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Viewpoint : Incentives and Economic Value Destroyed

Bruce Donnelly   bruce@gdi-solutions.com    (Biography)

It is just one of many types of tax burdens on business, with pros and cons like any other tax, but the premise behind such a tax is useful to consider, as elaborated below.  This is not the same thing as “economic value added” as defined by some consultants in recent years as another financial performance metric.

Business and government services both add value to communities, although it is noteworthy that governments have not been rushing to adopt reporting metrics for their own performance at achieving social objectives or creating a more competitive business environment.

Businesses can destroy value through irresponsible, illegal or ill-informed choices, including environmental damage which may not even have been recognized as such.   Governments can destroy value through uncompetitive social choices and poor performance.

In effect, local businesses are taxed directly and indirectly by the economic and social choices which government leaders make (wisely or not) on behalf of their communities.

That affects whether the companies and the communities involved remain competitive.  The choices made by a society have consequences.  Competing areas may make very different choices.  These are, in effect, an indirect tax on business to achieve social goals.  This is somewhat like an "unfunded mandate" by national governments to push costs down to local levels, except that it pushes higher social costs onto business through non-tax obligations.

This indirect taxation of business can be defined as an “economic value destroyed tax” by government.  Some governments choose to destroy more economic value than others.

As executives choose where to invest, the relative business climates and social costs matter.  Incentive negotiations help to "level the playing field" among places which are viable as potential business location alternatives, but which involve very different social and other costs.  Once again, this involves more than just relative tax costs on business.

Indeed, such philanthropy has been a tradition of companies and wealthy individuals for centuries, which is why so many large non-profit organizations have the resources they need to do social and environmental work that is not adequately performed by governments or with many small private donations. 

Most members of society simply have not been willing or able to invest in the taxes necessary to perform such services through government.  Instead, non-profits have become an efficient mechanism to achieve special social interests privately.  It is somewhat like a voluntary tax on business and wealth, paid selectively to non-profits according to personal interests and performance expectations, rather than to build government bureaucracies.

The general idea behind the triple bottom line is to offer more than just financial reporting metrics for the performance of a business, so that socially-motivated investors are free to make informed choices about the companies in which they may choose to invest or not, and also to know how the business leaders are using the capital they invested in the business.

The traditional financial metrics are therefore complemented by a variety of voluntary social and environmental metrics to help identify the social impact of the company on the places where it does business, and thus encourage improvement in such performance by focusing management attention on specific goals of interest to shareholders in this regard too.

The idea is a response to the simple notion that the obligation of companies is just to maximize shareholder value, rather than to deliver other types of value to society and improve their environmental impact through metrics which recognize that some investors expect more than just financial performance, and that the communities where companies operate are also "stakeholders" in their performance.

Sovereign governments (democratic or not) are free to try to impose social costs and "social responsibility" expectations on businesses and residents, but companies and individuals are ultimately free to vote with their feet by moving out despite the high costs, disruption, and many other challenges or even government obstacles to discourage relocation choices.

For those who doubt this, remember the Berlin Wall, or visit the US-Mexico border.   In the absence of very severe repression (as in North Korea), people and capital will seek opportunities.  Private capital (foreign or domestic) will grow or go.

Investment incentives are basically a mechanism for governments to encourage businesses to invest or remain in a location where the social choices have destroyed economic value relative to competing locations.  In some places, incentives simply will not attract private investment, and in other places they are not needed at all to attract business investment.  Social choices matter.

The "Triple Top Line" can be defined as the impact of social and environmental choices by government and special interest groups in societies where a company has chosen to do business.  It is, in short, the indirect social cost of doing business in such places relative to viable alternative business locations which have made different choices.  In other words, if the business chose to do the same things in a similarly viable business environment, would the social costs to the business be higher or lower?  Have the business leaders chosen to invest in a presence in a high-social-cost location, or does the business derive added value through global configuration choices which reflect measurable differences in social costs?

Despite all the talk about "sustainable development" in the context of "green" development initiatives, there is little talk about sustainable development in the context of creating a sustainable business environment.  Instead, there is simply criticism of business as executives choose to shift operations to more competitive business locations.

Shareholders may feel that CSR is more a matter of ethical governance and open reporting standards, and that it is up to the shareholders to decide how they support charitable social causes with their financial resources, rather than the responsibility of corporate executives to choose how to invest the capital of their investors in social causes beyond those which are directly applicable to their business activities.  In any case, that is a matter for debate between shareholders and the management they entrust for the growth of their wealth.

Executives may also have very different perspectives, both professionally in the context of the industry practices which are common to their business, including "best practices" which they may or may not choose to pursue, and also as private individuals who have social and humanitarian interests.  They may wish to use their positions of economic power, visibility, and influence for good causes - through both private and corporate philanthropy.

In any case, there can be very different perceptions of what is "responsible" or not.

It is not a topic for which there are clear, objective metrics and priorities on which everyone agrees.  Instead, the recent debate has largely become a political one about defining the appropriate role of business in society, and the definition of ethical governance expectations for corporate boards and executives.  Much of the focus has been internal - regulating how large businesses operate - rather than actually improving their external impact on society.

A handful of corporate scandals in recent years (out of millions of companies) reinforced the notion that it was necessary for government to impose greater standards on business, such as through the Sarbanes-Oxley process and other mandates.  Advocates of various causes have seized on this political opportunity to try to advance their own special interests, while critics of "American-brand capitalism" in Europe have also seized the opportunity to push their own social agendas despite the economic harm they have self-inflicted on Europeans.

It is, in many ways, analogous to the concepts of "noblesse oblige" in royal or even tribal societies, in which leaders or elders are expected to use their power, wealth, and experience for good social causes beyond personal power and self-interest. 

The ideas of altruism, philanthropy, ethics, and social justice have been debated for centuries, with viewpoints as diverse as Plato and Machiavelli, or more recently Adam Smith and Karl Marx.  Even the collapse of the Soviet Union and most communist and socialist regimes around the world has not ended the populist or leftist anti-business rhetoric in favor of finding more productive ways to work together to achieve business and social goals.

Indeed, the great universities where philosophical debates and many virulently anti-business polemics exist are, ironically, largely funded by private wealth and business philanthropy rather than government, although few (unlike Hillsdale College in Michigan) refuse any government money or influence as a matter of principle for academic independence.

Advocates of "corporate social responsibility" in general, and special interest groups for specific charitable causes for social and environmental issues in particular, including concepts such as "sustainable development', often promote the concept of a "triple bottom line" for business because it is another way for them to push their own self-interests.

In short, they argue that businesses have a social obligation to do more than just pay taxes to the communities and protect the environment in the places where they operate.  That goes beyond anything which is directly required by law, regulation, or common business practices and social norms to become competitive in such locations in the context of local market expectations.  It's basically an unfunded mandate to do the work of government.

For example, different societies are free to make different choices about what they expect of businesses.  It is monocultural arrogance to assume that the values of one society are applicable to all, or that the same choices will or should be made at very different stages of social and economic development.  Local expectations may change over time, and there are few objectively right or wrong answers about the many social choices to be made.

This is somewhat analogous to asking government to tell private individuals what they should be doing for society, rather than just creating a societal framework in which competing ideas are free to attract private or governmental support.  It enforces adherence to the social ideals of particular special interest groups.  What would most individuals say if their government simply decided one day that they should all be required to invest in a specific charity?  That is not very different than insisting that private businesses must do what the activist groups want.  It is a subtle attack on individual freedom behind the thin veneer of a noble cause.

However worthy their causes may seem at the time, costly and harmful social policies can be created by special interest groups behind a thin veneer of apparently good intentions.

For example, the Corporate Responsibility Coalition (CORE) is a group of major non-profits which is now pushing the idea that the voluntary approach to corporate social responsibility has already failed; with an explicit agenda for "putting people and planet before profit".

This shifts the focus away from the "triple bottom line" concept (metrics for recognizing financial, social, and environmental performance by corporations) to a more regulatory rather than voluntary approach which enforces corporate social responsibility as they define it.

Some try to intimidate businesses through violent actions, while others try to do it through lawyers and government, academic, and media influence.  In any case, it is no longer a constructive process to try to achieve social goals together.  It is just an attack on business.  Terrorism doesn't require brains or viable solutions to problems.  It is very easy to criticize and attack the choices made by others, rather than to persuade them to change.

To illustrate our view, consider the criticism of the environmental movement by one of the founders of Greenpeace, Dr. Patrick Moore at www.greenspirit.com or some of his "The Sensible Environmentalist" columns for ESPN Outdoors, or buy a copy of his book. 

His essay on "Environmentalism for the 21st Century" is highly recommended.  Although some activists portray Moore as an "Eco-Traitor", we think that he raises very legitimate concerns about political activism which apply to more than just the environmentalist groups.

Corporations are a "legal person", and like other free citizens they must operate within the norms of the societies where they operate, but it is a slippery slope for special interest groups to try to enforce their own social agendas through government mandates.

In theory, the social infrastructure which supports the success of the business is being supported by a tax which is proportional to the value created by the business.

Whether a business is large or small, or very profitable or unprofitable, the fact that it is doing something which creates value is being taxed to benefit the society in which that business is operating. 

Governments tax businesses for a share of the value they create, whether by VAT or other means.  Business incentives basically tax government for the economic value they destroy for business through uncompetitive choices based on general social priorities.  They are less likely to offset major structural economic differences between business locations.

One cannot, for example, obtain incentives in the US to offset the lower costs of labor in China or Mexico.  One can, however, negotiate incentives related to variances between competing locations - if the local government is motivated to do so because the leaders want to attract or retain the business.  For example, in some places the government may adamantly feel that their higher social and other costs are justifiable, in which case the executives are free to choose whether or not they agree with that view for their purposes.  Not all companies choose to evacuate Germany, Japan, or California for low-cost places, for example.  There are reasons why some high-cost places are competitive locations.

Although members of such governments and societies may perceive their choices as creating a higher-value environment in which to do business, private investors are basically free to choose whether they concur with that assessment or not as they weigh their investment alternatives.  This analysis is unique to each business.

Frankly, their customers may not really care whether the company is based in a location which offers very attractive social infrastructure and benefits.  If their customers don't really care where the business is located, which is often the case, then it can become hard to compete against companies which choose lower-cost business environments. 

The value of the local business environment varies between companies.  Some need a high-value location, but others don't.  Some need a low labor cost location, but others need other factors which are more critical to the success of their ventures than labor costs.

In other words, communities can compete for investment by becoming inherently better places to do business as efficient clusters which take advantage of their relative strengths, or by compensating businesses for the economic value destroyed by local choices about social costs and benefits which are not limited to the current tax costs of government.

For example, countries which have been economic disasters as business locations for a long time may not have enough money to offer or taxes to cut to attract a business, nor many resources to invest to create a more attractive business environment in general. 

They have, in effect, dug themselves into an economic hole over many years from which it can be very hard and take a long time to climb out.  Investment incentives may not have much real impact other than as an indicator of goodwill and government commitment to making changes for the better.

For example, management can model the cost of staying at an existing location relative to the cost of relocating the operation elsewhere.

There are obviously complex implications in any relocation decision, such as potential disruption of the business and the loss of key skills among the existing employees, but these can be quantified as a one-time cost of relocation.  Such hypothetical costs can be added to whatever variances there may be from cost differences (positive or negative) at other locations - including both governmental costs such as taxes as well as the variances in the other major cost drivers for the business.

This helps to quantify the business cost of the choice to maintain the same configuration, such as to continue to add value and create jobs in existing locations rather than elsewhere.

Some of the variance between existing locations and potential business locations will be explained by fundamental economic differences, including business costs which may change over time as economically attractive locations develop. 

Part of the variance, however, will reflect the differences in social choices and costs between the competing locations.

In effect, this becomes a measure of location efficiency, reflecting consideration of variances in both the direct and indirect costs of government and other social mandates in a country as well as variances in other business inputs (labor, materials, logistics, space, etc.) and investment risks. 

The executives basically have to choose whether it is in the interest of the company to stay in the same place, or to move or gradually migrate operations to more competitive locations.  If the existing configuration is clearly no longer as competitive as in the past, this would basically quantify how much such location inefficiency is costing the company each year as a top-line charge. 

On the other hand, this can also help to measure the economic value added for business by the business climates in which it has chosen to operate, and monitor how such location value changes over time.

It's an imprecise process, rather than a financial accounting metric, just as the "triple bottom line" is an imprecise way to measure the social and environmental impact of a business.

The point is to measure the estimated impact on the business of "governmental business responsibility" choices in the locations where the company does business, versus where it could be doing business, so that the benefit or cost of retaining, expanding, or relocating operations can be considered by executives and better understood by government officials and those who advocate additional social costs for business according to their own agendas.  It is an attempt to quantify that such social choices have business consequences.

This reflect the strategic choice to do nothing or to change, since competitors are free to consider location choices as a way to gain advantage over established companies.  The neglect of growing disparities in location costs can make a successful business risky.

It is widely accepted that it is valuable for communities to attract and retain successful  businesses, but it is also counterproductive to throw money at efforts to protect or “save” those ventures which are demonstrably no longer competitive just because the local community still benefits from their presence.  That is like investing in a failing venture.

For communities to be sustainable, governments need to create and sustain an attractive business climate, rather than just benefit from the taxes and other social investments made by companies and the people they employ. 

In short, this is “government social responsibility” as the counterpart to “corporate social responsibility”.  The “triple bottom line” for government is that it cannot neglect the need to do what is necessary to sustain a globally competitive business environment.  There is virtually no reporting process in government, however, to measure the economic impact on business of the social choices which are made by government leaders other than the direct tax costs which they may impose.  They can literally drive businesses out of their regions without any public recognition of the self-inflicted harm of government policies.  Instead, the political leaders and communities just criticize the business leaders for choosing to leave, without recognizing any need to act to create a more competitive business environment..

At the core of the debate is the vain notion that, if it makes business sense to invest in the location for market reasons, there should be no real justification to offer incentives.  Everyone likes to believe that their own location is so wonderful that nobody would choose to invest somewhere else instead.  There are also perceptions that it is unfair to negotiate incentives with some businesses which may not be offered to others.

If one location is not as competitive as location alternatives for a given business, then the business should presumably just go to the more competitive location.  Efforts to persuade the company to invest somewhere else are simply a matter of using government money to encourage investment someplace where it would not otherwise occur because, for whatever reason, the location is not perceived by the potential investors as attractive without such incentives.  Typically, incentives are used more as a tie-breaker between two places which both make good sense as business locations, but which involve different costs.

In that context, one could argue that incentives are in part a “value-destroyed tax” on communities which have failed to become and remain as competitive as business locations in other communities.  In effect, incentives are a tax on the failure of the local, regional, or national governments to create and maintain the attractive social and business environment which would sustain competitive businesses without any investment incentives at all.

Business is mobile.  Companies, like people, are not obligated to stay in one place.  They are free to choose where to operate, with the special exception of nationalized companies or services to governments which oblige suppliers to be local, regardless of whether or not the local companies are the most competitive at delivering such services. 

Some companies may also require their suppliers to be local, such as to provide higher service levels or “just in time” capabilities, but many types of investments are actually mobile even if they provide services which are local in nature (hotels, restaurants, retail, etc.).  The hotel, restaurant, or retailer can also invest in some other attractive community.

One can certainly argue that it is not necessarily a failure of government that a business location is no longer as competitive for a particular type of business or economic activity as it was in the past.  Markets change.  Other places are constantly working at becoming more competitive and attractive to business.  They want to achieve the benefits of economic development too – according to whatever priorities they may have, and how they define “development” for the purposes of their society.

People in different parts of the world do not all share the same expectations and aspirations for either their government services or their business communities.  They are free to make different choices, and live with the consequences of such choices.  As proven in places like Hong Kong and Singapore, local government policies toward business development matter.  Two communities a few miles apart can achieve very different economic outcomes despite many apparent similarities.  Social choices have consequences.

Similarly, however, it is not the fault of business that specific communities sometimes are no longer the best place for them to operate.  They need to be flexible, and adapt to changing markets to survive, because they can’t add value in a sustainable way to become and remain profitable unless they are constantly considering how to be more competitive and more productive than their competitors anywhere else in the world.  Successful companies face relentless competitive pressures - and so do communities.  Government leaders, however, sometimes neglect the legacy of a successful economic environment.

Good business environments can easily fail to remain competitive.  Unattractive business environments can be improved in innovative ways.  In fact, it may be easier to transform unattractive environments because there is less debate about the need for improvement, although there may be debate about the problems and how to achieve the desired results.

In successful communities – from the local to national levels – there may be a greater tendency to become complacent and assume that continued success is assured – just as large and successful companies sometimes become complacent, bureaucratic, and lose market share to smaller, more agile, and effective new competitors. 

Competitors constantly find innovative ways to take advantage of the complacency or slow response to market changes by large corporations despite the great disparity in their available resources.  The same is true in the competition among communities for economic development.  Past performance does not guarantee future success.  Winners can lose.

The need for innovation and entrepreneurs in business is widely accepted, but the need for innovative, entrepreneurial approaches to government services and business community development as a government priority is not.  Despite the growth of interest in “social venture entrepreneurs” and many innovative initiatives, government is largely a low-innovation, risk-averse, slow-to-change institution driven by complex forces to arrive at some consensus or accepted expectations for government services and how those services are to be funded.  There are even widespread perceptions that it is inappropriate for government to do things to help create successful business communities, rather than just tax and regulate them.

Once again, different societies are free to make very different choices about their expectations for their own governments, but these choices also exist in a global context, in which such choices affect capital flows and thus have very real economic consequences.  Private capital grows, or goes.  Choices which are perceived to have a negative impact on local business investments will, sooner or later, drive capital investment away.  The ability of government to harm a healthy business environment should not be neglected.