Friedman-proposition

     I concluded my blog about the Friedman proposition by agreeing with the statement “the business of business is to increase its profits”. But amusingly, I did not agree when I started writing my own thoughts about it.

     I began with arguing that businesses have the freedom to produce whatever they want and how they want. But during my own reasoning, I realised that if a sustainable business is not able to sell its products or services, it will not be able to maintain. So therefore I changed the point that I planned on to make when I was writing my thoughts about the business of business, from not agreeing to agreeing on it.

     But I do not agree on the way he builds his arguments for the statement. I have built my own argument on the believe that consumers can change the supply, which is something that I learned in my bachelors Earth Science and Economics. So I am not sure what literature helped me to develop that opinion in what way.

     The actual reasoning I made was not collected from any material, I tried to build up an argument on why I did not agree, but in the end only our reasonings were very different but I agreed on the Friedman proposition.

Rational decisionmaking

The news item I have chosen to discuss is the decision of the president of the US to bomb Islamic State (IS). The main actor representing the US is Barack Obama, the president.

The first step in the Rational Actor Model (RAM) is that the actor has an optimal believe about the world. In the beginning, Obama had a believe that IS had to be eradicated because the organization is dangerous for, especially American, citizens.

                The second step in the RAM is that the actor’s belief is supported by evidence. In the case of Barack Obama, the evidence supporting his belief are the video’s posted by IS where American hostages have been decapitated and threats have been addressed to the whole nation and its citizens.

The third and last step in the RAM model is that the evidence must result from optimal investment in information gathering. National and foreign informative agencies have checked the video’s and its content, containing the threats to the US, for authenticity. When those agencies concluded the videos were real and the threats for terroristic attacks in the nation were real, Obama decided his army should start the bombing of IS. 

Week 1 - Q2

“The business of business is to increase its profits”

                Being a right-centred economist, I had some thoughts and comments that I would like to share after reading the paper by Friedman (1975). Ironically, I do not agree on his reasoning, but I agree on his conclusion for a different explanation, let me show you why.

I do not agree the way he reasons that an executive is becoming a non-democratically chosen civil servant, by imposing taxes because he is spending “the money in a different way than [the stockholders or the customers or the employees] would have spent it” (Friedman, 1970). I do not agree that a tax is imposed, because my definition of a tax is “an compulsory payment to a governmental body where no individual performance of the governmental body to the payer is returned”. In the case of the stockholders, no tax is imposed because stockholders are free to fire the executive if the latter party is not acting as agreed on in the job description. If stockholders agree on Social Responsible business policy for whatever reason (improvement of the company’s image or conscience), it is no longer compulsory but free choice. So the obligated part of my definition is not compelling with his reasoning for stockholders.

                No tax is imposed on the customers, because in a market of free competition with product differentiation, consumers can chose to buy another product. In that case the compulsory payment is not applicable. Another important point where I don’t agree with Friedman’s reasoning, is that in my definition the purchase of a Social Responsible product is private, so an individual performance is a returned consequence of my purchase. A good example is the difference between street lightning, where I am obligated to pay for in the form of taxation but I get no individual performance because street lightning is not only for my personal usage, and eggs, where I have the choice of buying biological (Social Responsible) ones or not according to my own preferences and I can exclude other users if I want, meaning that I get an individual performance for my purchase.

                Employees, when for example their wage is reduced to produce in a more social responsible way, have the freedom to get another job and are therefore not obligated to make a payment, in the form of a wage reduction, to the company. Therefore they are not being taxed according to my definition of taxation.

               

Because neither of the three main groups an executive has a professional relation with, are being taxed according to my definition, a Social Responsible businessman is not being “simultaneously [a] legislator, executive and, jurist” (Friedman, 1970) by imposing taxes and making expenditures to foster social objectives, while he has not been elected through a political process but by being selected by the stakeholders to serve their interests.

                Friedman’s reasoning about why a Social Responsible executive spending money on this cause, “belonging” to either the stockholders, consumers or employees, is taxing those relations, concludes with the following point of view of the so-called “doctorine of social responsibility: “"social responsibility" involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce re­sources to alternative uses” (Friedman, 1970), on which I do not agree, just like Friedman. I believe that sustainable Social Responsibility can only be achieved by market mechanisms without governmental interference, just like Friedman, and for that I make the following reasoning which is different from Friedman, assuming a situation of complete competition and product differentiation.

                I believe that Social Responsible products are claimed on the demand-side of the economy when the government is not interfering but acting as an informative actor about the consequences of consuming. This increasing demand over time will result in an increase of the supply of Sustainable Responsible products. If the government would act as an interfering body in the market by supporting those products, an unsustainable system would emerge: when the supporting, interfering government is not able to fulfill these tasks, the market for Social Responsible products would collapse on the short term. So the only possibility for a sustainable market is to stimulate the demand-side, by the supply of information about products from cradle to grave, resulting in increasing prices for non-Social Responsible products passing the point of decreasing prices of Social Responsible products.

                So this is the part where I actually agree with Friedman’s conclusion but for another reasoning: the business of business is to increase its profits (Friedman, 1970). Because the demand-side of the economy asks for Social Responsible products (implying they are willing to pay more), larger companies will comply to that demand (assuming no cheating will occur).  This, because if there was no demand for Social Responsible products, no profit would be made and no executive/company would be able to maintain his business.

References

              Friedman, M., 1970. The Social Responsibility of Business is to increase its profits. The New Yokr Times Magazine, 13 Septemer.

Week 1 - Q1

 Explanations Industrial Ecology puzzle

The Industrial Ecology puzzle of my choice is the Natural Resource Curse as described by Richard Auty  for the first time (Auty, 1994). On the question whether a natural resource is beneficial or harmful to an economy, one would intuitively answer that it is beneficial. The reasoning for that is mostly that an natural resource is “free” to an economy, meaning that it can be extracted within the country and can be sold for a relative high price per unit. But when one investigates the answer to this question a little further, one will actually find a negative correlation between natural resources and economic growth.

Numerous papers have been written on this negative correlation, including Jeffrey Sachs and Andrew Warner in 2001. In this paper the following graph is presented:

Figure 1: Growth and natural resource abundance (Sachs & Warner, 2001).

The graph presents the correlation between the export of natural resources as a percentage of the GDP in 1970 and the real economic growth per capita from 1970 to 1989 of the majority of the countries in the world. One can observe a negative trend in the dots that each represent a country, indicating that an increase of the export of natural resources results in a lower real economic growth. It is important to note that a lower growth rate is not the same as a negative growth rate. A lowering growth rate means that the economy is still growing but only using a lower percentage than previous. To me it is interesting to dig deeper in why this may or may not be a causal relation, because at first sight one may never believe that a natural resource might harm the growth of an economy.

First some reasons will be discussed on why this correlation may be a statistical delusion. I will try to argue why this is not the case for the Curse of the Natural Resources. After that I will try to work out three possible explanations: the Dutch disease, the governmental investments and corruption.

There is a possibility that the theory of the Natural Resource Curse, based on the visual representation of the data in the graph above, is in fact based on a fault correlation. First because it can be possible that there is a variable, different from export of natural resources and correlating negatively with economic growth just like the export. This may result in explanations based on the wrong variable and therefore wrong correlation. This statistical fault is called onmitted variable. A way to overcome this, is to control for previous growth rates and variables like climate and geography (Sachs & Warner, 2001). That is exactly what Sachs and Warner did in their statistical analysis that resulted in the graph above. So this will not hold against the statistical phenomenon and it explanations.

Another counterargument for the theory can be the fact that there is no distinction made between the different natural resources, because minerals have very different rents (higher) than agricultural products (Sachs & Warner, 2001). But the worldwide variation in natural resources is mainly caused by the mineral export of countries, so the inclusion of agricultural exports might even lower the observed deviation but in fact it does not alter the basic results from the statistical analysis (Sachs & Warner, 2001).

The final counterargument discussed in this blog is the reasoning that the currently richest countries in the world, used the resources from their colonies to achieve the wealth they experience nowadays (Sachs & Warner, 2001). Two points can be made against that reasoning. First is using the scarce historical data available, the resource intensity ratio until about the 20^th century were much lower to ratios nowadays and are therefore incomparable (Sachs & Warner, 2001). Secondly, due to the strong global infrastructure network, relatively inexpensive energy necessary for the development of the industrial sector, cannot be considered to be a limiting for growth because transportation is fast and cheap (Sachs & Warner, 2001).

The first explanation for the correlation in Figure 1 is the Dutch Disease. The name for this phenomenon results from the time the natural gas fields in the north of the Netherlands were discovered (van der Ploeg, 2010). Other countries were interested in buying the Dutch gas, resulting in an increased demand for the Dutch currency, the Guilder (van der Ploeg, 2010). This appreciation resulted in a more expensive Guilder for foreign buyers (van der Ploeg, 2010). For buyers interested in the natural gas it was not considered to be a problem, but for buyers of other Dutch products that did not concern the natural gas (for example Dutch shoes called “klompen”), those products got relatively more expensive (van der Ploeg, 2010). This resulted in a decline of the export of Dutch manufactured products, so a decline of the growth of those sectors (van der Ploeg, 2010).

This story is not only applicable for the Dutch situation, because a situation of increased currency exchange due to discoveries of natural resources, resulting in a decline of the export of non-natural resource related sectors, can happen (and is happening) to other economies as well (van der Ploeg, 2010).  

The second explanation is based on less sustainable investments. Industries that concern the extraction of natural resources usually do not require high skilled employees and/or technologically advanced capital like the manufacturing and service sectors (Gylfason, 2001). Those two latter sectors result in higher sales and profits, resulting in higher economic growth and are therefore more beneficial for the evolution of society (Gylfason, 2001). Both are more sustainable in the lifetime of the capital, considered to be in this case knowledge or so-called “human capital”, compared to the capital of the extraction sector: the natural resource (Gylfason, 2001).

But the “easy-money” made with the natural resources on the short term results in investments and entrepreneurship in the extraction sector, instead of manufacturing and services (Gylfason, 2001). Therefore the economic growth of economies that have a relatively higher share of natural resources in the export is less compared to economies that are more focussed on pro-growth activities in manufacturing and services (Gylfason, 2001).

The third explanation has to do with so called “rent-seeking”. This is a form of activity that does not produce anything but tries to claim the wealth from goods that have weaker property rights, like natural resources (Marotta, 2013). Companies often lobby governments to get a benefit from some public policy, like taxing or spending (Marotta, 2013). Rent seeking does not entail positive social benefits and most of the time the overall effect is even negative (Scholtens, 2004). This phenomenon coheres with prestige projects that do not increase production and therefore social benefits (an example are golden cranes in governmental offices).

Governmental officials are temped for rent-seeking and corruption because profits from natural resources are high, concentrated and mostly easily appropriable (Sachs & Warner, 2001). This will contribute to less pro-growth activities and lower growth.

Research done by Auty (2000) points out the transfer from a development state to a predatory state when a new natural resource is discovered.

My personal thoughts on the theory on the Natural Resource Curse are maybe interesting too to conclude this article on my blog. I have done some research myself on whether the Dutch economy has truly suffered from the Curse. The results of that investigation were not reliable enough to make strong conclusions, but anyhow I believe it can be a good lesson for policy makers. Even though it is a correlation that has not got one outstanding explanation, it is important to take notice of it when the rules and policy around the extraction are created in any country. For example, it will never be harmfull to invest the short term profits made from the extraction, in longer term capital like education and infrastructure. Because whether or not a governmental officer is convinced of the legitimicy of this theory, the improvement of education and infrastructure will increase the personal benefits of every individual in the concerning economy. 

References

Auty, R. M., 1994. Industrial policy reform in six large newly industrializing countries: The resource curse thesis. World Development, 22(1), pp. 11-26.

Gylfason, T., 2001. Natural resources, education and economic development. European Economic Review, Volume 45, pp. 847-859.

Marotta, D., 2013. Forbes. [Online]
Available at: http://www.forbes.com/sites/davidmarotta/2013/02/24/what-is-rent-seeking-behavior/
[Accessed 18 09 2014].

Sachs, J. D. & Warner, A. M., 2001. The curse of natural resources. European Economic Review, 45(4-6), pp. 827-838.

Scholtens, L., 2004. Aardgasbaten verstoren de economische ontwikkeling. Economische Statistische Berichten, 89(4431), p. 174.

van der Ploeg, F., 2010. Natural Resources: Curse or Blessing?. Oxford: s.n.