Stakeholders and Going Beyond Profit Maximization

The right framework

^Governments have to stop pretending that they can exhort people to make changes when the prices people pay tell them otherwise*^

Simon Upton, chairman, OECD Roundtable on Sustainable Development

Badly framed markets cannot encourage sustainable progress. In its 1992 report to the Earth Summit, the then BCSD called for.

• A steady, predictable?- negotiated move toward full-cost pricing of goods

and services

• The dismantling of perverse subsidies

• Greater use of market instruments and less use of command-and-control

regulations

• More tax on things to be discouraged, such as waste and pollution and less tax on things to be encouraged, such as jobs (in a fiscally neutral setting)

-• More reflection of environmental resource use in .standard national accounts

Other bodies, such as the US President's Council on Sustainable Development, made similar calls. Yet there has been very little political support for such moves from gov- ernments, civil-society organizations, or, frankly, most of business. If basic framework conditions push us all in the wrong directions, then that is the way society will go— until extreme, vociferous forces compel a change.

Other conditions for sustainable development include:

9 Democracy and the accepted rule of law

• Effective intellectual and physical property rights

« Reliability of contracts

2. THE RIGHT FRAMEWORK 59

• Lack of corruption

• Equitable trade terms and respect for comparative advantage

• Ordered competition among businesses

• Fair and transparent accounting standards

• Accountability and predictability of government interventions

e Investment in education and enabling technologies

• Reform of taxation so that it funds collective investments rather than penal- * izes income

There has been progress in many countries in some of these areas. The World Commission on Environment and Development (WCED 1987) listed as

preconditions for sustainable development:

• Access to information

0 Access to decision-making

• Access to justice

These are also framework conditions for economic development. These and the other conditions listed above tend to attract investment. Nations simply cannot compete effectively in international markets if they deny any of their people these rights of < access based on their sex, race, religion, ethnicity, or culture.

We do not intend to wait for perfect conditions before pursuing more sustainable, development. We do, according to our mission statement, intend to work with gov-. ernments and civil-society organizations to 'promote the role of eco-efficiency, inno- vation and corporate social responsibility toward sustainable development' (WBCSD 2001 h).

Many companies are willing to be held accountable for their actions and are work- ing to be more transparent. They expect governments and civil-society organizations also to become more accountable and transparent.

The framework In 1994, BCSD members Roberto de Andraca of the Chilean holding company CAP SA and Ken McCready of the Canadian utility TransAlta found that, despite their very different origins and types of business experience, they were so in agreement about how markets ought to work that they wrote a Council report about it: Internalizing Environmental Costs to Promote Eco-efficiency. Their conclusion was that companies can go only so far in delivering sustainability; sooner or later they are constrained by the policies and framework conditions governing their operating environment: 'While businesses can do much to encourage eco-efficient practices in their operations, they are ultimately limited by the government-established policy and regulatory frame- works within which they operate' (de Andraca and McCready 1994: 7).

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Optimum frameworks would have as their core objectives the generation of eco- nomic value, the regeneration of the environmental resource base, the reduction of poverty and inequality, and the improvement of standards of living — all within an open and accountable system of governance (Robins 2000: 56). Chief among the characteristics of a sustainable development market framework, according to the OECD (2001 b: 48), are long-term planning horizons, appropriate pricing, delivery of public goods, cost- effective ness, environmental effectiveness, policy integration, pre- caution, international cooperation, and transparency and accountability.

Ideally, market frameworks should reflect a nation's sustainable development strat- egy. However, few nations have such strategies, and most market frameworks have grown up ad hoc and uncoordinated through years of scuffling by special-interest groups. Most existing regulatory and policy frameworks are awkward hybrids of policy tools that do not serve the sustainability strategy and of outdated, entrenched instruments that serve instead as barriers to change. This sends the wrong signals to market players and perpetuates unsustainable practices. If markets are to deliver sustainability, this policy and regulatory architecture must be overhauled and stream- lined to encourage behavior that fulfills, not hinders, the aims of this strategy.

In addition, to ensure the market mechanism is harnessed in favor of sustainable development, these instruments should establish the full-cost pricing of goods and services, personal security, freedom, and democracy (see also Table 1).

. Back in 1 994, de Andraca and McCready called on governments to integrate more flexible, market-based approaches into their national sustainable development strate- gies. Persistent framework problems were hampering the market's ability to deliver more environmentally sound forms of production and consumption. To correct these, de Andraca and McCready (1 994: 8) advocated the use of economic instruments, tax shifts, the intern a I ization of environmental costs, the reduction and removal of harm- ful subsidies, the encouragement of voluntary agreements with industry, the reform of existing regulation, and an expanded program of education and information to enhance public understanding of the issues. By resorting to a combination of such tools, governments could ensure that environmental values were efficiently and cost- effectively integrated into the market.

During the 1 990s a number of new social and developmental issues moved quickly up the business agenda — new views of corporate social responsibility/ the need to address the developmental needs of the South, and the question of how to tackle the gap between the 'haves' and 'have-nots'. As a result, designing the right framework has become not simply an issue of ensuring greater eco-efficiency but a complex balancing act of securing progress across the economic, social, and environmental bottom lines — without cluttering the market with rules and regulations that hamper efficiency.

In designing the right frameworks for sustainability through the market, national governments need to operate more effectively on multiple levels: the global, the regional, the national, and the local. Although this does not alter the fundamental characteristics of a sound policy and instrument mix, it does make the task of streamlining and dovetailing different tools more complex.

2. THE RIGHT FRAMEWORK 61

Legislation and regulations should promote:

Competition among enterprises

Effective intellectual and physical property rights

Reliability of contractual terms

Fair and transparent accounting standards

Accountability of government intervention

Predictability of government intervention

Freedom and democracy

Full-cost pricing of goods and services

Otherwise. . .

Innovation and productivity will lag, resources will be used inefficiently, and quality of life will stagnate

There will be no benefit for those who develop better more sustainable, products and services

Fraud and short-sightedness will pervade, challenging economic and social equity

Corruption will thrive, draining resources from the economy and increasing the gap between the rich and the poor

Perverse subsidies will encourage unsustainable practices

Entrepreneurs who could create jobs and wealth will be deterred from investing

Social exclusion will grow

Undervalued resources will be wasted

Table 7 MARKET FRAMEWORK BASICS Source: Holliday and Pepper 2001: 29

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So what policy tools are needed to create a market that encourages sustainable development? To encourage companies to go beyond regulatory compliance, the WBCSD has long advocated the greater use of market-based instruments such as taxes, charges, and tradable permits that reward sustainability-oriented behavior and dis- courage pollution by making the polluter pay. Regulations, necessary as they are in so many cases, are like requiring everyone in a school class simply to pass an exam; good economic instruments encourage everyone toward excellence. Such instru- ments have a number of advantages over other command-and-control regulations: cost-effectiveness, a lower administrative burden, greater flexibility in the choice of means, and stronger incentives for improvement and innovation. In addition, eco- nomic instruments tend to increase transparency, are more easily adaptable than regulation, can be harnessed to achieve multiple objectives, and, critical for competi- tion, pose less of an obstacle to market entry (de Andraca and McCready 1994: 45- 47).

The most important feature of market-based instruments is that they harness companies' creativity and self-interest to achieve environmental and social objectives. The flexibility inherent in market-based instruments plays to the strengths of busi- ness—namely, competition, creativity, and innovation—harnessing these qualities in tne searcn for solutions. Less-flexible, regulatory approaches can stifle innovation, removing the incentive for continuous improvement and can result in technological lock-in.

The optimal mix of policy instruments for sustainability is listed in Box 2. Key actors need to form policy partnerships to make instruments work. On their

own, economic instruments will not stimulate change where informational, structural, "and politicaPobstacles impede them. Market instruments, regulation, and voluntary initiatives each have their role to play, but any sound mix of these needs so-called horizontal measures that support their use. These include education, capacity-build- ing, infrastructure, institutional and regulatory reform, and the empowerment of citizens and consumers to play their part in shifting markets toward' more sustainable forms of production and consumption. Most importantly, governments need to work with key actors to streamline government policies and dismantle those policies and instruments that hinder sustainable development.

Sending the right signals is a good start, but changing market behavior also means changing culture and attitudes. Effective policy partnerships, together with the approaches discussed above, form what the WBCSD has dubbed a 'smart' hierarchy of policy tools (see Box 3). Within the right framework, an optimal combination of command-and-control regulation, economic or market instruments, and voluntary initiatives or self-regulation by business, combined with horizontal support mechan- isms such as education, information, and research, are by far the best means to achieve sustainable development objectives through the market (Schmidheiny 1992: 19).

Ultimately, the choice of tools will also be guided by administrative feasibility, politi- cal acceptability, and by the urgency, nature, and complexity of the problem being addressed. As Figure 4 indicates, there is a policy continuum whereby the choice of tool can be seen to evolve in keeping with the nature of the issue being addressed.

2. THE RIGHT FRAMEWORK 63

An optimal mix of policy instruments should be determined by:

• Environmental effectiveness

• Economic efficiency

• Flexibility of response

« Administrative .feasibility

». Confidence in the regulatory environment

o Gradual introduction and progressive implementation

« Fiscal neutrality

• Equity and a level playing field

e Transparency of compliance

• Acceptability

e Simplicity and complementarity

• Shift from 'goods' to 'bads'

Box 2 INSTRUMENT CHARACTERISTICS

Sources: de Andraca and McCready 1994: 49; Schmidheiny 1992: 29-30

0 Voluntary initiatives should be preferred, since these often provide the most flexible and/ultimately, overall most cost-effective way to achieve a desired result.

a Negotiated agreements can provide high operational flexibility if focused on what is required rather than on how it is to be achieved.

« Economic instruments can provide incentives but must be carefully designed to avoid unintended, unwanted consequences—such as the creation of perverse subsidies.

o Command-and-control regulations are needed to outlaw unsafe and'unaccept- able behavior and to provide the framework within which innovation can flourish. Alone, however, they cannot deliver continuous improvements, since the most effective solutions cannot be predicted or prescribed in advance.

Box 3 THE 'SMART' HIERARCHY OF PUBLIC POLICY TOOLS

Source: Holliday and Pepper 2001: 33

*"• *

^Innovator

Market shaper

, Compiler,

.__.._—,_ I Laggard " Free-rider

Performance excellence

Competitive drive for resource productivity

< " Eco-efficiency

Standards

Process and product standards create preference toward performance

targets and eliminate the old ways

EU energy labeling

Regulation

Performance targets set by law; enforcement bans processes,

products and fines infringement

Montreal Protocol

Eco-taxes

Additional taxes levied on use of resources, either via producers or

directly on consumers

UK landfill tax

Public-private ventures

Government supports research and capital investment to meet voluntary

business targets

Cf" US EPA Waste Wise

Consumer incentives

Information, purchasing discounts, or exchange schemes change

consumer behavior

Solar energy credits

Performance targets

Government, business, and stakeholders agree on performance

targets and deadlines

AISE Code "

Covenants

Negotiated targets are binding; failure to perform would trigger

command-and-control legislation

Dutch Packaging Covenant

Substitution is price-sensitive

Complex: requires new approaches

_J