Beyond Government: Business Self-Regulation in International Affairs

Source: Carnegie

Virginia Haufler Discussion Paper #1

• A group of major television, computer and entertainment industry corporations recently formed a coalition to develop a common set of rules for "lazy interactive TV"—a mix of television programming, Internet data and interactive capabilities.
• A group of credit card issuers and information technology firms has developed standards for the new "smart cards" now coming into widespread use.
• A group of chemical manufacturers, through their industry association, established and now promotes internationally a set of rules regulating how chemicals should be handled.
• A group of major corporations created an international non-governmental organization whose members commit themselves to a set of principles for sustainable development to guide corporate strategy.
• A group of industry representatives and international organizations signed a voluntary agreement banning child labor in soccer ball manufacturing.

All of these are variations on the current trend towards business self-regulation through voluntary standards setting and corporate codes of conduct. They are examples of a significant trend redefining the expectations we have about corporate behavior, a redefinition going on both within the corporation itself and in the wider international society of which it is a part. Business is interacting with governments and civil society in new ways, resulting in new forms of regulation. What is significant is that the regulators and the regulated are in this case the same, and the rules that govern their behavior are adopted voluntarily.

This is a global trend that has garnered surprisingly little notice in foreign policy circles. Even the business community rarely acknowledges that their activities may contribute to global public policy. This may be in part because the phenomenon itself is difficult to see. We tend to assume that regulation is an activity of governments, therefore blinding ourselves to other varieties of rule. Much self-regulation occurs as a matter of course within industry associations, and is viewed as simply a process of determining business "best practices." The adoption by corporations of codes of conduct that lay out their rights and responsibilities has become increasingly common, but it has occurred in such an ad hoc fashion that it is difficult to determine the scope of this trend--only recently have different organizations launched projects to collect and analyze corporate codes. Partnerships among business, international organizations, governments and non-governmental actors have expanded in number, but their purpose is often such a mix of providing public goods and setting standards that the regulatory aspect of them is hidden, as seen in many environmental codes. The variety of activities that constitute self-regulation, as seen in the examples above, may lead us to miss the important fact that at core they all involve businesses that design voluntary rules for themselves. And they are doing this not just at home, but around the world.

The main participants in self-regulation are multinational corporations based in the industrialized countries. They are driven both by changes in the international system and by more proximate causes lying in the nature of business competition today. The trend towards business self-regulation affects who wins and who loses in global markets, giving advantages to some corporations and hindering others. This in turn may change the pattern of international trade and investment, and thus the location of economic growth, affecting the distribution of wealth around the world. Most significantly, business self-regulation may have profound effects on the nature of governance itself. Some argue that it substitutes for governments in ways that may undermine government capacity. Others argue instead that it complements government efforts by facilitating the larger purposes of regulatory initiatives. It seems more likely, however, that the dynamic of cause and effect is different for each industry sector and each issue area, for companies that are large and for ones that are small, for developing and developed nations. At this point, we still know too little to tell.

Multinational Corporations and International Regulation

Since multinational corporations first emerged after WWII, most regulation of them has been by individual countries and not by international organizations. In the 1970s and 1980s the UN and the OECD both hosted attempts to negotiate a comprehensive international agreement defining the responsibilities of foreign corporations to their host countries, for instance, that they should follow local law and contribute to local development. These attempts either ended in complete failure or had only limited success. More recent negotiations in the WTO and the OECD focused instead on the rights of foreign corporations with regard to host countries, for instance, to be treated the same as national companies and for their property and profits to be protected. These negotiations also ended in failure or only limited success. In place of formal international law covering both the rights and responsibilities of corporations, we see emerging an array of voluntary non-state initiatives—"soft law," or self-regulation.

Two models for such regulation influence the trends we see today. First, there is the model of technical or market promoting standard setting, typically specifying the physical qualities required for the sale and use of industrial or commercial products and services. Industry associations have a long history of designing and promoting good design practices for their members. These are intended to facilitate international exchange of goods and services, enhance the reputation of the industry, and reduce the costs of doing business. For instance, the pharmaceutical industry has strict standards for marketing drugs, since bad practices will undermine consumer trust and potentially weaken the market itself. International bodies such as the International Organization of Standardization (ISO), whose members are a mix of government and non-government representatives, negotiate agreements that specify rules, guidelines and characteristics for materials, products, processes and services. For instance, the exact format of credit cards is contained in an ISO standard. Standards agreements are based on consensus among interested parties, and they are voluntary but widely accepted. They are viewed as a rational, scientific response to the need to develop uniformity to facilitate market exchanges.

The second model comes from activist initiatives of the 1970s and 1980s: the Sullivan Principles for businesses operating in apartheid South Africa (1977), and the MacBride Principles for operations in northern Ireland (1984). In both cases, individuals outside the corporation worked with companies to develop guidelines or codes of behavior addressing a quite specific political objective. Both were successful in bringing public attention to an important problem, and many companies adopted them. They had less success in actually changing the political situation. Despite their mixed record, both efforts brought to the attention of a wide audience the possibilities for achieving social reform through a change in corporate behavior, and thus set the stage for the expansion of the corporate codes movement.

There is no central repository of voluntary agreements and corporate codes, so it is difficult to get a clear fix on the extent and nature of this trend. Most major corporations today have some statement of principles, however weak it may be. Most industry associations, national and international, promote voluntary standards for the activities of their members. And, most visible of all, more and more corporations are partners with governments, international organizations, and non-governmental organizations in designing and implementing a variety of voluntary initiatives.

Motivations for International Business Self-Regulation

There exist both underlying causes for the expansion of business self-regulation, and more proximate factors driving corporate behavior.

The Context of Change

Developments in the world political and economic system have set the stage for the expansion of business self-regulation. The multinational corporation has been a potent force in the political and economic dynamics of countries all over the world for many decades now. Although the early expansion of corporations internationally was by American companies in the 1950s investing in Europe, today corporations from all over the world invest regionally and globally. Both large and small firms have an international presence through trade, joint ventures, strategic alliances, and outsourcing of production to local manufacturers abroad. In doing this, they face myriad conflicting cultures, often weak national governments, and markets so thin of economic activity that foreign corporations easily dominate them.

A confluence of factors has driven more and more countries to open their markets in the past decade, furthering this process of globalization. Development policies in the years following WWII initially advocated state ownership, industrial policy, import substitution and protection, but had only limited or temporary success in spurring growth. The end of the Cold War and collapse of the Soviet system is viewed by most observers as a triumph for the Western model of a market economy, encouraging the widespread adoption of liberal policies by states in the developing and formerly communist worlds. Beginning in the 1980s, most industrialized countries loosened their restrictions on capital flows, spurring further investment abroad. Political parties took power advocating smaller government and minimal regulation. These two factors—internationalization of business activity and liberalization of markets—increase the demand by corporations for particular rights abroad and more uniformity in business conditions, while governments demand that foreign investors realize they also have responsibilities.

The existing system of international governance is too weak and fragmented to respond quickly or effectively to these new demands. International organizations are overburdened and underfinanced, and negotiating new agreements can be a long and painful process. The ability of even the most capable governments to keep up with a marketplace that is moving so fast is in doubt. The complexity of new technologies and the rapidity of change in market conditions make it difficult to design the kind of hard and fast rules of traditional regulatory systems, and raise questions about whether they are effective and desirable under current conditions. In finance, information technology, and other areas U.S. government policymakers have discussed the possibility that the private sector is simply more capable than the government of designing appropriate regulations. "The marketplace is moving so fast that the government is unable to keep up with it," according to a former FDIC Chairman. This rapid change is also true for social values or norms, as reflected in the shifting demands of consumers, activists, and the media--all three of which are now active transnationally. They demand not only high quality goods, but also products and production processes that meet new standards for human rights and environmental protection. The end result is a system in which the demand for global standards lags behind supply, and traditional governance mechanisms are suspected of being unable to cope with emerging issues.

There may be other important contextual factors that this discussion misses. The dynamics of how they work together to reinforce or undermine the trend towards business self-regulation need to be explored. But the various aspects of political and economic globalization tell only part of the story here. We need to examine more closely the responses by corporations themselves, and the reasons why they have initiated voluntary agreements covering a wide range of issues.

Changing Business Behavior

An initial look at the factors that might be driving corporate behavior can be summarized as efficiency, reputation, liability, autonomy, and leadership. This may not encompass all the relevant variables, and the strength of each may vary across industries, firm size, and issue area. We do not yet have a comprehensive framework for putting these together and yet it is critical that we do so in order to answer the bigger questions raised at the beginning of this paper.

Global markets today are more competitive than they have ever been before, and businesses are looking for every advantage they can get. One advantage comes with efficiency gains, and these can be obtained in a number of ways. First, technical standards set the limits of a market by establishing criteria for such things as the exchange of financial data across borders, or how a corporation and its suppliers can assure that the parts they supply fit together. This gives particular firms a special advantage if their technology is the one adopted on a widespread basis. Sometimes this occurs through winning in the marketplace, as with the dominance of Microsoft Windows as a computer operating system. Sometimes this occurs through business-to-business negotiation, as with standards for the new smartcard technology. And sometimes this occurs through global processes that include non-industry participants, such as within the ISO.

Efficiency gains are also obtainable through harmonization of national regulatory systems. The costs of complying with a different set of regulations in every market can be high. But international negotiations on this issue are proving extremely difficult, and one way to obtain some relief may be through industry standard setting. When an industry sets global guidelines among its members, all of them gain by clearly defined best business practices that ensure a certain degree of similarity in operations that each firm can expect of its global partners. Corporations that set high standards for themselves in response to the demands of consumers in an important market can use this industry harmonization to make sure they are not at a competitive disadvantage relative to other firms.

Finally, efficiency gains also can be found in specific practices that combine technical standards with social responsibility values. Many companies are committed to environmentally sound management because they see it as contributing to the bottom line by limiting wastes and preventing pollution, increasing production efficiency, and decreasing government regulation. For example, electronic commerce, which is seen as a huge potential source of profitability, will only succeed to the degree that consumers are convinced that the privacy of their personal and financial information will be protected. This issue combines both the preference of the public for privacy with the development of the market for a new product or service.

Reputation has become one of the most precious assets of many corporations. A commitment to the highest technical standards and to corporate responsibility (including everything from employment policies, philanthropy, environmental protection, human rights, and corruption) can enhance the reputation of a company with its customers, employees, and business partners. The power of reputation as a driver in the adoption of voluntary standards has been enhanced by competitive pressure for a company to have access to markets around the world, where meeting certain standards is a prerequisite for doing business. The spotlight of the media, demands of activist organizations, and the impact of both of these on consumers and shareholders also has made reputation important to corporations, as seen in the case of Nike. And in the information rich environment we have today, business activities are increasingly transparent to those monitoring their behavior. When a corporation adopts a corporate code for social responsibility, it gains advantages in consumer marketing, public affairs, and employee relations.

Autonomy and liability are related factors in driving corporations towards self-regulation. Corporate executives prefer to have the most freedom of operation possible, and view government regulation as a cost and not a benefit. Therefore, to the degree possible, many firms favor a shift to self-regulation and fight off any attempt at traditional command-and-control regulation in new issue areas. A corollary to this, particularly in the United States, is that any perceived infringement of regulatory policy can lead to litigation and a finding of liability. In environmental affairs, liability has been especially important in driving corporations to adopt corporate policies that go beyond mere compliance in order to forestall both litigation and further government regulation.

Finally, leadership is a key factor in business adoption of voluntary self-regulation. Leadership in this case has many different dimensions. Certain corporations view themselves as leaders within an industry, particularly in terms of best practices. For them, participation in self-regulatory efforts solidifies their status within the industry. Leadership is also associated with a proactive policy towards emerging issues, requiring effective use of information to develop new values, train and educate employees, and modify behavior in ways that help the company to manage change in the surrounding environment. Leadership may also preempt outside criticism and forestall government regulation. In many cases, the leadership of particular people—the executives of major companies—has been a critical component in the adoption of voluntary standards and corporate codes of conduct. They hold particular values that make them receptive to change, and are willing to promote those values throughout the operations of the company. Often, they are open to a "stakeholder" view of corporate governance, in which the company management must take account of its rights and responsibilities with regard to a range of constituencies: shareholders, employees, customers, suppliers, and the community.

The variables discussed above—efficiency, reputation, autonomy, liability, and leadership—may not cover the full range of factors underlying the trend towards business self-regulation. They also are not static but dynamic factors; they have each evolved over time. How and why has the definition of efficiency changed in the minds of many executives—but not others? Why is reputation a more important influence for some sectors than for others? How do social commitment and regulatory liability vary across countries, each with its own tradition of business-government relations? How has business leadership evolved, and can it be a useful focus for policy? Finally, given current economic instability and the possibility of a dramatic downturn in the world economy, how durable are the effects of these factors in driving the shift towards business self-regulation?

Further Considerations

Why should we care that business is now participating directly in regulating its own behavior? As noted in the introduction, self-regulation can affect competition within markets, the distribution of wealth, and the character of governance itself. The actual content of voluntary standards and corporate codes of conduct is at issue in most cases, since they can represent narrow industry interests and not wider public ones. Many critics contend that they lower standards, and that self-regulation means no regulation. Supporters argue that government regulation is not necessarily more effective internationally, and that voluntary standards set an aspirational goal that puts pressure on companies to raise their standards higher. Still others would simply argue that current self-regulatory commitments codify existing behavior among the leading corporations. Probably the biggest issue that corporations, governments, and non-governmental organizations wrestle with is the degree to which these voluntary commitments should be monitored and enforced.

At bottom, the debate over business self-regulation has to address the issue of whether or to what degree we should expect that harmful behavior can be controlled by the participants themselves. We have to consider whether businesses should determine for themselves what constitutes harm, and to what degree they should be required to change their behavior. New technology may make it possible to decentralize government to a greater degree than before, and sub-contract out more government activities, but we are not completely certain of the gains and losses that might follow.

Richard Newton, director of BP Europe, noted recently that "If people think you have power, then—to some degree at least—you do." Both the perception and reality of corporate power in a global economy have made the role of the private sector in international affairs a source of contention. The shift in power away from governments portends a future in which the relationship between business and society may be very different from what we see today. In making this assertion, we must acknowledge the profound differences across countries. But the pressures of competition and globalization make it likely that business self-regulation will continue to increase internationally.