Stakeholders and Going Beyond Profit Maximization

2. THE RIGHT FRAMEWORK 65

This figure shows, moreover, what type of business strategy each choice of tool is likely to favor. In addition to these considerations, instrument choice should be guided by equity and by the need to create a level playing field and to promote more open and competitive markets.

Non-market measures Non-market measures are needed to support the market measures, especially in developing countries and economies in transition to market systems.

Niall RtzGerald (2001 b), chairman and CEO of the Anglo-Dutch food and home products company Unilever, maintains that in addition to market liberalization 'the means and the will to provide schooling, prevention-oriented healthcare and stable legal regimes for individuals and property rights rank as high'.

For developing countries lacking the resources and institutional infrastructure to implement and enforce complex regulatory systems, market instruments offer a promising alternative (Panayotou 1992). But the pacelind manner of their introduc- tion will be critical in determining their success. Before such'instruments are adopted, adequate governance structures must be in place and the capacity-building and institution-strengthening necessary to the smooth functioning of the market must occur. • •

So, in addition to fiscal and economic measures such as full-cost pricing/ tax reform, subsidy shifts and elimination, and the creation of sound property rights, we believe that a number of fundamental social conditions must prevail: democracy and governance, human rights, the elimination of bribery and corruption, and greater transparency and accountability. These are dealt with in the following sections.

Fyli-cost pricing S •at'

Full-cost pricing can be a frightening concept. First, that term 'full cost' makes it sound very expensive. Second, the implications are unsettling: in places where water is scarce and costly for a government to provide to its people, must it be priced so high that few can afford it?

Full-cost pricing is not necessarily expensive nor does it place resources out of the reach of the poor. It is not some fixed mathematical goal but a direction of move- ment. It is also the most fundamental way, and the most cost-effective way, in which the market can encourage, rather than discourage, sustainable development. De Andraca and McCready (1994) concluded that 'increasing the visibility of all costs associated with waste and pollution will encourage businesses to design products and services that reduce impacts on environmental systems and add value for consumers'.

The policy framework implications of such costing are twofold, according to Ger- many's Wuppertal Institute. First, at the micro-economic level, environmental 'exter-

66 WALKING THE TALK

•wi

nalities'—namely, the neglected social costs of environmental damage—must be 'internalized' into business and consumer budgets to encourage more sustainable production and consumption patterns, through the application of pollution charges, tradable pollution permits, fees for natural resource use, or by establishing property rights over natural assets (Bartelmus 1999). Second, at the macro-economic level, governments should establish what the Wuppertal Institute dubs 'environmentally adjusted aggregates', such as a green GDP or satellite accounts, like the Yale sustain- ability indicators or indexes launched by the World Economic Forum (WEF) in 2001. UNDP's composite human development index (HDI), meanwhile, addresses the social aspects of sustainability. Complementing traditional economic indicators with social and environmental factors in this manner would improve macro-economic policy- making by integrating social and environmental values into decision-making, and allowing governments to benchmark progress toward or away from their sustainable development objectives.

There has been some progress over the past decade. A 1992 OECD survey of market-based instruments found some 169 instruments in use across 23 countries. Most common among these were product taxes (e.g. on packaging and fertilizers) and deposit-refund systems (e.g. on glass bottles and aluminum cans) (Pearce and Barbier 2000:1 70-73). Since 1992, the rationale of economic instruments appears to have been broadly accepted, at least in theory; but governments have a hard time integrating such tools into existing legislative contexts (Pearce and Barbier 2000: 209). The increased cost to a consumer or to a company of such an instrument is immediate and obvious, but the savings to society are not so immediate or obvious. So such changes are resisted.

Thus/ overall progress in appropriately costing resource use and pollution and adjusting national accounts has been slow. UNEP (1999: 206) reported in its Global Environmental Outlook 2000 that 'the Earth Summit placed great stress on economic incentives as a means of making production and consumption patterns more sus- tainable, but despite pleas for more use of market-oriented instruments, increase in the use of such instruments has been limited'.

Full-cost pricing and full-cost accounting have not been widely adopted, and environmental and social values remain largely excluded from the most fundamental of market tools—the pricing mechanism (see Figure 5). The result is that markets are still essentially failing to reflect the true cost of production and consumption. One salient consequence of this failure to price natural resources accurately is that vital environmental commons such as fresh water, ocean fisheries, and the atmosphere continue to suffer from overuse, depletion, and escalating concentrations of carbon dioxide.

Another problem is that in this competitive world a company that might want to embark on such a full-cost pricing journey cannot do so unilaterally. The goal must be to encourage whole market segments to change so that supportive companies are not doomed to unfair competitive disadvantage.

Lack of progress is partly a result of the theoretical difficulties inherent in valuing natural resources, services, and sinks. Attaching a value to nature is both complex and controversial and, although efforts are underway to develop frameworks for the inter- nalization of external costs, these have yet to be harmonized and widely adopted. As argued a decade ago in Changing Course (Schmidheiny 1992: 16), however:

2. THE RIGHT FRAMEWORK 67

Companies barely internalize the financial implications of environmental policies and measures

20

% of 996 companies surveyed

40 60 80 T O O

All industries

Basic materials

Consumer, cyclical

Consumer, non-cyclical

Energy

Financial

Healthcare

Industrial

Technology and telecommunications

Utilities

v A

T A

T A

T A

T A

T A

T A

T A

T A

T A

T Environmental profit and loss accounting to some degree

A Environmental accounting influences product pricing to some degree

Source:

• Only T O ! companies conduct a systematic financial analysis of their environmental policies and measures

• 39 state that their 'environmental accounting' influences certain product pricing measures

Figure 5 ADOPTION OF ENVIRONMENTAL ACCOUNTING

the lack of accuracy in determining the actual and future costs of pollution should not allow us to conclude that no price can be established at all. As individuals set prices for privately owned goods, society must establish through political processes prices for the use of goods held in common: waters, atmosphere, and so on. This work must be based both on the best

• available scientific evidence and on people's preferences and choices.

Simon Upton, former New Zealand environment minister and now chairman of the OECD Roundtable on Sustainable Development, calls on his fellow politicians to find more political will for the issue. He states that 'governments have to stop pretending that they can exhort people to make changes when the prices people pay tell them otherwise' (Upton 2001:1 3). The European Environment Agency (EEA 2001: 12) acknowledges this, admitting that a 'fair and efficient pricing' policy for the European Union (EU) 'is far from being achieved; road and aviation in particular, the modes with the highest external costs per transport unit, thus receive an implicit subsidy from society'. To deal with this, the Commission of the European Commu-

I1:

70 WALKING THE TALK

• Fiscal neutrality. If environmental taxes are established, other taxes should be reduced to prevent over-taxation.

• Credit for early action. Companies that take voluntary early action in environ- mental impact reduction should not be put" at a competitive disadvantage by subsequent regulatory action.

« Border tax adjustment. Trade in goods and services should not be unduly affected by the tax policies of specific nations.

• Transition mechanisms. Temporary mechanisms are required during changes in market structure in order to avoid negative social, economic, and environmental consequences.

• Adequate phase-in time. A transition period should be allowed for to avoid undue impacts on infrastructure industries with long lead-time investment obligations.

Box 4 DESIGN CRITERIA FOR ENVIRONMENTAL TAXATION Source: Holliday and Pepper 2001: 34

Australia, and South Africa have all gone some way toward removing subsidies in the water sector. Indonesia, Bangladesh, and Hungary, meanwhile, have achieved size- able savings in government spending through removing pesticide, fertilizer, and irrigation subsidies (Panayotou 1998: 69-70).

The days may also be numbered for distorting subsidies on the world's fisheries, since Australia, Iceland, New Zealand, Norway, Peru, the Philippines, and the USA, which take some 25% of the world's marine fish catch, have called for the WTO to oversee reform of the sector's subsidy regimes. It is a move welcomed by Ross Tocker, general manager of operations at Sealord Group, the largest fishing quota holder in New Zealand, who has urged the eradication of incentives for vessel overcapitaliza- tion (Tocker 2001), and by Volker Kuntszch, buying director of Frozen Fish Inter- national, owned by Unilever. Says Kuntszch (2001: 6):

We've set ourselves the goal of buying all our fish from sustainable sources by 2005, [but] this goal will be difficult given fish stock declines. I'm con- cerned that some policy-makers and other stakeholders remain unaware of the fish stock crisis—and 1 strongly question the value of subsidies for this sector.

Subsidies may be of some help toward sustainable development, though that is a controversial notion. As Pearce and Barbier (2000: 156) have ob'served, 'investing in new and clean technology is risky. Subsidy payments could greatly assist the reduc- tion of those risks, stimulating further output of renewable/nuclear energy, and further environmental benefits.' In the USA the senate of the State of Michigan passed a package of bills in 2001 aimed at helping low-income families install energy-efficient appliances. In Germany, parliament agreed to increase subsidies to solar, thermal, biogas, and geothermal energy in 2002 from the equivalent of $135 million to $180 million (Reuters 2001: 422).

2. THE RIGHT FRAMEWORK 71

Many natural resources are undervalued in our market system, and many ecosystems services are provided forfree. As markets depend primarily on price signals to function correctly, these resources are frequently wasted or overused, since their depletion or dysfunction are market externalities, and consumers rarely value what they use for free (Holliday and Pepper 2001: 35).

Economists Pearce and Barbier (2000: 1 66) have identified four different types of property right: private ownership, state ownership, common ownership, and open access (in which access to the resource is open and free to all). Of these, the first is most likely to favor sound resource stewardship, since private owners will seek not to despoil their asset. The last, on the other hand, is most likely to increase the risk of rapid resource exploitation, since individual users have an incentive to extract as much personal value as possible over as short a time as possible in competing with other users, even at the cost of depleting the resource. Establishing and enforcing effective property rights is therefore a vital step in the creation of a properly valued market for environmental goods and services, argue Pearce and Barbier. An appro- priate and effective system of ownership 'will lead to greater incentives to conserve natural resources at the local level' (2000: 169).

This theory is borne out by experience in the fishing industry, where lack of defined property rights has been widely blamed for extensive over-fishing of the.marine commons. Both in the US North Pacific and in New Zealand's fisheries, the problem of fish stock depletion has been tackled through the use of tradable quotas, or property rights. Under New Zealand's quota management system (QMS), introduced in 1986, the government decides each year what quantity or total allowable catch (TAG) of all quota species may be caught by commercial and non-commercial fishers. Commercial operators such as Sealord, which is the largest quota holder in New Zealand, each receive an individual transferable quota (ITQ), which they can fish, sell or lease to other operators. This approach, says the company, 'is actively supported by the New Zealand fishing industry. . . [It] gives the industry security of access, coupled.with flexibility, and encourages seafood companies to look after their assets' (Sealord 2001).

According to Ross Tocker (2001: 6-7), general manager of operations at Sealord Group, the New Zealand property-rights quota system has helped establish sustain- ability as a key corporate objective, resulting in voluntary industry initiatives, such as a code of practice to avoid catching fur seals:

Allocating property rights ensures that sustainability becomes a priority for the owner of the right—namely, the company—as well as for government. If there's no property right, then individual businesses simply compete for fish with other companies.

Property rights are just the first step in creating a market for natural resources. As we argue in Chapter 9, .creating an effective market requires the clear definition of objectives, performance measurements, establishment of an exchange, capping and trading. It needs effective monitoring, penalties and enforcement for non-compliance, and should include performance objectives to reduce free-riders. Above all, it requires good governance, which is discussed below.

72 WALKING THE TALK

tm

To work efficiently, markets need rules and enforcement mechanisms and they need organizations and institutions promoting market transactions. Chief among these are an effective governance framework, transparent and unbiased legal and judicial sys- tems, an efficient financial regulatory system, and a social safety net (World Bank 2002: 1). To work sustainably, they need, in addition, cohesion, inclusivity, and long- term vision. Without accountable government and effective institutions, sustainable development is impossible.

Governance is the exercise of administrative, economic, and political authority over a nation's, or a company's, affairs. According to the OECD (2001 b: 246), it requires, along with the rule of law, 'predictable, open and transparent policy-making, a professional bureaucracy, an executive arm accountable for its actions and strong civil society participation in public affairs'. Sustainable development needs strong political leadership. It means committing to a long-term vision, a new approach to policy- making and negotiating difficult trade-offs between conflicting interests. And, beyond 'putting one's own house in order', it means becoming a responsible partner in a globalized world (CEC 2001).

Harvard University's Theodore Panayotou (2000) is firm about the link between good environmental stewardship, wealth creation and improved governance:

As long as property rights remain ill-defined and insecure, as long as pollut- ing inputs and extractive industries are being subsidized, as long as polluters free-ride on the environment and users of public services free-ride on the treasury, and as long as the dynamics of private sector and the spirit of civil society are bureaucratically constrained from making their full contribu- tions, current trends cannot be reversed and the gap between economic and environmental performance will continue to grow.

He adds that:

only a policy paradigm shift can put the developing world on the fast track to environmental recovery that parallels its fast track of economic growth. The new policy paradigm involves less government bureaucracy, an enhanced role for the private sector and civil society, and the aggressive pursuit of untapped win-win policy reforms and high-return investment opportunities that would result in both environmental and economic gains.

In societies where these elements are ineffective or lacking, progress toward sus- tainable development and participation in global markets will be hindered. 'This is a barrier we impose upon ourselves/ says Eugenic Clariond of Grupo IMSA in Mexico, 'It's a consequence of our own mismanagement. We have very inefficient bureau- cracy; there's corruption and red tape. To incorporate a corporation in Mexico takes over 75 days—in the US it takes two! These things harm our productivity.'

According to the World Bank, good governance and strong institutions are also key to solving poverty and its related development challenges. In its 2001 World Develop- ment Report, governance and institutional capacity issues predominate (World Bank 2001 a). Drawing on the work of Peruvian development economist Hernando de Soto, the World Bank found that the economies that are most likely to develop and become competitive are those that promote the open flow of information, that ensure good

2. THE RIGHT FRAMEWORK 73

protection for property rights of rich and poor and that provide widespread access to judicial systems. 'Efficient formal and informal institutions ... are crucial for turning subsistence farmers, petty traders and other would-be money-makers into a boon for the general economy', comments The Economist (2001 d); 'if it is too expensive and time-consuming, for example, to open a bank account, the poor will stuff their sav- ings under the mattress'.

De Soto (2000) has argued that a great deal of poverty is avoidable, given some basic institutional improvements. Even the very poor have assets, de Soto maintains, but many of these fall outside the legal property system and therefore cannot be leveraged to produce additional wealth. The result is so-called 'dead capital'. By providing simple and accessible institutions to the poor, such as deeds for their homes, the 'extralegal' economic activity that currently dominates developing-world economies can be legitimized and harnessed for wider societal wealth creation. Growth, in other words, follows respect for the property rights of the poor, given the right institutional framework.

Future governance challenges will include achieving greater policy coherence across the economic, social, and environmental domains, particularly as increased crossover between policies, greater international interdependence, and growing complexity of issues heighten the need for consistency and integration in policy- making (WWF 2001 a).

The ideas and rhetoric of human rights, along with the notion of respect for human rights as a fundamental precondition for sustainable development, have gained a great deal of prominence in recent years. It has come to be accepted by many in business that we have a role to play in their pursuit and enforcement, exerting our influence to ensure that human rights are observed in the countries in which we operate.

Others in business, however, feel that using corporate power and influence to pressure national governments and guide their behavior is wrong and that companies have no business 'meddling' in politics to pressure governments on human rights issues. Whichever view you take, the fact is that companies are best at respecting human rights within the sphere of their own operations and are less successful trying to force governments to do likewise.

Rio Tinto has expressed support for the UN Secretary General's Global Compact, which encourages industry to adhere to nine principles of best practice in the areas of human rights and environmental and labor standards. Says Sir Robert Wilson (2001), company chairman:

The Global Compact fits together well with a wide range of Rio Tinto initia- tives in the fields of corporate social responsibility and sustainable develop- ment. For example, our statement of business practice, The Way We Work, includes policies in all the areas covered by the Global Compact.

Rio Tinto's aim in this area is to contribute to the development of best practice. With the help of outside experts, the company has developed detailed guidance on imple- menting its human rights policy. The guidance covers four areas: communities, employees, security, and 'difficult issues'—setting out procedures and a checklist of questions for the manager. Rio Tinto is realistic about its power to influence govern- ments over human rights issues. Wilson (2001) notes that 'We focus on what we can manage and what we can strongly influence, recognizing that we don't have a

mandate for global diplomacy.' Shell in 1997 revised its business principles, and a key change was accepting a duty

to speak out for fundamental human rights while noting that fulfilling its responsibil- ities as a corporate citizen should not mean trying to dictate Western cultural norms (Watts 2000). This more active advocacy role acknowledges the influence that com- panies can exert in countries where they have a presence, but it also has at its heart the notion that universal recognition of the ideal of human rights should not be used

to undermine human diversity.

Bribery and corruption

«*

Tolerance or encouragement of corruption is a serious policy flaw which impedes sustainability through the market and subverts free and open trade.

As well as rendering the market inefficient by raising the cost of business trans- actions, corruption has a negative impact on the corporate bottom line. In 1999, The Economist estimated that bribes made to Indonesian bureaucrats totaled some 20% of business costsin that country (BSR 2001). A World Bank survey in Uganda, mean- while, found companies were paying an average of 6% of their turnover in bribes (jafferji 2001). Fighting corruption is therefore in companies' self-interest. In a corrupt environment, where contracts may be awarded not on merit but on the size of the kickback, competitive advantage based on efficiency and innovation is undermined. Bribery corrodes the rule of law and undermines democratic institutions, hampering • development by diverting funds away from local communities and the poor and by eroding public services. Paradoxically, corruption can lead to even greater bureau- cracy and red tape as officials seek further opportunities to raise illicit revenue and governments create more bureaucracy to limit corruption. The degree of corruption can range from the petty—often among civil servants, motivated by low salaries—to the grand, whereby fraud and extortion become so entrenched the entire state

system becomes a 'kleptocracy'. The growing global market has moved corruption toward the top of the global

political agenda. By standing firm against corruption, companies can begin to cut unnecessary costs, minimize bureaucracy, and, usually, become more competitive. Taking a strong ethical stance on graft also helps iron out any ethic of corruption among employees, and being seen to be clean often carries with it tangible benefits to brand and image. General Electric holds that campaigning against bribery actually spurs competitive advantage. The company now uses its compliance program and ethics handbook as a sales tool with customers—and can point to contracts won in