July 25, 2024


General Line

Free market lessons from automotive crash test ratings

By Satish Bapanapalli

Is it that time of the year yet? You know … time to bash Milton Friedman and his “Shareholder Doctrine.”

Yes it is! In fact, 2020 marked the 50th anniversary of the famous Friedman Doctrine, which was published in the New York Times in 1970.

Of all of Friedman’s great ideas, the Shareholder Doctrine is perhaps the most misunderstood by academics, in large part because many left-leaning intellectuals use the good old straw man argument to misleadingly caricature the doctrine as a “profit-at-all-cost system regardless of human toll.”

Case in point, the latest sermon by some reputed academics published in Fortune magazine: “50 years later, Milton Friedman’s shareholder doctrine is dead.”

This one has all the usual tropes, including the claim that “Friedman … urged business to use its muscle to reduce the effectiveness of unions, blunt environmental and consumer protection measures, and defang antitrust law. He sought to reduce consideration of human concerns [such as] treat[ing] workers, consumers, and society fairly.”

Friedman said no such things. Read it for yourselves. Friedman’s primary argument was that it is not the job of the officers of a corporation (corporate executives) to fight for social causes. The officers must only act in accordance with the shareholder’s wishes, “which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

Of course, in some cases, the shareholders may themselves encourage charitable spending and other corporate policies and activities deemed “socially responsible.” In which case, executives are tasked with finding the best ways to fulfill those objectives. In his article, Friedman clearly demonstrates why this is a logically precise position.

The scolds, who authored the Fortune article, put forth an alternative. Their “three pillars” proposal advocates for laws to be imposed on corporations with vague and fuzzy objectives (note the italicized words) such as “responsible corporate citizen[ship]”, “treating workers … fairly”, “avoiding externalities, such as carbon emissions, that cause unreasonable or disproportionate harm to others”, and corporations should make profits by “benefiting others.” To rub foolishness on the vagueness, the proposal calls for putting the onus on the corporations to measure and demonstrate progress on these fuzzy objectives! To put it in Friedman’s own words, such proposals “are notable for their analytical looseness and lack of rigor.”

As appealing and high-minded as these vague top-down “solutions” may sound, the corporate-political complex (to paraphrase Ike) will undoubtedly turn the “three pillars” proposal into another legislative morass, completely undermining the noble objectives and, in many cases, producing the opposite of the intended outcomes. Instead, we should pursue a pragmatic free market approach, which I believe Friedman would fully endorse. But first, let’s take a look at a real world example where this approach worked beautifully.

In 1965, another famous corporation scold by the name of Ralph Nader published a book called Unsafe at Any Speed to inveigh against automotive companies’ alleged tendency to resist the introduction of safety features and their reluctance to spend money on improving safety. In a famous interview from the 1970s, the inimitable TV host Phil Donahue asked Milton Friedman, “Tell us how we are going to get [automotive companies to] sell us safety with the same vigor that they sell us cosmetic [features]?”

Friedman’s response to Donahue was simple: “If the public … really wanted to buy safety rather than cosmetics, it would be in the self-interest of the automobile [companies] to sell them safety.” He gave the example of the Checker Superba, which was a car primarily marketed for its safety. However, not many people wanted to buy it.

Fast forward a few decades. Car companies are spending millions of dollars per day to crash test their vehicles. The cost of just one modern human-like crash test dummy could run upwards of half a million dollars. Vehicles are rigged with all kinds of expensive sensors and tested in various crash scenarios such as frontal-impact, side-impact, pole-impact, and rollover tests under the watchful eyes of multiple high-speed cameras and highly-paid engineers.

The result: from 1966 to 2013, the traffic fatality rate dropped by over 80 percent (from 5.5 fatalities per 100 million miles driven to 1 per 100 million miles) even though the total population and number of cars has multiplied since then, and the average speed and engine power of automobiles has increased tremendously.

So, what changed?

The post-World War II prosperity gradually improved the families’ pocket books so that, starting in the 1980s, people could afford to pay for expensive safety features. And in this environment came the NHTSA’s 5-star Safety Ratings, and the non-profit IIHS’ Top Safety Pick Awards, which are based on rigorous testing and steadily-improving safety standards.

Consumers’ willingness to pay for safety and the information available in the form of simple safety ratings and awards proved to be a potent combination. And, as car companies realized people were willing to pay for more safety features, they began going all out with a plethora of innovations like anti-lock braking system (ABS), tire pressure monitoring system, front and side-curtain air-bags, collapsible steering columns, traction control, back-up cameras, collision avoidance/ prevention systems, lane-departure and blind-spot warning systems, adaptive cruise control, safe vehicle exit assist, and soon-to-come self-driving cars!

It seems as if the greedy automotive corporations transformed into noble organizations that care for consumer safety. Is that true?

In reality, notwithstanding all the hand wringing by Ralph Nader, and in the decades preceding the government’s establishment of the NHTSA (in 1970), automobile companies had tremendously improved the safety of automobiles with the introduction of seat belts and research into child car seats among many other technological improvements. As people became richer and were willing to pay for more safety features, car companies obliged by developing even more advanced technologies.

Crash test ratings and safety awards are easy to sell to common people. As a result, shareholders of car companies are encouraging their corporate executives to increase profits by benefiting society with safer cars.

Corporate Social Responsibility (CSR) will not be taken seriously by corporations unless it affects the bottom lines. All the tall talk coming out of the Business Roundtable will not be worth a nickel unless shareholders and executives truly believe that consumers care about CSR.

The best way to achieve this is to follow the route of Automotive Crash Test Ratings. Develop a rating system such as 5-Star CSR Ratings, and Top CSR Pick Awards. Then, sell it to consumers.

Ratings have to be simple and easy to understand for regular people. Crashworthiness of a vehicle is an extremely complex technical measure, and involves understanding of complex fields of human physiology and structural mechanics. NHTSA and IIHS have done a great job of boiling down this complex information and translating it into layman terms. Five-star rating is “excellent”. One-star rating is “worst.” Top Safety Pick Award is great!

Ratings should add value to customers. Most people want to do the right thing. As long as they can afford it, they will pay for ethical business practices. It will not be a tough task to come up with some objective measures. The real challenge, however, is to design the measures to truly capture what people value. Therefore, such ratings will not be easy to develop.

If the customers don’t value it, then the problem is with the rating system. Don’t try to pass it off as a “market failure.” If the cost of your objectives is beyond the affordability of consumers, then the society is not in a position to support your objectives. Staying with the example of automobiles, if you forcefully impose the high US automotive safety standards in India, you would kill the automotive market because only a few people would be able to afford such expensive automobiles.

In reality, free market mechanisms already impose CSR objectives on companies. Whenever people realize some companies are using bad practices, and those practices are brought to light by investigative media, people start avoiding those company’s products where feasible. That is why companies take great pains to build their brand recognition and reputation.

As people become richer, they can afford to choose between more alternatives. That is why libertarians always emphasize faster economic growth. When the economy grows fast, people become richer. When people become richer, they have more discretionary income to patronize the high minded ideals such as caring for the environment, labor practices, diversity and inclusion. To paraphrase a great quote, don’t preach morals to a hungry man.

If the customers demand products from companies that have high CSR ratings, then it is in the shareholders’ best interest to direct their corporate executives to follow business practices that will earn them the high ratings. The companies themselves will seek to achieve the high CSR rating without any need for government regulations, just as is the case with automotive crash test ratings today. In other words, the CSR ratings provide a way to implement the Friedman Doctrine to achieve the CSR objectives.

Establishing an easy-to-understand, and value-added rating system is tough. However, it would be far more valuable for society if the passionate CSR advocates spent their efforts developing these ratings instead of shirking that responsibility in favor of seemingly easier, coercive, top-down legislative methods. In the end, free market mechanisms will get you closer to achieving your objectives than any government mechanisms.

Satish Bapanapalli

Satish Bapanapalli

Satish Bapanapalli is an immigrant to USA from India. His educational training is in engineering and business, and works as a manufacturing operations leader in a Fortune 500 company.

This article was originally published on FEE.org. Read the original article.

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