A Remark on Friedman's "The Social Responsibility of Business is to Increase its Profits"

Conor Clarke's posting excerpts from Milton Friedman (1970), "The Social Responsibility of Business is to Increase its Profits" gives me an opportunity to get something off my chest that has been lying there for decades: Friedman's argument never made any sense to me.

As Clarke quotes:

Creative Capitalism: The Social Responsibility of Business is to Increase its Profits: What does it mean to say that the corporate executive has a "social responsibility"...?... [I]t must mean that he is... to refrain from increasing the price of the product in order to contribute to... preventing inflation.... Or that he is to make expenditures on reducing pollution beyond the amount that is in the best interests of the corporation or that is required by law... to contribute to... improving the environment. Or... at the expense of corporate profits... hire "hardcore" unemployed... to contribute to... reducing poverty. In each of these cases, the corporate executive would be spending someone else's money for a general social interest. Insofar as his actions in accord with his "social responsibility"... reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers' money. Insofar as his actions lower the wages of some employees, he is spending their money.

The stockholders or the customers or the employees could separately spend their own money on the particular action if they wished to do so.... [R]ather than serving as an agent... he spends the money in a different way than they would have... in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other.

This is weak toast. This is thoroughly unconvincing. What reason is there not to turn this around? What reason is there not to say, instead:

• If customers don't want to pay higher prices and so buy from corporations that pursue social responsibility, they are (as long as product markets are competitive) free to do so at their option.
• If workers don't want to receive lower wages by working for corporations that pursue social responsibility, they are (as long as labor markets are competitive) free to do so at their option.
• If investors don't want to receive lower profits by investing in corporations that pursue social responsibility, they are (as long as capital markets are competitive) free to do so at their option.

If workers, customers, and investors expect that the executives of the corporations they deal with will pursue social-responsibility objectives, where's the foul? The executives aren't doing anything wrong at any level--they are in fact performing a valuable function by as workers', customers', and investors' trusted and honest agents by pursuing social-responsibility goals. They are helping them pool their resources to achieve what they want to see happen. This pooling-of-resources agency function is an important one--it is, after all, why we have large organizations in the first place. So why limit it to narrowly profit-maximizing goals?

Comments

[jerry]

According to Thom Hartmann, in other countries, companies are expected to "invest" in the community welfare in order to keep their corporate charter. As you say, if everyone understands this about a company and how it will be managed, where is the harm?

Why does Friedman insist that Google *do* evil?

[ferd]

"If you didn't want us dumping mercury in your water, you should have written a law!"

[Bernard Yomtov]

Friedman's claim is wrong on many grounds, including those you cite.

Suppose a firm may legally dump waste in a river, thereby damaging the health and livelihood of those living downstream. Can anyone seriously claim that the firm's responsisbility is to do so in order to save the cost of treating the waste? It's necessary to kill for money as long as it's legal? What nonsense.

Brad says that as long as the investors know what they're getting into all is well. True, but I'd say that it doesn't even matter if they know. How do the executives presume to know that nothing but profits matter to shareholders? Suppose, in my example, someone asked the investors whether they would be willing to sacrifice, say, ten cents a share to treat the waste rather than dump it. Can we be sure of the outcome?

Fianlly, if you're going to be as rapacious as Friedman thinks is appropriate, why bother obeying the law if you don't have to, or if breaking it is cheaper than obeying? You're wasting the shareholders' money, aren't you? In other words, by drawing the line at legality, Friedman concedes that there are things the firm shouldn't do even if they are profitable. On what basis, if any, does he decide where the boundary is?

[Kip Manley]

Weak tea. Toast can only be burnt, or dry.

[Eric Crampton]

Brad,

If workers, consumers, or investors are as you suggest they might be, I cannot imagine satisfying them necessarily being inconsistent with narrow profit maximizing.

[bigTom]

I think it may be possible to argue from an efficiency standpoint. A corporation seen by its customers, employees, shareholders, -even competitors, doing social good, will likely receive intangible from its efforts. These benefits may be in the form of better PR, better motivated employees, perhaps a greater share price as the class of people who would consider being shareholders increases, and perhaps even some of the competitors employees might apply for a job. None of these are the sort of thing that can be even remotely measured -at least in terms of financial return to the corporation. That doesn't mean they aren't real. Even if the (unmeasurable but real) return is well under one times the incremental cost, the return to society may well be bought at a discount. If that discount is greater than it would be if the social good works were to be paid for by another mechanism, then it is an efficient usage of resources.

[Graydon]

Profit maximization makes sense if you do not recognize money as fundamentally collectivist; if you think of money as being the product of some sort of natural law, like gravity and the coherence of matter, it's a thing, and some portion of it can be purely yours.

If you recognize the fundamentally collectivist nature of moneyit takes a complex culture and a lot of co-operating people to have trade, never mind moneyyou recognize that this money stuff is inherently a kind of joint endeavor and that trying to get as much of it as possible in your pile is a hostile act. (Also, and which reduces the overall size of the pile over time.)

This is one of the things that has always made me doubt Milton Friedman and his intellectual heirs; they're lacking a sufficient complexity in their models of systems of account. (How much is the market value of your children sold for medical experimentation? This could be calculated, but hardly anyone uses the 'money' system of account to consider their children, so the question isn't asked, and serious suggestions that it should be asked would be treated with some hostility.)

The other part of profit maximization that I think is seriously missed is that profit is, fundamentally, a side effect of some other thing you are doing, which thing has value to others. You can't do a very good job of making a profit in conditions of actual market choice if you aren't able to think incisively about what constitutes value to others. This leads to strenuous efforts to remove or limit market choice. (There are also efforts to identify value, too, but generally in much smaller scale firms, and it has far less political effect. Money has political value; having the most spare money starts having serious selective advantage in legislative terms...)

[tom f]

I think Brad's analysis is politically naive in ways others than outlined above by Graydon. Workers, customers, and shareholders (let alone the citizens external to the transactions, which Graydon adresses) have no practical means to pursue their interests in relation to the ease with which corporation pursue theirs. 100B kg might be more massive than 10B kg, but if the 10B is unified into a single body it will exercise more gravitational pull than 100B kg of satellites. One thing all these interested parties can do is pass laws. Thus both Friedman's and Brad's argument is effectively circular.

[derek]

The *social* responsibility of business is to increase its workers' wages. Isn't that what "socialism" means?

Or, the social responsibility of business is to decrease the prices of its goods. Isn't that what we're always told is the beauty of the free market society?

If the social responsibility of business is to increase the profit it gives its capital investors, well, that after all is what "capitalism" means. The mystery to me is why so many people conflate "capitalism" and "the free market society".

[Robert Waldmann]

I don't see exactly how "The stockholders or the customers or the employees could separately spend their own money on the particular action if they wished to do so" if their aim was reduced industrial pollution. That is, your counter argument is not just an argument as good as Friedman's which leads to the opposite conclusion -- it is an argument which makes sense while his does not.

As usual, Friedman assumes collective action problems away. Note that his favored approach to social responsibility is individual giving not public policy working via taxes and spending. He goes so far as to imagine that individual choice would imply an optimal response to negative externalities due to pollution (explicitly one of his examples). This isn't just extreme, it is completely inconsistent with standard economic theory (which Friedman liked fine so long as it gave him the conclusions he wanted).

Evidently, the right level of pollution abatement according to Friedman is exactly that required by law -- that is, in this case, and no other, he assumes that public policy is optimal. This is an assumption that he would never make if the question was about say the optimal tightness of anti-pollution regulation. Furthermore, Friedman assumes that the right response of a corporation to the elimination of all anti pollution regulation would be to pollute at the profit maximizing rate. Why does the right corporate action change so much, when the public policy changes ?

Also, oddly, he only considers obeying the law or doing more. A profit maximizing corporation would violate pollution standards if it knew it could get away with it. Does Friedman think that a socially responsible executive would break every costly regulation if he could get away with it ? Friedman might argue that, in the real world, crime doesn't pay. Hw would be wrong, and besides it is irrelevant as the question was hypothetical. Why does corporate responsibility require obeying the law *and* going no further ? I don't see any trace of an argument for that position in the brief quotation of Friedman which you posted.

[Robert Waldmann]

On the other hand and in defence of Friedman, if consumers are willing to pay more and workers and investors willing to be paid less in exchange for, say reduced pollution, then it would be profit maximizing to reduce pollution. That is if people freely reward socially responsible corporatoins, then total greed head executives will act as if they personally cared. Friedman didn't make this argument and he clearly doesn't find it convincing. You made this argument, but it seems to be an argument for rational profit maximization and not for blinkered stupid profit maximization.

[James Wimberley]

Brad's counterexamples work by widening the choices open to the parties that interact with the corporation: workers, customers, and investors. For socially responsible businesses (Body Shop etc) to raise welfare this way, they have to be in competition with classical nasty businesses (WalMart, Exxon etc.). Cf. standard Abrahamic theology on free will and sin. Most advocates of corporate social responsibility want WalMart etc to repent as well. Part of the idea is I think reducing the all-round level of Hobbesian business aggression and increasing the social capital of trust. The economic success of the early Islamic caliphate may well be explained by its creation of a large area of high trust between sometimes distant Muslim merchants.

[ogmb]

"Evidently, the right level of pollution abatement according to Friedman is exactly that required by law -- that is, in this case, and no other, he assumes that public policy is optimal."

I don't think he does that. The way I read it Friedman only assumes that the public actor is better at finding the optimal level of pollution abatement than private actors. As such, he's very much in line with North & Thomas: "Sustained economic growth in the Western world required the creation of institutions and property rights that served to bring the private rate of return to individual activities more nearly in line with the social rate of return." In Friedman's view, we should not expect private actors to take over the task of aligning private and social returns. That's the government's job. I'm not sure he actually wanted to push that angle, but I can't say I disagree with it.

[Joe S.]

Friedman is wrong, but not for the reason Brad says he is.

Friedman would be correct in a world of atomistic producers that can maximize profits only by producing cheaper, better, and newer. Invisible hand, and all that stuff. However, there is another way of maximizing profits: invest in a legislature. Producers do a whole lot of that, with a superb ROI. This kind of profit is a shonda for capitalism.

"Corporate responsibility" is a way of getting some of this profit back to society. It's a lousy system. I would rather see pure profit-maximizers who don't write the law. But if the corporate charter allows rent-seeking in the legislature (enshrined in the Constitution as "corporate free speech,") we may as well guilt some of these rents out of corporations.

[jhe]

Isn't the real problem one of signaling? I can easily value a paycheck, a dividend or a price but the value of any of these plus the good works of my trading partner are less easily valued. Should I buy my meat from the butcher who only buys grass-fed anti-biotic-free beef or from the one who buys corn-fed beef but treats her employees better?

I'm also not sure that I want (or can audit compliance) to delegate my moral decisions. Isn't it easier to hire the government to set and enforce minimum standards? I'm not saying that I would license managers to acting immorally but there is a certain morality in faithfully executing to the two standards that I ought to be able to measure: economic performance and obeying the law.

I've always looked at businesses as all stomach and loins. It would be nice if people informed their commercial decisions with their morality and ethics, but I'd hate to count on it.

[ogmb]

"The executives aren't doing anything wrong at any level--they are in fact performing a valuable function by as workers', customers', and investors' trusted and honest agents by pursuing social-responsibility goals."

You missed out on the core of Friedman's argument. His point is that among the three ways in which a corporation can create social returns:

1. The investors set up an enterprise with a social agenda
2. The investors set up an enterprise with a private profit agenda, the hired executive chooses an investment alternative that maximizes social returns at a private cost to the enterprise
3. The investors set up an enterprise with a private profit agenda, the hired executive chooses an investment alternative that maximizes private profit to the enterprise and the investors spend their dividends on a social cause

the second one creates a breach of contract and an expropriation by the social-minded executive vs. the investors.

The problem with Friedman's argument is not that he ignores other forms of enterprises (e.g. a for-profit-but-not-profit-maximizing enterprise), but that he posits that the investors, if they just spend their dividends on social causes, are always able to alleviate the social damage caused by the commercial activity. There are many examples, esp. in mining, where the clean-up costs of commercial enterprises exceed the aggregate profits by far.

[Michael Cain]

Friedman and company assume that markets are an end unto themselves; that is, the role of "society" is to do that which is necessary to enable markets, and no more. I assume, as several other commenters appear to, that society has its own set of goals that have evolved over time: employment, retirement, health care, environment, etc. Markets are a tool for delivering these goals. Perhaps the best tool we know of. But that's not a good reason to forbid society from imposing constraints on its markets in order to achieve those goals.

The part of economics that I enjoy is trying to answer questions regarding the minimum set of constraints that need to be imposed, and the differences between "good" and "bad" constraints.

[Mark Keavney]

Another point is that many companies explicitly make social responsibility part of their philosophy, and present mission statements to their employees, customers, and shareholders to that effect. If these companies then turn around and pursue profit-maximizing policies, they are not acting in the interests of their stakeholders, they are essentially committing fraud on their stakeholders.

[vantelimus]

When Friedman stepped out of economics proper and into the realm of moral philosophy, he was a shallow thinker prone to very simple logical errors in service of his ideology. I recommend "Capitalism and Freedom" as an excellent study in how not to think. In that tome, Friedman shows his complete ignorance of the moral sphere by confusing an end with the means used to obtain it and by arguing that means are always justified by the end they obtain. Most precious was his assertion that if moral stricture prevents one from adopting an evil means to a good end, then one cannot be said to have to the good end as their goal. It is all very sophistical and if adopted in other areas could be used to justify genocide as a means to end racism.

It is time to get over Friedman's simplistic ideology. Free markets as Friedman conceived are an unattainable ideal in this world. As our recent forays into deregulation have shown, given an opportunity, there will always be men who manipulate markets to drastic economic consequence for the country and world (e.g. Enron, sub-prime mortgages, etc.). It is best to put our efforts towards understanding how to get the theoretical benefits of free markets by regulation that prevents manipulation and leave aside the childish dreams of Friedman's flawed gedankenexperiment.

[Elliot]

I don't think DeLong's remark is at odds with Friedman. I've always viewed Friedman's argument as this:

Stockholders own the business. Therefore, the business should be run in the shareholders interests. People typically buy stock in order to make money. So public companies should aim to maximize profits.

If the aims of the stockholders are social responsibility, there's nothing wrong with that. The aims of the stockholders are still being fulfilled.

Clive Crook at Creative Capitalism has a response to DeLong that echo's my thoughts so instead of me writing them out, i'll just link.

http://creativecapitalism.typepad.com/creative_capitalism/2008/07/a-quick-reply-t.html#more

[piotr]

The notion of "social responsibility" covers a lot of stuff. Some of it is so vile that if it is not criminal, it should be -- but for the corporate influence over the law making.

For example, meat packers have a habit of setting working condition in a way that literally maims workers with repetitive motion injuries.

Another example is influencing lawmaking by funding junk science, to counter the expert opinion of genuine scientists. It is actually hard to make it illegal, but it is vile even so.

Finally, corporations seem to spend quite a bit to convince the public that they are socially responsible. If the image of being socially responsible has monetary value (they pay for it), the real thing is perhaps valuable as well.