Chapter 4

The Limits of Privatization

The corporation is an externalizing machine, in the same way that a
shark is a killing machine. There isn’t any question of malevolence or of
will. The enterprise has within it, as the shark has within it, those
characteristics that enable it to do that for which it is designed.
— Robert Monks, 1998

It’s tempting to believe that private owners, by pursuing their own self-interest, can preserve shared inheritances. No one likes being told what to do, and words like statism conjure fears of bureaucracy at best and tyranny at worst. By contrast, privatism connotes freedom.

In this chapter, we look at Garrett Hardin’s second alternative for saving the commons: privatism, or privatization. I argue that private corporations, operating in unconstrained markets, can allocate resources efficiently but can’t preserve them. The latter task requires setting aside some supplies for future generations—something neither markets nor corporations, when left to their own devices, will do. The reason lies in the algorithms and starting conditions of our current operating system.

The Algorithms of Capitalism 2.0

If you’ve ever used a computer spreadsheet, you know what an algorithm is. Each cell in the spreadsheet contains a set of instructions: take data from other cells, manipulate the data according to a formula, and display the result. The instructions within each cell are algorithms.

If you think of the economy as a huge spreadsheet, with each cell representing a producer, consumer, or property owner, you can see that the behavior of the whole is driven by the algorithms in the cells. Our current operating system is dominated by three algorithms and one starting condition. The algorithms are: (1) maximize return to capital, (2) distribute property income on a per-share basis, and (3) the price of nature equals zero. The starting condition is that the top 5 percent of the people own more property shares than the remaining 95 percent.

The first algorithm is what drives corporations. It tells them to sell as much as they can, pay as little as possible for labor, resources, and waste disposal, and make shareholders happy every quarter. It focuses the minds of managers every day. If they work in marketing, they wake up thinking about how to sell more; if there’s no demand for their product, they must create some. If they work in finance, they worry about margins and leverage. If they’re in labor relations, they bargain hard, replace long-term employees with temps, and shift jobs to places where wages are lower. All the while, the CEO feeds sweet numbers to Wall Street.

The second and third algorithms then mesh with the first. It’s the combination of these algorithms that causes the wheels of capitalism to devour nature and widen inequality among humans. At the same time, nothing in the algorithms requires or encourages corporations, either individually or collectively, to preserve anything.

This doesn’t mean people inside corporations don’t think about protecting nature, raising their workers’ pay, or giving something back to society. Often, they do. It does mean their room for actually doing such things is too narrow to make a difference. Nor does it mean that, from time to time, some brave mavericks don’t briefly flout the corporate algorithm. They do that, too. What I’m saying is that, in the great majority of cases, the corporate algorithm and its brethren are obeyed. For all practical purposes, the publicly traded corporation is a slave to its algorithm.

Socially Responsible Corporations

To survive over time, every organization needs to take in more money than it spends. (The only possible exception may be the U.S. government.) This means that even nonprofit organizations must, in a sense, make a profit. But making a profit isn’t the same as maximizing profit. In the first instance, profit is a means to an end; in the latter, it’s the purpose that trumps all others. Millions of organizations earn enough money to stay alive, yet pursue goals other than profit. Is it possible for publicly traded corporations to be like that? Can they have multiple bottom lines? Can they, in other words, rise above their profit-maximizing algorithm?

There are several ways this might be possible: enlightened managers might choose a higher goal than profit, shareholders might insist on it, and government might require it. Let’s consider each possibility.

ENLIGHTENED MANAGERS

Managers are human beings; they don’t care just about money, they also care about the larger world. The problem is, they’re trapped in a cold-hearted system. Managers are paid to do one thing, and to do it well. At best, they can be public-spirited as long as they don’t harm the bottom line. This gives them some range to operate—for example, if using recycled paper adds minimally to their costs without reducing quality, they might use it. But if it adds substantially to their costs, they won’t—or more accurately, can’t—sacrifice profit for the sake of a few trees. What matters at the end of the day isn’t the managers’ personal values, but the difference in price between recycled paper and paper made from newly felled trees.

There are other reasons not to rely upon the voluntary benevolence of corporate executives. As The Economist has written, “The great virtue of the single bottom line is that it holds managers to account for something. The triple bottom line does not. It is not so much a license to operate as a license to obfuscate.”

As a businessperson, I find this argument compelling. Every large organization, to be managed well, needs a mission. That mission should be as clear as possible. It’s hard enough to manage to one bottom line; it’s more than thrice as hard to manage to three. How do managers know, much less quantify, the external consequences of what they do? And even if they know, what do they do when goals conflict? Does profit trump nature or vice versa? If managers are accountable to shareholders for profit-based performance, to whom are they accountable for commons-based performance?

Hypothetical answers to such questions can no doubt be drafted, but what would happen in the real world, I suspect, is what The Economist surmises: profit maximization would dominate, accompanied by obfuscation about other goals. Corporate communications departments would try to maximize the appearance of social responsibility for the lowest actual cost. We’d see beautiful ads and reports, but little change in core behavior.

It’s important to remember that the profit-maximizing algorithm is enforced not just by laws, but by a variety of carrots and sticks. For example, CEO compensation is typically based on a list of goals established by the board. These often include nonfinancial goals, but the goal that carries the most weight, and is least amenable to obfuscation, is profit. Further, the CEO and other top managers usually receive stock options. Since stock prices are driven by reported quarterly earnings, managers who own stock or stock options strive to maximize these.

When carrots fail to motivate, sticks come into play—and they can be brutal. An “underperforming” corporation will be devalued by the stock market. This makes it susceptible to takeover. A classic example is the Pacific Lumber Company of California, the largest private owner of old-growth redwood trees in the world. Prior to 1985, Pacific Lumber was a family-run business that took a long-term perspective. When it logged, it left up to half the trees standing, creating natural canopies and keeping much of the soil stable. It was also generous to its workers, renting them housing at below-market rates and refraining from layoffs during downturns.

Sadly, however, Pacific Lumber’s responsible behavior made it easy prey for a takeover. Its concern for nature and its employees diminished its profits and hence its share price. Because of its cutting practices, it held tremendous stands of virgin redwoods that could be liquidated quickly. In addition, its pension plan was overfunded. Spotting all this, corporate raider Charles Hurwitz offered to buy the company in 1985 through a holding company called Maxxam. At first the directors refused, but when Hurwitz threatened to sue them for violating their fiduciary duty to shareholders, the directors succumbed.

Hurwitz financed his purchase with junk bonds, the interest on which was more than the historical profits of the company. To service this debt, he terminated the workers’ pension plan and began harvesting trees at twice the previous rate. Such were the fruits of the previous managers’ enlightened practices.

It is possible for a company to pursue multiple bottom lines if it’s closely held by a group of like-minded shareholders—that was the case at my former company, Working Assets. But once a corporation goes public—that is, sells stock to strangers—the die is pretty much cast. Strangers want a stock that will rise when they plunk down their money, and profit is the sure path to doing that. It’s just a matter of time, then, until the profit-maximizing algorithm kicks in.

I’ve spent a good part of my life talking with people who wish publicly traded companies could be socially responsible—not just cosmetically, but sufficiently to make a difference. They contend that corporations were once dedicated to public purposes, escaped their bounds, and can be put back in. They recall a time when companies were rooted in their communities, hired workers for life, and contributed to local charities. The trouble is, those days are irreversibly gone. Today, owners live nowhere near workers, labor and nature are costs to be minimized, and it’s hard to see what might displace profit as the organizing principle for publicly traded corporations.

SOCIALLY RESPONSIBLE SHAREHOLDERS

Managers are ultimately responsible to shareholders, so if shareholders demanded social responsibility, perhaps managers would pay attention. That’s the thinking behind socially responsible investing. Could this tactic tame corporations?

Partisans of this approach employ two techniques: screened investment (putting money in “good” companies and withholding it from “bad” ones) and shareholder activism. Screened investment funds have made considerable progress since I cofounded Working Assets Money Fund in 1983; they’ve grown from virtually nothing to over $2 trillion in assets, or approximately 10 percent of professionally managed money in the United States. These funds vet the corporations whose securities they buy, not just for financial performance but for social and ecological behavior as well. Their vetting process typically excludes firms that sell tobacco or alcohol, violate environmental regulations, discriminate against minorities, treat workers badly, or manufacture weapons. In theory, if enough people invested this way, they could lure corporations into behaving better than they otherwise might.

In reality, though, it hasn’t worked like that, and doesn’t seem likely to. One reason is that socially screened investment funds (with a few exceptions) aren’t willing to accept a lower rate of financial return. “Doing well by doing good” is their mantra, and they strive to beat, or at least equal, the returns of funds that are not socially screened. When they succeed (and often they do), this “proves” that social responsibility makes good business sense. On the other hand, it means the funds can demand of companies only “good” behavior that enhances the bottom line. In this sense they’re in the same narrow boat as managers who want to do good but can’t if it hurts their profits.

A deeper reason for the funds’ lack of impact may be found in this contradiction: as the funds get bigger, their screens necessarily get looser. If you have a few million dollars to invest, you can be picky about your nonfinancial criteria. If you have billions, you’ll run out of places to put your money if you’re too persnickety. Thus, as Paul Hawken has noted, over 90 percent of Fortune 500 companies now appear in portfolios that call themselves socially responsible, and the managers of those portfolios rarely bite the hands that feed them. Success, in this way, is its own undoing.

The second technique—shareholder activism—has also picked up steam in recent years. In this approach, concerned shareholders meet with top managers and urge them to change the company’s ways. If the managers resist, the shareholders file resolutions that, if approved at an annual shareholder meeting, would change corporate policy. In 2003, over three hundred resolutions were submitted on issues ranging from CEO compensation to labor and environmental practices. None passed, because managers, through proxies, control the great majority of shares, although in some cases the resultant publicity did lead to changes.

A grander vision of shareholder activism involves the employee pension funds that, collectively, own over half the shares of many U.S. companies. In this vision, American workers, through their retirement funds, would require publicly traded corporations to place workers, communities, and nature on a par with short-term profit. In reality, pension funds have come to play a larger role in capital markets, but ironically, it’s usually as the swing votes when raiders seek to take over underperforming corporations. In these situations, the pension funds often vote with raiders to enhance stockholder value.

Recently, pension funds have also pushed for improvements in corporate governance. But pension fund trustees are hardly sans culottes in pinstripes. They’re tightly bound by their fiduciary responsibility to retirees, and must seek the highest rates of return or face reprisal from the U.S. Labor Department, which oversees them.

It would be a luscious irony if capital markets could become a check on runaway capitalism. But capital markets suffer from the same disease as corporations themselves—an incurable devotion to maximizing profit. This isn’t to say that efforts to improve corporate responsibility are a waste of time; such efforts raise consciousness and are incrementally helpful. And they’re certainly a form of right livelihood. But do they carry within them a systemic solution to the defects of capitalism? This I deeply doubt.

MANDATORY RESPONSIBILITY

I don’t think it will ever happen, but consider this scenario. Imagine Congress passes a law requiring every corporation—in exchange for limited liability—to have a triple bottom line. The law also says that at least a third of corporate directors should represent workers, nature, and communities in which the company operates. And it protects directors from lawsuits if they favor nature over profit. You’re the CEO of Acme Corporation. What changes do you make after the law takes effect?

Well, you might start by increasing your accounting budget. You’ll need, henceforth, to keep track not only of money but also of your nonmonetary impacts on society and nature. This isn’t easy, though presumably shortcuts will be developed. Next, you assign people to find ways to reduce Acme’s negative impacts on nature and society, ranking the proposals by years to payback. You budget a modest sum for the most cost-effective projects, giving preference to those with public relations value. You publish ads and reports, patting yourself on the back for doing what the law requires. And you remind your board of directors that, if they choose, they can snub offers from the likes of Charles Hurwitz and forgo large capital gains for shareholders.

All this would be well and good. But given the algorithms that still rule, how much difference would it make? And even if it did have some effect, would it make enough difference in the right ways? After all, you might spend your small green budget on one thing, while nature most needs something else.

Now, as an alternative, imagine that the price of nature is no longer zero. All of a sudden, it costs big bucks to pollute or degrade ecosystems. Overnight, your managers scramble to cut pollution and waste. The higher the price, the faster their behavior changes. And it changes in response to specific natural scarcities, as indicated by specific prices.

The question is, which of these approaches would work better—mandatory social responsibility, or increases in the price of nature? The answer, without doubt, is the latter.

Free Market Environmentalism

One other version of privatism is worth considering. Its premise is that nature can be preserved, and pollution reduced, by expanding private property rights. This line of thought is called free market environmentalism, and it’s favored by libertarian think tanks such as the Cato Institute.

The origins of free market environmentalism go back to an influential paper by University of Chicago economist Ronald Coase. Writing in 1960, Coase challenged the then-prevailing orthodoxy that government regulation is the only way to protect nature. In fact, he argued, nature can be protected through property rights, provided they’re clearly defined and the cost of enforcing them is low.

In Coase’s model, pollution is a two-sided problem involving a polluter and a pollutee. If one side has clear property rights (for instance, if the polluter has a right to emit, or the pollutee has a right not to be emitted upon), and transaction costs are low, the two sides will come to a deal that reduces pollution.

How will this happen? Let’s say the pollutee has a right to clean air. He could, under common law, sue the polluter for damages. To avoid such potential losses, the polluter is willing to pay the pollutee a sum of money up front. The pollutee is willing to accept compensation for the inconvenience and discomfort caused by the pollution. They agree on a level of pollution and a payment that’s satisfactory to both.

It works the other way, too. If the polluter has the right to pollute, the pollutee offers him money to pollute less, and the same deal is reached. This pollution level—which is greater than zero but less than the polluter would emit if pollution were free—is, in the language of economists, optimal. (Whether it’s best for nature is another matter.) It’s arrived at because the polluter’s externalities have been internalized.

For fans of privatism, Coase’s theorem was an intellectual breakthrough. It gave theoretical credence to the idea that the marketplace, not government, is the place to tackle pollution. Instead of burdening business with page after page of regulations, all government has to do is assign property rights and let markets handle the rest.

There’s much that’s attractive in free market environmentalism. Anything that makes the lives of business managers simpler is, to my mind, a good thing—not just for business, but for nature and society as a whole. It’s good because things that are simple for managers to do will get done, and often quickly, while things that are complicated may never get done. Right now, we need to get our economic activity in harmony with nature. We need to do that quickly, and at the lowest possible cost. If it’s easiest for managers to act when they have prices, then let’s give them prices, not regulations and exhortations.

At the same time, there are critical pieces missing in free market environmentalism. First and foremost, it lacks a solid rationale for how property rights to nature should be assigned. Coase argued that pollution levels will be the same no matter how those rights are apportioned. Although this may be true in the world of theory, it makes a big difference to people’s pocketbooks whether pollutees pay polluters, or vice versa.

Most free marketers seem to think pollution rights should be given free to polluters. In their view, the citizen’s right to be free of pollution is trumped by the polluter’s right to pollute. Taking the opposite tack, Robert F. Kennedy Jr., an attorney for the Natural Resources Defense Council, argues that polluters have long been trespassing on common property and that this trespass is a form of subsidy that ought to end.

The question for me is, what’s the best way to assign property rights when our goal is to protect a birthright shared by everyone? It turns out this is a complicated matter, but one we need to explore. There’s no textbook way to “propertize” nature. (When I say to prop-ertize, I mean to treat an aspect of nature as property, thus making it ownable. Privatization goes further and assigns that property to corporate owners.) In fact, there are different ways to propertize nature, with dramatically different consequences. And since we’ll be living with these new property rights—and paying rent to their owners—for a long time, it behooves us to get them right.

Consider the matter of who represents pollutees. Coase presented his model in its simplest form: a single polluter and a single pollutee. In the real world, there are usually a few large polluters and millions of people who are polluted upon. It’s prohibitively expensive for individual pollutees to sue large polluters, just as it is for large polluters to negotiate individually with pollutees.

For the Coasian model to work, the class of pollutees as a whole needs to be represented by an agent. What’s more, it matters to whom that agent is accountable, and what principles drive its actions. If either the accountability or the principles are wrong, the agent will sooner or later do the wrong things. But if the agent’s accountability and principles are right, we may actually have a fix for capitalism’s predisposition to pollute. The key is to make each agent a trustee for future generations and all living citizens equally.

Then there’s the matter of who gets the initial property rights, and whether or not they have to pay for them. Consider pollution trading as it’s been put into practice so far. Government issues permits to dump a particular pollutant into the commons. It gives the permits—for free—to large polluters, based on how much they polluted in the past. Past polluters who reduce their future pollution can benefit by selling permits they no longer need.

This kind of pollution trading involves both propertization and privatization. First, a new kind of property is created—a right to emit a particular chemical into the commons. Then, this piece of property is given to private corporations. I have no problem with the first part of this process, propertization. What troubles me is the second part, privatization.

Giving away pollution permits, instead of auctioning them to the highest bidders, is like handing out free leases to an office building. Worse, it’s like handing out free leases and letting the freeloaders sublease to others and pinch the rent. And we’re not talking about pocket change, either. When it comes to carbon dioxide emissions, the assignment of property rights is potentially worth trillions of dollars. That’s money consumers will inescapably pay in higher prices for energy. To whom they pay it depends on who gets the property rights to the sky.

Propertize, But Don’t Privatize

Simply turning the commons over to corporations, without compensation or further ado, is like putting the fox in charge of the henhouse. There’s no guarantee the corporations will preserve the asset, much less share its benefits widely. We’re asked to believe that corporate owners will do the right things, either because it’s in their self-interest or because they’re socially responsible, but historical evidence and the inner logic of corporations suggest otherwise.

Nevertheless, it’s possible to propertize a natural inheritance without privatizing it, and in the next chapter I’ll show how this can work. The basic idea is to turn pieces of the commons into common property rather than corporate property. This would let us charge corporations higher (and truer) prices for using the commons, while sharing the benefits of those higher prices broadly. And it would ensure that the quantity of usage rights sold—which is to say, the level of pollution allowed—is set with the interests of future generations foremost in mind.