Thursday, August 30, 2012

Profit is Charity

July 2011 (ed Aug 30, 2012)

Profit – legally and ethically generated - is one of the best measures of social value-add.

Clients buy services and products only when they can extract value from them. Example, if a company sells a soap for Rs 10 (when it costs it Rs 8 say), the customer buys it only because s/he can extract more than Rs 10 of value from it (say Rs 12). Hence while the company generates profit in the transaction, the customer also gains. A company’s profits therefore are a measure of the cumulative value it injects into the society. If the soap making company is earning crores of rupees in profits, it is doing so by adding value to millions of people.

A business need not do any traditional ‘Corporate Social Responsibility’ (CSR) activity for contributing to the society.  In fact traditional CSR – like donating to schools or hospitals - may not be a very economically efficient or effective way of impacting developmental outcomes. As long as a business keeps generating higher and higher profits ethically and legally, it will be making greater and greater social contributions by injecting value to its customers, and helping them inject value into their own lives or into the lives and businesses of their customers who are next in the chain.
Donating to a school or a needy child or family produces immediate visible outcomes. Therefore, these are typically more satisfying personally, and may be necessary for keeping one motivated towards social welfare. However, these may not be the most effective and efficient ways for achieving desired outcomes. For example, the same effort, time and money contributed towards governance reforms in education may help create more schools[1] and raise more people out of poverty.   

Perfect markets require information symmetry between buyers and sellers, and absence of monopolies etc. Long term complex developmental outcomes – like reduction of corruption, governance reforms, environmental sustainability etc –  whose benefits are spread across several people and are difficult to quantify may not find easy market based solutions. Even though these things will be economically beneficial for many individuals and businesses, it may be difficult for these objectives to raise business investments[2] due to complexity of information involved, long term diffused results, collective action problem etc. Such efforts therefore may still largely depend on traditional charitable and philanthropic support. Individuals (rather than business organisations) should consider philanthropic donations (out of their personal bank balance, rather than their organisations’ profits) towards solving such social problems which do not find market solutions.

However, while organisations need not spend on CSR, they should avoid ostentatious display of wealth (or control 'wasteful expenditure') and instead focus on maximising profits. Also, they should remain respectful and empathetic to the communities they are located within and people they interface with.
  
Please watch the following video interview by Nobel Laureate Prof. F. A. Hayek’s for more on these lines: http://vimeo.com/4063439



[1] Example, refer to this seminal paper - Reinikka, R., & Svensson, J. (2004). Local Capture: Evidence from a Central Government transfer Program in Uganda. The Quarterly Journal of Economics , 119 (2), 679-705.
[2] There are some interesting attempts though. Check this out: http://www.ted.com/talks/shaffi_mather_a_new_way_to_fight_corruption.html

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