Building blocks – Page 2 – Escondido Framework

What We Owe Each Other, by Minouche Shafik

Minouche Shafik, Director of the London School of Economics

There is much to celebrate in Minouche Shafik’s argument that we need a new social contract[1], not least a title that uses the language of obligation and duty rather than employing the language of rights. This is even if she falls back, in her closing remarks, on answering her question of what it is that we owe to each, that it is “to muster the courage and sense of unity” that the Beveridge Report said was necessary for the “winning” of “freedom and want”. I was looking for more, and shouldn’t be too critical her effort at a rallying cry to round off the book when she has addressed a variety of policy measures, without being unduly prescriptive about their precise form, that would address “our interdependencies, provide minimum protections to all, share some risks collectively and ask everyone to contribute as much as they can for as long as they can….investing in people and building a new system of risk sharing to increase our overall well-being”.

Shafik’s underlying argument is that we need a new social contract to meet the needs and opportunities facing both individual society and global society in the 21^st century, including those of an environment threatened by global warming and the degradation from human activity, of an ageing population, of an inequity between generations, and of the alienation of communities left as others have prospered that as consequence poses a threat the liberal democracy. She is qualified for this task by her personal history which includes an affluent childhood in Egypt that exposed her to third world poverty around her before her family emigrated to the USA, a career largely “in the trenches of policymaking” spanning international institutions and in the central government and central banking in the UK, and finally her current appointment as Director of the London School of Economics in 2017 where she launched a programme of research, ‘Beveridge 2.00’, to rethink the welfare state.

Having spent many years in healthcare and the application of health economics, I felt initially that her chapter on health was skated over too much. But this was before I reflected that the chapters outside my own area of knowledge were throwing me snippets of valuable information and new insights that left me with respect for the ambition within her 189 very readable pages (Thomas Piketty could learn a thing or two from Minouche Shafik!). Plenty of the examples in this book are familiar, such as the marshmallow test, but others cited, such as the evidence of the value of quite modest investment in early years intervention, such as weekly hour-long visits by Jamaican community health workers for 2 years to encourage mothers to interact and play with their children to develop cognitive and personality skills that 20 years later yielded 42% higher earnings than the control group.

Shafik sensibly avoids too many narrowly defined prescriptions, reflecting on data presented in the book that different countries have successful applied different policy solutions (for example in how they fund and organise healthcare) to achieve broadly similar outcomes (even if the one nation in the case of healthcare that doesn’t do this in a coherent way – the United States – ends up spending far more in aggregate, and in terms of public money, than everywhere else only to realise worse outcomes). However, the general thrust of her argument in each area of policy is clear.

Shafik poses interesting questions around the intergenerational social contract. On one hand, younger generations are blessed with material well-being that the old generations could not have dreamt off. On the other hand, as David Willetts documented in the The Pinch[2], the millennials and generation Z have good reason to be aggrieved as they pay for the higher education and the home ownership enjoyed by their parents appears out of reach. Shafik recognises, in the emphasis that she places on investment in education in new social contract and various mechanisms for achieving this that she suggests. There is also the issue of the price that they and future generations will pay in terms of the environmental degradation resulting from the previous generations’ approach to achieving their wellbeing and economic growth. I am surprised at the complexity that she builds in to potential solutions to this when the solution should lie in regulation, a national income calculus that better reflects the value of the natural world that currently calculated GDP or national income, and environmentally based taxes that capture the externalities of industrial and agricultural activity that damages the environment.

The book also gives rise to a set of interesting questions about what this means for businesses. Where do they sit within this narrative? There are important lessons for the people who sit at the heart of businesses, the “controlling minds” in terms what they can do, both in relation to their own workforces, customers and suppliers, in terms of contribution to a new social contract. For the business to thrive, and sustain itself in the long term, the core lesson is that it should be a player, alongside the individual citizen, in such a new social contract. Otherwise, its profitability and in due course its survival will be undermined by the very same pressures the Shafik describes threatening both individuals and liberal democracy.

I have a fear about one element in the approach Shafik takes to the need for a new social contract. This relates to what goes into the “increase in our overall well-being”. Some of the steam that is driving populism is increasing material inequality and the sense that communities are being “left behind”. Some of this populism is a function of identity politics, which may be whipped up by the perception that communities with other identities (often, but not exclusively, framed by other ethnicities or immigrant groups) are posing an economic threat or gain an advantage. But the perception may nothing to do with actual material wellbeing. Indeed, in the case of some of the 52% of the British population voting for Brexit, or the potential majority in Scotland for independence from the UK, this may be a desire to escape from or avoid the “other” despite the prospect that of material disadvantage. Some may be seduced by arguments that “getting back control” will leave them better off materially, but many others take the view that independence from Europe or the UK is more important than the economic benefit of remaining part of the whole. There is, at least at an abstract level, a link between the communitarian spirit in Shafik’s argument for a social contract “that addresses our interdependencies” and the desire to be part of a union, whether of states sharing a continent or Kingdoms sharing a small archipelago at the continent’s north western edge. Those same people who resist the membership of the country they occupy in a union of countries are also likely to be those most resistant to her arguments for a renewed social contract.

[1] Shafik, Minouche (2021). What We Owe Each Other: A New Social Contract. ISBN 978-1847926272.

[2] Willetts, David (2010). The Pinch: How the Baby Boomers Took Their Children’s Future – And Why They Should Give It Back. ISBN 978-1848872318.

Applying the Escdondido Framework to Dark Ages Britain

I often wonder about the applicability of the Escondido Framework model of the firm to organisations in other cultures and at other times to the developed world in the 21^st century . One of the claims of the Escondido Framework is the degree to which it can be applied universally. Certainly, the model can be applied to public sector and third sector organisations, and can be applied wherever there is some sort of corporate collective structure that can be shown to create value that is greater than the sum of the efforts of the people who are working together within the structure if they were together in a set of discrete collaborations brought about by a set of separate agreements (whether explicit or implicit).

I have just completed reading Max Adams’ account of Britain in the 5^th to 7^th centuries, The First Kingdom[1]. This covers the period often known as the Dark Ages, following the departure of the Roman Empire and before settled control of England by Anglo-Saxon rulers in the Heptarchy. He pieces together the considerable research undertaken in recent years to describe a fragmentation of society, depopulation of most cities and towns and replacement by what may in many respects to a pre-Roman pattern of village economies and local tribal leadership, subject to incursions by Viking and north German raiding parties, but still with some loose links to continental Europe, with the Christianity that had arrived in the Roman period hanging on in places prior to reintroduction both from Ireland with Colme Cille (St Columba) and with St Augustine from Rome, and with continuing trade.

One of the key themes of the Escondido Framework is the identity of the corporation independent of stakeholders, the “societé anonyme” whose ultimate purpose is to survive, and which outlives its “controlling mind”. Adams marks the end of the period that he is describing by an important transition, from one in which the individual “kingdoms” were pretty fluid, some very small and sitting within and subject to other kingdoms (in a system described as Tribal Hidage), and most regimes pretty ephemeral.

“Victory on the battlefield and political success measured in tribute and booty secured the loyalty of secular élites for their king and his eligible successors; but for a life interest only. Defeat, if not fatal, weakened a king and exposed him to internal coup of external domination…..The luck of the tribe was invested so heavily in the person of its kings that when they died any imperium that they may have exercised over rival kings was void.

“As Bede so vividly described it, the pagan supernatural experience was in some sense like the passing of a sparrow into and out of a hall whose warmth and fellowship matched their brief period of Earth while all before and after was cold darkness unknown…..

“Pagan kingship was not stupidly irrational. Rulers were bound by conventions of honour, reciprocity and political pragmatism. They calculated odds as coolly – and with about as much reliance on superstition – as any politician or football coach whose tenure might be equally precarious.”[2]

But this changes with a new social contract, between church and king, that reflects the new world being constructed with the arrival of Christianity and the conversion of the rulers, whose souls continue after death. Adams cites a law of Wihtred, king of Kent 690 -725: “The Church shall enjoy immunity from taxation; and the king shall be prayed for” before noting:

“The rapid seventh-century establishment of monastic communities across the Insular kingdoms, supported by extensive, formerly royal estates and nurture by their relations with kings, parallels the history of secular territorial lordship founder on the right to exact and collect renders from lands and communities, but with a a critical difference. The unique brilliance of this new social contract was to convert landed assets otherwise held for a mere life interest – the so-called folcland held by the thegns and gesiths form the king, which returned to the royal portfolio on their death – into a freehold bocland of abbots and abbesses. Bocland or bookland – what we would call freehold – was fundamental to a relationship meant to last for eternity on Earth and in heaven. It allowed the church to invest in physical labour and material wealth in permanent settlements free from the obligation of military service and taxation; to capitalize agriculture an technology. It laid the foundations for a literate, institutional clerical caste and formation concepts of obligations owed by kings to their people.”

Permanence is the key word – even if in due course the success of the monastic corporations became the seed of their undoing at the Reformation. The monastery or convent was greater than the abbot or abbess. The kingdom also secured more permanence, even if an institutional fluidity remained until the major kingdoms of the Heptarchy progressively consolidate and became on under Athelstan in the 10^th century.

[1] Adams, Max (2021). The First Kingdom: Britain in the Age of Arthur. ISBN-13 : 978-1788543477

[2] Ibid. pp 398 -399.

Lockdown reading: Piketty’s Capitalism and Ideology

The Year of Revolution - a clash of ideology Chartists meet on Kennington Common in 1848 — Chartists meet on Kennington Common in 1848 – the year of the Communist Manifesto and “All things bright and beautiful”

I went into the first Covid-19 lockdown in March with three doorstep sized volumes to keep me going.

The 912 pages of Hilary Mantel’s Mirror and the Light were riveting, even if I knew from the outset that Thomas Cromwell’s career would come to an abrupt end at Tower Hill in 1540. The 1088 pages of David Abulafia’s magisterial The Boundless Sea kept me entertained as it opened my eyes, chapter by chapter, to the way that different parts of the world became progressively connected by maritime exploration, communication and trade.

I had started turning the 1041 pages of Thomas Piketty’s Capital and Ideology before restrictions started to be lifted in May but, despite finding some stimulating ideas in his opening account of the different sources of power of different parts of premodern society (which he describes as ternary or trifunctional, and have echoes in the Escondido Framework’s account of the three currencies or sanctions), it was not until the re-imposition of lockdown (the UK government’s Tier 4 restrictions) that I finally completed it.

I admire much of what Piketty has done in Capital and Ideology. His effort to document the movements in the shares of income and wealth between different groups in different societies throughout human history, and particularly the past century or so, is admirable and revealing. It is possible to challenge some of his assumptions and definitions, but the picture he paints of the direction of the trends in material inequality are compelling. I agree with his spin on Rawls’s maximin principle: “To the extent that income and wealth inequalities are the result of different aspirations and distinct life choices or permit improvement in the standards of living and expansion of the opportunities available to the disadvantaged, they may be considered just.” (p.968). His chapters on the increasing support of the “Brahmin” classes educated to degree level for parties of the left and the corresponding “Nativist” alignment of parties of the traditional right and “left-behind” communities are persuasive. But the book is far longer than it needs to be, many of its graphs add little, and he strays from the professorial scholarship of the economist/social scientist-turned-historian into an undergraduate level of prescription.

Piketty’s underlying thesis is that “no human society can live without an ideology can live without an ideology to make sense of its inequalities.” I didn’t need to read 1041 pages to recognise this: growing up in a churchgoing family, I remember singing the third verse of “All Things Bright and Beautiful”

The rich man in his castle,
The poor man at his gate,
God made them, high and lowly,
And ordered their estate.

These days, it is generally omitted!

It may or not be a coincidence that Mrs Cecil F Alexander wrote these words in 1848, the “Year of Revolutions”, in which Marx and Engels also wrote The Communist Manifesto. Piketty chooses to reformulate the opening words of its first chapter “The history of all hitherto existing society is the history of class struggles” as “The history of all hitherto existing society is the history of the struggle of ideologies and the quest for justice.”

There is something in Piketty’s thesis about the relationship between the ideas that prevail at any point in time and the organisation of society and its impact on the distribution of wealth and income. It may be that I started out as a historian whereas has come to history by way of economics, but I find that he oversimplifies to sustain his argument. Ideas ebb and flow and they can influence behaviours, but this is not the same thing as saying that they determine behaviours. He falls into the trap of assuming that the behaviours that are generally ascribed to “capitalism” are the product of the past few centuries.

He frequently quotes Karl Polanyi with approval, who was even more blinkered in this respect, regarding capitalism as an entirely modern phenomenon. Peter Acton has undermined Moses Finlay’s thesis that the ancient economy was shaped by considerations of status and civic ideology rather than rational economic considerations, demonstrating in Poiesis: Manufacturing in Classical Athens demonstrates that the commercial decisions of Athenians “were for the most part…consistent with today’s understanding of good (rational, profit-maximising) business practice[1]. It does not require a 21^st century reading of the biblical parable of the talents to see that the notion of investing for a return was established by the time the Christian gospels were written. And Abulafia’s The Boundless Sea, contains plenty of evidence for the commercial underpinning of the development of maritime trade over many centuries. One of the primary shortcomings in Polanyi’s approach was that set very specific conditions around anything that he would define as a market and, by framing his argument in this way, created a platform for his dismissal of the longstanding heritage of commercial activity. It is as though Polanyi, and to a lesser extent Piketty, seek to dismiss market mechanisms and their place in human societies on the basis that, prior to Adam Smith and his successor, the conditions assumed in classical economics had neither been articulated nor did they prevail.

Essentially, it is not that Piketty is wrong, but his case is overstated and needs reframing. It is not that ideology determines the form of economic organisation, but it helps shape relationship between the parties. In Escondido Framework terms, the prevailing ideological frameworks will influence the attitudes and trade-offs made by parties in their relationships with each other at market interfaces. For example, a religious ordained prohibition on usury does not undermine the human behavioural drivers for gratification today over gratification tomorrow and discounting for risk (although these can be culturally influenced), but historically has resulted in work-arounds (eg Islamic finance) or lending being undertaken by a community less constrained by the prohibition. Certain activities, as in caste based societies, may be undertaken by tightly defined social groups, with implications for the commercial terms on which these activities take place. But this is not the preserve of caste societies: while the boundaries may be less clearly defined and not religiously ordained, even in contemporary society there is an intergenerational stickiness in occupations and values, traditions and attitudes acquired in childhood shape occupational choices and behaviours.

So, two cheers for Picketty for the underlying thesis. And, in due recognition of his own disclaimer in his concluding chapters, he has set out to provoke further debate and provide the foundation for further scholarship rather than provide the definitive answer

However, where I find Capital and Ideology most flawed in when Piketty moves from diagnosis to prescription. In particular, his leap from describing to the increasing inequality in economic outcome for the richest few percent compared to the poorer mass of the population to concluding that all would be solved by appointing worker representatives to corporate boards highlights the danger of straying too far from your own area of expertise.

The inequality that Piketty documents arises from the endowments that we start out with in life (geography, genetics, family wealth, upbringing, education) and our life choices and chances (too many possibilities to enumerate). These will shape whether we end up with investable wealth (the impact of this on equality is thoroughly documented in his earlier work: Capital in the 21^st Century) and whether we end up in positions in which we have market power and are able to extract economic rent, which has arisen most egregiously in recent years for executive directors of large companies as a result of shortcomings in corporate governance. Addressing inequality arising from our endowments needs primarily to be by “levelling up” in terms of investment in education and social support, particularly in early years, and widening opportunities, but in relation to inherited wealth is a proper area for taxation. Addressing inequality arising from investable wealth is also clearly an issue for taxation and also needs international solutions, but is a complex matter not least because of the risk of creating perverse incentives and unintended outcomes. Taxation has its place in addressing inequalities in income, but as with addressing issues surrounding taxation of wealth and wealth transfer, is also fraught with difficulty. Piketty raises these issues quite correctly.

But addressing inequality arising from market power and the ability to extract economic rent is a proper matter for better corporate governance and regulation to address market failure. Piketty fails to recognise the role of market failure and consequently the need to address this, and also the problem of the increasing ability of corporate management (and some of the services that support them), to extract economic rent (ironically, at least in part, at the expense of the owners of investible wealth), and that this is purpose behind the need for reform of corporate governance. His own prescription, worker representation on boards, is not the solution for reasons that I have argued elsewhere. Rather, and this comes back to his underlying thesis around ideology, there is a need to widen the understanding about the proper purpose of the company (the core of the Escondido Framework), and an improved understanding of the role of boards in serving them.

[1] Acton P (2014) Poiesis: Manufacturing in Classical Athens. New York: Oxford University Press

First Reith Lecture 2020: Value does not equal price

I listened this morning to the first of Mark Carney’s Reith Lectures, portentously titled “How we get what we value: from moral to market sentiments”. The promise on the BBC’s web site was that

In this lecture, recorded with a virtual audience, he reflects that whenever he could step back from what felt like daily crisis management, the same deeper issues loomed. What is value? How does the way we assess value both shape our values and constrain our choices? How do the valuations of markets affect the values of our society?

Dr Carney argues that society has come to embody Oscar Wilde’s aphorism: “Knowing the price of everything but the value of nothing.”

It added up to a stimulating hour both from the former Governor General of the Bank of England and from an eminent audience delivering a barrage of pertinent questions but it didn’t really deliver. In many respects, although well referenced and I will come back for later episodes, it was disappointingly superficial and lightweight. However, I’ll wait until I have heard the full series of lectures and have transcripts before making a more considered commentary.

In the meantime, it is sufficient to observe that I was particularly frustrated by a looseness of language and a tendency to equate price with value and speak as if value and values are absolute. Markets generate prices but do not tell you much about the value that an individual places on anything – whether a loaf of bread, a ticket for the opera, their freedom or the impact of climate change on future generations. I place a different value on any of these to somebody else, and I may place a different value on any particular item at different times, even from hour to hour. Prices are the outcome of the differing judgements about the value of whatever is in question at the particular time – the downward slope of the demand curve reflects willingness of different people to make purchase at different prices, reflecting the value to each of them. (By extension, although Carney and his audience were only addressing financially denominated markets at the time, this applies also to marketplaces that, as I have described elsewhere, where the currency is political expression or force)

One particular exchange illustrated the shortcomings of the broader debate and demonstrated that thinking about value and that it means remains work in progress. We have known for years that national income statistics are fundamentally flawed in terms of failing to capture what is more widely considered as “value”. But Carney, notwithstanding his overall thesis that value is an elusive concept, appeared to fall into the “price =value” trap in a discussion of home-schooling, something whose value is not recognised in national income or GDP calculations. He talked as though this can be treated as lost and unmeasurable. However, there are at least two ways of quantifying the value placed on it even if it is not part of an market transaction with a formal price. One is the cost of alternative provision, reflecting either the cost per student of the child’s education in the state-funded schools or the price that a parent would pay for education in a private school. The other is the opportunity cost of the parent’s time if they were in salaried employment.

There are three more lectures in the series (to be broadcast on 9^th, 16^th and 23^rd December). I am sure that I will find them provocative, but I hope for more positive reasons than this opening salvo.

Understanding Apple’s implausible explanation

Apple has just announced that it will reduce the commission it charges smaller developers (those who earned less than $1 million last year through the App Store) from 30% to 15%.

As someone with an advisory role and financial interest in just such a business for the past ten years, the explanation provided by Apple’s CEO, Tim Cook, has a hollow ring:

“Small businesses are the backbone of our global economy and the beating heart of innovation and opportunity in communities around the world. We’re launching this program to help small business owners write the next chapter of creativity and prosperity on the App Store, and to build the kind of quality apps our customers love. The App Store has been an engine of economic growth like none other, creating millions of new jobs and a pathway to entrepreneurship accessible to anyone with a great idea. Our new program carries that progress forward — helping developers fund their small businesses, take risks on new ideas, expand their teams, and continue to make apps that enrich people’s lives.”

The suggestion that this is a natural evolution and being done out of the goodness of Apple’s corporate heart is implausible at best. The small businesses that rely on the App Store to reach iPhone customer have been “the backbone of the global economy and beating heart of innovation and opportunity” throughout the iPhone’s existence and have put up with being fleeced. The entrepreneurs have funded their businesses, taken risks on new ideas, expanded their teams and made apps that enrich people’s lives without any help from the black shirts* formerly of Infinity Loop, now Apple Park.

The likely explanation is provided by the threat of action from the European Commission, which opened an investigation into Apple’s anti-competitive behaviour in June, and potentially from the US, with Congressional hearings into the monopolistic conduct of the tech giants later in the summer. This is an illustration of the strategic solution space available to a company being reduced by the prospect of regulatory intervention.

In parallel with this reduction in the price charged to its small customers for using the App Store, Apple revealed at the Congressional hearings something about the shape of the market interface between the App Store and the “customers” who sell through it when it disclosed that it had agreed a 15% commission with Amazon for in-app charges within the Prime Video app.

The interesting question is what happens next. Apple has had to cave in to the threat of another web behemoth flexing its market power and potential to lobby against it. It has accepted, so far in part only with the new deal for smaller developers, the political reality of the forces gathering against its abuse of its power over a large slice of the market for apps on mobile phones. What of the middle-sized App Store developer customers? How long will it take Apple to develop an implausible but face-saving formulation to explain why it has reduced their commissions too? Or will it try to tough it out until competition authorities around the world run out of patience and take Apple, and potentially some of the other tech giants, apart in the way they did to the US rail and oil industry over a century ago?

* for the avoidance of doubt, this is a reference to the sartorial style of the late Steve Jobs and his successors and not a comment on either their conduct or politics.

Investors and consumers both need good sustainability reporting

The FT has been carrying stories for the past two weeks about improving the quality of information provided by companies to their investors on the environmental impact of their activities and the sustainability of their businesses in the face of climate change. It may just be a coincidence, or it may be a conscious decision of the editorial board, but the Fashion Editor writes in “Life and the Arts” section of the Weekend FT on the same subject under the headline “Sustainable fashion? There’s no such thing”

On 5^th November, Erkki Liikanen, Chair of the IFRS Foundation Trustees, delivered the keynote speech at the UNCTAD Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting, introducing the Trustees’ Consultation Paper on Sustainability Reporting.

On 9^th November, Rishi Sunak, Chancellor of the Exchequer, delivered a speech to the House of Commons on financial services. In the course of setting out his plans for supporting the City at the end of the transition period as the UK leaves the EU and plans to launch a Sovereign Green Bond, he declared:

“We’re announcing the UK’s intention to mandate climate disclosures by large companies and financial institutions across our economy, by 2025.

“Going further than recommended by the Taskforce on Climate-related Financial Disclosures.

“And the first G20 country to do so.

“We’re implementing a new ‘green taxonomy’, robustly classifying what we mean by ‘green’ to help firms and investors better understand the impact of their investments on the environment.”

On 10^th November, the Financial Reporting Council launched its Statement on Non-Financial Reporting Frameworks, opening with the preamble:

“Climate change is one of the defining issues of our time and, by its nature, material to companies’ long-term success. Boards have a responsibility to consider their impact on the environment and the likely consequences of any business decisions in the long-term. Our 2020 review of climate-related considerations in corporate reporting and auditing found that boards and companies, auditors, professional associations, regulators and standard-setters need to do more.”

before recommending that companies should try to report “against the Task Force on Climate-related Financial Disclosures’ (TCFD) 11 recommended disclosures and, with reference to their sector, using the Sustainability Accounting Standards Board (SASB) metrics” and setting out its own plans over the medium term to help “companies to achieve reporting under TCFD and SASB that meets the needs of investors”.

Today, 14^th November, the FT’s fashion editor writes about the dilemmas facing those of her readers who are concerned about the impact of their purchasing decisions. She recognises that the best way to live a sustainable life is to buy less, but also that her readers want to find ways, while supplementing and refreshing their wardrobes, to plot their way through the “greenwash” claims of the fashion brands. Both these consumers and some of the brands themselves want clearer and more reliable accreditation of products that come from supply chains that are, if not truly environmentally friendly, at least less environmental unfriendly.

Following up the themes in this article, I found a great piece written by Whitney Bauck in Fashionista, in April last year:

“If you’re aware that there are ethical issues baked into making clothes but don’t have time to do in-depth supply chain research every time you need a new pair of socks, there’s a good chance you’ve thought at some point: ‘If only someone could just tell me for sure if this brand is ethical or not.’

“You wouldn’t be alone in that desire. In years of writing about both sustainability and ethics, it’s a sentiment I’ve heard from fashion consumers a lot. While many people want to be more conscious with their consumption, they also wish it were easier to tell which brands are truly being kind to people and planet.

“If you fall into that category, there’s good news and bad news. The bad news is that a one-size-fits-all ethical fashion certification will probably never exist, partly because not everyone agrees on what qualifies as “ethical.” Should that word refer to job creation in impoverished communities or animal welfare? Should it mean making clothes from organic materials or recycled synthetic ones? Not every ethical fashion fan has the same standards or priorities, and that will always make a one-size-fits-all approach to ethical fashion certification difficult.”

I wrote in a blog post four years ago about the benefits that the team I led at WH Smith believed would arise from developing and selling green stationery ranges. The issues described by Lauren Indvik in the FT are nothing new. We faced similar challenges both in terms of selecting products and in terms demonstrating to our customers that buying these products would better than buying alternatives.

The challenges facing investors and consumers in taking environmental and other ethical considerations into account in what are otherwise commercial decisions are identical. Both investors and consumers want the best information, to put into the mix with the other things that influence their decisions – the complex trade-offs of exposure to multiple risks, timing, and return for the investor, or look, feel, comfort, durability, after sales support and cost* for the consumer.

The similarity between these challenges is evidence for the symmetry in all businesses – investors are customers for investment opportunities presented by the company, in the same way that consumers are customers for products and, indeed, that employees are customers for the jobs that companies provide. In an age when people – in their multiple roles as investors, consumers, and employees – want to invest in, buy from, and work for organisations that behave responsibly in relation to wider society and to the environment, they need reliable information to inform their decisions.

* and a host of other possible features depending on the product or service category

America decides……

Primed by Trump, militias gear up for 'stolen' election (Sunday Times — Primed by Trump, militias gear up for ‘stolen’ election (Sunday Times)

The US electorate (at least those who have not already cast their votes) goes to the polls today to choose a new president, senator, congressman, governor, mayor, and ratcatcher. The presidential campaign has been the most vituperative I can recall and has given rise to anxiety that the losing candidate’s supporters – whether militias driving pickups and toting semi-automatic weapons (including the Proud Boys who have been following the instruction to “stand back and stand by”), or masked rioters with bricks and molotov cocktails – will take to the streets.

The election itself and the accompanying scenario represent a living illustration of the “Three Sanctions” and their relationship.

One of the major underlying differences between the two parties is the view of the proper boundary between the cash and market-based sanction and the political sanction. The party of small government (and by extension, the dispute of states’ rights over federal responsibility, which goes back to the Founding Fathers*), is less inclined to recognise the market failures that others see requiring the intervention of government. On the other side, the interventionist Democrats recognise the merit of anti-trust measures need to curb monopolistic excess and deliver the benefits attributed to the market system; recognise that unfettered markets result in huge social inequality and that post tax income disparities in the US are way beyond anything required to provide incentives to maximise the nation’s overall material wellbeing; and fear for the future of the environment under a government that does nothing to address the externalities of unregulated commerce.

The threat of a violent response to the outcome of the election represents a potential failure in the political market-place, which depends on a degree of consent and recognition of the legitimacy of a constitutional settlement, anchored in a document drafted in Philadelphia in the summer of 1787 to meet the needs of thirteen small former colonies on the east coast in age bounded by limited horizons, communication, scientific understanding and technology. We will see in the next few days whether the political marketplace in the United States is operating under sufficiently favourable conditions – particularly consent for the constitutional settlement – for those who are disappointed by the outcome not to resort to resort to third sanction to address their sense of powerlessness and injustice. Even if they do not, the very fact of the threat that they might should prompt a deep search for an enhancement of the constitutional settlement to reduce the risk of political market failure.

*The diligent student of US history will recognise that during the mid 20^th century, the alignment of the parties on this issue switched over

“…… because they still do the same thing: they primarily serve shareholders”

Dame Vivien Hunt, until this year managing partner of McKinsey’s offices in the UK and Ireland, has written in today’s Financial Times on workplace diversity and equality under the heading “Change how boards work to achieve to true diversity”.

She asks why, when one third of the seats on the boards of FTSE 100 companies are now occupied by women, “those boards still look similar……still filled with people who have the same skills carved out of similar professions, networks and university degrees.” Her explanation is that it is “because they still do the same thing: they primarily serve shareholders.”

I am pleased that one of the current leaders of the organisation where I started my professional career takes such an unambiguous and very public position strong position on both the composition of boards and their purpose. Back in the 1980s, most of my colleagues were beholden to the orthodoxy of “shareholder value” and, although there were a small number of senior non-white consultants (including Keniche Ohmae, who led the Tokyo office, and Rajat Gupta, who became an office managing partner shortly after I left and subsequently global managing partner), the firm was anything but diverse.

Dame Vivien argues that “we need to find people who represent not only our investors but everyone else – from buyers to suppliers, to local communities, to our natural environment”. Her use of language and her argument is not entirely clear here: her article could easily be interpreted as making a case for a board of representatives of stakeholders as opposed to a board that understands the broader mandate of the company and the need to take all stakeholders’ interests into account.

I have argued elsewhere against boards being composed of representatives of stakeholders. As is implicit in Dame Vivien’s article, directors should have a duty to all stakeholders, because their wellbeing of all groups is critical to the wellbeing of the company. Furthermore, in UK unitary boards composed of executives and non-executives, at the board may be the executive directors responsible for sales and marketing who should be the effective advocates for interests of consumers if they are fulfilling their role understanding and satisfying consumer needs. Similarly, executive directors of workforce and of operations should be able to represent to colleagues, who may place a primacy on the interests of shareholders and customers, the interests of the people they recruit, support, and manage. Whether or not they are full board members, most large companies employ directors of communications and public affairs (or similar) whose primary role may be to advocate externally for the company but also represent to the board the case for taking into account the interests of local communities, the environment, politicians and lobbyists.

Her underlying argument for diversity on boards is compelling, not for the purposes of representation but because a genuinely diverse board “brings diversity of thought, skills and experience that will lead to better decision making”. However, better decision making also depends on boards understanding their purpose of their companies, which is the sustainable creation of value for all those the company engages with, by producing goods or services more efficiently than would be possible in the absence of the company. The purpose of the company is not the creation of shareholder value: shareholder value is the necessary return provided to shareholders in return for their investment and the sustainable creation of shareholder value is the result of serving the interests of all stakeholders.

I was thrilled to read Dame Vivien’s piece and pleased to see her continued work championing diversity in business. But, notwithstanding my concern about some of the logical flow and detail in her argument, I was even more encouraged to see her set out the case that genuine diversity on boards will not be achieved until shareholder primacy is consigned to the waste bin.

Rio Tinto’s dynamiting of the Juukan Gorge: Jean-Sebastien Jacques’s solution-space implodes

Juukan Gorge caves after Rio Tinto dynamiting

What better illustration could there be of the Escondido Framework approach to understanding ESG investing described in last week’s blog than the defenestration of Rio Tinto’s chief executive, Jean-Sebastien Jacques, by the company’s shareholders?[1]

In relation to the distinction made in last week’s article between the impact of regulation on the solution space available to executive teams, one of the interesting aspects of the dynamiting of Juukan Gorge and the two rock shelters is that the company had previously negotiated native title agreements with the Puutu Kunti Kurrama and Pinikura people, giving it rights to mine the area and had also secured regulatory approval. In Escondido Framework terms, as illustrated in last week’s blog post, the company thought that it was operating within the solution space defined by the market transaction with the owners of the land and that the regulatory market interface had not reduced the solution space available to the company.

However, the executives had failed to appreciate the sensitivities of the company’s investors to such an egregious violation of the heritage of not only the indigenous population but humankind as a whole.

Perhaps the board and executive team at Rio Tinto paid too much attention to the likelihood that investors in mining stocks are already a self-selected group that is less sensitive to ESG considerations than the investment market overall.

It matters little whether the response of the investors whose pressure on the board finally persuaded chairman Simon Thompson (who previously had insisted that Rio Tinto would not fire Mr Jacques) was a reflection of the potential for the scandal to increase future regulatory pressure on the industry, or a concern for the response of the upstream investors in their funds, or the consciences of fund management executives themselves being pricked by comparisons between the dynamiting of the caves with the actions of the Taliban blowing up the Bamyam Buddhas in 2001.

Either way, the shape of the investment market interface was sufficiently different to that perceived by Mr Jacques and his colleagues for them to have placed themselves, not temporarily but at a personal level permanently, outside the solution space available to them.

[1] For anyone who missed the story, Rio Tinto blew up two 46,000-year-old Aboriginal rock shelters in Western Australia, offending not only the Australia aboriginal community for whom the sites were sacred but also a wider public sensitive to an ancient archeological heritage. Initially the board decided to withhold bonuses for the executives involved, but has now decided that Mr Jacques should go (albeit not until early next year and without any further financial penalties)

Understanding ESG investment

The Financial Times has published a flurry of articles and the occasional letter about ESG (Environmental, Social and Governance) investing recently.

For example, Geeta Aiyer, president of Boston Common Asset Management, was the subject of a profile on 29^th August. This followed the success of Boston Common and other investors to secure the change of name of the Washington Red Skins American Football team by applying pressure on FedEx, the logistics company which sponsors the team’s stadium.

On 1^st September the paper published an article about write-downs at BP and Shell in response to “scores of asset managers who have doggedly pressed the oil companies to set targets to reduce carbon emissions and recognise the financial impact climate change could have on their operations” . The article cites a number of leading fund managers who comment on the “explosion” in ESG investing. It also notes the role of regulation in changing perspectives, citing the requirement now placed on pension fund managers in the UK take sustainability issues into account in their investment decisions and the impact of the EU’s sustainable finance package which will, from March 2021, push asset managers to incorporate ESG risks in their decision making.

A day later, on 2^nd September, the FT published an article by Chuku Umuna, former Labour business spokesman and now lead for ESG with Edelman, the public relations consultancy, arguing that “a company’s ability to manage ESG factors is widely viewed as a proxy for prudent risk management, and with good reason”, citing work by Société Générale on the impact of ESG-related controversies that found that “in two-thirds of cases a company’s stock experienced sustained underperformance, trailing peers over the course of the following two years.”

A few months earlier, on 9^th July, Gillian Tett wrote an article that opened by observing that the major ESG indices in the US and in Asia had outperformed the equivalent all share indices in terms of the financial returns to shareholders and cited a report from BlackRock making the same case, not only in the past year but also in 2015/16 and in 2018. BlackRock put this down to two primary reasons: the momentum created by ESG investors pushing up prices as they seek to acquire these stock for their clients and beneficiaries; and the value to companies seeking to improve their ESG ratings the scrutiny to which they subject their supply chains and employee practices and the consequent benefits that arise to their businesses.

Does the Escondido Framework approach to understanding organisations help us understand what is going on?

The Escondido Framework approach to looking at the firm is described in detail elsewhere. In essence, it explains that firms exist as a virtual space defined by their market interface with the suppliers of capital, labour, suppliers of goods and services, and customers, plus others whose needs may need to be satisfied, such as government or the wider community who implicitly or explicitly provide the firm with a license to do business. Their survival depends on creating value through the efficiency of their internal operations for there to be such a space. Where the firm places itself within the space will determine the distribution of economic rent to the stakeholders, how much may retained by the executive management, and how is available for reinvestment either in assets or long term relationships with one of more sets of stakeholders. As the market interfaces changes – through changes in supply and demand, competition, or the trade-offs made by the other parties to the markets place exchange – the virtual space (which can also be considered as the solution space available to the management team) may expand or contract (increasing or reducing the range of options, strategies and potential profitability available).

If a new external party intervenes, for example a government agency imposes regulation, the virtual space will be reduced correspondingly. Indeed, even the threat of regulation will have the effect of reducing the space as the firm is likely to take the view that it cannot afford to provoke the regulator.

Impact of new regulation to reduce solution space

So what is going on with ESG investment? ESG considerations have an impact on investment decisions in multiple ways.

Some investors will choose only to invest in businesses whose practices meet certain standards in terms of environmental and/or social responsibility and impact. When I was trustee of a large medical charity, we initially had a relatively limited list of sectors that we guided our fund managers to avoid, but progressively widened the list to avoid those whose products were implicated in contributing to the ill-health we working to address. Other charities have much wider exclusion lists, and many private individuals also choose to invest in ethical funds. Such investors are making an explicit trade-off between such potential increased returns as may be available from investing in companies (eg defence, tobacco) that don’t satisfy their ethical criteria.

Other investors decide to invest in ESG funds and businesses that meet ESG criteria because they believe that companies that with sound governance, ethical approaches to the communities in which they operate and setting high standards in their supply chains, and responsible approaches to the environment will ultimately deliver higher long term returns and be sustainable. Such investors may also take the view that these approaches also represent good business. Working in retail management as a merchandise director in the 1980s, I certainly took the view that being as environmentally responsible as possible was good business. I led a team that decided to adopt policies towards sourcing products from sustainable raw materials, reducing packaging, and developing “green” product ranges making extensive use of recycled materials on the basis that it was good for the business. It was good for our brand as it improved our standing with increasingly environmentally conscious customers. It was good for our sales, since people appeared keen to buy less environmentally harmful alternatives. It was also good for recruitment and retention of good staff, who seemed motivated (as I was) by working for a company that was trying to be environmentally responsible.

High standards of governance should also be appealing to investors, and the evidence is strong notwithstanding the mercurial successes of a few mavericks. As chair of a committee investing £200 million for the charity on which I was a trustee, I was attracted to Edinburgh based fund managers, Baillie Gifford, precisely because of the demands that it placed on the governance of their investee companies and its willingness to vote the shares it held for client like us to improve governance of the investee companies – and we were rewarded for our confidence in the approach by returns that consistently exceed the benchmarks for the fund.

If, as the flurry of FT articles suggests, there is an increasing appetite for ESG investing for whatever reason, the impact on companies is that (at least for the visually minded) the shape and precise orientation of their interface with the investment market will change reflecting either the trade-offs (in the case of the first type of investor described above) or the beliefs about the sustainability and long term returns (in the case of the second type of investor). The consequence of the appetite for ESG investing on companies is that those with business practices that align with the demands and expectations of ESG investors will face a slightly lower cost of capital and consequently increase the size of the solution space for the management teams when looking at their strategies.