Anticipating the Unintended #70: Concentrated Costs, Diffused Benefits

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

India Policy Watch #1: 50 Years Of That Friedman NYT Article

Insights on burning policy issues in India


On September 13, 1970, Milton Friedman wrote his famous piece on the social responsibility of business in The New York Times. The clarity of Friedman’s thinking and his powerful articulation of the doctrine of shareholder value maximisation has made it, arguably, the most influential business article of all time.

Friedman scoffs at businesses talking of ‘social responsibility’ suggesting any attempt to do so will turn political that will force the individual to conform to the more general social interest. Who determines this social interest? In the hands of a dictator or a demagogue, this decision can be detrimental to society.

It is a compelling article. I would suggest you read it before you dismiss it as free-market fundamentalism. Friedman concludes:

“But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book “Capitalism and Freedom,” I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”

Enduring Appeal

Over the years it has been attacked and its central message discredited in the light of the global financial crisis. Even businesses are reluctant these days to invoke shareholder value maximisation as their goal. There have been calls for societal value maximisation, stakeholder wealth creation and conscious capitalism to replace the Friedman doctrine. All good intentions aside, nothing has truly replaced it in how businesses operate. What explains its enduring appeal? Three reasons:

  1. A simple and measurable metric: The shareholder value maximisation goal is easy to set and monitor. It helps that there is a common understanding of the metric. The alternatives are amorphous. It is difficult to understand what does maximising societal value entail, for instance. Who will define what society wants? Are societal objectives of India and the US similar?
  2. Rewarding the risk takers: The shareholders invest risk capital in an enterprise. This willingness to take risk is what leads entrepreneurs to build new products, satisfy the consumers and create new jobs. The shareholders deserve the pursuit of maximum return by the firms for this risk they undertake. It is up to them what they do with these returns. They can invest it in newer enterprises or use it to improve the society as they deem fit. The management or anyone else should have no claim on how to invest the returns that belong to the shareholders.
  3. Shareholders are the residual claimants: Everyone who contributes to the value creation of an enterprise – the employees, the management team and the customers – get their fixed claim on the value through compensation for their efforts, stock options and the value derived from the products or services offered by the enterprise. Only when these fixed claimants are served well, the value for the residual claimant (the shareholder) is maximised. So, the pursuit of shareholder value will by itself serve the other stakeholders well.

Rajan’s Reassessment

Promarket, a publication of the Stigler Centre at Chicago Booth School of Business, is marking the 50-year anniversary of the Friedman article with a debate on the social responsibility of business on its pages. Eminent academists like Oliver Hart, Luigi Zingales and Lucian Bebchuk have written with depth and intellect on the relevance of the Friedman doctrine in today’s times. This week Raghuram Rajan weighed in on the debate with an article titled “50 Years Later, It’s Time to Reassess”. Rajan takes a clear-eyed view on what has worked for the Friedman doctrine and where it is fraying. He repeats the usual points that we have listed above in favour of the doctrine. Additionally, he emphasises the political argument of Friedman for shareholder value maximisation that seems relevant in the current times when we are debating the enormous clout of big tech in our lives.

Rajan writes:

“Finally, Milton Friedman thought that there was a political argument for shareholder value maximization, which keeps the role of the government and the role of the corporation separate. He thought that was important because he felt that corporate social responsibility was a backdoor way for special interests to push what they could not get through Parliament and therefore make rules for the firm which they could not make through legislation. In some sense, this is a very important argument because it says that sometimes, these pressures can be anti-democratic rather than pro-democratic—that because you’re frustrated in Congress or in Parliament, you might try to push that stuff through the backdoor by directly targeting corporations.”

But Rajan believes this separation of business from politics that Friedman advocated has turned into its primary problem:

“And that leads to what I think is the deepest problem with Milton Friedman: shareholder value maximization means completely turning a tin ear to politics. It sounds sinister. It sounds pro-rich. It sounds evil, even if it may be the right thing to do for society under many circumstances.”

I’m not quite sure why something that sounds evil while it might be the “right thing to do for society” needs to change. There are many economic concepts that sound evil or counter-intuitive – efficient market mechanism, free trade, comparative advantage or Ricardian equivalence. They shouldn’t be discarded or changed because of it. Instead, they need to be explained better.

Read the full edition here.

Disclaimer: Views expressed on Anticipating the Unintended are those of the authors’ and do not represent Takshashila Institution’s recommendations.