Business needs to focus on business

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Appeared in the Hub, February 2, 2022
Business needs to focus on business

In Canada and other western countries, there are increasing demands for a fundamental overhaul of the role of business in society. But in making their case for reform, prominent business leaders and intellectuals often misrepresent the status quo, minimize the power of markets to deliver broad prosperity—including environmental improvements and social progress—and present their proposals as costless. In reality, however, such radical recommendations to effectively socialize business will fail to achieve their intended goals and impose enormous costs.

Essentially, this new frontier of top-down socialism—whether it’s called stakeholder capitalism or environmental, social and governance (ESG)—requires businesses to prioritize loosely defined goals (including environmental and social goals) over goals directly related to their businesses. The claims of advocates, that such activities enhance profits, render the need for government action via laws and regulations redundant because if these activities were actually good for profits, firms would undertake them voluntarily.

Stakeholder capitalism (and ESG) promotes fundamental changes to the role of business in society, which will inevitably reduce firm profitability. Firm resources are reallocated from business priorities such as research and development, supply chain enhancements and worker training, towards other endeavours unrelated to operating businesses.

But the goal of businesses, since their inception, has been to provide a return to owners by efficiently producing goods and services the public wants and is willing to purchase. Businesses are forced by competition to worry about the needs and wants of their customers, figure out innovative ways to produce and deliver goods and services, and provide post-sale support to promote future business. The only way around this market discipline is for businesses to secure protection or preferential treatment from government.

It's also unclear why advocates of stakeholder capitalism and ESG assume that businesses—owners, executives and managers—can identify and execute environmental and social goals better than non-profits or democratically elected governments. Harvard law professors Bebchuk and Tallarita, in their paper The Illusory Promise of Stakeholder Governance, conclude that stakeholder capitalism will fail to achieve its stated goals while also diminishing the accountability of corporate leaders because of its opaque and subjective nature (a recent analysis found more than 600 ESG reporting frameworks, many of which conflict with one another).

Perhaps the most salient fact, however, is that these so-called reforms are unnecessary. The historical evidence is clear that societies that rely more on individuals, families, entrepreneurs and businesses to make bottom-up decisions rather than governments (top-down), enjoy higher standards of living, improved quality of life, greater social progress, better environments and interestingly more peaceful societies—the stated goals of stakeholder capitalism and ESG.

The idea that businesses ignore the communities where they operate or fail to treat their employees fairly seemingly ignores the real world around us. Consider how many local sporting, cultural and youth events are sponsored by local businesses. Or think about the lengths businesses go to retain and attract workers.

Finally, this push for greater spending by businesses on non-business-related priorities occurs while business investment in Canada is collapsing. A number of prominent economists including the governor of the Bank of Canada have noted that economic recovery and rising living standards cannot sustainably occur without increased business investment.

Business investment (excluding residential housing) declined by 4.0 per cent between 2015 and 2019 (before the COVID recession) compared to an increase of 30.8 per cent between 2004 and 2008, the equivalent period before the last recession. Investment in only factories, plants, machinery and equipment declined by 6.5 per cent (2015 to 2019) compared to an increase of 33.9 per cent (2004 to 2008). As prominent economist Jack Mintz recently argued, recovering and improving business investment should be the single priority of the federal government and yet it wasn’t even mentioned in the recent throne speech.

It's within this context that advocates for stakeholder capitalism and ESG want businesses to reallocate increasing amounts of resources to activities unrelated to improving profitability, thereby further discouraging business investment. Again, contrary to the rhetoric, there’s an opportunity cost when firms divert resources to unprofitable activities. If these ideas were actually good for profits, firms would undertake them voluntarily.

There’s little evidence this new brand of top-down socialism, whatever it’s label, will result in better economic and social outcomes. Indeed, the answer to many of society’s current problems is less, not more government. We should rely more, not less, on individuals, families, entrepreneurs and businesses to direct the resources of society. History is clear—when we do, we achieve many of the goals espoused by today’s reformers, but with the benefit of a prosperous economy.