The Corporate Ethics Crusade

Ethan B Kapstein. Foreign Affairs. Volume 80, Issue 5. September/October 2001.

The Best Intentions

Are multinational enterprises getting religion? So it seems. Around the world, corporate codes of conduct on human rights, labor standards, and environmental performance are proliferating. These codes reflect the growing pressure being placed on firms by nongovernmental organizations (NGOs), activist shareholders, and the portfolio managers of “socially responsible” investment funds. A veritable corporate ethics crusade has been launched, and it has been surprisingly successful in forcing executives to take its concerns into account.

But ample reason exists for raising some red flags about this movement. The major parties involved—multinational firms and NGOs in industrialized nations—are beginning to forge a symbiotic relationship that could actually harm the least powerful actors in the world economy, including developing countries, small and medium- sized enterprises, and the poor everywhere.

Consider the linkage of labor and environmental standards to multilateral trade agreements. Improving working conditions and air and water quality are laudable goals, and firms should do so whenever it is economically and technically feasible. NGOs can usefully contribute to that process by providing governments and firms with information, advice, and policy alternatives. But forcing the standards of industrialized nations on developing countries and the firms that operate in them could backfire by reducing investment and job creation. More workers would be chased into the informal economy, which has even lower standards, if any at all.

Activists who wish to establish ethical codes need to reconcile their aspirations with the fact that most nations do not generally share common laws or regulations on labor rights and the environment. Differing levels of wealth explain much of this divergence, but the peculiarities of political systems and social organizations have also left their normative footprint. The ethics crusade represents, in effect, an attempt by one group to impose its values on other groups. Far from making economic relations more harmonious, that effort could lead to greater conflict.

Consider the International Labor Organization’s core labor standard that recognizes freedom of association. What does that imply as a universal rule? National laws regulating unionization vary enormously from country to country. Even among advanced industrialized democracies, the relative political and economic standing of unions differs significantly; in Germany, for example, they are much more powerful than in the United States. Furthermore, outside intervention to promote unionization in developing countries could have the perverse effect of increasing existing levels of income inequality, as those outside the collective bargaining framework get left behind.

The global debate over corporate ethics therefore needs some rules of engagement. The obvious starting point is that companies ought to abide by the laws of the land where they do business. But these laws are often too weak to protect workers and the environment, and this weakness opens the door to legitimate disputes over interpretation and enforcement. When profound differences arise over corporate social responsibility in such areas, the parties involved should set out the advantages and disadvantages associated with adopting higher standards before declaring any proposed policy solution to be the obvious best choice. That sort of analysis has been woefully absent, and instead we are witnessing the rise of ethics by intimidation.

Do the Right Thing

The roots of today’s corporate ethics crusade go back to 1989. At the end of the Cold War, democratization and economic liberalization converged on a global scale. Democratization was accompanied by a renewed focus on freedom and human rights, and economic liberalization promised to turn any economic frog into a spry and wealthy prince. Together, they offered a better life for billions of people around the world.

By the mid-1990s, however, this hopeful vision was dissolving like a fading mirage. Even in those countries that sought to apply the “Washington consensus” formula of fiscal stabilization and open markets, the benefits of these policies seemed questionable at best. Many people sought villains and found them in multinational corporations, along with the international organizations, such as the World Trade Organization (WTO), that served as their lackeys. These giant firms appeared to drive economic outcomes more than any government could. They could flee countries with high tax rates, undermining those governments’ fiscal bases and igniting a feverish “race to the bottom” among countries desperate for investment dollars. And despite their rhetoric of free-market competition, these firms engaged in a series of mergers and acquisitions that threatened to form global monopolies exerting absolute power over consumers.

Against these impersonal corporate forces, society began to mobilize, just as it had during the first wave of globalization in the late nineteenth century, which produced labor unions and socialist parties. Take the case of the Multilateral Accord on Investment (MAI). First unveiled in 1995 by the Organization for Economic Cooperation and Development (OECD), it promised to create new rules for international investment. Such a venture would hardly be expected to generate public controversy. Yet apparently out of nowhere, a coalition of NGOs concerned with labor and environmental standards began an Internet campaign against the MAI. Activists were troubled most by the secretive nature of the talks—not the accord’s details—and they charged that international rules were being made by a handful of advanced countries and their multinational firms. Many governments, chiefly that of the United States, also came to view the proposal as fundamentally flawed. But the degree of hostility against the MAI clearly caught the OECD and its member states off-guard. The opposition of NGOs was probably decisive in killing the accord.

Had this been an isolated case, public officials might have been quick to dismiss the potentially disruptive role of NGOs. But their potent (and violent) demonstration during the Seattle trade talks in December 1999 provided another example of a growing antiglobalization wave. The Seattle protests were followed by similar demonstrations at other meetings, and soon the WTO and related institutions were under full-scale assault.

Today, an alliance of consumer groups, socially responsible investors, labor unions, environmentalists, and human rights activists—based mainly in the rich countries—have begun to agitate against recent changes in the global economy. Recognizing the difficulties associated with influencing or overturning government policy at the domestic level, they have shifted their attention to multinational firms and international organizations. These NGOs have become a David battling the corporate Goliath, using every weapon at their disposal to make the giant stagger. The Internet and the news media have been invaluable in that assault, enabling the ethicists to score several major victories in their corporate crusade.

Sound and Fury

The most effective weapon of the NGO-based ethics movement has been publicity campaigns aimed at firms whose behavior it deems unacceptable. The goal is to get companies to change their business practices “voluntarily” or else risk the consequences of bad press and a consumer boycott. (As Oscar Wilde once said, “morality is the attitude we adopt toward people we don’t like.”) It has proved an effective strategy, as many corporate executives in the textile, energy, and pharmaceutical industries will testify. But the ethical outcomes of such targeted campaigns are hardly straightforward. Independent analysis is lacking, and in its absence, noise and passion are ruling over logic.

Apparel companies were among the first targets of the ethics crusade. A coalition of unions and NGOs, such as Clean Clothes and No Sweat in Europe and the National Labor Committee in the United States, began focusing on “sweatshop” conditions in developing-world clothing factories. These groups cleverly turned protectionist arguments on their head: Western consumers should reject imported garments not because cheap labor in Indonesia was undermining textile employment in South Carolina but because multinational corporations were gruesomely exploiting local workers. These laborers were earning slave wages while the products they made sold for a fortune. The crusaders thus lobbied on behalf of people who had no role on the world political stage, and the villains in that story were the very brand names that had achieved heroic status among the consumer class.

Many prominent apparel companies, including Nike, Adidas, and the Gap, began to experience the full force of NGO and media rage, with a barrage of stories and Internet-based campaigns aimed against their products. Students lobbied their universities to sever business ties with companies that employed sweatshop labor. As a result, several firms changed their behavior, raising standards abroad and inviting independent monitors to assess their progress. A growing number of companies even hired vice presidents for “corporate social responsibility.”

But these changes have not always been for the better. Take Nike, whose labor practices in Asia were ridiculed in Garry Trudeau’s cartoon Doonesbury. Nike recently announced that it would no longer employ workers younger than 18 in its shoe factories, putting an end to any fears that it was hiring child labor. That plan sounds nice, but it does little for the 17-year-old in Indonesia or Vietnam who would rather work for an American multinational than for a domestic employer. Eighteen is well beyond the end of minimal compulsory education in most Asian countries, which is where the child labor line should be drawn.

Child labor is a difficult issue that is naturally fraught with emotion. But Nike’s “solution” to that problem is partial at best and perhaps even counterproductive, because it ignores the economic reality facing millions of children around the world. The best thing for children, of course, is to stay in school, acquiring skills that will increase their future earning capacity. Several developing countries, including Brazil and Mexico, have recently launched innovative schemes aimed at providing financial support to poor families so that their children need not leave school to beg or seek work. If they truly wanted to be more socially responsible, corporations would complement these schemes by offering scholarships to vocational schools and universities or internships to provide poor kids with work experience.

But not all kids stay in school, and for them employment in a multinational firm’s manufacturing plant may be better than the next- best legal alternatives: working in domestic industries or begging. Take the famous case of soccer balls. During the 1990s, an ethics crusade was launched against major manufacturers of soccer balls, including such brand names as Reebok and Nike. Their balls were made mainly in Pakistan, often by children. Due to the outcry, the companies set up a new manufacturing facility and outlawed the use of child labor. What was the outcome? The community that once made the balls suffered when the companies quit town, with fewer job opportunities and no greater educational prospects for local workers, especially women and children.

In the environmental arena, groups such as Greenpeace have adroitly targeted corporations such as Royal Dutch Shell and discovered that the media loves its dramatic antics. Greenpeace’s war against Shell began in the early 1990s, when the oil company announced plans to bury one of its old platforms at sea. Shell claimed this solution would have less of an environmental impact on the North Sea ecosystem than would the alternative—dragging the platform back to shore and dismantling it on land—and it provided a number of independent consulting reports in support of its decision. Dissatisfied with the evidence (or perhaps just smelling blood in the water), Greenpeace began a vigorous, media-driven campaign against the operation, featuring illegal helicopter landings on the rig and similar acts of derring-do. Shell backed down and accepted the NGO’s demand to bring the platform back to shore. But it later turned out that Shell had been right all along about the environmental impact. Greenpeace eventually issued a public apology.

More recently, pharmaceutical firms have fallen under the ethical spotlight of NGOs and the global press. NGOs have demanded that these corporations provide African aids victims with drug therapies at reduced prices. But even in such a heartbreaking case, the costs and benefits should be analyzed with care. The starting point for a global discussion on aids should not be a unilateral demand for cheap drugs but a search for the most effective way to end the epidemic.

NGOs first took on their crusade against pharmaceutical companies in 1997, after a group of firms decided to sue the South African government for unfair trade practices. With 20 percent of its population testing positive for the virus that causes aids, Pretoria had passed a law allowing the import and production of cheap generic substitutes for the patented therapies then on the market. Merck, along with other drug giants, charged that the law would violate international trade rules governing property rights. The United States government initially backed the firms in this action, threatening to haul South Africa before the WTO.

But the lawsuit generated a massive amount of negative publicity and ill will, thanks in part to the advocacy of such NGOs as the Nobel Prize-winning Doctors Without Borders, which had promised to buy and distribute the cheap generic drugs. Not surprisingly, the Clinton administration responded by abruptly lifting its opposition to the South African law—a move that the current Bush administration has decided not to reverse. This past spring, after months of almost daily abuse by the press, Merck and several other pharmaceutical companies announced that they would sell aids-therapy drugs at production cost to developing countries—a classic example of damage control. Subsequently, they dropped their suit against Pretoria.

If any case supports the argument for greater corporate social responsibility, surely it is this one. Had the drug companies recognized that saving lives must come before making profits, the bold gambit of providing drugs at cost would have won them global praise. It is hard to argue against making drugs available to patients that desperately need them, regardless of their nationality or income bracket. Yet the possible adverse consequences of this decision need to be considered. If the giveaway means lower profits for manufacturers—and thus less incentive for innovation—this victory will prove a hollow one for future patients with deadly and debilitating diseases.

And who ought to subsidize the drugs sold to developing countries — pharmaceutical companies, governments of developing countries, foreign aid agencies, or charitable organizations in the industrialized world? Most advocates think that only drug firms should be responsible for shouldering these costs. But that is cynical posturing and cheap talk on the part of the world’s politicians and activists. The public health policies of many developing countries are a shameful mess, and industrialized nations put up no more than a pittance to help them. Yet only pharmaceutical manufacturers have become the scapegoat.

There are no cheap or easy solutions to the aids crisis, no matter what the drug companies do. United Nations Secretary-General Kofi Annan has called for a $7 billion fund to combat the disease, far more than the current $1 billion spent on it annually. But at the U.N. aids summit in June, donor countries pledged only an additional $700 million. Clearly, more money must be allocated for preventive health and educational measures as well as for vaccines, and those costs must be shared by firms, governments, and international organizations.

For their part, the best contribution that pharmaceutical manufacturers can make is to continue their search for effective aids treatments—which they can do only if they expect an adequate return on the investment made in research and development. Given the financial straits of many developing countries, industrialized-world governments and international institutions can help stimulate innovation by offering grants and loans to buy drugs as they become available. The recent decision to provide currently available therapies at production cost gave drug companies some public- relations cover when they badly needed it, but it would be a shame if it distracted public attention from more sensible issues such as prevention.

In fact, if the aids epidemic is to be controlled, it will require a massive educational campaign focused on sexual practices. That is the lesson of the relatively successful cases of Botswana and Uganda, where the incidence of aids declined dramatically during the 1990s. But with the prospect of subsidized drug therapies now dangling before their eyes, African leaders may convince themselves and their citizens that cheap vaccines are on the way, thereby undermining public health programs aimed at prevention. Furthermore, all the media and NGO attention being lavished on aids treatments may cause policymakers to place less emphasis on such underresearched diseases as malaria, which unlike aids is found only in developing countries.

These cases illustrate an obvious but crucial point: the issue of corporate ethics is hardly straightforward, and most policymaking involves weighing tradeoffs among social goals. Environmental degradation and the health and safety of working people are critical issues, but few experts have one single answer for how to address them. No progress can be made on these problems without a careful cost-benefit analysis of alternatives.

Getting that message out will not be easy. It will require the kind of balanced reporting that is missing from most media accounts of corporate decision-making. For their part, NGOs have little incentive to perform such impartial research, since their success lies in asserting their own solutions rather than making compromises. By shouting loudly, they have compelled business executives to reconsider their operations in several important instances. In each of the above cases, the corporate about-face was driven by a combination of NGO activism and bad publicity.

Too Close For Comfort?

In the aftermath of these incidents, NGOs and multinationals have strengthened their relationship. Having demonstrated their clout on the global battlefield, NGOs are now getting serious corporate attention. Their leaders are invited to high-profile gatherings such as the World Economic Forum’s meeting in Davos, Switzerland, and are consulted on a more regular basis. As BP tells its managers, “Don’t be afraid of NGOs. Listen to them, hear their concerns and challenges. … This is due diligence.”

Beyond their role in getting firms to alter allegedly unethical business practices, NGOs have collaborated with activist shareholders to insist on greater corporate transparency. Today, businesses are sharing more information than ever before on their human rights, labor, and environmental policies. But that deluge of information has raised the issue of how to compare practices and performance across firms. As a result, the data glut has given rise to a host of external standards, certificates, and auditing procedures in the name of “triple bottom line” or “sustainability” accounting, which goes beyond financial statements to also assess a firm’s social and environmental performance. Meeting these expensive and time- consuming reporting requirements is onerous even for large firms. A company that makes this investment must therefore make sure that it serves not only the interests of consumers, “socially responsible” investors, and NGO-based critics, but also those of mainstream shareholders. To the extent that greater transparency among firms could spark a “race to the top” for higher labor and environmental standards, the call for such standardized reporting should be widely applauded. But few benefits come without a price.

Today, firms that seek medals for their social achievements encounter no shortage of them. Validations in the environmental arena are offered by industrial groups (e.g., the European Chemical Industry Council), accounting bodies (e.g., the European Environmental Reporting Awards offered by the Accounting Bodies of European Countries), and international organizations (e.g., the International Organization for Standardization’s 14000 series). Similarly, NGOs perform “social audits” and provide advice to portfolio managers seeking to invest in “responsible” firms.

The main problem with all this activity is that it carries a high price, which someone, somewhere, must pay. Small businesses in particular could be placed in a vulnerable position, since they are likely to find the expense of these auditing and certification procedures beyond their reach. The Gap, for example, spends $10,000 a year to hire independent monitors for just one of its factories in El Salvador, a cost that smaller firms could not support.

External certification may also have ambiguous effects on local workers. Take that same Gap factory. Outside monitoring has probably led to better working conditions, but wages are virtually the same as they were five or six years ago. Might not local workers have preferred some pay raises instead, had they been given the choice? On the other hand, a company’s failure to make this investment could lead ethical crusaders to target it, possibly forcing changes in its business plans. J.C. Penney and the Target Corporation (formerly Dayton Hudson) are among the American companies that have cancelled some of their contracts with suppliers in developing countries due to labor agitation that was supported by U.S.-based unions. One wonders whether local workers are made better off as a result.

Although external certification may help promote higher environmental and labor standards, it can also take these gains away by limiting competition, strengthening monopoly power, lowering wages, and undermining economic development. These costs and benefits need to be assessed, something that the shapers of triple bottom line accounting standards—generally big corporations, NGOs, and consulting firms—have failed to do. Nobody yet knows how to improve environmental quality and working conditions without imposing heavy costs somewhere. Corporate ethicists must be careful to balance their demand for standardization with incentives for performance and process improvement, because premature attempts to standardize corporate performance could stifle badly needed innovation.

Triple bottom line accounting provides a nice example of how NGOs have managed to cash in on the ethics crusade. As both supplier and monitor of these regulations, NGOs have been able to generate significant new sources of income for their activities. American foundations, for example, have provided generous support to NGOs that seek to act as multinational monitors, and corporations are even hiring these organizations to act in that capacity—another sign of the growing symbiotic relationship between firms and NGOs.

One prominent proponent of triple bottom line accounting is the Global Reporting Initiative (GRI), which grew out of the “Valdez principles” on corporate responsibility that emerged after the Exxon Valdez oil spill. Established in 1997 by the Coalition for Environmentally Responsible Economies, a consortium of business groups and NGOs, it provides further evidence of growing NGO power in the corporate world. Working with the U.N. Environmental Program, several foundations, and 21 multinational companies, the GRI has produced a set of detailed guidelines on the reporting of environmental and labor practices. Released in March 1999 and revised in June 2000, these initial guidelines prompted plans to establish an independent GRI institution.

Accounting firms have seized on triple bottom line reporting as a lucrative source of new business. According to one of the major players in this arena, PricewaterhouseCoopers (PWC), the GRI promotes a set of “uniform standards for measuring, reporting, and authenticating” the corporate commitment to “societal responsibilities.” PWC offers its services to those companies that wish to report their results using the GRI format, and some firms have already seized the opportunity. Nike, which the press has battered for its allegedly low labor standards in developing countries, is among the companies that have used PWC to monitor working conditions.

But ethical reporting is hardly a panacea. According to Dara O’Rourke, a professor at the Massachusetts Institute of Technology who accompanied PWC on some of its inspections of Nike plants, the auditors ignored hazardous chemical use, barriers to freedom of association and collective bargaining, violation of overtime and wage laws, and other infractions. O’Rourke concluded that the firm’s monitoring methods are “significantly flawed.”

Cynics should not be surprised by these failings. After all, auditors value their corporate relationships. So should ethical accounting be dismissed as another public-relations charade? Not necessarily—O’Rourke was invited along for the ride, after all. The bigger problem with triple bottom line accounting is its high price tag and the growing coziness between NGOs and large corporations, whose ethical efforts could impose costs on those least capable of bearing them.

Rules of Engagement

Where have governments been in the business ethics debate? On the one hand, they have defined the debate’s parameters, since a nation’s regulatory regime establishes the legal bottom line for corporate social responsibility. On the other hand, they have been hamstrung by a process that is unfolding largely outside traditional political frameworks. One of the more unexpected aspects of the ethics movement is that it has found direct action focused on big business to be more effective in altering corporate behavior than indirect action focused on government regulation. Bypassing the state is easier than influencing it.

To be sure, heads of state have routinely used their offices as bully pulpits, calling on the corporate world to serve the public interest as they define it. But being successful at that game takes a level of moral standing that few national political leaders currently possess, especially given the preponderant role of big business in financing election campaigns in the United States and elsewhere. It is unlikely that Italians, for example, will look to their scandal- plagued prime minister, Silvio Berlusconi, for lessons on corporate ethics.

Sensing this moral gap, Annan has cleverly defined a new role for himself. He is especially well positioned to define the meaning of capitalism with a human face. And given the extraterritorial nature of many ethics disputes, from labor conditions to pollution, it is not surprising that international organizations view corporate social responsibility as a growth industry. Annan has used his bully pulpit to mediate some of the high-profile conflicts between countries and firms. Most prominently, he is widely recognized for his work in helping pharmaceutical companies and the South African government reach an agreement on aids therapies.

The secretary-general has sought to establish a moral framework for multinational corporate operations through the U.N. “Global Compact,” which he launched last year at the annual Davos meeting of the World Economic Forum. The compact asks the world’s largest firms to subscribe to nine core principles in the areas of human rights, labor rights, and the environment. Drawn from existing U.N. agreements, these principles are claimed to be universal. Recently, Annan asked the former chairman of the Swedish multinational ABB to help him get other firms to sign on. But Annan’s credibility is undermined by his failure to criticize those U.N. member states that fail to uphold their own international obligations. China, for example, violates the core labor rights of free association and collective bargaining, and Myanmar shrugs off the ban on forced labor. Given this state of affairs, it is not surprising that NGOs have found it more productive to go after corporations directly rather than through the U.N. system.

Although the U.N. Global Compact is the most prominent international code, it hardly stands alone. In the wake of the MAI debacle, for example, the OECD sought to salvage its efforts by revising its long-standing Guidelines for Multinational Enterprises. These provide rules for multinationals in a variety of areas, including corruption (don’t engage in it), science and technology (transfer it), and taxation (pay what you owe). They have the benefit of being more detailed than the Global Compact, but their legitimacy is weakened by the fact that the OECD has no member states from the developing world.

Despite the political appeal of setting global codes of conduct, the most significant contribution that international organizations can make to the corporate ethics debate is to analyze proposed solutions impartially. They could, for example, perform a great public service by evaluating proposed changes in labor and environmental standards according to their costs, benefits, and likely distribution of winners and losers, because few sources of impartial information are currently available for guiding global discussions.

Finally, chief executives face a nearly impossible task in this new age of corporate social responsibility. Beyond satisfying their shareholders, consumers, and employees, they face a growing number of NGO-based watchdogs as well. The law still compels them to maximize shareholder value, but the number of variables that could influence the bottom line seems to be increasing at an exponential rate. The impact of this change is hardly neutral. In many cases, it could hurt the supposed beneficiaries of multinational investment, such as developing countries and unskilled workers. Executives concerned about such unintended consequences will need to speak out.

With few exceptions, corporate executives are invisible to the average consumer. That anonymity is likely to end as corporations face the harsh light of public opinion, and managers must use this new publicity wisely. Corporate leaders need to recognize that the ethical future is up for grabs. Although some executives might argue that they can do little to shape their business environment, they still have a responsibility to their shareholders and to society to bring the self-declared ethicists to heel when necessary instead of caving in to their demands.

Executives may still cling to the hope that the current focus on corporate social responsibility will simply fade away. A prolonged economic recession or slowdown could derail the movement as public and managerial attention turns to more immediate pocketbook issues. When individual firms encounter hard times, they tend to focus on the financial bottom line; jeans manufacturer Levi Strauss—an ethical star but a financial disappointment—provides a telling case in point. It recently appointed a hard-nosed executive to help improve its bottom line. But the corporate ethics crusade is not likely to soon disappear and may even be gathering momentum.

Grappling with poverty, inequality, gender discrimination, child labor, and environmental pollution are serious matters that rarely allow for easy solutions. Meeting these challenges will require the mobilization of huge sums of financial and intellectual capital, coupled with sound cost-benefit analysis of the policy alternatives. Here is where the ethics movement, with its moral certainty, has failed to live up to its potential as a positive force for change. By focusing attention only on issues that tug at the heartstrings of wealthy consumers, it has left aside those matters that may be even more critical to global economic development, such as the role of multinational firms in technology transfer and human-capital formation. It has also dismissed the ultimate importance of governments in shaping a country’s regulatory climate, believing instead that it represents some transcendent national or global interest in higher labor and environmental standards. Now that the ethics crusaders have assumed such prominence in the world, they must reconsider their responsibilities to those for whom they purport to fight.