Business and Governance in South Africa

Racing to the Top?

T. Börzel, C. Thauer, T. Börzel, C. Thauer

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9780230347779
• eBook ISBN: 9781137317810
• Topic: Politics & International Relations
• Subtopic: Business General
• Index: Politics & International Relations

The authors identify conditions under which firms seek higher rather than lower regulation in a context of weak regulatory capacities by engaging in self-regulation or partnering up with thegovernment and/or NGOs. They analyse how firms in theautomotive, food, textile, andmining sectors fight environmental pollution and HIV/AIDS.

Part I

Introduction

1

Business and Governance in Areas of Limited Statehood

Tanja A. Börzel

Conventional wisdom holds that economic globalization leads to a regulatory ‘race to the bottom’ among countries. Global competition allows firms to invest in areas of limited statehood where governments lack the capacities to set and enforce regulations and generally refrain from measures affecting the costs of production. Likewise, firms will press governments of highly regulating countries to lower regulatory standards in order to avoid competitive disadvantages. The competition of states for economic growth and foreign investments results in the degradation of natural resources and the compromising of social standards. From this perspective, firms are unlikely to provide governance in areas of limited statehood. Rather, they are presumed to drive states into a ‘regulatory race to the bottom’. Yet this book finds a number of instances where business contributes to governance in South Africa. Mining firms adhere to strict environmental and social standards. Multinational car companies are among those leading the fight against HIV/AIDS in the country, and provide employees with comprehensive health care services on a level high above what hospitals, clinics and other health care institutions offer to the general public. In some cases, corporations even put pressure on governments to adopt stricter public regulations. The automotive industry, for example, lobbied a few years ago for higher emission standards for new cars.

The literature on governance in areas of consolidated statehood has identified the threat of state legislation as the key incentive for governance contributions by business. We define governance as the setting and enforcing of regulation aimed at the provision of collective goods and services and the direct delivery of collective goods and services (cf. Risse 2011). In ‘areas of limited statehood’ (ibid) such as South Africa, however, this so-called ‘shadow of hierarchy’ is not available. The state lacks the capacities, and sometimes also the will, to make credible regulatory threats. How do we explain cases in which firms provide collective goods and services if the state lacks the capacity to do so? Why and when do multinational firms engage in a ‘race to the top’ fostering rather than undermining regulation in areas of limited statehood?

This book sets out to explain why firms are seeking higher rather than lower regulation in areas of limited statehood and why they are willing to engage in the delivery of collective goods and services. We argue that in the absence of a credible threat of state regulation (‘shadow of hierarchy’), asset specificity and reputational concerns (‘shadow of the market’), on the one hand, and the absence of any state governance (‘shadow of anarchy’), on the other, are important incentives for firms to contribute to governance in areas of limited statehood. The ‘shadow of anarchy’ and the ‘shadow of the market’ hence provide a powerful alternative to the ‘shadow of hierarchy’ to induce governance contributions by business.

Business as governance actors in areas of limited statehood

Non-state actors have gained prominence in research on global governance. While they initially focus on the role of civil society organizations, studies on the rise of ‘private authority’ (Cutler et al. 1999) that explore the opportunities and constraints of private self-regulation abound. Yet, the impact of companies on state regulation is still contested. In an increasingly globalized economy, companies are assumed to escape strict national regulation by relocating their production sites to areas of limited statehood where regulation is low and enforcement is weak. Countries with high levels of regulation will respond by lowering their standards; countries with weak regulatory capacities refrain from tightening regulation in order not to loose foreign direct investment (‘regulatory freeze’, cf. Madsen 2009: 1298). Thus, the behavior of firms drives states into a ‘race to the bottom’, leading to the degradation of natural resources and the compromising of social standards for the sake of potential economic growth or the attraction of short-term foreign investment.¹ On a more general level, transnational corporations are found to systematically undermine the regulatory capacities of states resulting in the ‘retreat’ (Strange 1996) or even the ‘end’ (Ohmae 1995) of the state as the main provider of governance functions (Ruggie 1998).

However, companies can also be ‘drawn into playing public roles to compensate for governance gaps and governance failures at global and national levels’ (Ruggie 1998: 13). Empirical evidence abounds on companies that voluntarily commit themselves to social and environmental standards and adopt private self-regulatory regimes – even in the absence of a regulatory threat by the state (Mol 2001, Vogel and Kagan 2004). Studies show, for example, that foreign direct investments originating from a home country with high levels of self-regulation unleash norm-diffusion dynamics among competitor firms, which in turn lead to higher levels of business self-regulation in the weakly regulating host country; that is, where the investments are made (Prakash and Potoski 2007, Thauer 2010). Exporting to a highly regulating country also creates a surge for higher standards in low-regulating countries (Greenhill et al. 2009). Companies can, thus, contribute to the provision of collective goods and services and the regulation thereof. What remains to be explored is the conditions under which firms are willing to foster regulation rather than undermine it.

Why should companies doing business in areas of limited statehood engage in regulation or the direct provision of collective goods and services? Unlike states and civil society actors, firms are not committed to the public good but the pursuit of private interests. Their business is to maximize profits, not social welfare.² Nonetheless, we argue that under certain conditions business actors actively contribute to governance in areas of limited statehood by fostering regulation. The governance literature posits that the ‘shadow of hierarchy’ cast by the state is a main incentive in this respect (Halfteck 2008, Héritier and Lehmkuhl 2008, Mayntz and Scharpf 1995b). In order to avoid state regulation, firms may choose voluntarily to commit themselves to reaching a regulatory outcome closer to their preferences. Moreover, the possibility of state intervention reduces the incentive to renege on their voluntary commitment (cf. Börzel 2010).

In many parts of the world, the state’s capacities to regulate business behavior are weak and a ‘shadow of hierarchy’ is therefore absent. Nevertheless, we do find corporate regulatory engagement in these areas of limited statehood, which we understand as areas in which the state lacks the capacity to set and enforce collectively binding decisions on the provision of collective goods and services or to directly provide them (cf. Risse 2011b). Multinational companies (MNCs) not only adopt global regulation to govern their worldwide business activities (Epstein and Roy 2007, Potoski and Prakash 2006, Prakash and Potoski 2007). They also voluntarily implement environmental protection standards, provide HIV/AIDS-related services and agree on using sustainable energy or policing local communities (Deitelhoff and Wolf 2010, Flohr et al. 2010, Hönke 2013, Thauer 2010). In some instances, they regulate their supply chains (Héritier et al. 2009) and seek to foster state regulation by pressing for stricter legislation and helping to strengthen the enforcement capacity of state actors (Flanagan 2006, Mol 2001, Vogel and Kagan 2004). How can we explain such contributions to governance by business in the absence of a credible ‘shadow of hierarchy’?

Explaining business contributions to governance in areas of limited statehood

In order to solve this puzzle, we draw on the existing literature on business and governance. We develop a theoretical framework that helps us identify conditions under which firms contribute to the provision of collective goods and services. It starts from the assumption that firms are profit-oriented. Since regulation tends to increase production costs, firms targeting the same reference market should prefer no or weak regulation over strict regulation (Oates 1996). At the same time, they operate in an economic, political and social environment, which poses additional demands next to market forces. Companies need to take these into account when calculating the costs and benefits of their regulatory choices (Brousseau and Fares 2000, Wolf et al. 2007: 299–300). In the context of these demands, firms engage in strict self-regulation, lobby for stricter regulation, strengthen the regulatory capacities of the state and directly deliver collective goods and services. There is nothing altruistic about such governance contributions; they are a matter of self-interest, if fostering regulation generates economic advantages and helps avoid competitive disadvantages (Vogel 1995, Vogel and Kagan 2004). In what we call the ‘shadow of the market’ cast by international competition in globalized markets, stricter regulation can yield efficiency gains by enhancing the product quality and, as a consequence, the prospect of a more efficient marketing of the product (Anton et al. 2004, Parker 2002). Likewise, by incorporating environmental and social regulation into their management systems and business practices, companies have been able to secure and expand their market shares and reduce production and transaction costs (Barney 1997, Porter and Kramer 2002). Competitors may follow suit for fear of losing market shares or because they seek to emulate peers they consider innovative and successful, particularly in conditions of high uncertainty (Bansal and Roth 2000, Potoski and Prakash 2005, Prakash and Potoski 2006). We suggest that such ‘California effects’ (Vogel and Kagan 2004) are also at work in areas of limited statehood. High standards yield efficiency gains when firms have invested substantially and with long pay-off periods – that is, when their business model is based on ‘asset specificity’ (Thauer 2010, 2014). Originally developed by Oliver Williamson (1975) to explain the ‘make or buy’ decision, asset specificity refers in the context of this book to two arguments. On the one hand, asset specificity describes substantial investments in a production unit with a long duration to pay off. Such long-term investments are particularly vulnerable to areas of limited statehood, where weak state capacities give rise to high uncertainty. In situations of such asset specificity, self-regulatory standards reduce the risk for uncertainty by providing an insurance of firms against potential changes in the environment, that is, they make the firm less dependent on its socio-political context (Thauer 2010, 2014). Hence, we argue that firms that make asset specific investments set high self-regulatory standards. On the other hand, asset specificity is about investments in employee skills. Such investments motivate firms to adopt high social and labor standards in order to keep staff turnover low and maximize productivity (Thauer 2010, 2014).

Second, another incentive for governance contributions generated by the ‘shadow of the market’ is the reputation of a company and the loyalty of its clients. These constitute a major corporate asset that may generate a strategic advantage over competitors (Spar and LaMure 2003). This is especially true if companies sell to the ‘LOHAS’ (Lifestyles of Health and Sustainability) market segment, that is consumers who value and demand sustainable products and the respect of social and environmental standards and are willing to pay a premium for this (Haufler 2001, Mol 2001: 97–100). While LOHAS consumers are only begining to emerge in areas of limited statehood, companies may export to countries where they constitute a substantial share of their markets (Bansal and Roth 2000). In particular, companies with a brand name and/or products highly visible to end-consumers (Deitelhoff and Wolf 2010) will gain a competitive advantage vis-à-vis competitors if they take the lead position in their industry with respect to strict self-regulatory standards (Auld et al. 2008, Epstein 2008, Smith 2008a). Conversely, a competitor in that segment that is found blatantly to neglect its corporate social responsibilities will lose customer loyalty and its reputation and, consequently, market share (Blanton and Blanton 2007, Haufler 2001, Mol 2001: 97–100). Moreover, obvious violations of social or environmental standards may provoke campaigns by transnational NGOs (Baron 2003, Flohr et al. 2010, Newell 2001) and local community-based organizations (Bowen et al. 2008, Eweje 2005, Lund-Thomson 2005), particularly if companies have signed up to transnational voluntary programs, such as the Global Reporting Initiative, ISO 14001 or the Voluntary Principles on Security and Human Rights (Schepers 2006). Such public shaming can result in consumer boycotts, loss of reputation and market share, falling stock market prices and criticism by shareholders (Hendry 2006, Waygood 2006, Wheeler 2001). We expect that companies under attack will seek to pacify the critics through an adoption of high self-regulatory standards and an ostensive commitment to their social responsibilities (Halfteck 2008, Hoffman 2001, Schepers 2006, Trullen and Stevenson 2006). Pressure to engage in governance contributions, finally, can also emanate from peers who are concerned that ‘one rotten egg spoils the entire cake’, that is the reputation of an industry sector (Hönke 2013, Prakash 2005). Business associations and informal networks often act as transmitters of peer pressure (Kollman and Prakash 2001). A company’s vulnerability to these various kinds of pressures is stronger if it has intra-firm investments in technology and human capital formation (Thauer 2010, 2014) or a brand name to protect, targets a high-end market or has an international (export) orientation, or if its product is highly visible to end-consumers. Highly visible MNCs operating in areas of limited statehood, such as those in the extractive industries for instance, are not only confronted with an alert public but also with a general suspicion that they are doing bad in these areas. Engaging in governance, even without having been targeted by a specific shaming campaign, is a way to signal good behavior to shareholders and the public (Hönke 2013). In sum, we expect companies which are concerned about their reputation to contribute to governance in areas of limited statehood by engaging in self-regulation.

Third, while companies operating in areas of limited statehood hardly face a credible ‘shadow of hierarchy’ cast by the host state, it may be precisely the absence of the threat of strict(er) regulation that creates an incentive for companies to contribute to governance. If government is not capable of adopting and enforcing collectively binding decisions, companies are not confronted with a situation in which they have to weigh the costs of cooperation and voluntary commitment against the possibility of a suboptimal hierarchically imposed policy. Rather, they face the danger of not having a common good at all. If the pursuit of their individual profit depends on the provision of certain common goods and collectively binding rules to produce them, respectively, and government is not capable or unwilling to provide them, the ‘shadow of anarchy’ (Mayntz and Scharpf 1995a) generates a major incentive for companies to step in and fill the governance gap (Ruggie 2004, Börzel 2010), in particular when they have made asset-specific investments and therefore depend in their future operations on the investment environment in which they are set. Yet, they still confront free rider problems. Hence, instead of voluntary self-regulation, we expect in such situations collective activities in the context of business associations, which can mitigate the free rider problem through strict rules, information provision and the imposition of costs for non-compliance (Ronit and Schneider 2000).

Fourth, while the ‘shadow of anarchy’ substitutes for the ‘shadow of hierarchy’, the latter can also be generated externally. International organizations and foreign governments can commit companies to the common good. On the one hand, under international law, MNCs can be obliged to comply with standards of good governance in areas of limited statehood (Ladwig and Rudolf 2011). On the other hand, national governments of (consolidated and democratic) states, where MNCs have their headquarters, may also force them to contribute to governance in areas of limited statehood. In this particular case, home country laws are in place and enforceable which require non-state actors such as companies to comply with standards of good governance or other regulations (e.g. environmental laws) irrespective of where they invest or act. High-regulating countries are reluctant to regulate their companies outside their territory, the Alien Tort Claim Act of the United States being a rare exception (Deitelhoff and Wolf 2010: 213). Yet, we know that international firms tend to transport their regulatory standards abroad as these are interpreted as ‘quality signals’ (Potoski and Prakash 2006) by business partners and customers (Murphy 2004, Kolk et al. 2005). We expect such firms to apply them in areas of limited statehood, contributing to an increase in regulatory standards in the country of investment.

Fifth, governance by business may still rely to some extent on statehood (Börzel et al. 2012). The ‘shadow of hierarchy’ can be substituted by economic incentives generated by the ‘shadow of the market’. However, firm activities that further the common good may need to be institutionally embedded in the state to be sustainable and in order to avoid unintended negative effects. In other words, their effective implementation might depend on a functioning state structure. This is particularly likely in the case of complex governance tasks ...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures and Tables
• Preface and Acknowledgements
• Notes on Contributors
• List of Abbreviations and Acronyms
• Part I Introduction
• Part II Fighting HIV/AIDS in South Africa
• Part III Fighting Environmental Pollution in South Africa
• Part IV Conclusions
• References
• Index