Do the economics of Corporate Social Responsibility matter for Private Sector Interventions?

Corporate Social Responsibility (CSR) has attracted significant discussion and controversy since the times of Milton Friedman’s famous 1970 NYT article stating that the only social responsibility of firms is to maximize profits. However, the conclusion that CSR automatically is in conflict with profit maximization or strategic firm behavior and therefore should be reduced either to a market failure or some form of altruism turned out to be incorrect. Quite the opposite: my article in the Journal of Economic Literature jointly written with Jay Shimshack not only shows that CSR constitutes an economically important phenomenon that may well be strategic (i.e. profit maximizing), but also argues that, when concisely defined¹, CSR can be efficient. In other words, it can be a viable private channel of public goods provision and a formidable complement or even alternative to classic government intervention.

Development institutions such as the World Bank Group stress that the private sector has an important role to play in the development of an economy, however, the supply of environmental, social or other goods (or the curtailment of bads) with public character is believed to be government and rule rather than market-driven. But what happens when governments and rules fail to provide these goods and services? While, it appears that markets and corporate behavior won’t be able to reach a social optimum e.g. when it comes to pollution or renewable energy levels, they often can do better than governments. In the short and middle term, CSR can be welfare optimal. Eventually improved public politics and CSR may even be mutually reinforcing elements in the longer run.

Given the fact that institutions and the formal regulatory environment in developing and emerging market economies often are limited or capacity-constrained, CSR may play an especially important role in the development context. What, then, are the key incentives that induce firms to engage in the provision of public goods beyond legal requirements? The main drivers of CSR identified in the empirical literature are consumer markets as well as private and public politics (as opposed to induced innovation, moral hazard, labor markets or shareholder preferences). Whenever sufficient information about the nature and quality of both the production process as well the product itself is available, consumer preferences and their willingness to pay a price premium do the trick. On the other hand, in a dynamic environment, the threat of a consumer boycott, an activist campaign pointing out bad behavior and even expected tightening of regulation drive corporate strategy towards hedging against reputational and financial risks through CSR.

Ultimately, CSR may play an important role in an international context. Developing and transitional economies typically have limited formal regulation when compared to developed markets, while firms are becoming ever more global. Coordination problems across countries weaken the role of government provision of global public goods, suggesting that CSR may gain a comparative advantage. Disparate locations between production, consumption, and ownership establish an elevated role for preference-based CSR mechanisms. Consumers in developed countries may influence the environmental and social performance of firms operating in the developing world. A necessary condition for CSR mechanisms to operate across borders is information, and the costs of information acquisition and processing may be increasing due to geographic and cultural distance. There may be trade-offs between cost-motivated outsourcing and firm reputation--such as the backlash from labor-related allegations toward Nike operations in Southeast Asia.

In this context, the empirical literature focuses on political mechanisms for strategic CSR, and results generally support a role for politics in developing country contexts. Community characteristics such as education, income, and voter turnout proxy for legal institutions, political organizational ability, freedom, information accessibility, and NGO presence and often drive CSR. A positive correlation between local income and education and firm environmental performance is evident. In India, for example, voting rates and literacy turn out to be positively correlated with water quality. Public firm ownership shields firms from community activism, while the number of community complaints or firm-community agreements affects abatement expenditures in Korea. Capital markets in Argentina, Chile, Mexico, and the Philippines react to citizen complaints and high profile environmental spills, while managers of Chinese firms report that community and NGO pressure is the most important driver of changes related to social behavior like innovation or greening of the supply chain. Also, expanding formal regulations with extensive monitoring and enforcement may drive environmental performance, e.g. Korean regulators appear to engage in a tit for tat strategy with firms, where facilities that perform well are  rewarded with more lenient regulatory oversight and treatment.

In a nutshell, the economics of CSR should be seen as a valid, important and dynamic research area with great potential for integration into the World Bank Group’s strategy and operations. Given our unique access to data, the aim must be to test and develop theoretical and preliminary empirical insights to eventually be able to fully exploit the benefits and complementarities of private sector development.

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¹As the corporate provision of public goods (ranging from reducing environmental externalities or pollution to setting new and advanced social and labor standards or financial stability) beyond legal/regulatory requirements