Tuesday, May 4, 2010

Oil spills and externalities

What does business owe the world? OK, now that's a pretty big question. Where do you even begin to start the long list of demands and grievances that are stacking up against the corporate world? But this is the question that the Harvard Business Review has posed in a new online debate launched a week or so ago. It's a provocative starting point, and not simply (as some might have expected from HBR), an excuse to really ask 'What, if anything, does business owe the world?'.

With uncommon good timing, the debate kicked off with a lively exchange of blogs from invited contributors on the issue of externalities, and whether the internalizing of externalities - or moving from external to internal (e2i) costing of social impacts - is an appropriate expression of corporate responsibility. We say good timing because just as the first part of the debate was drawing to a close, the US began to experience one of its worst oil spills in history in the Gulf of Mexico. Now pollution is a standard example used to explain externalities - i.e. it imposes costs on those not party to the original transaction. So it is little surprise that the 'blame game' regarding responsibility for the current spill has already started. Obviously though, because this is the result of a specific accident rather than just standard run-of-the-mill everyday pollution, the questions over whether BP, the rig's owner and operator, should be held responsible are somewhat more straightforward. It should. US President, Barack Obama has said as much. In the discussion around whether firms should e2i, we need to consider social and environmental costs imposed on others from 'normal' business activity, not just accidents. So the question then becomes, should BP take responsibility for the impacts of its products (e.g. the pollution caused by burning its gasoline), for example by adopting a pricing model that accounts for the full environemntal costs of petrol.

The HBR debate seeks to tackle this question head-on. The first post is written by Chris Meyer and Julia Kirby and stems from their April HBR article arguing that companies indeed should focus on externalities. Or as they put it, "the true measure of corporate responsibility—and the key to a business’s playing its proper role in society—is the willing, constant internalization of externalities." This is nothing new in itself. A focus on externalities has been a feature of the CSR debate for some time. In fact in our CSR textbook, published a couple of years ago, we specifically identified "Internalizing or managing externalities" as one of the 6 core characteristics of CSR. So in one sense it's kind of disappointing that HBR is passing off standard business school textbook material as a "Big Idea". That said, the article (and blog) do accomplish an important task in bringing these ideas into the mainstream, and in a way that is readily digestible by executives. They also do a good job in stirring up some important debate on whether this is indeed the right way to go about CSR, and about how it can be practically accomplished.

Of course, the proposition that firms should consider e2i remains for some a distinctly controversial idea. In the HBR debate, Michael Schrage provides a lively, if slightly scatty, account of why in fact it's "the road to hell". In doing so, he makes some good points - and probably captures the understandable fears of many in the business community. But in presenting "the natural conclusion" of the e2i philosophy - that businesses become accountable for every social impact, however indirect, of their actions - his argument becomes somewhat shrill and reductionist:
"If everything is increasingly interrelated — and it is! — then who won't be aggrieved? Who won't be wounded? Who won't be disadvantaged? Who won't be harmed — or see themselves as harmed — in some meaningful way? What won't be an externality to some third party?"
Yes it's true that once you embark on a path of acknowledging some kind of responsibility for the 'side effects' or 'spillovers' of economic actions, it is difficult to determine a clear line in the sand beyond which you no longer have responsibility. But the point is that no one is saying that firms are responsible for ALL externalities, only that focusing on externalities helps identify those impacts where responsibilities are most critical, and where market mechanisms, namely pricing, can be leveraged to institutionalize that responsibility. It is intereting in fact that Schrager argues that e2i is about more government interference whereas in fact it is a market alternative to regulation. That is, rather than governments dealing with all the problems caused by economic activity, you make companies and consumers more responsible for their own actions by establishing a mechanism whereby the true costs of their activities are factored into the market price. It's no different from establishing a price for carbon, which is one of the best known recent examples of e2i pricing.

That a debate on externalities should provoke a row over government interference is perhaps not completely surprising given the orientation of HBR ... and the fact that their invited experts, for all their starry credentials, are all based in the US. It is hardly the best recipe for starting a conversation on what business owes the world (as opposed to say, what US business owes the US). Some different voices from other parts of the globe would be sure to enrich the debate (...so if that is you, then do take the opportunity to add your comments to the blogs). And you never know, with HBR's timing, by the time the debate gets to its final week's subject of "Are activists out of bounds?" we might have another very real case to discuss (... any activists reading this, now would be a great time to get "out of bounds"!)

Photo by NASA Goddard Space Flight Center. Reproduced under Creative Commons licence

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