Correcting a misunderstanding of the Friedman Doctrine

The Business Roundtable is a non-profit organization consisting of chief executive officers of major U.S. companies. For years they have advocated a shareholder theory of the corporation that places the interests of stockholders over the interests of other business stakeholders, such as employees or communities. Recently, the organization issued a statement that “Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans’.” According to the organization, “Each of our stakeholders is essential.”

Many commentators hailed this change in language, some even going so far as saying it repudiates a position advocated by Milton Friedman nearly 50 years ago. For example, University of Chicago law professor Eric Posner, writing in The Atlantic, simply declared, “Milton Friedman was wrong.”

Portrait_of_Milton_FriedmanIn an essay published in 1970 in the New York Times Magazine, Friedman wrote that “the social responsibility of business is to increase its profits,” which has become known as the Friedman Doctrine. This is what Friedman said:

“In a free-enterprise, private property system, a corporate executive is an employee of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

Unfortunately, both business executives and critics of Friedman misrepresent his argument, suggesting that he advocates maximizing profits at any cost. For example, in his Atlantic essay, Posner writes “Friedman argued that because the CEO is an ’employee’ of the shareholders, he or she must act in their interest, which is to give them the highest return possible.” It’s the period after the word “possible” that is problematic. Placing a period before the qualification Friedman added implies he does not support any constraints on the profit-making activities of businesses, which Friedman never did. Simply stated, it is not true that Friedman’s essay “seemed to absolve corporations of difficult moral choices and to protect them from public criticism as long as they made profits,” as Posner writes. In contrast, business executives must consider the moral choices of their decisions.

First, Friedman said it’s “generally” appropriate to make as much money as possible, not absolutely required. Second, he adds the necessity of “conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.” This second condition imposes considerable restraints on profit-making activities.

In an essay entitled “Smith, Friedman, and Self-interest in Ethical Society” published in the Business Ethics Quarterly, my colleague Farhad Rassekh and I complained about scholars and other writers who misrepresent Milton Friedman as well as Adam Smith. We wrote: “It is common in many business ethics textbooks to find Smith and Friedman interpreted as follows: People should pursue their self-interests; businesses should do whatever improves their financial position, even if others are harmed; and in some way the ‘invisible hand’ ultimately makes the effects of such actions right for society. Is this interpretation correct?” Our answer was a simple “no.”

Prior to publishing our paper, my co-author sent a draft of the paper to Friedman, who replied, “As you recognize, I have been very unhappy about some of the interpretations that have been placed on my position.”

After studying Friedman’s writings, Rassekh and I concluded the following:

“Although Friedman argues that business executives should focus on profit maximization, he does not condone all behaviors that increase financial returns. Quite explicitly, he places four restrictions on profit seeking: Business people must obey the law, follow ethical customs, commit no deception or fraud, and engage in open and free competition. The last restriction means political rent-seeking and anti-competitive behavior in any form must be avoided. For Friedman, social responsibility means pursuing one’s interests (such as making a profit) without adversely interfering with the freedom of others, so that everyone can freely enter into agreements ‘with their eyes open.'”

There are many things businesses have done in the interest of maximizing profits that Friedman would never have condoned because they violate ethical requirements or other conditions he places on businesses, such as mistreating workers, discharging harmful pollutants into the environment, withholding information about dangers created by their products, and abandoning communities in order to produce in lower-cost countries.

I wonder what would have happened if businesses in fact followed the Friedman Doctrine as Friedman actually declared it, and if commentators accurately represented Friedman’s position on the issue. I suspect the whole debate about stockholders versus stakeholders would have ended years ago and anything the Business Roundtable said today about the issue would have been a nonevent.

 

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Unequal wages and claims of unfairness

A recent story on NPR, “2-Tiered Wages Under Fire: Workers Challenge Unequal Pay For Equal Work,” describes how workers at a US plumbing manufacturer responded after learning that some workers were paid differently than others for doing similar work. Simply stated, those paid less than their peers were not happy. According to the NPR story, “[One worker] says the unequal wages caused friction in the [company’s] distribution center, where newer, lower-paid workers grumbled at being asked to perform the same tasks for less money.”

Factory

After the “Great Recession” in the late 2000s, many companies changed their hiring practices, so that workers hired after the Recession were paid less than workers hired before the Recession. Even after the Recession ended, the two-tier wage structure persisted.

Is it fair that workers doing the same work receive different wages, even after controlling for time on the job?

Business executives might argue the situation or practice is fair. If workers agree to work at a wage of, say, $10 an hour, then how can they say that is not fair? Workers willingly accepted the terms of the contract. If they don’t like those terms, then they can work somewhere else. Besides, isn’t it better to be employed, even at a lower wage, than to be unemployed?

This is the challenge of dealing with issues of fairness. Fairness perceptions can be very subjective. What is perceived as fair to you might be seen as unfair to me. So, subjective assessments can be very difficult to assess. Which side is right? I guess it just depends on which side you look at. Assessing unfairness claims is also difficult when people adopt different conceptual or theoretical frameworks, such as principles of procedural or distributive justice or theories of John Rawls or Robert Nozick, because different perspectives weight elements of the problem differently (e.g., something is fair if the rules are followed, or something is fair if the outcome to everyone is the same, or something is fair if the size of the reward is commensurate to the effort expended, etc).

Asking which side is right misses the problem. Just because one person makes a good case that something is fair doesn’t mean that the other side’s perspective is without merit. Is there a way to assess objectively the merit of unfairness claims, such as those made by workers paid less than their peers?

Mary Hendrickson and I, along with our colleagues, have been working on this problem for a while. We have developed an innovative approach for assessing claims of unfairness that does not require the a priori selection of a specific theory or conceptual framework. Instead of picking our favorite theorist or theoretical perspective, we focus on the expectations that individuals have. Expectations are important because claims of unfairness usually arise when expectations are violated. For example, if my student expects an A in the class but receives a C, then it would not be surprising to me if she complains. Similarly, if I get pulled over for speeding and expect to get off with a warning but instead get a ticket, I might claim, “That’s not fair!”

In a series of papers (“Power, Fairness and Constrained Choice in Agricultural Markets: A Synthesizing Framework” and “The Assessment of Fairness in Agricultural Markets“), we show that evaluating the reasonableness of expectations is a way of assessing claims of unfairness, because reasonableness can often be evaluated objectively. If a person’s expectations are reasonable and if the expectations are violated, then the resulting claim of unfairness has merit. Conversely, if a person’s expectations are not reasonable, then any claim of unfairness resulting from a belief that expectations were violated would not have merit. For example, suppose an outside observer asked my student who received the C why she expected an A, and suppose she said, “because I worked hard and attended class every day.” Suppose further that the outside observer reviewed my course syllabus, which clearly stated that a grade of A is only awarded to students earning a score of 90 percent or higher on all tests (but makes no reference to “effort” or “attendance”), then the outside observer would likely conclude that the student’s expectations were not reasonable and hence the resulting claim of unfairness was without merit.

Several conditions can provide a reasonable basis for expectations. The first is equal treatment of equals. In our work we refer to this as “structural equivalence”. People who are structurally equivalent to others, that is, who are in the same position and doing the same work, would reasonably expect to be treated the same. The second is based on the idea of time consistency. For example, someone who has received a year-end bonus for many years would reasonably expect a year-end bonus this year. The third is rights, which by definition determine expectations. If I have a right to vote, then it is reasonable for me to expect to be allowed to do so. We discuss other ideas in our papers as well.

Are the complaints by workers in the plumbing manufacturer about the unfairness of wages with or without merit? Stated differently, is it reasonable for workers to expect to be paid the same as their peers for doing similar work given the length of time they worked in the company? I think this is reasonable. Why wouldn’t it be? If two workers are doing the same work for the same amount of time but one is paid more than the other, then the person receiving the relatively lower wage would have a claim that the wage structure is not fair.

Apparently the plumbing manufacturer agreed, too. A worker strike and a tight labor market brought labor and management to the bargaining table, with the company agreeing to phase out the two-tier wage structure within the next five years. According to the article, it was leverage that convinced the company to pay fair wages. Workers didn’t have leverage during the recession, but they have it now.

As great as leverage and other economic incentives are in moving businesses and people to fairer outcomes, it would be nice if instead they did that simply because it was the right, or fair, thing to do.

Corruption, 2018

Transparency International, the non-governmental organization responsible for the Corruption Perceptions Index (CPI), has released its new findings for 2018 (here). The CPI “ranks 180 countries and territories by their perceived levels of public sector corruption according to experts and businesspeople, [using] a scale of 0 to 100, where 0 is highly corrupt and 100 is very clean.”

2018_CPI_Globa_Map

The top three spots are held by Denmark, New Zealand, Finland, Singapore, Sweden and Switzerland (there are ties at position #3). Compared to 2017, Denmark and New Zealand swapped places, while Singapore and Sweden bumped Norway out of the top three. Denmark’s score remained the same while New Zealand’s fell by 2 points.

The United States was ranked #16 in 2017, but it dropped to #22 in 2018, losing 4 points off its CPI score. Its score of 71 is the lowest since 2012; neighbors on the list are France, United Arab Emirates and Uruguay.

We often focus on countries at the bottom of the CPI, such as Sudan, North Korea, Yemen, South Sudan, Syria and Somalia. These countries deserve attention. Corruption in those countries is compounded by violence and political unrest.

But countries at the top of the CPI are not perfectly clean, either. An analysis by Transparency International, entitled “Trouble at the Top: Why High-scoring Countries Aren’t Corruption-Free,” describes cases of money-laundering, bribery and other cases of public and private malfeasance. The problem is that these countries are home to large multinational corporations that export many goods and service, and that “most of these countries are failing to investigate and punish companies when they are implicated in paying bribes overseas.”

It’s important that we promote transparency, rule of law, democratic processes and leaders of integrity. But it’s probably more important that we care. Vice thrives in an environment of indifference and distraction. Caring means we pay attention to reports of corruption and what goes on in the world, including our own backyards. Less important is what’s the latest show to binge watch on Netflix or what’s happening in our Facebook feed.

Who should control CAFOs?

In the U.S., a concentrated animal feeding operation (or CAFO) is a livestock farm where animals are “confined on site for more than 45 days during the year.” What makes such operations “large scale” depends on the type and number of animals — “1000 head of beef cattle, 700 dairy cows, 2500 swine weighing more than 55 lbs, 125 thousand broiler chickens, or 82 thousand laying hens.”

According to the U.S. Department of Agriculture’s (USDA’s) recent Census of Agriculture (here), there were 93.6 million cattle and calves residing on nearly 883,000 ranch farms in 2017. Approximately 1.25% of those farms were “large scale,” controlling more than 38% of all cattle and calves (in 2012, 1.15% of cattle farms were large scale). In the case of hogs, more than 93% of the 72.4 million hogs raised on farms in 2017 had at least 2,000 animals; that is, 12.5% of the 66,000 hogs farms in the U.S. were large (compared to 12.2% in 2012).

Princess-Anne-CAFO

CAFOs, especially large ones, are controversial for many reasons, but mostly because of the impact they have on the environment. These operations produce millions of tons of manure every year. Even when properly managed, the risks to the environment and public health are significant. For example, the U.S. Environmental Protection Agency (EPA) says that “Manure and wastewater from AFOs have the potential to contribute pollutants such as nitrogen and phosphorus, organic matter, sediments, pathogens, hormones, and antibiotics to the environment.” Operators of CAFOs are required to follow a compendium of federal and state rules.

Since federal and state rules govern the operation of CAFOs, should local governments also have a regulatory say? Stated differently, should states prohibit local governments from regulating or controlling the placement and operation of CAFOs in or near their communities?

On May 2, 2019, the Missouri Senate “passed a bill to block local officials from regulating industrial farms more strictly than the state does.” The measure, Senate Bill 391, states that “county commissions and county health center boards shall not impose standards or requirements on an agricultural operation and its appurtenances that are inconsistent with or more stringent than any provisions of law, rules, or regulations relating to the Department of Health and Senior Services, environmental control, the Department of Natural Resources, air conservation, and water pollution.” The Missouri House will now weigh in on the measure, a vote that could come as early as May 17.

On the one hand, placing restrictions on local control of CAFOs provides a uniform policy to producers within the state and allows states to balance the benefits from the efficient production of beef and pork, as well as dairy, broilers and eggs, with the environmental, health and other costs. Estimating benefits and costs might also be easier at a macro than at a local level. On the other hand, the direct environmental impacts of CAFOs are almost always felt at the local level. It’s hard to ignore the complaints of neighbors who suffer because of the stench of a pig manure lagoon a mile down the road, unless you are a state legislator who doesn’t live near one.

Another way to think about this is as a battle between economic interests and quality of life. Are the economic benefits from having a large hog operation in the community worth the unpleasantness of living near one? Not surprisingly, states usually opt in favor large scale agriculture, especially if large agribusinesses have well-paid lobbyists.

The issue in Missouri is not new. A story in the Chicago Tribune in 2006 entitled “Hog Wars: Missourians Raise Stink Over Giant Operations” tells of how communities are being divided over the issue of proposed CAFOs. One state representative quoted says “It’s the new Civil War.” Local communities want to regulate, but “Agribusiness interests … are alarmed by this rural insurrection and have been pressuring the state legislature to outlaw such bans.” I guess it is finally coming to pass.

This tension between the interests of the many (via the State) and the concerns of the few  (via local communities) is as old as time. It also hearkens to the conflict between utilitarian and Kantian perspectives. A utilitarian position might favor the operation of CAFOs, especially those that are improving efficiency and are effective in controlling pollution, such as utilizing manure as an energy source. Videos explaining efficiency improvements in and other issues relating to pork production are here, and a National Geographic article on the topic of turning manure into energy is nicely titled: “Harnessing the Power of Poo: Pig Waste Becomes Electricity.” A Kantian position will often support the perspective of local communities. Local governments argue that because the operations are in their communities, then principles of autonomy and rights favor their being able to have some say in how they operate, or even if they should operate at all. After all, if states benefit from CAFOs, should they do so at the cost of local communities?

Reconciling utilitarian and Kantian dilemmas is not easy. But the problem with CAFOs is largely one of our making. We like meat. We like it cheap. And we eat lots of it. If we ate less meat then the economic justification for CAFOs might be weakened. That’s a tough call for someone looking forward to his next burger.

The final exam game

Final examYou are taking a college course. Near the end of the semester, the professor reminds the class that the final exam is worth 100 points and is scheduled for the day and time specified by the University. The professor then says there are two options for the final exam.

Option 1 is a regular final exam–the kind you are accustomed to having. You come to class on the day and time of the exam and take the test. Whatever score you get on the exam will be your final exam grade.

Option 2 is the following “final exam game”: If no one shows up to class on the day and time of the exam, then everyone in the class will receive a 90 on the test (out of 100 points). However, if any students show up on the day and time of the final exam, then they will take the test and the score they receive will be their final exam grade. However, anyone who did not show up will receive a 0 on the final because they did not come to class to take the exam.

The professor says he will only allow option 2 (“final exam game”) if 100% of the class agrees to proposal. If even one student chooses option 1, then the class will have a regular final exam (option 1).

So, as a student in the class, do you choose option 1 or option 2? Does it matter how many students are taking the class? If you like the idea of not having to take a final exam, and if you have an opportunity to talk with others in the class, then how do you convince everyone to select option 2?

Incidentally, there is at least one strategy for convincing the class that option 2 is not risky, and it doesn’t involve coercion or threats of violence.

In defense of the morality of capitalism

I am tired of capitalism being misrepresented by politicians, academics and other commentators. Both proponents and critics of capitalism are to blame.

Proponents typically argue that if the government gets out of the way and if people are free to own property and pursue their own interests, everything will be fine. Generalized statements such as this demonstrate virtually no understanding of what capitalism is and how and why it works.

Critics point to problems (e.g., market cycles, corporate scandals, income inequality, etc) as evidence that capitalism is not working and cannot work. Is the fact that the profits of some companies are so high (Apple made $48 billion, Verizon and AT&T about $30 billion each, and Wells Fargo $22 billion in 2018, according to Fortune) an indication that capitalism is functioning as intended, or not?

Several years ago my wife brought home a book from the library for me to read by an academic who proposed ideas on how to solve many of the economic problems we are observing in society. In the introduction the author noted that “standard textbook economics” supports the view that an unregulated capitalistic system consisting of private enterprise will solve all of our problems. Frankly, I am not familiar with any contemporary economic textbook that makes such as claim, and if there is one the author (presumably an academic) should immediately be stripped of tenure. I didn’t finish the book.

adam-smith-9486480-1-402The crucial element of capitalism that is missing by proponents and critics alike is the role of self-restraint, public virtue and justice. Capitalism cannot persist without a people that is willing to exercise some self-control in their personal, economic and public behavior. Even the “father” of modern capitalism, Adam Smith, recognized this. He wrote Theory of Moral Sentiments before Wealth of Nations. Moral sentiments are the foundation, not a by-product, of capitalism. There is a plethora of modern scholarship supporting this view of Smith. Unfortunately, our policymakers, and even many academics, do not keep up with the academic literature.

Justice is the pillar that holds up capitalism. Justice requires both a just people and just institutions. Many, if not most, of the problems we are experiencing in economic society occur because people are excessively selfish. Period. Where is the other-regarding behavior necessary for capitalism to survive? While self-interest is a central aspect of Smith’s economic system (capitalism), selfishness is not.

But the line between self-interest and selfishness is thin. Both Smith and Darwin noted that altruism does not necessarily give individuals a selective advantage, but groups made of up altruistic individuals will. In his 1871 book, The Descent of Man, Darwin said that a group that has members “possessing in a high degree the spirit of patriotism, fidelity, obedience, courage, and sympathy, [who] were always ready to aid one another, and to sacrifice themselves for the common good” would out-compete selfish groups. I can’t believe I’m writing this, but Darwin is correct. So everyone else practice public virtue while I lie, cheat and steal. And that is the rub. Since other people will have this same thought, public virtue and moral behavior decline. Another example of the Prisoner’s Dilemma. This is the root cause of our economic failings.

Capitalism is not the problem. The problem is people who believe that anything they do to enrich themselves will be good for society. Adam Smith’s “invisible hand” does not work this way. If we can’t live with an invisible hand, then someone, or something, else’s iron hand will become all too visible. Note the connection with the foundation of a Constitutional republic. Quoting John Adams: “Our Constitution was made only for a moral and religious people.” And Benjamin Franklin: “Only a virtuous people are capable of freedom. As nations become corrupt and vicious, they have more need of masters.”

If we lose capitalism in our selfish pursuits, then are we really willing to accept what must come in its place?

Should voluntary actions to improve water quality require a regulatory nudge?

Missouri_River_near_Hermann_9-1990

Water quality is a huge problem in many parts of the world. People and animals need clean and uncontaminated water to live. But people also work in and live near enterprises that can create serious risks of contamination, so balancing our interests in producing with our interests in drinking safe water can be a challenge. For example, factories can discharge pollutants and chemicals into waterways, or they might incorrectly store waste resulting in eventual leaching into waterways and underground aquifers. Farms use fertilizers or other chemical inputs that drain into rivers and streams. Ranches and concentrated animal feeding operations produce a lot of animal manure that can contaminate water sources. How do we address these issues in a way that is fair to all stakeholders?

One way of doing this is educating relevant stakeholders and encouraging them to take voluntary actions to reduce their share of contaminants reaching water sources. An example is the Nutrient Reduction Strategy. This is an effort by 12 states, whose farms and businesses contribute to the problem of hypoxia in the Gulf of Mexico, to reduce contamination of the Mississippi/Atchafalaya River Basin (MARB). The US Environmental Protection Agency (EPA) coordinates the effort and encourages states to develop their own strategies “for implementing and developing load reductions,” according to the EPA’s website on the topic (here). This website also links to each state’s strategies and reports on their progress.

Important here is that the EPA “calls” for states to develop and implement nutrient reduction strategies, but it doesn’t require them to do so. In effect, this creates a classic prisoner’s dilemma. While all states recognize the importance of reducing contamination of the Mississippi River, the ideal is for 11 states to do this aggressively while the 12th state does it slowly, since regulations can be costly and unpopular. But if all states face this incentive, then the push for states to get the job done is weakened. So, sometimes a regulatory or legal nudge is needed to move all states to a cooperative outcome.

One way of doing this is to bring a lawsuit against a state that does not seem to be making the progress that one thinks it might otherwise have completed. This recently happened in Iowa. According to a Feedstuffs article, “Groups sue Iowa over water runoff. Suit alleges state of Iowa is failing to protect its waterways from farms.” The lawsuit states the following, as reported in the Feedstuffs article:

“The most recent ‘Iowa Nutrient Reduction Strategy Progress Report’ was released on March 7, 2019. The report acknowledges that adoption of the strategy’s agricultural best management practices was not making sufficient progress towards its nonpoint-source nutrient reduction goal. While annual progress continues in the implementation of these practices, early [Nutrient Reduction Strategy] efforts only scratch the surface of what is needed across the state to meet the nonpoint-source nutrient reduction. Progress has occurred, but not at the scale that would impact statewide water quality measures. Local water quality improvements may be realized in the short term where higher densities of conservation practices are in use, but the ability to detect early trends in measured water quality will vary from case to case. Statewide improvements affected by conservation practices will require a much greater degree of implementation than has occurred so far.”

However, lawsuits can be a double-edged sword. On the one hand, if successful they can push state legislatures to be more proactive in promulgating laws to reduce point and non-point water pollution. On the other hand, defending against lawsuits diverts government attention away from the very thing the lawsuit stresses. According to one farmer quoted in another news report of the Iowa lawsuit (here), “At a time when farmers are struggling financially from low commodity prices and also now from historic flooding, this lawsuit is a low blow. It will divert the state’s financial resources from implementing soil and water conservation practices, and also divert resources away from helping our farmers recover from the latest natural disaster.”

The ideal, of course, is for all of us to recognize the responsibilities we have to be mindful of the environment and our role in contaminating it. Stewardship is a good word here. Those who intensively use natural resources have a particular responsibility to be wise stewards over those resources and to be cognizant of how their actions affect others. Solving the prisoners dilemma is possible without formal laws and regulations, but it requires that everyone cooperative and share the burden.