices) will help companies avoid the pitfalls of a reactive or ad hoc approach. It will also benefit new market entrants as they consider starting operations in poor countries. Nothing about this should be considered prescriptive for all companies in all circumstances, but it does add new dimensions for companies to consider as they operate in developing markets.

[n p chekkutty]

@Stephen Landsburg: Undermining the anti-sweatshop movement would be an excellent place to start.

This an excellent proposition because one of the first things the West can do to help the poor in the developing world is to dispel the sentimental nonsense revolving around this concept about 'sweatshops' in those countries. The fear of sweatshops and the 'conscientious' objection to the products from these countries is a virus fast spreading all over the developed world and I am sure, it would hurt the poor of our world much harsher than any other steps the West can take, say the protectionist legislations or even the the refusal to help with aid.

A few days ago in response to a post by Tim Harford, I had made the following observation: "Avoiding goods for fear of aiding sweatshops even inadvertently might harm a family somewhere, who are dependent on this little money for their survival."

I feel that since Prof Landsburg has made a scathing criticism about the way the West is dealing with this issue, it is necessary to look at it from the standpoint of those countries and people who are likely to be hurt by such measures.

First let us accept that the working conditions in most of the developing world is not as comfortable as the workers in the developed world enjoys. But the crucial aspect is that while there may be choices for the workers of the developed world, there is precious little choice for those living in these parts of the world. The less choice, the less bargaining power you have. Hence exploitation of the labor is at a much higher level in these parts, no doubt about it.

So what to do? Leave them to the care of God and disallow their products from the Western shops? And thereby deny them the daily meal, if at all they are able to afford a meal by all these exertions? I have seen hundreds of kids who work in road projects, small workshops, mills, canteens, etc, and then go to school to build their lives. By refusing to buy the products that may have their sweat on it, what we actually do is to deny them the only chance to hold on to a better life, stonewalling the only glimmer of hope they may have.

The best way here is to put pressure on the governments, the factory owners and the business community in these parts of the world to improve working conditions, to go for stricter law and enforce labor standards. Here the trade unions and political parties who are deeply involved with the poor people's lives could be of immense help. So what we need to do is to think of building strategic tie-ups with the political establishment, say the trade unions, political parties, etc, and enforce change. But the Gates Foundation memo never even speaks of such a strategic initiative as they do not think the political society in the third world can be a valuable ally in the effort to promote creative capitalism. I think this is a fundamental mistake on their part. They speak of Prahalad and the gains to be picked up at the bottom of the pyramid. Fine. But unless you have somebody alive at the bottom how can you pick up anything from there?

[Tracy W]

First, is there such a thing as a "good corporate citizen", a company that can be valued by a measure other than its straightforward profit-making capacity?

Define "good corporate citizen".

If you want to value a company by a measure other than its profit-making capacity, there's plenty of ways of doing it. Hold a vote and see who wins (this is how democracy does its valuations). Value it by the number of people it employs. Value it by the size of the sign on the corporate headquarters. Hire some fashion designers to value its employees' dress sense. The problem is finding a value that is likely related to "good corporate citizen". I suppose the simplest one could be "Percentage of employees convicted of crimes committed while employed by the firm".
(I've eliminated the word "straightforward" because I know enough about accounting to know that valuing a company's profit-making capacity is not straightforward).

Specifically, if "bad behavior", short of outright illegality, maximises profits at the expense of customers, or employees,

How does this bad behaviour maximise profits at the expense of customers or employees? If it's by producing shoddy products, well there's an incentive for someone else to find a way of servicing customes with better products. So that limits "bad behaviour".
If it's by mistreating employees, then employees have an incentive to find a different job. If you want to make profits, it's rational to care about the interests of other stakeholders. Having run a business, I found it unavoidable if I wanted to make a profit at all.

[Tracy W]

It’s also a false dichotomy that companies that explore opportunities to serve poor customers dilute their opportunities to serve the rich.

Well if you are doing one thing, you have less time to do another thing. You can hire other people to do the other things, but they need to be managed and monitored. Consequently we often find that companies specialise one way or another. This is not necessarily a rich vs poor thing, there are some things that everyone buys (eg Coke), and other things can be differentiated by the same company (economy class versus first class).

But sometimes it does make sense to focus on either the luxury end of the market, or the cheap end of the market, as management time is limited.

. But companies that do operate in poor countries can benefit from a thorough understanding of creative capitalism as a means to improve their business.

Companies that operate in poor countries probably can also benefit from a thorough understanding of uncreative rigorous evaluation techniques as a means to improve their business.

[Amitav]

Tracy W: the false dichotomy that Prof Landsburg presents is the idea that we are asking companies to make investments in one opportunity (poor consumers) at the expense of another (rich consumers). My understanding is that we are just asking companies to evaluate opportunities at the bottom of the pyramid, in addition to their existing set of opportunities. They can then make investment or non-investment decisions on the merits. All companies of any size make trade-offs among their various business initiatives every day; I don't see why expanding the opportunity set is in any way controversial.

An opposing position might be that if there really were opportunities at the bottom of the pyramid, they already would have been addressed by natural market forces, and therefore it's a waste of time to even suggest that companies explore such opportunities. Yet the management consulting industry inexplicably persists in the face of such reasoning; sometimes companies just can't recognize that there really is a $10 bill in the street. The fact that we are still debating the validity of this approach when it has already been successfully executed by a variety of companies just highlights the importance of this discussion.

Companies that operate in poor countries probably can also benefit from a thorough understanding of uncreative rigorous evaluation techniques as a means to improve their business.

Very true. Does this preclude the use of creativity as well?

[dWj]

Sole proprietorships frequently maximize something of which "profit" is only a part. What they maximize is perhaps best termed "whatever the proprietor wants".

Goldman Sachs, when it was a partnership, regularly engaged in "social good" sorts of things. There weren't a whole lot of owners, and there was very little in the way of agency costs; the concerns they occasionally valued over that extra possible nickel in profit were widely agreed to, and were of long enough standing that you understood that, joining the partnership, you were probably signing on to this in some form. When the firm went public, it emphasized in its offering that this would not change, and it hasn't. Current shareholders as a whole approve of things of the nature of contributing a big swath of land (which Goldman came to own by foreclosing on it) to environmental preservation and the operation of an employee volunteer program (which might have some financial value to the firm in terms of effects on hiring and training, but let's posit that it isn't enough to completely justify having $300 an hour bankers paint barns). These are not situations in which the firm is simply doing something each individual share holder could do; donating the land obviously reduced transaction costs from what they might be if the land had been sold to the highest bidder while various shareholders tried to join with other contributors to buy some similar piece of land for preservation. It may not be profit maximizing, but if the shareholders value the preservation, it may be shareholder-value maximizing.

So, in short, most of the shareholders -- being ordinary human beings in spite of also owning shares of a publicly traded corporation -- value things other than simply profit; the firm behaves in such a way as to optimize things other than simply profit; and any minority shareholders who disagree with the nonpecuniary values the firm are largely coming to the nuisance.

Oh, but, by the way, I agree with almost everything you said. If the argument is how best to maximize profits, we shouldn't pretend to be arguing about something other than how best to maximize profits. If we're trying to maximize something else that isn't stipulated to be maximized the same way, we shouldn't pretend that we're still maximizing profits.

Also, by way of disclosure, I used to work for Goldman Sachs, and am a (small) shareholder.

[anonymous]

Capitalism has brought most of the world out of poverty, and nothing else has ever brought any substantial number of people out of poverty. Ever.

I believe this, but I am always struck by the horrific amount of central planning that goes on in China as it experiences double-digit growth. I know of course that it's market liberation and not central planning that is the root cause of this growth. My worry is that confiscatory governments could use a strong private-sector economy as an excuse for practicing and condoning political oppression. I realize China is an isolated case, but it nevertheless worries me that it might only take one role model to inspire other countries to keep trying out expedient, partially capitalist, dictatorial models of growth. I hope my worry is unfounded.

). My understanding is that we are just asking companies to evaluate opportunities at the bottom of the pyramid, in addition to their existing set of opportunities. They can then make investment or non-investment decisions on the merits. All companies of any size make trade-offs among their various business initiatives every day; I don't see why expanding the opportunity set is in any way controversial.

There are still only 24 hours in the day. If you spend more time evaluating options at the bottom of the pyramid, you are spending less time doing something else, be that evaluating options at the top of the pyramid, evaluating your existing product lines, or less time at home playing with the family dog.

Perhaps companies should be spending more time evaluating options at the bottom of the pyramid, at the cost of some other activity. All I am explaining here is why that suggestion is controversial.

Me: Companies that operate in poor countries probably can also benefit from a thorough understanding of uncreative rigorous evaluation techniques as a means to improve their business.

Amitav: Very true. Does this preclude the use of creativity as well?

Nope. But why do you focus on creativity so much? What's special about creativity as a way of improving profits? Why isn't this blog titled "Rigorous research-based capitalism"?

[Tracy W]

Sole proprietorships frequently maximize something of which "profit" is only a part. What they maximize is perhaps best termed "whatever the proprietor wants".

As indeed I do with my owner-operated company. The trouble is the more other people you get involved, the more you run into disagreements about what values to pursue. At some point it gets easier just to focus on what you can get agreement on, and pursue your other interests through other organisations.

These are not situations in which the firm is simply doing something each individual share holder could do; donating the land obviously reduced transaction costs from what they might be if the land had been sold to the highest bidder while various shareholders tried to join with other contributors to buy some similar piece of land for preservation.

Environmental charities are perfectly capable of buying and owning land.

Am I the only person on this blog who is aware that there are civil organisations? Has no supporter of creative capitalism ever even heard of the Sierra Club? Or the Red Cross? Or even a local hiking club? Why oh why do these people think that the options are either a company does something or individuals have to do it all by themselves? I mean, it's not like I even have to search out these non-profit organisations, my mailbox is deluged by brouchures from those sorts of places, even ones I care nothing for. I didn't know that it was *possible* not to know about them, but on this blog people keep making comments like the above, indicating a total ignorance of the possibility of non-profit organisations. Huh?

Okay, rant over. For now.

So, in short, most of the shareholders -- being ordinary human beings in spite of also owning shares of a publicly traded corporation -- value things other than simply profit; the firm behaves in such a way as to optimize things other than simply profit

It's interesting that in your description you only mention the firm's donations of land and employee's time, not how much good it actually did do by these donations. I suspect in this case what the firm is optimising with its non-profit-making works is "appearing to do good", which is not the same as "doing good".

[Adam]

I started to read Dr Landsburg post, however, found it so lacking in thought I had to stop. Indeed, the only assertion I read was his claim that the phrases "This isn't about changing capitalism" and "Creative capitalism is an effort to get more companies involved in work that reduces inequity" are mutually exclusive.

This is silly. We can absolutely change the framework on which capitalism takes place (e.g., one very crude way to accomplish redistributio would be to retool the legal system so as to make it prohibitively expensive for companies to not help mitigate inequality--this would, I am sure, have profound uninteded consequences but is only a crude example). If we do this we still allow capitalists to seek profit and make decisions based only on this (to do so, however, they would now have to consider inequality).

I read Dr Landsberg's Armchair Economist, and while most of it was excellent, the last section on environmentalism was absolutely absurd (he commits the same sin (but in terms of anti-environmentalism) he accuses environmentalists of: a dogmatic, religions approach).

[tillerman]

Adam,

Congratulations. It took you three paragraphs to say "(1) I didn't read this post, (2) I didn't understand the part that I read, and (3) One time I read a book by this author, the last chapter of which I also didn't understand."

We can absolutely change the framework on which capitalism takes place (e.g., one very crude way to accomplish redistributio would be to retool the legal system so as to make it prohibitively expensive for companies to not help mitigate inequality--this would, I am sure, have profound uninteded consequences but is only a crude example). If we do this we still allow capitalists to seek profit and make decisions based only on this (to do so, however, they would now have to consider inequality).

Your implicit assumption is that "changing capitalism" always and only means "not allowing capitalists to seek profits and make decisions based only on this." If this assumption were true--it isn't--we could, say, outlaw purchases by consumers and make companies in every industry compete for government contracts. Companies would still be trying to maximize profits, and you would say we haven't "changed capitalism." That's absurd.

[dyoe qhfcms]

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