Upload
doanquynh
View
220
Download
0
Embed Size (px)
Citation preview
Rethinking Governance for Sustainability
Atle Midttun (editor)
With contributions from: Fritz Balkau Tom Burns
Reinier De Man Carlos Joly
Alberto Martinelli Jordan Nikoloyuk Mikael Román
Philippe C. Schmitter Throstur Olaf Sigurjonsson
Guido Sonnemann
Report nr. 2 2009 CERES21‐Creative Responses to Sustainability
www.CERES21.org
1
2
Foreword
This report brings together scholars who have undertaken to rethink governance for the 21st century across disciplinary and institutional boundaries, drawing largely on work done under the research project CERES21: Sustainability Across Continents (Ceres21.org).
The CERES21 project involves a four‐year quest to identify cultural, political and economic sources of the main problems bedevilling creative adaptation to the climate challenge. This report marks our first attempt at exploring new governance opportunities in today’s institutional terrain.
Given the difficulties experienced in current intergovernmental negotiations in global climate policy, there is an urgent need to explore governance innovation. The report presents novel models of governance entrepreneurship, illustrated with examples from ecology, finance and general politics. The scholars’ disciplinary backgrounds include political science, sociology, finance, and systems analysis.
We are grateful to Adam Collingsworth for language editing and to Hilde Nordbø for editorial assistance. We also gratefully acknowledge the financial support for this endeavour from the Research Council of Norway
Oslo, October 2009
Atle Midttun
3
4
Foreword…………………………………………………………………………………………………………. 5 Introduction……………………………………………………………………………………………………. 7 Chapter 1: Globalization and Governance for Sustainability Alberto Martinelli and Atle Midttun…………………………………………………………….…. 13 Chapter 2: Why Responsible Investment Falls Short of its Purpose, and What To Do About It? Carlos Joly……………………………………………………………………………………………………… 33 Chapter 3: The Icelandic Bank Collapse: Challenges to Governance and Risk Management Throstur Olaf Sigurjonsson……………………………………………………………………..……… 59 Chapter 4: Managing Sustainability Through the Value Chain Fritz Balkau and Guido Sonnemann………………………………………………………………... 81 Chapter 5: Sustainable Palm Oil: The Promise and Limitations of Partnered Governance Jordan Nikoloyuk, Tom R. Burns, and Reinier De Man…………………………………… 101 Chapter 6: Governing from the Middle: The C40 Cities Leadership Group Mikael Román………………………………………………………………………………………………… 121 Chapter 7: Governance Arrangements for Sustainability: A Regional Perspective Philippe C. Schmitter……………………………………………………………………………………… 141 Chapter 8: Montesquieu for the 21st Century: Factoring Civil Society and Business into Global Governance Atle Midttun……………………………………………..………………………………………………….… 161
5
6
Introduction
Atle Midttun In “The Age of Stupid,” a 2008 film with an intriguing title, the protagonist looks back at our world from the year 2055, human civilization in ruins after ecological disasters, and asks: What went wrong 50 years ago? Why was no action taken to save our planet and civilization from climate change? For one, they might say that we were not able to forge governance and collaborate to confront the tremendous challenge posed by the climate crisis to global human welfare.
The sustainability challenge is not new; the Brundtland report, outlining a vision of global sustainable development, was already published in May 1987. Like its chairwoman, it reflected a social democratic belief in political solutions, optimistic and enlightened concerted action, and global redistribution. The underlying governance model was implemented by national governments collaborating through international treaties under leadership of the UN.
The ensuing 20 years, however, demonstrated the limits of this governance approach. Most countries have failed to sign major initiatives such as the Kyoto treaty. Almost all of those who have signed up have failed to live up to their commitments. Global summits and treaty negotiations continue to be held, but with limited expectations.
As illustrated in, “The Age of Stupid,” the failure to forge coherent strategies to meet the sustainability challenge places human civilization. We are facing an acute climate threat due to increasing Western emissions and unrestrained Eastern growth. The scale of the crisis depicted in business‐as‐usual scenarios by international expert forums such as the IPCC and the IEA/OECD is unprecedented.
While the sustainability challenge has become more dramatic in recent decades, the world has also changed economically and politically. Massive deregulation has opened borders and allowed globalized corporations to acquire resources on an unprecedented scale. Civil society organizations have emerged as moral voices, mobilizing around core humanist values and sustainability issues, while confronting capitalism and Western values around the world. The media and communication industry has grown into a major sector worldwide. These developments create new complexities and interdependencies that undermine the traditional sovereignty of nation‐states. Yet they also provide anchors for new modes of governance: the combination of civil society organizations and open media communication can provide new catalysts and channels for collective welfare concerns, and globalized corporations can provide
7
instruments for implementation of policy agendas in addition to their main commercial concern. New international arenas are emerging for collaborative action and partnered governance across political, economic, and civic divides.
With the rather bleak scenario from “The Age of Stupid” in mind, this report seeks to bring together scholars with interesting ideas and examples to rethink governance for the 21st century across disciplinary and institutional boundaries, drawing largely on work done under the research project CERES21: Sustainability Across Continents (Ceres21.org). The chapters explore new governance opportunities in today’s institutional terrain, with a focus on the global sustainability challenge. They examine governance at global, regional, national, and local levels while exploring new institutional combinations. Innovative models of governance entrepreneurship are illustrated with examples from ecology, finance, corruption and general politics. The scholars’ disciplinary backgrounds include political science, sociology, finance, and systems analysis.
The first chapter, “Globalization and Governance for Sustainability,” takes stock of core arguments in some of the most central governance traditions and discusses their capacity to deliver solutions. It starts with an appraisal of the strengths and weaknesses of the ideas of market‐, state‐ and civil‐society‐led governance, then the effects of media and communication are considered as governance arenas in their own right. Finally, it reviews core arguments put forward in broader approaches to governance where different governance mechanisms are combined.
Out of the critical analysis this chapter distils an approach to governance that combines three basic elements: the need to secure creative tensions between the state, the market and civil society to reduce governance “lethargy” and to encourage governance entrepreneurship; an argument for polyarchic, multilevel governance, where flexible institutional frameworks at various levels of aggregation allow actors to jointly engage in developing governance; and the need to include open communication as an important governance element, to empower new actors, set new agendas and trigger institutional change.
The second and third chapters address governance challenges in the financial system: Against the backdrop of the financial crisis, the second chapter asks “Why Responsible Investment Falls Short of its Purpose and What To Do About It?” Numerous analysts have seen the financial institutions practicing responsible investment as a major governance force to further sustainable development. However, following the financial crisis, these expectations must be re‐examined. After a brief summary of the financial crisis and what is at stake, the chapter reviews the various forms of Responsible Investment and identifies the
8
shortcomings of each. It also describes critical conflicts of interests between CSR and RI and suggests regulatory measures to correct certain systemic problems.
The third chapter, “The Icelandic Bank Collapse: Challenges to Governance and Risk Management,” also addresses the financial crisis using the case of Iceland. The chapter documents a strong laissez‐faire attitude to governance that led financial entrepreneurs to euphorically pursue profits, even as risk and balanced development were largely ignored. In the end, the bank sector collapsed with disastrous consequences for Icelandic economy and society. The chapter documents serious failures of governance due to lack of transparency and entangled ownership within the industry, following an extremely lax public regulation and a lack of public debate. Against this background, the authors proposes new governance arrangements at the corporate, sectoral, and societal levels.
The fourth and the fifth chapters argue for a systemic approach to globalized governance: “Managing Sustainability through the Value Chain” takes a life‐cycle approach to governance, and argues for optimization of entire value chains to account for factors such as environmental pollution and degradation. The chapter argues that environmental management still too frequently looks only at individual points of our (inefficient) production‐consumption chain. As a result, pollution abatement merely displaces the problem to another section of the value chain. The chapter argues that sustainable development requires more widespread application of prevention‐oriented life‐cycle governance thinking, and more emphasis on optimizing the system as a whole.
“Sustainable Palm Oil: The Promise and Limitations of Partnered Governance” discusses The Roundtable for Sustainable Palm Oil (RSPO) as an example of an emerging new governance model that attempts to promote sustainable development. The chapter shows how the RSPO developed as consumer‐oriented businesses partnered with civil society organizations and palm oil producers to address what was seen as a long‐term threat to their financial interests. The chapter concludes by suggesting ways in which partnered governance can be developed and optimized. One of the key findings was a major structural problem with such partnerships for sustainability: that their emergence and development typically depends on powerful players. In the case of deforestation caused by oil palm expansion, national government intervention was absent and international regulation could not be mobilized. While the RSPO’s system of partnered governance may have many shortcomings, the chapter points out that there are few real alternatives that have been as successful in addressing this type of sustainability issue.
9
Governance on global issues is traditionally discussed in the context of intergovernmental agreements and sometimes in the context of international organizations. While states and international institutions have central roles, they are often blocked by a lack of consensus and ambition. The sixth and seventh chapters discuss governance potentials at other levels: cities and regional organizations.
The sixth chapter, “Governing from the middle: the C40 Cities Leadership Group,” explores a city network that emerged in direct opposition to the top‐down policy process of international climate change negotiations. The chapter analyzes what it calls “governance from the middle” (below the national, but above the grass roots level), where city networks across continents come together to develop and implement technologies with industrial partners, to increase energy efficiency, retrofit buildings, handle waste, and make transportation more ecologically sound. Based on the C40 initiative, the chapter undertakes a critical examination of “governance from the middle” and discusses the potential prospects and risks of such an arrangement.
Taking the European Union as a point of departure, “Governance Arrangements for Sustainability: A Regional Perspective” explores alternatives to inter‐governmental conferences and treaties at the global level as a basis for promoting the Brundtland Commission’s vision of sustainable development. The chapter suggests an alternative strategy that focuses on governance arrangements (GA’s) at the regional level rather than government agencies at the global level. The chapter also explores how such arrangements gain legitimacy from those affected by their decisions and argues that the success of GA’s depends on their conformity to certain basic principles for the chartering, composition and decision‐making. If regional governance agreements succeed in Europe, it argues, their norms may diffuse to other parts of the world.
The final chapter, “Montesquieu for the 21st Century: Factoring Civil Society and Business into Global Governance,” argues for rethinking governance through the prism of Montesquieu’s model of checks and balances within state powers. As globalization has eroded exclusive government control, governance must be revitalized as a dynamic interplay of government, civil society and business. The chapter further reveals interesting parallels between governance innovation and the product cycle in technological innovation theory. The conceptual analysis is supported with the example of the Extractive Industries’ Transparency Initiative (EITI), a major new governance initiative aimed at lifting the “resource curse” from countries with an abundance of both natural resources and corruption. While this report cannot cover the whole array of governance issues surrounding sustainable development, it can still inspire a
10
reassessment of governance given the challenges of our time. At a point where the financial and environmental crises demonstrate the extent of interconnection between economies and societies across the world, our cultural and institutional differences still limit our capability for collective action. Only when creative governance can transform our interconnectedness into an advantage will we be able to say that we did our part in avoiding “The Age of Stupid.”
11
12
Chapter 1
Globalization and Governance for Sustainability
Alberto Martinelli and Atle Midttun Introduction In recent decades, we have witnessed an extraordinary economic globalization. Events such as the demise of central planning in the former Soviet Union and Eastern Europe, as well as economic liberalization in a number of developing countries in Asia represent a remarkable success for commercially driven competitive market economies.
On the one hand, market‐driven globalization has spurred exceptional growth and fostered the social modernization of several emerging economies. The high growth of global wealth has, for instance reduced poverty in large countries like China and India.
On the other hand, it has also fostered new economic and social inequalities. Materialconsumption and environmental externalities that were manageable, when pursued by small elites, are now increasingly being replicated around the world on a mass‐scale with disastrous consequences for human livelihood.
The recent financial crisis has demonstrated that the one‐sided globalization of the market economy without adequate financial and social governance is putting the world at risk. Speculative strategies pursued with new and unregulated financial vehicles have evaded ineffective national control and slack international financial regulation (Martinelli, 2004).
Additionally, the climate challenge is showing us that there are ecological limits and that growth in the Western economies, now followed on a larger scale in Asia, have put the world on a fast track towards ecological crises. This chapter takes stock of core arguments in some of the most central governance traditions and discusses their capacity to deliver solutions. Against this background, it also suggests supplementary governance approaches for sustainable development going forward.
Three Institutional Anchors for Governance Today’s discussion of global governance builds on a long debate about the relationship between the state, market and society. Following the Great
13
Depression of the 1930s and World War II, the post‐war period saw an epoch of state‐building in most western economies with a belief in democratic leadership and active government.
The 1980s and 1990s saw a return to belief in markets with deregulation and privatisation of the economy (Derthick and Quirk, 1985; O’Sullivan and Sheffrin, 2002; Midttun and Svindland, 2001). The arguments for the new market approach included fiscal crisis as well as political overload on the nation state, but also challenges facing the nation states under competitive internationalization of the economy.
The late 1990s and early 2000s saw a return to stronger concern with societal governance. Following the wave of deregulated commercialisation, business was challenged by civil society to include social and environmental responsibility in their agenda in the form of Corporate Social Responsibility (CSR).
The present financial and economic crisis has again raised demand for a return of regulation and government intervention, although this crisis comes with the need for a re‐conceptualization of the role of the state in the complex societies of a globalizing world. In analytical terms, much of the governance debate revolves around three institutional anchors: government, markets and civil society, or their combinations: a discussion about different modes of coordination and control. Governance, in this understanding, is about striking a balanced combination of authority, open exchange, and norms (Martinelli, 2003).
Market Led Globalization The extraordinary economic globalization we have seen over the last few years has been driven by a highly successful diffusion of markets and commercial entrepreneurship, as well as by the expansion of multinational companies and their supplier networks. International regimes and organizations have also been successfully built up to lower border tariffs and to support the globalization process (OECD/IEA, 2007), expanding their scope in the wake of the collapse of the state planning model in the USSR.
In response to initial political reductions of trade barriers, commercial entrepreneurship has taken the process further. Markets and production of different countries have become increasingly interdependent through changes induced by the dynamics of trade and capital flows.
The expansion of trade and liberalization of capital movements, combined with advances in communications technology, has strengthened global competition. As pointed out by the Organisation for Economic Co‐operation and Development (OECD) in 2006, the acceleration of capital movements and greater
14
mobility of factors of production has led to a situation where the economy increasingly depends on the synergy generated by a broad range of specialised industrial, financial, technological, commercial, administrative and cultural skills located in different regions or even on different continents.
Multi‐National corporations (MNCs) have been a key factor in globalization. From the international model of the 19th century, where most operations were centred in their home countries, with only elements of sales and distribution happening overseas, the multinational model of the 20th century created companies replicating small versions of themselves in each country as a response to the trade barriers that arose after the World Wars. Now, globally integrated enterprise locates functions anywhere in the world (Maerki 2008).
However, this market‐led globalization has not delivered sustainable results. By the end of the first decade of the new millennium, globalization is facing two serious challenges:
First, this system has spurred exceptional growth in emerging economies such as India and China, with disturbing global consequences for the environment. Competition for resources between OECD member states and developing economies basically doubles the ecological burden on the globe (OECD/IEA, 2007).
Second, the Anglo‐American‐led global market economy, with the financial sector playing a hegemonic role, has provoked an over‐financialization, with an excess of investors looking for increasingly higher financial returns. With financial stakeholders dictating ever stronger short‐termism in the conduct of corporations, speculative creativity has been pushed beyond reasonable limits. The result has been a collapse of the global financial system which has created the global recession, and the growth of inequalities among and within national societies.
The present ecological and financial crises clearly show the limitations of the market‐driven model, and challenge the notion of the market as a spontaneous order capable of self‐regulation. There is now the need for a thorough reappraisal of the relationships between market, state and civil society and for the design of new models of governance.
State Led Internationalisation of Governance The classical alternative to market‐led globalization is state‐led internationalization of governance. Admittedly these are not exclusive alternatives—globalization of markets depends on facilitating national and international regulation—and internationalised political governance of the economy is hardly conceivable without elements of market dynamics. The issue is, therefore, the relative weight of the two governance elements.
15
One of the basic problems with state‐led global governance is the highly dualistic juxtaposition of growing democratization within nation states running parallel with non‐democratic relations among them. As Held (2002) points out: accountability and democratic legitimacy inside state boundaries coincided with hard‐nosed realpolitik between states. This contradictory juxtaposition of internal democracy and external rule of power creates two potential flaws for state led international governance: the exclusive political accountability of state government to domestic electorates tends to turn them into egoistic international actors. The common ground for truly global agreements is therefore often a minimalist common denominator, lacking the means for serious implementation. Smaller groups of states may have more immediate common interests and therefore succeed in mobilizing support for stronger common policies. However, this may create regional solutions that could intensify rivalry with other regions and block truly global solutions. Nevertheless, state‐led governance can also note some successes. One of the outstanding success stories is the Montreal Protocol and the phasing out of 96% of ozone‐depleting substances. As most of these substances are also potent greenhouse gasses, the Protocol has also delivered substantial climate benefits (UNEP, 2008). However, critical issues such as financial regulation, global warming, migration, and distribution between the poor and the rich, remain fundamentally unresolved.
In light of some of the state‐led governance failures, the regime school of governance argues that international governance may emerge without full intergovernmental consensus through consolidation of principles, norms, rules, and decision‐making procedures which again trigger actors’ expectations in a self‐reinforcing way (Krasner, 1983; Haas et al. 1993; Breitmeier et al., 2007). This could strengthen governance and expand its outreach. However, more traditional realists—while recognising occasional success for regimes in moving beyond commonly accepted minima—argue that this can only come about if they rely on the existence of a hegemonic state that possesses the ability to create and enforce international norms via economic, technological, and military dominance, and the will to do so (Waltz, 1999). Furthermore, political governance is fraught with serious efficiency problems. Wherever the state widens its role from regulator to active player in the economy, the risk arises of the formation of state monopolies characterised by lack of innovation and loss of productivity, as well as the risk of powerful lobbies capturing state‐controlled sectors in favour of specific interest groups (Martinelli, 2005). The risk of corruption is also immanent wherever a huge administrative apparatus manages key sectors of the country economy, as in the case of energy and raw‐material producing countries.
16
Substitution of state‐led for market‐led governance is therefore hardly likely to get us any further.
Civil Society Led Internationalization of Governance Broad mobilization of civil society for human rights and fair trade as well as for environmental protection represents a third route to governance for sustainability. Civil society mobilization can play a key role in the global arena, since it is far less nationally constrained than governments. With an increasing engagement by civil society organizations and new and old media, the global governance agenda has, therefore, become far more open, fluid and coupled across state borders.
Its amorphous organizational freedom, at least in many western democracies, makes civil society open to reconfiguration around new issues. It is less locked into vested interests of existing party systems and may often—more easily than established governance institutions—come up with a variety of new interesting ideas from which promising answers to new governance challenges may be selected and later mainstreamed into established institutional practice.
Some civil society engagements have already noted considerable success. Through its mobilization capacity and moral persuasion, civil society has been able to exercise influence on both business and politics. Civil society organizations have managed to implant elements of public accountability into transnational firms, thereby short‐circuiting traditional political regulation and engaging directly to civilize markets. Through activist campaigns, social mobilization and organizational pressure, civil society has also influenced public policy agendas to include social and environmental issues across national boundaries.
Wapner (1996) talks about “world civic politics” and Kaldor (2003) about a “global civil society” whose actors have helped to facilitate genuine political activity at the global level. Ruggie (2004) talks about “a new global public domain” as an arena of discourse, contestation and action organised around the production of public goods. These processes have been vital in promoting and establishing international regimes with social and environmental agendas, such as global labour rights, human rights and numerous environmental issues.
Yet, on a number of issues, civil society and NGOs have not delivered. While they are good at voicing critique and mobilising public opinion in moral and ecological issues, they are highly reliant on governments and business for implementation, and thereby quickly run up against the problems of political
17
aggregation and commercial limitations that characterise the state‐led and market‐led governance. Furthermore, civil society’s influence in political and commercial decision‐making remains largely contingent on open democratic societies. Pressure on decision‐making and business practice in authoritarian states, therefore, remains limited and often indirect.
Expanded Governance Agendas Given the limitations of dominant market‐, state‐, and civil society‐led governance, strong arguments have been presented for more balanced solutions. The classical liberal synthesis, in fact, combines the state and market in complementary roles. Likewise, arguments have been voiced for engaging civil society and social movements more strongly with conventional state politics to balance the latter’s nationalistic bias. Finally, the movement for CSR has fostered alliances between business and civil society for recalibrating the global economy.
State and Market – Variants of the Liberal Synthesis The classical liberal governance synthesis is built on a combination of market and state. Market economics presupposes the rule of law and a properly functioning regulatory framework, whereas state‐led governance presupposes well functioning economic value creation to support public welfare and provide tax revenue. However, the relative balance of free price formation and supply and demand on the one hand, and public engagement in determining market outcomes on the other, may vary. In a market‐led system, the state component is reduced to a minimum, and prices of goods and services are determined in a free price system set by supply and demand. In a state‐led, planned economy, on the other hand, government regulates everything with only marginal elements left to autonomous supply and demand. By engaging selectively in the market economy, governments may seek to calibrate the market forces and tune them to respond to more than just individual preferences, namely also to more general environmental and social needs.
The mixed economy strikes a balance somewhere in the middle. The government controls the economy partially, but leaves other elements to free market forces. However, the balance may be struck in different ways. As argued in the literature on the varieties of capitalism (Albert, 1991; Hall and Soskice, 2001; Schmidt, 2002), market economies come in many variants, ranging from the Anglo‐Saxon market‐driven variant, to the continental European ‘social market economy’ model and the Japanese ‘developmental state’ model. The Chinese/East Asian authoritarian model has increasingly opened up for commercial dynamics, but still retains a strong authoritarian government control.
18
While the mixed economy model, in the context of a sovereign nation state, allows a flexible mix of state and market forces, a similar flexibility is hard to attain in the globalizing economy. Markets and commercial actors have had the capacity to scale up operations across national borders at a rate that by far outpaces public authorities.
Attempts to scale up state governments to complement the extending markets include initiatives to reach international governance through intergovernmental agreements. Fairly successful international regulation has been achieved in some cases. This includes the GATT (General Agreement on Trade and Tariffs) which was later consolidated into the World Trade Organization (WTO), as well as free trade initiatives in the OECD, The political leaders of the most important economies (G20) have pledged to intervene in their economies in order to restore confidence, growth and jobs, as well as to save large firms in crisis, and to repair the financial system and strengthen financial regulation. However, it remains doubtful whether the most powerful countries will really be able to agree on common actions to address the global crisis rather than putting their national interests first and foremost. Another attempt to scale up political governance internationally has been through internationalization of liberal democracy. The Commission on Global Governance (1995) and researchers such as Rosenau (1997) and Ikenberry (2001) have maintained that, in order to face the threats to social cohesion and the ecological and political risks of globalization, it is necessary to extend the model of representative democracy beyond the boundaries of the nation state, generalizing its norms and institutions on a global level.
Key actors for liberal internationalists remain the nation states, although international organizations and regimes—acting according to liberal‐democratic rules—play a growing role. The main problem for liberal internationalists is the accountability of decision‐makers (Keohane, 2002). Since there is no global constitution, the entities that yield power and make rules are often not authorized to do so by general agreement. Key global actors such as powerful states, transnational corporations, and religious movements have an accountability gap, i.e. they are only internally accountable to those who confer authority and resources, but not externally accountable to many of those who are affected by the consequences of their decisions.
Radical and Cosmopolitan Approaches to Democracy: Combining State and Civil Society Led Governance Facing the limitations of the liberal synthesis model, one strand of literature has sought to expand the basis for global governance by combining civil society and
19
state led approaches. There are several variants, of which the two most acknowledged models will be described here: radical democracy and cosmopolitan democracy (Held et al., 1999). The radical democracy model argues for the creation of alternative mechanisms of economic, social and political organization worldwide, based on the principles of self‐government, equality of rights, the common good and harmony with the environment. It aims at creating the conditions necessary to empower people to take control of their own lives and to create self‐governing communities. Key actors are collective movements, such as the environmental, peace and women’s movements, which first developed in the national context and then extended their range of action to global society. These new movements are engaged in mobilizing transnational communities of resistance and solidarity against impending global ecological, economic, social and security crises. These movements aim at spreading new transnational identities and new notions of global citizenship, using the same information technologies employed by transnational corporations to control the market. They experience new forms of direct democracy at the community level, such as the participatory city budget (as in the case of Porto Alegre (Goldsmith 1999)). This model differs from the liberal internationalist one mostly in terms of key actors and its conception of democracy. Whereas the former model is addressed to responsible political, economic and intellectual elites and governing classes and develops a notion of representative democracy, radical democracy appeals to collective critical movements, non governmental organizations and discriminated social groups with a bottom up theory of democratization (Gret and Sintomer, 2002).
By engaging conventional political processes more strongly with these movements, the goal is to vitalise the democratic process and to expand perspectives and policies beyond the traditional boundaries of the nation state.
In this respect, innovations such as participatory budgets, deliberative polls, mini‐caucuses and similar instances of direct democracy are interesting proposals to re‐vitalise democracy. If it is already hard to implement them at the local level, it is almost impossible at higher levels. While the radical democracy model brings interesting solutions to bear on political functions at the local level, its ability to address global governance is less convincing. Global governance cannot be achieved through only the addition of tens of thousands of self‐governing communities.
The cosmopolitan democracy model is based on a ‘cosmopolitan law’ that entrenches several, universally shared principles: equal worth and dignity, active
20
agency, personal responsibility and accountability, consent, reflexive deliberation and collective‐decision making through voting procedures, inclusiveness and subsidiarity, avoidance of serious harm, and the amelioration of urgent need. Key actors are the citizens, i.e. individuals enjoying citizenship in the diverse, overlapping political communities that significantly affect them, from the immediate local community to the wider regional and global networks (Held, 2002; Archibugi et al., 1998). A basic pre‐requisite is the growth of a global civil society where democratic cosmopolitan institutions and democratic public discourse can develop. The cosmopolitan law goes together with the institutions of legal cosmopolitanism (such as an interconnected global legal system, embracing elements of criminal, commercial and civil law), political cosmopolitanism (such as multilayered governance and diffused authority), economic cosmopolitanism (such as global taxation mechanisms) and cultural cosmopolitanism (such as the growing awareness of overlapping ‘collective fortunes’ that require collective solutions). In the words of one of its major proponents, “the core of the cosmopolitan project involves re‐conceiving legitimate political authority in a manner that disconnects it from its traditional anchor in fixed territories and instead articulates it as an attribute of basic cosmopolitan law which can in principle be entrenched and drawn upon in diverse associations” (Held, 2002). Key actors are cosmopolitan institutions. The proponents of this project remark that the process has already begun, as political authority and forms of governance are diffused ‘below’, ‘above’ and ‘alongside’ the nation state. The cosmopolitan democracy project is the most ambitious one in its attempt to design the principles and institutions of a democratic world polity, but is for this very reason even easier to criticize.
First, it underestimates the dimension of power and the persisting importance of nation states and their conflicts. Second, it fails to identify the key actors which could make the project real, and when it does it provides a utopian picture of their motivations and strategies. That is, it overestimates both the diffusion of the institutions of cosmopolitan democracy, which are actually fragmented and heterogeneous, and the degree of the existing consensus for the principles of the so‐called cosmopolitan law, which is at best restricted to ‘enlightened minorities’ (Martinelli, 2004).
Corporate Responsibility: Combining Market‐ and Civil Society Led Governance While radical and cosmopolitan democracy approaches have sought to expand global governance through recombining state‐ and civil‐society‐led governance, the corporate social responsibility approach promotes a governance model that
21
combines market‐ and civil‐ society‐led approaches. Utilising multinational industry as a vehicle, civil society organizations piggy‐back on companies’ international networks to impose a social and environmental agenda on the global economy. On the market and business side, corporate responsibility literature presents a functional argumentation for extending the firm’s social and environmental responsibility. On the civil society side, this literature focuses on the capability of civil society organizations to mobilise public opinion directly through media and thereby to exercise influence on business practice. The functional business arguments for extended corporate responsibility range from general stakeholder theory via reputation/branding theory, to cluster theory, to a social innovation perspective.
The stakeholder approach implies that the incentives for integrating social and environmental concerns in business practice lie in the fact that the firm must justify its strategies not only to its shareholders and to authorities, but also to an extensive group of stakeholders such as owners, financiers, employees and trade unions, customers and consumers’ associations, suppliers, competitors, government authorities, local communities, activist and political groups (Freeman, 1984). Stakeholder engagement, it is argued, allows the firm to avoid losses due to conflicts and blockage of business projects. On the other side, stakeholders can also unleash resources and ideas that may contribute significantly to value creation.
The reputational approach (Fombrun et al. 1996) is another major perspective in the CSR literature. The argument for social and environmental responsibility in this approach is that a well chosen portfolio of societal engagements may help companies build reputational capital, and strengthen their ability to negotiate better contracts with suppliers and authorities and to position themselves in high‐price segments with their products, and build competitive advantage.
Incentives for sustainability‐oriented self‐regulation are also seen to exist in positive spill over effects from cluster engagements. Drawing on Porter’s well known cluster theory; Porter and Kramer (2006) argue that collective social investment by participants in a cluster can improve the context for all players, while reducing the cost borne by each individual player.
Other scholars have argued for sustainability oriented self‐regulation from a social innovation perspective. In this tradition, Moss Kanter (1999) has focused on an emerging paradigm for innovation, based on partnership between private enterprise and public interest that produces profitable and sustainable change for both sides. Moving beyond CSR to corporate social innovation, she argues,
22
involves new engagements where innovative corporations can stretch their thinking, reap the advantages of a first mover, acquire a deep knowledge of new markets, and develop strong relationships with those markets.
In more conventional economic theorising, the enlightened value maximisation approach has also created some space for socially and environmentally responsible economic self‐regulation. Shifting the focus from short term profit to long term value maximisation and factoring in the stakeholder dialogue, Jensen (2001) has argued for what he calls “enlightened value maximisation.” The orientation towards value maximisation, as Jensen sees it, solves the problems that arise from the multiple objectives that accompany traditional stakeholder theory.
The civil society contribution to socially and environmentally sustainable governance through promoting CSR lies, inter alia, in its ability to engage with and pressure business to follow a broader business agenda. By pressuring business to take on board a triple‐bottom‐line agenda—including financial, social and environmental dimensions—throughout their global commercial networks, civil society may have a widespread influence. Midttun (2008) has argued that, in modern media‐driven societies, idealistic stakeholders acquire bargaining power vis‐à‐vis industry and the state through public legitimacy bestowed upon them by media in open public debate. The CSR approach has, however, also met with fairly strong critique. The Canadian law professor Joel Bakan (2004) has thus pointed out the paradox that corporations, the cornerstones of CSR based governance for sustainability, are themselves, by legal design, irresponsible to society. The restriction of responsibility to shareholder value and the tendency to externalise further responsibilities to society at large implies a collision between sustainability and the basic business mode. Furthermore, the expansion of social and environmental obligations to the entire international value chain based on contractual obligations remains a secondary concern compared to cost and product performance. Such responsibilities from firms are therefore highly dependent on NGO pressure.
Contestability, Polyarchy, Communicative Governance Going forward towards a normative position distilled from the previous discussion, we would like to emphasise three elements: contestability, polyarchy and communicative regulation. The first element is the idea that the interaction between the three institutional anchors of governance (the state, markets and civil society) can form a system of contestability, or checks and balances, in analogy with Montesquieu’s
23
principle of division of constitutional powers. Montesquieu’s focus on constitutional powers of the state reflects a state‐centric approach, which in our time needs to be woven into a more complex fabric of governance, including civil society and business markets as well.
The second element is the idea of polyarchic, multilevel governance, which implies accountability without sovereignty since there is no threat of censure by a hierarchical authority that can assure sanctioned reactions. Participants are accountable in the sense of being obliged to justify their own autonomous choices in front of their peers in terms of efficiency, effectiveness and equity (Martinelli, 2004). Under the shadow of authority, actors know that if they do not comply then policy making goes back to the traditional form with the resulting risk of higher inefficiency and iniquity.
The third element is the idea of implicit governance in open communication, or recourse to a communicative arena that questions and exposes decisions in other arenas and territorial units. Debate and publicity in the media may change power relations, and bestow “moral rights” on weaker parties, or undermine legitimacy of decisions made in other fora.
Obviously the three elements need to work together dynamically in shaping future governance for sustainability, and obviously they will have to interplay with traditional market and state based governance.
Contestability Drawing on Montesquieu’s theory of division of state powers, the doctrine of societal balance of powers entails the maintenance of autonomous centres of expertise in each of the three spheres that can challenge each other in free public debate. As pointed out in a consecutive part in this report, pluralism of powers may entail constructive rivalry that keeps all powers alert and creative and thereby prevents stagnation. Given their different recruitment, organization and social functions, the state, markets and civil society may have diverse governance capabilities that allow them to engage in global governance in complementary ways. The availability of several competing governance arenas implies that governance initiatives can be brought forward even if they are blocked in one arena. For instance, governance initiatives that do not find state support may be adopted by the market, or pushed forward by civil society. The three powers may thereby form important complementary arenas for addressing global governance, just as the legislative, executive and judiciary powers did in Montesquieu’s analysis of the state.
24
Polyarchy Drawing on the European experience with the open method of communication, the polyarchic approach to governance advances an alternative to both inter‐governmentalism and supra‐nationalism – and is a new way for enhancing democratic participation and accountability by opening up the policy‐making process to inputs from NGOs, social partners and local and regional actors.
The experience of the EU (Majone, 1996; Sandholtz, and Stone Sweet 1998; Kohler‐Koch and Eising,1999, Martinelli 2007, Zeitlin, J. and Pochet, P. 2005), has, since the 1987 Single European Act, developed a new architecture of public rule making, in which EU institutions and member states jointly define the main goals – such as reduction of carbon emissions, energy saving, water quality, etc., but retain extensive freedom to choose own strategies of implementation at the same time as they agree on procedures and indicators for the empirical evaluation of the attainment of goals. This approach to European policy‐making has been labelled the Open Method of Co‐ordination (OMC), which, although not without criticism (Radaelli, 2003) has been praised as a “third way” for EU social policy between regulatory competition and harmonization
As seen in the EU, elements from the polyarchic governance repertoire could also be applied to other regional settings such as NAFTA or the Mercosur, as well as to the global arena in institutional settings creating new legal global standards, such as the International Monetary Fund and the Financial Stability Forum.
Communicative Governance The third element in our rethinking of governance, going forward—communicative governance—takes as its point of departure that modern societies are extensively media‐driven. The massive scale and scope of traditional mass media give them an important agenda‐setting function and thereby influence what issues are debated. Media contribute to governance by facilitating other governance mechanisms: they may facilitate contestability and checks and balances between markets, states and civil societies, as media convey information about opportunities and failures. Media may also facilitate polyarchic governance by enhancing transparency and legitimacy in stakeholder negotiations, where traditional democratic representation is not involved. As implied in the term “monitory democracy” coined by Keane (1991), media may also function as a super‐governance arena in itself.
In addition, media may facilitate empowerment. Idealistic stakeholders may acquire bargaining power vis‐à‐vis industry and the state through public legitimacy bestowed upon them by media in open public debate. As argued by Midttun (2008), “moral rights” bestowed upon CSOs through media
25
“canonization” may carry extensive weight in a brand‐oriented commercial context where negative media exposure could inflict serious brand damage. Similarly, CSOs also carry moral weight when they challenge the state and public policy in their domain. Such mechanisms may, to some extent, make up for the weaker position of civil society vis‐à‐vis the state and industry in open societies with free press and thus recalibrate the checks and balances between the three “powers.”
The communicative governance thesis is conditioned by democracy and free press (Habermas, 1989). Traditional mass media are, in fact, typically organised from the top down, which in democratic societies with open editorial policies allows mass spread of critical information, but which in autocratic societies allows for centralised control. So‐called new social media, on the other hand, allow bottom up communication, and may penetrate authoritarian censorship.
Dynamic Interplay in the Complex Web of Governance – a Concluding Note In conclusion, we envisage a web of parallel governance initiatives where the classical model of interstate institutionalization is only one of many. Sometimes these initiatives support each other, while at other times they compete.
When they engage constructively together, the three domains of governance: state, markets and civil society stimulate each other in a dynamic chain reaction to promote sustainable governance. Experimentation with new civil‐society‐driven initiatives may feed into more formal arrangements in the longer run. Governance may, in other words, be seen as an innovative process, where early phase experimentation takes place in informal arenas, and successful initiatives are gradually diffused into the formal system. In legal terms, this implies building bridges between soft and hard law. When soft law causes states to act in a certain way, for instance in adopting sustainable practices, this contributes to creating a precedent that de facto may translate into hard law (D’Amato, 2008). Strong implementation of policies for sustainability may also take place through the engagement of business channels. For example when supply chains of multinational companies are used for furthering workers rights and fighting corruption with legal contracts.
While the carrying capacity of each governance mechanism under contestation may be limited, the strength of the joint web of governance may be greater. The polyarchic multi‐layered web of governance may provide resilience and contestability may provide creativity that together produce governance solutions to the sustainability challenges which the world is facing today.
26
However, contestability, polyarchic creativity and free civic engagement cannot be taken for granted. They are all governance preconditions that need to be precariously guarded and, if necessary, fought for.
27
References Albert, M. (1991), Capitalisme contre Capitalisme, Editions du Seuil, Paris. D’Amato A. (2008): “International Soft Law, Hard Law, and Coherence” Northwestern University School of Law, Public Law and Legal Theory Series No. 08‐01; Chicago Archibugi D., Held, D. and Kohler, K.(1998). Re‐imagining Political Community.Studies in Cosmopolitan Democracy, Polity Press, Cambridge. Bakan, J. (2004): The corporation : the pathological pursuit of profit and power; New York : Free Press Breitmeier, H., Young, O. R, and Zurn, M. (2007), Analyzing International Environmental Regimes, The MIT Press, Cambridge. Commission on Global Governance, (1995), Our Global Neighbourhood, Oxford University Press, Oxford. Derthick, M. and Quirk, P. J. (1985), The Politics of Deregulation, the Brookings Insitutions, Washington D.C.
Fombrun C. J; Gardberg, Naomi A. and Barnett M. (2000); "Opportunity Platforms and Safety nets: Corporate Citizenship and Reputational Risk". Business & Society Review, Vol. 105 NO. 1, pp. 85‐ 106.
Freeman, R.E.,(1984), “Stakeholder Management: Framework and Philosophy”, in R.E Freeman (Ed), Strategic Management ‐ A Stakeholder Approach, Pitman, Boston.
Goldsmith, W. W. (1999), “Participatory Budgeting in Brazil. New York: Planners Network”, available at: <http://www.plannersnetwork.org/htm/pub/working‐papers/brazil/ brazil_goldsmith.pdf> accessed 9. Nov 2009
28
Gret, M. and Sintomer, Y. (2002), Porto Alegre. L’espoir d’une autre démocratie, La Découverte, Paris.
Haas E., Keohane R.O. and Levy M.A. eds. (1993), Institutions for the Earth, Sources of Effective International Environmental Protection, MIT Press, Cambridge.
Habermas, J. (1989), The Structural Transformation of the Public Sphere: an Inquiry into a Category of Bourgeois Society, Polity Press, Cambridge.
Hall, P.A. and Soskice, D. (2001), Varieties of Capitalism. The Institutional Foundations of Competitive Advantage, Oxford University Press, Oxford.
Held, D., McGrew, A., Goldblatt, D. and Perraton, J. (1999), Global Transformations: Politics, Economics, and Culture, Polity Press, Cambridge.
Held, D. (2002), “Law of States, Law of Peoples. Three Models of Sovereignty”, Legal Theory, Vol. 8 No.1, pp. 1‐44. Ikenberry, G. J. (2001), After Victory, Princeton University Press, Princeton. Jensen, M. J. (2001), “Value Maximisation, Stakeholder Theory, and the Corporate Objective Function”, Journal of Applied Corporate Finance, Vol.14 No.3., pp. 8‐21 Kaldor, M. (2003), Global Civil Society. An Answer to War, Polity Press, London. Keane, J. (1991), The Media and Democracy, Polity Press, London. Keohane, R. O. (2002), Power and Governance in a Partially Globalized World, Routledge, London. Kohler‐Koch, B. and Eising R.(1999), The Transformation of Governance in he European Union, Routledge, London. Krasner, S. D. (1983), International Regimes, Cornell University Press, Cambridge. Maerki, (2008): “The globally integrated enterprise and its role in global governance” Corporate Governance, Volume: 8, Issue: 4 pp: 368 ‐ 373
29
Majone, J. (1996) Regulating Europe, Routledge, London. Martinelli, A. (2003), “Markets, Governments, Communities and Global Governance”, International Sociology, Vol.18 No. 2, pp. 291‐324. Martinelli, A. (2004), La Democrazia Globale, Università Bocconi Editore, Milano. Martinelli, A. (2005), Global Modernization. Rethinking the Project of Modernity, Sage, London. Martinelli, A. (2007), Transatlantic Divide. Comparing American and European Society, Oxford University Press, Oxford. Midttun, A and E. Svindland Approaches to and Dilemmas of Economic Regulation (ed with) 2001, Macmillan Press Ltd. Midttun (2008): “Partnered Governance: Aligning Corporate Responsibility and Public Policy in the Global Economy.” Journal of Corporate Governance (2008) VOL. 8 NO. 4, pp. 406‐418 Moss Kanter, R. (1999), “From Spare Change to Real Change”, Harvard Business Review, Vol. 77 No. 3, pp. 122‐132. OECD (2006) World Economic Outlook available at: www.oecd.org/oecdEconomicOutlook (accessed 10. sept 2009) OECD/IEA (2007) World Economic Outlook. available at: www.oecd.org/oecdEconomicOutlook . (accessed 10. sept 2009) O’Sullivan, A. and Sheffrin S. M. (2002), Economics: Principles in Action, Pearson. Prentice Hall, New Jersey. Porter, M. E. and. Kramer, M. R. (2006),“Strategy and Society. The Link Between Competitive Advantage and Corporate Social Responsibility”, Harvard Business Review, Vol.84 No. 12, pp. 78‐92.
30
Radaelli, C. (2003), The Open Method of Coordination: A new governance architecture for the European union?, Swedish Institute for European Policy Studies, Stockholm.
Rosenau, J. (1997), Along the Domestic‐ Foreign Frontier, Cambridge University Press, Cambridge.
Ruggie, J. (2004), “Reconstituting the Global Public Domain‐Issues, Actors, and Practices”, European Journal of International Relations, Vol. 10 No. 4, pp. 499‐531.
Sandholtz, W. and Stone Sweet, A. (1998), European Integration and Supranational Governance, Oxford University Press, Oxford.
Schmidt, V. (2002), The Futures of European Capitalism, Oxford University Press, Oxford. UNEP, (2008), “Montreal Protcol” available at: http://ozone.unep.org/Events/ozone_day_2008/press_backgrounder.pdf (accessed at 10 September 2009) Waltz, K. (1999), “Globalization and Governance”, Political Science and Politics, Vol.32 No. 4, pp. 693‐700. Wapner, P. K. (1996), Environmental Activism and World Civic Politics, SUNY Press, New York.
Zeitlin, J. and Pochet, P. (2005), The Open Method of Coordination in Action, Peter Lang, Bruxelles.
31
32
Chapter 2
Why Responsible Investment Falls Short of its Purpose and What To Do About It?
Carlos Joly
"We can have democracy in this
country, or we can have great wealth concentrated in the hands of a few, but we can't have both.” Louis Brandeis, Judge of the Supreme Court from 1916 to 1939 “The widespread acceptance of rational expectations and the efficient market hypothesis has taught us never to underestimate the ability of the economics establishment to get an idea brutally and expensively wrong.” Jeremy Grantham, Co‐Founder, GMO Funds, May 2009
“Get your facts straight, apply them to the current valuation of the market, take decisive action, and then hold on for dear life as the mob hopefully comes to the same conclusion a little way down the road.” Bill Gross, Managing Director, PIMCO, May 2009
Introduction When the banking system fails, no investment is safe, including Responsible Investment (RI). Responsible Investors have been laggards as regards the current crisis, neither identifying it early nor doing anything to try to prevent or contain it. Can we trust them in the future to help protect the retirement savings of principals? I will argue that we cannot because of the deeply imbedded conflicts of interest all along the investment supply chain. RI could conceivably take on a watchdog and lobbyist role in a socially and environmentally responsible market
33
economy, but this will only come about through a) new regulatory measures, b) tough legal enforcement with real sanctions, and c) strong independent NGO supervision to investigate and put pressure all along the investment chain. Regulation is not enough, just as NGO action without proper legal instruments to back it up is not enough. Both are needed. But one thing is certain: we can no longer go by the myth of self‐regulation.
The logic of this chapter is to: I) briefly summarize the contours of the crisis, II) define what is at stake, III) review the various forms of RI and identify the shortcomings of each, IV) describe critical conflicts of interests in CSR (Corporate Social Responsibility) and RI, V) suggest regulatory measures to correct specific systemic problems, VI) indicate (for elucidation elsewhere) the role of RI in sustainable development, and VII) provide a summary conclusion. Each roman numeral denotes a section below. To clarify terminology at the outset: Responsible Investment (RI), Sustainable Investment (SI), Socially Responsible Investment (SRI), and Environmental, Social and Corporate Governance Integration (ESG) can be used synonymously. As defined by the UN PRI [1], RI aims at ESG integration in portfolio composition and/or engagement, and is justified on grounds of fiduciary duty, i.e. protecting the long term value of the capital of principals. As such, it sidesteps the issues of making ethical exclusions (e.g. weapons, tobacco, GMOs), or of putting the pursuit of profits within the boundaries of societal, larger economic, and ethical concerns; whereas SRI often denotes ethical exclusions or assessments with or without ESG integration. Most mainstream fund providers who claim to do RI do some version of ESG, SRI or thematic environmental funds. I discuss the issue of ethics in sections VI) and VII) below.
I. The Global Banking Crisis and Stock Market Crash Set up a New Challenge One thing has become excruciatingly clear as this crisis unfolds: when banks screw up, they hold the world hostage. We need banks to collect savings. We need banks to make loans to help productive businesses grow. We need banks to arrange bonds for governments to provide public services not funded by current taxes. What we don’t need are bankers and a banking system that is organized and incentivized to pirate away the public’s pension savings. The ultimate stress
1 RI is defined and promoted by the UN Principles of Responsible Investment organization, a voluntary initiative created by large pension funds seeking grounding and legitimacy for their extra‐financial interests. Pension funds are full members, asset managers and consultants are associate members. It now has hundreds of signatories with trillions of dollars in assets under management, making it the mainstream expression of SRI. (Available at http://www.unpri.org)
34
test is not Geithner's on the solvency of banks but rather how countries will be able to work themselves through the huge destruction of capital that has just occurred. The 4.1 trillion in loan losses estimated to be the fallout from the crisis 2 means that in 2009 Japan’s GDP will have fallen by over 6%, the US by 3%, Europe by over 2% (Germany ‐6%) and average global growth may reach only 0.5% 3. This means tens of millions of people will be forced out of work4, defined benefit pension schemes will become even more severely underfunded5, and public finances will be in shambles for at least a decade, with all the negative implications this has for public health services, education, retirement benefits, and cultural activities‐‐witness the example of California. For 2009 and 2010 the IMF estimates budget deficits in the G20 will, on average, be over 6% (9% in the USA, 10% in Japan, 11% in the UK, and 6% in Germany). The ratio of US government debt to GDP will go from 60% to about 80%, a level that would force sovereign default for a developing country. (Argentina’s is 55%, Brazil’s 45%). The cost has to be financed through new government bond issuance, which the IMF estimates at $10 Trillion. Private estimates range from $15 to $33 Trillion6. Where will the money come from? Will this cause deflation or inflation? Nobody knows yet. Safety used to be equated with size: big banks were supposedly safe because they were “too big to fail.” We now know that if a bank is too big to fail it is just too big, and should be broken down. Perhaps the same holds true for
2IMF reports that of the total $4,100bn in expected global write downs until 2010, the global banking system accounts for $2,800bn. Of that, a little over half – $1,426bn – is sitting in European banks, while US banks account for $1,050bn. FRS Flow of Funds data show that 40% of U.S. originated securitizations are held abroad‐‐> about $4.4T out of $10.8T securitizations held abroad, $4 T are assumed to be in Europe. That is, Wall St has been very effective at passing on the toxic junk to willing gullible fools at European banks and insurers. Adding all up, expected losses among European banks amount to about $450bn exposure to U.S. securities +$730bn domestic&foreign loan losses+240bn CEE=$1.4T. Source: RGE Monitor, http://www.rgemonitor.com accessed 28.04.2009.
3 IMF forecasts of January 2009. Japan government forecast of April 2009. Germany’s of June 2009. http://www.imf.org
4 In 2008 the ILO reported 160m unemployed in the world, and forecasts additional 50m new unemployed in 2009. http://www. ilo.org
5 $650 billion underfunded in USA in 2006, before the crisis! Ferraris, V. and Marano, A. (2007) “The underfunding of the US corporations defined‐benefit pension plans”, Cuaderni di ricerca, No 30, available http://www.ref‐online.it/pannelli/abstract/WP_REF/abstract_q30ref.pdf 6 Reinhart, C. and Rogoff, K, (2009) “The Aftermath of Financial Crisis”, Working Paper NBER, December 19, available http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1329274#
35
industrial conglomerates. The demise of GM is a case in point. The mega‐companies have grown too large to manage and control. Their managers don’t know what is going on7, and those supposedly supervising and controlling them on behalf of the public know even less. Lending to creditworthy businesses and families has been pirated away by years of irresponsibility. Hedge funds habitually geared up to 30 times their equity, with banks happy to disregard the most elemental rules of credit in order to book the fees that provided the basis for royal bonuses. If this narrative has an outraged tone, it is intentional. We are in the midst of a global systemic financial crisis made in the USA, based on its libertarian ideology of free marketeerism, self‐interest, and greed. It has undermined the well‐being of society at home and abroad. Its effects are externalized to the real economic life of people and countries who had no role in its creation. Their life savings are decimated, their livelihoods affected, their homes no longer a haven of safety, their futures uncertain. But as the banks report their first quarter of dubious8 profits – as of May and June of 2009 – we learn that the same banks being kept alive with taxpayer money are setting aside large sums for bonuses to the very executives and traders that got us into this mess9.
II. What’s at Stake What is at stake now is the way we govern banks and the financial system in general. The previously held conventional wisdom that banks and other financial institutions can regulate themselves has been proven completely wrong. We now ask ourselves whether the regulators are able to regulate, who the regulators should be and what rules should apply; and, at the heart of the problem, we cannot but ask ourselves what has become of the role of finance, how has it
7Societe Generale, famous for its quant competence and its risk controls, infamously lost €5 billion to a rogue trader last year, and now another €5 to €10 billion is discovered in derivatives losses. At Lehman, AIG, BofA, UBS and Citi nobody at the top was able or willing to see the risks.
8 Citi´s 1Q 2009 profit is mostly the result of accounting changes. Financial Times,4 April 2009: “Bank stocks were boosted on Thursday by an accounting rule change that is expected to allow managers to repair balance sheets by recalculating the value of some of their most troubled assets. The Financial Accounting Standards Board voted on Thursday morning to allow banks more freedom to use their own valuation models, rather than current market prices, for assets where markets have become illiquid. A second rule change means banks will only have to recognise a part of any impairment in their profits.” Available http://www.ft.com 9 Bloomberg reports that the six major US banks have set aside $36 Billion for bonuses in just the first trimester of 2009, equal to the generous payments of 2007.
36
changed society and what fundamental changes we need to make to put things right?
Socially Responsible Investment (SRI), or its reincarnation as Responsible Investment (RI), represents the voluntary non‐governmental approach by the financial community to reforming itself. It claims to be a more responsible form of financial management, and as such should have spotted the roots of the finance crisis and worked to have the system deal with the excesses at an early stage. It should at least have saved investors from severe losses by pulling money out of shares early on or advising clients to do so. RI also sees itself as a vehicle for forcing business to internalize social and environmental responsibility. Therefore, it is fair to test the effectiveness and viability of this form of self‐governance by asking:
1. Does RI satisfy its purpose with regard to pension savers or beneficiaries?
In particular: a. Does it cause change in companies for environmental and social
good? b. Is it more responsible when it comes to protecting its principals
against classic agency problems? 2. Does RI have a good response to the problem of short‐termism?
I raise these questions as a practitioner, not as an academic. It is time those of us who have been pioneering and promoting Corporate Social Responsibility (CSR) and the integration of environmental, social and governance criteria (ESG) in the investment chain ask ourselves whether we have been too prone to wishful thinking. A dose of self‐criticism is needed10. We need to ensure that the aims of RI do not become compromised as it becomes increasingly mainstream. 11
10 The author, during 30 years a banker and fund manager, was co‐founder of the UNEPFI and Chair of its Asset Management Working Group, Co‐Chair of the Expert Group that drafted the UN PRI, founder of Aksjefondet MiljøInvest (1989), of Storebrand Scudder Environment Value Fund (1996) and Natixis Impact—Climate Change (2009). Sustainable development funds and alternative energy thematic funds are a commercial success and show good growth in assets under management. The “I” of SRI works, but what about the “SR”? 11 RI is defined and promoted by the UN Principles of Responsible Investment organization, a voluntary initiative created by large pension funds seeking grounding and legitimacy for their extra‐financial interests. Pension funds are full members, asset managers and consultants are associate members. It now has hundreds of signatories with trillions of dollars in assets under management, making it the mainstream expression of SRI. (Available at http://www.unpri.org)
37
Discussing Responsible Investment against the background of the recent financial crisis provides a special challenge: Responsible Investors have been laggards as regards the current crisis, neither identifying it early nor doing anything to try to prevent or contain it. Can we trust them in the future to help protect the retirement savings of principals? I will argue that we cannot because of the deeply imbedded conflicts of interest all along the investment supply chain. RI could conceivably take on a watchdog and lobbyist role in a socially and environmentally responsible market economy, but this will only come about through a) new regulatory measures, b) tough legal enforcement with real sanctions, and c) strong independent NGO supervision to investigate and put pressure all along the investment chain. The underlying principle of RI/ ESG/ SRI is that a pension fund or asset manager can make a competitive return on investment for principals by buying the stocks of companies that go about their business in a way that actually improves environmental and social conditions in the world while making a good profit. The idea is that the concept of sustainable development, expressed in companies through CSR programs, is taken up in the investment world by giving preference in portfolio composition to the better environmental and social performers and/or by influencing companies to achieve better ESG performance in practice. In a general sense, we wanted to see CSR and RI as a way to “civilize capitalism.” We believed that the failures of the market to internalize the environmental and social costs it displaces onto society could be somewhat contained and redressed by a voluntary system of self‐regulation. My re‐assessment is that it has either not worked, or done so only marginally. At the very least, going forward, we should ask: How can we believe the banks and insurers that have failed so miserably are capable of doing right by CSR or RI [12]? Can we trust the RI and SRI community to apply RI to itself and, if not, how can we expect it to apply it robustly to others? Are environmental and social costs actually internalized? In other words: Can we trust the people that are the ESG analysts and portfolio managers to prevail against bad leadership and a faulty ideology ingrained in the culture and operations of the business? This is the dilemma of good people in organizations that are top‐heavy with conflicts of interest. I argue that the shortcomings in actually implementing RI and SRI show the limits of personal‐values‐driven strategies for organizational and governance improvement (Lorsch, Berlowitz, and Zelleke, 2005). What follows are my answers to these questions as a participant and observer. 12AIG, Citi, Bank of America, Societe Generale, Goldman Sachs, and so forth, are signatories of UNEP FI or the UN PRI, in contrast to their own records on tax sheltering, irresponsible lending, toxic derivatives and structured products.
38
III.Mainstreaming: from SRI to RI SRI has gone from a niche product sponsored by ethically motivated independent fund managers in the 80s and 90s to a product offered by most mainstream financial institutions. As assets in SRI funds become an increasingly significant percentage of total assets under management [13], the hope has been that this movement would become an agent of change for environmental improvement, increased economic justice (starting with fair compensation in the workplace), and the adoption of longer investment horizons better reflective of pension needs. To understand a) why this hasn’t happened and b) whether, and how, it might still be made relevant, I will briefly recapitulate how the prevailing modes of SRI function. Best in Class A portfolio of equities is chosen from companies deemed to be among the best in each sector on certain defined environmental, social or corporate governance criteria. It should be understood that there is no commonly acknowledged definition for critical criteria (such as how to measure and compare the impact to global warming or natural resource conservation or fairness of compensation‐‐either for a single company or comparatively between companies), no accepted minimum set of criteria, no concept of what the weighting of the different criteria should be in the overall assessment of a company’s or sector's ESG performance, no general rule for where the threshold of acceptability should be set for a given criterion or a set of criteria (e.g. should the threshold for sector´s CO2 emissions be set so as to include the 25% best ranked companies? or the best ranked 50%? or all but the worse 30%?). Given this, obviously, all kinds of rankings can result within a sector and the only way to know if a fund has a stringent or lax RI profile is to look closely at the definitions of the criteria, the depth and independence of sources, the quality of the analysis, the weighting of the various criteria sector by sector, the weight given to past company ESG performance vs. aspirational statements, and the threshold for inclusion or exclusion in a portfolio. Clearly, individual investors have no way of doing this, and most institutional investors and their advisers haven’t a clue. This lack of standards should result in notably different RI portfolios, however, one sees remarkable portfolio similarities across funds. Why?
13 A recent estimate by Booz Allan Hamilton consultants says by 2020 SRI AUM can reach 20% of the total. At the end of 2008 in France, SRI AUM grew to €30 billion.
39
First, half a dozen specialized ESG rating agencies supply ratings to most RI fund managers 14 since very few institutional investors or fund managers have sufficient internal staff and competency to do their own analyses. The danger is the homogenization of the investment universe around companies that are good at answering questionnaires and reporting, which are generally the large cap companies. Just as too much reliance on the credit rating agencies creates bad credit decisions, too much reliance on the ESG raters can create biases and misleading judgments about ESG quality. Second, a major factor driving portfolio similarity is that most RI funds focus on large cap companies and their managers seek to avoid deviating from a market index like the MSCIWI, the Footsie or the EuroStoxx. RI funds usually have tracking errors of 3 or less and their managers use software such as APT and BARRA to control volatility risk.15 In other words, RI managers in effect track the market’s generally unenlightened disregard of environmental, social, political, and economic risk rather than the real risks. RI funds, by locking into tracking strategies, act according to the same theory of market efficiency that traditional funds do – “the market is always right” – even though the market repeatedly gets it wrong and fails to discount for the externalized social and environmental costs that will eventually arise. Stock market valuations and indexes generally reflect the past, immediate future or the psychological state of the market at a given point, which may, coincidentally, be coherent with reality, but very often is not. The technology of modern portfolio management, the investment industry’s belief in the market’s rationality and efficiency, and its consequent focus on near index performance objectives serve to create Best in Class RI products that are really not that different from standard funds. In short, the same lemming behaviour that applies to most equity funds16 applies to most Best in Class RI funds, even to those funds that claim to be aligned with sustainable development principles (Johnson and de Graaf, 2005). Insights gained by fundamental analysis get diluted by having to include a great number of generally mediocre companies in portfolios in order to comply with the diversification needed to track the index of reference within the pre‐established band. The result could be called Active Management Light.
14Leading firms include, Innovest, Vigeo, Ethys, Eiris, ASRIA and SAM.
15 Tracking error is a measure of the volatility (standard deviation) of return on invested capital relative to a benchmark, usually a market index like the MSCIWI or FTSE that select certain companies, usually based on their size.
40
As a consequence of this lemming behaviour, most RI funds provide only the illusion of diversification. Whether the market is in bubble or meltdown mode, you are diversified into it, not out of it. True diversification would allow one to exit in time, either tout court into cash or to an uncorrelated market. At the extreme are the passive funds, following their index without any attempt to generate additional performance through stock picking, under the belief that market efficiency implies that over time no active manager can individually beat the market. The reductio ad absurdum of the efficient market theory would occur if everybody did as it says and simply sought to replicate the broad market index. In that case, who would make prices? How would “all of the information” become integrated into prices? Passive investment taken to its ultimate conclusion means the end of markets made up of buyers and sellers, the end of information and of making judgments about the future. It is the ultimate falsification of the efficient market theory. Taken to its logical conclusion, this theory fails on its own terms. Importantly, tracker funds have little to no engagement with companies on any ESG issues [17]. Conclusion: As long as tracking error constraints to the standard indexes rule RI investment strategy, longer‐term thinking does not have a chance. This is one crucial institutional barrier that needs to go. Its current importance needs to be replaced by strategic asset allocation based on a long‐term view of geo‐economic trends (which developed markets are facing stagnation or decline relative to developing countries?), socio‐economic justice, climate change impacts, technological innovation and uptake, and the trustworthiness of regulatory institutions. Engagement “Engagement” is the term generally used by asset managers to refer to all the modes of action whereby a portfolio manager seeks to influence the behavior of a corporation of which it owns shares, as regards some aspect of policy or practice on an ESG matter. Engagement can range from “dialogue with companies” to voting in opposition to management at the general assembly. It can be done by institutional investors singly or acting in concert with other investors or with NGOs. The extent to which RI funds or UN PRI signatories have succeeded in 17 Local Authority Pension Fund Foundation (2009), UK, June. 11 full time staff at 6 major UK passive managers covers 3,000 companies and GBP700 billion in assets…fig leaf engagement.
41
changing corporate behavior deserves much more rigorous study than it has received. Given the hundreds of billions of dollars managed in RI and other funds by signatories to UNEP FI (United Nations Environment Programme Financial Initiative) , UNPRI (United Nations Principles for Responsible Investment) and similar initiatives, one would think that RI´s influence on corporate behaviour would be truly significant. It is not. Notable exceptions exist; for example, investors of the size of CalPers, PGGM or the Norwegian Government Pension Fund have gotten some multinationals to take specific environmental or human rights actions. Another example is the Norwegian Government Pension Fund (NGPF) which claims that its active ownership activities in Monsanto have contributed to a significant reduction in the use of child labour in the company’s hybrid cottonseed production in India. Nevertheless, whether this holds true needs to be determined over time; in addition, all Monsanto’s problems with GMO monoculture propagation, infestation of non‐GMO fields and glyphosate health hazards remain to be investigated by the NGPF. In general, companies are centrally concerned with the mainstream pressure to meet quarterly earnings guidance and current year financial targets, while RI interests are at the margin and rarely discussed at analyst meetings. It is worth noting that Best in Class and other forms of RI that address only portfolio composition and that do not involve any form of engagement activity do not serve to influence the behaviour of companies, as they neither “talk” to company management nor “invest in” companies. They simply trade paper on the secondary market in the exchange of shares for money between one investor and another, seeking a financial return without a desire to become an agent of change. The argument that owning stock in a company helps the company reduce its cost of capital and therefore “helps good companies” is truly far‐fetched; as is the argument that buying stock “rewards” a company and selling it “punishes” it. There is no credible evidence that the relatively small size of Best in Class RI fund holdings has any significant impact on cost of capital relative to other factors such as interest rates, the moves made by hedge funds and lender commercial behaviour. In any event, top management is in no way “punished.” Take the issue of compensation fairness and bonuses. Few, if any, RI funds have made a concerted effort to promote compensation fairness in the workplace. This would seem to be a key governance issue, central to the morale and efficiency of workers, and – as the philosopher John Rawls would say – a basic feature of a well‐ordered society (Rawls, 1975). The extent to which executive and board compensation has been perverted over the past twenty years is a clear rupture of the implicit social contract and values that underpin a democracy. We have witnessed the emergence of a financial oligarchy – hedge fund and private
42
equity managers – made possible by bankers providing easy credit without proper collateral, with the blessing of the FRB and the SEC. “Money for nothing,” as Krugman put it quite well (Krugman, 2009). There is no justification why senior bank management, hedge fund managers, or traders get hundreds of times more than rank and file employees. The money at risk is not their own – it is the savings of ordinary people who are now losing their jobs and seeing their nest eggs evaporate. The agents have failed to act for the benefit of the principals, which constitutes a basic failure of fiduciary duty. Conflicts of interest within the investment supply chain, as well as the natural career survival instincts of professionals responsible for corporate engagement in ESG, keep any serious change from happening on this front. Note the irony of bank‐managed SRI money market funds investing in the certificates of deposit of the banks that have brought us the crisis, get the bailouts, and use tax havens, as well as the general failure of RI mutual funds to lobby against excessive executive compensation. French SRI funds, for instance, have done nothing since 2008 to engage banks, insurers and CAC40 companies on executive compensation, since all French SRI funds are sponsored or distributed by the banks and insurers (Novethic, 2009) [18]. The same criticism can be levelled against UK and US mutual funds. This is a prototypical example of the limits of self‐regulation. It proves that governments need to step in, as they are doing in Germany and Sweden. An important development was that in May 2009 Swedish authorities required the government‐sponsored AP pension funds to act on the issue of executive bonuses. Interestingly, this interaction, exemplifying Robert Boyer´s theory of regulation, pits a centre right government against the business establishment, and constitutes the first clear case of political‐regulatory direction for RI engagement activity (Boyer, 2002). This case does not seem to have received press coverage outside of Sweden. Unfortunately, the US financial system is rigged for the survival of the Wall Street oligarchy, and the fact that Summers and Geithner now run the show suggests that robust regulatory reform, with pay fairness imbedded in it, is unlikely under the Obama administration (Johnson, 2009). There is very little academic analysis of the actual effectiveness of this type of engagement, and its proponents, not surprisingly, under‐appreciate the conflicts of interest that constitute a barrier to its development. Conclusion: For RI engagement to live up to its promise, governments should pass legislation requiring concrete action in selected areas like limiting top executive
18 Also, Y. Roudaut (2009), “Le rendez‐vous rate des fonds activists” Le Monde, 6 June. In other countries the actions have been few, the exceptions highly publicized, witness Shell, Exxon Mobil and Fortis.
43
pay, and requiring representation of stakeholders (such as labour unions and environmental NGOs) with voice and vote on the board of directors. Exclusion In the seventies, SRI worked by means of categorical exclusions. The first categorical exclusion to reach mainstream dimensions was the boycott against the South African apartheid by US university endowments, foundations, and pension funds in the late 1960s and the 1970s. Categorical exclusions can be fashioned for many different categories, and investors can choose which categories they wish to negatively screen out of their portfolios, depending on their ethical interests. Typical screens are against tobacco stocks, weapons manufacturers, nuclear power, GMO seed producers, liquor companies and casinos. There is also a market for religious screens, such as the one applied with Sharia rules (Novethic, 2009). Negative screening can be applied to traditional funds, such as those that only exclude for tobacco, or it can be applied in conjunction with a Best in Class ESG approach and/or in conjunction with engagement. Most users of categorical exclusions hesitate to dismiss companies from their universe so as not to have a significant effect on tracking error. The case of tobacco stocks reveals the limits of exclusion. Tobacco has probably become the most widely implemented exclusion category, yet this has had no effect on the survival of tobacco companies. They are going strong and continue to grow in sales and profits by expanding in emerging markets, as well as specifically targeting the young and women. In a travesty of CSR, one of the major cigarette makers has contracted a US outfit called Business for Social Responsibility to help them clean up their image by becoming “more socially and environmentally responsible” through “dialogue” and charity in the communities where they have factories. Conclusion: exclusion, then, makes sense in terms of protecting investors from moral complicity by association with certain business activities they find objectionable [19], but, like most boycotts, that does not serve to terminate the activity in question and furthermore, usually does not translate into an environmental or social improvement on the ground.
19On complicity and shareholding, see Kutz, C. (2008), Ethics and Law for a Collective Age, Cambridge U Press.
44
Thematic Funds Thematic funds invest according to specific themes, such as the aging of the population (in which case they invest in health care providers, drug companies, nursing homes, special equipment manufacturers, and so forth), or environmental protection (in which case they invest in pollution control equipment, alternative energy, recycling, waste management, energy efficiency systems, reforestation and the like). In general, thematic investors are not concerned with broader ESG or ethical issues. Some waste management companies, private hospital companies, and drug companies are of very dubious merit when assessed from the perspective of inclusive ESG criteria (Novethic, 2008). Conclusion: It should not be assumed that a green thematic fund or a health fund satisfies sustainability and ethical criteria just on the basis of the theme itself. Private Equity: The next Frontier in RI? As the previous recapitulation indicates, the only form of RI that has the potential to affect changes in business on the ground is engagement, if an investor or group of investors have sufficient influence over management and if they apply their influence for ESG purposes. This is particularly true if and when it is done against a concrete agenda with specific aims by very large investors acting in concert, publicly, and with the support of NGOs. The limitation of engagement with listed companies is that it takes a great deal of effort, coordination and time to get enough investors to agree on a course of engagement action, and even then the management of a large corporation can decide to procrastinate or kill the issue at the General Assembly, where they are generally able to prevail. But if a private equity investor decides to engage in environmental or social matters that is a different story. A private equity investor is an owner that has the authority and capacity to act as an active owner on all matters, has a seat on the board, and the power to unseat management if needed. Conclusion: The next frontier in RI effectiveness will be if and when the large private equity funds take charge of progress on the environmental agenda of the companies in their portfolios. In 2008 the assets in PE funds reached €2 trillion 20! What would motivate them to do so? How could this come about as a matter of course rather than unusually, as, for example, when Texas Pacific and
20Source: http://www.wealth‐bulletin.com
45
Kohlberg Kravis teamed up with the Environmental Defense Fund for the $38 billion takeover of TXU21? I will suggest an answer further below.
IV. The Lack of Self‐discipline in SRI Let us consider two popular arguments against regulation in financial services: Regulation will be ineffective because ways can and will be found to circumvent it; and regulation will be inefficient because promoting and instilling good ethical conduct will involve far less cost and will create far less operational dislocation while doing a better job. As for the putative ineffectiveness of regulation, suffice it to say that the existence of crooks is no argument against having laws; on the contrary. As for the efficiency of promoting personal values and internal codes of ethics, I will answer this with an informal survey I’ve conducted among my peers. One might suppose that RI fund managers would observe a high ethical standard of fiduciary duty, certainly insofar as putting the interest of clients before their own. My telephone survey of a twelve RI fund managers, individuals working for banks and insurers as well as those working for independents, reveals they or their firms failed to advise their clients to pull out of the stock market, get out of their RI funds and go cash as the market was crashing in late 2007 or early 2008. Either none figured that the market was ripe for a major crash, which is quite a failure for firms who pride themselves on extra‐financial analysis and early trend detection22; or none dared say so in order to protect their management fees23. Even if some professionals within these firms were expecting a crash, they could not go ahead and tell clients to sell unless their firm had instructed them to do so, because acting against company policy can be career suicide. The unavoidable conclusion is that RI investment professionals, regardless of their personal values and politics, are loyal to the businesses they work for; they identify with the financial interests and culture of their businesses, the same as
21 An uncharacteristic example of private equity working with an environmental NGO, The Environmental Defense Fund, to create a financial and environmental value‐added proposition, orchestrated the $38 billion takeover of TXU, the Texas utility, by Texas Pacific and Kohlberg Kravis. EDF reduced the number of planned coal‐fired plants, carbon emissions and lowered consumer tariffs. (NYT, 8 March 2008.)
22The early warnings were there for analysts suspicious of conventional wisdom to see. Nouriel Roubini, the economist who has done most to warn the public, has written about the early warnings given by Kenneth Rogoff, Raghu Rajan, Nassim Taleb, Hyun Shin, William White, Gillian Tett, and Paul Krugman. See: http://wwww.rgemonitor.com , 1 May 2009.
23Equity funds typically charge 1%‐2% pa, whereas money funds 0.2%; a strong disincentive to advise switching from equity into cash.
46
professionals not involved in RI. These are not “bad people.” They are you and me. This clearly shows the weakness of any reformist strategy for financial institutions that is predicated mostly on appeal to the honourable personal values of its managers and employees. Personal values can be trumped by many other factors, including pressure to meet budgeted objectives, loyalty to colleagues and corporate culture, jockeying for promotion, the need to keep a job, peer pressures to conform, or simple greed. Conclusion: This confirms the aspect of agency theory that assumes the agent pursues his/her own interest rather than the principal’s; but it falsifies the tenet that in the private sector agents are self‐correcting, because principals can change agents if they underperform (Villalonga, 2002). When all agents act in the same way, principals have no choice. When market discipline is absent, government regulation is required.
In spite of significant efforts, CSR is still coming up short. As mentioned at the outset, one of the goals of SRI, RI, and ESG is to pressure business to internalize social and environmental responsibility. One might think that the large and growing numbers of listed companies that produce CSR reports and have sustainability or corporate citizenship staffs in place is just the development RI has been looking for to do its own job. But does CSR really deliver? Not quite. In the past 10 years CSR has gone mainstream. Why the success? What business problem does it resolve? Today’s crisis of trust in banking was preceded by other crises of trust in business. Remember Enron, WorldCom, or Three Mile Island? In the 1990s big business decided that these problems could be fixed internally without the trouble of convoluted, misguided, and inefficient regulation. Thus emerged the WBCSD (World Business Council for Sustainable Development), the Global Compact, and similar bodies. The business argument for CSR is that it can do the job that would otherwise be made more difficult by bureaucratic inefficiency and stupidity. Companies quickly picked up on the idea that CSR was a way to distinguish their brand identity. Business associations saw CSR as a way to project the message that “most companies are good” and should not be confused with the “few bad apples.” But we need to question whether CSR, as defined by global corporations working through the WBCSD, the Global Compact, and the UNEP FI, addresses or sidesteps matters that are crucial to corporate citizenship as seen from the public interest. Companies justify voluntary CSR with “the business case”: 1) The eco‐efficiency argument is that money is saved when fewer resources are used per
47
unit of production24. 2) The reputation risk argument is that, by consulting with NGOS´s and civil society, a company can avoid mistakes like Shell’s Brent Spar de‐commissioning fiasco in 1995. 3) The brand building argument is that, by showing good corporate citizenship, a company can increase market share, gain favor with regulators for license to operate approvals, and perhaps even reduce the chances of nationalization25. In general, whenever a company justifies a CSR action other than by the business argument, it is by virtue of philanthropy, in which case CSR becomes an optional add on. As I argue below, we need to move beyond this and accept two tenets: first, that responsibility is not optional‐‐ it applies even when not justified by the “business case”; second, that CSR has to apply principally to the core of the business rather than to ancillary benevolent activities. There are two structural ways in which CSR fails. One has to do with the legal protections accorded to companies, particularly limited liability; the other has to do with the internal allocation of resources and benefits and involves the conception of who the company is supposed to serve. Limited liability, the wonderful invention that has allowed for modern capitalism, allows risk‐taking with one's own or other people’s money. Its unfortunate corollary is the externalization or transfer of risk onto the public in the absence of specific countervailing legislation that either limits pollution or puts financial liability for damages back onto business. Crudely stated, I make the profit, you take the risk; I pollute, nature dilutes (until it can’t absorb anymore). Unless a law puts a price on, penalty for, prohibition against or incentive to cease a corporate act that harms the public, and authorities enforce the law, companies generally will not refrain from acts that result in public harm. The demonstrative case is emission of greenhouse gases (GHGs). Emissions reduction does not take place until a limitation or the threat of a limitation with financial benefits and/or penalties exists, as was also the case with chlorofluorocarbons (CFCs), sulfur dioxide (SO2), and other kinds of toxic waste. Unless a regulation puts a cost or benefit to an event of pollution (an externality), internalizing it and making “the business case,” companies do not change course in their core business. We have yet to see whether the Obama administration’s declaration that GHGs are a health hazard is sufficient to give legal basis to claims against coal plants, as was the case with tobacco companies. 24 Making great strides in eco‐efficiency: Hewlett‐Packard, SC Johnson, Unilever, WBCSD Case Study Report, July, 2005; CH2M HILL & Nike: eco‐efficiency through supply chain metrics, WBCSD Case Study Report, February, 2002. Accessible at http://www.wbcsd.org
25President Chavez says that the reason why he has not nationalized any Brazilian companies operating in Venezuela while nationalizing Techint and other Argentine companies has to do with the later´s nonexistent CSR practices.
48
The second failure of CSR is its absence in the key decisions that reveal the ethical DNA of a company, such as: 1) Budget decisions: how much profit to serve up vs. how much to pay in salaries, performance bonuses and stock options and their allocation to different employee categories; how much to invest in R&D or in upgrading plant and equipment, pay into the employee pension scheme, pay out as dividends, and pay in taxes. These decisions reflect where a company stands on distributive justice to its stakeholders and the public, and should be at the core of corporate citizenship discussions and decisions. 2) Corporate financing strategy: borrowing too much can risk the survival of the enterprise and force massive job losses but may be favored over the dilutive effects of a new equity issue on existing shareholders or on management’s stock options. 3) Lobbying: how much is right for a company to pay into political campaigns to influence legislation in management’s favor26? All of these decisions involve a strong element of ethical judgment. They should be addressed within the CSR policy framework and the annual CSR reports of companies. However, I know of no CSR report where this is discussed, probably because it presupposes a different conception of company purpose than maximizing shareholder return. In short, there are many reasons for skepticism towards the hopeful view that a considerable role for CSR based self‐regulation in the global economy is plausible and empirically supported by case studies. A central precondition is the ability of civil society organizations to establish “moral rights” as credible voices for “just causes” in a media‐driven communicative society, and thereby put pressure on brand sensitive industry” (Midttun, 2008). First, the issues CSR deals with are generally not at the core of business decisions (R&D, strategic investment, compensation policy, etc.) and do not deal with matters of “just causes,” but rather with secondary effects (e.g. child labor is the result of poverty, among whose causes are unfair terms of trade, IPR, bad wages, privatization of natural resources, etc.); second, the impacts of civil society through blogs and the press, which generally focus on symbolic or highly emotional cases, arguably serve as a political escape valve (the whales, the seals, oil spills) and their effectiveness is questionable; third, RI engagement is of limited utility; fourth, big business has sufficient resources and know‐how to co‐opt and water down the potential positive impacts of public‐private partnerships (over 30,000 registered lobbyists in
26US financial firms in 2007 paid $150 million to PACs and lobbying efforts to water down regulations. In November 2008, a month after getting bailout money, JP Morgan Chase, Goldman Sachs, Citi, BofA created the CDS Dealer Consortium to lobby against legislative regulation of derivatives, hiring Washington lawyers Cleary Gottlieb. Contrast this with the $1‐2m yearly budget of the UNEP Finance Initiative, which has nearly 200 banks and insurers, including Citi, BofA, HSBC, BNP, etc. as signatories.
49
Washington, not counting Brussels, etc.); fifth, whatever the CSR, PR, or Media department does is usually overwhelmed or constrained by what the Legal, Regulatory, or Lobbying department decides. Thus, SRI and RI do not deliver the goods required to fulfil their purpose.
V. What Needs to be Regulated and how? In light of my diagnosis of why RI falls short of its purpose, different kinds of regulation can be considered as an answer to what can be done. To recapitulate, the following areas are in need of reform: 1. Executive compensation: excesses are inimical to economic fairness; 2. Tyranny of the indexes and tracking error, which reinforces short‐termism and lemming behaviour; 3. Short‐termism, which short‐circuits true sustainable development investment and the integration of climate change impacts in investment strategy; 4. Engagement, which is generally at the margins rather than at the core of RI; 5. Failure of private equity funds to integrate ESG; 6. The inability of investors and investment managers to correct the externalization of environmental and social costs; and 7. The failure of companies to make explicit the ethical judgments involved in core strategic and budgetary decisions. Progress on each one would improve with application of governmental regulatory measures: Command and Control Measures to Limit Executive Compensation The excesses of executive compensation could be curtailed with a simple set of regulations limiting total compensation for executives, portfolio managers, and traders of listed financial services companies to a reasonable multiple of the median wage (for example, 20 or 30 times, as opposed to 200 or 300 times); stock options not tied to long term value creation could be prohibited, as well as any form of backdating. Certainly all countries that are bailing out their banks have good reasons for doing this. So far, however, only President Sarkozy in France seems to be serious about this and to a lesser extend, perhaps, Angela Merkel. But the US and UK authorities seem unwilling or unable to address executive compensation, probably because Wall Street is too embedded in the White House, Treasury and Congress. Experience shows that the greed that demands excessive compensation in listed companies very often leads to poor business judgment and incentivizes “creative” accounting. Limiting executive compensation and privileges in listed companies is not an attack on free enterprise because free
50
enterprise does not imply a license to steal, which is what can happen when the board of a company is stacked with the CEO's cronies. Administrative Measures to Limit the Tyranny of the Indexes, Tracking Errors and Mindless Investing
a) Encourage quarterly or semi‐annual reporting of equity and bond fund performance and performance comparisons, rather than the current emphasis on daily and weekly comparisons which serve to create chaos and excessive trading.
b) Abolish the global oligopoly of the Credit Rating Agencies. End conflicts of interest by prohibiting payment by rated firms. Require risk assessment by individual institutional investors or pools of institutions.
Administrative Measures against Short‐termism
a) Require institutional investors to pay performance fees to managers (if any) only at the end of each mandate cycle, typically no less than a three or five year period.
b) Set an upper limit for the allocation of passive investment strategies by institutions.
Market and Command or Control Measures to make RI Effective
a) Establish demand pull by large government funds or pension funds, such as NGPF, ABP, PGGM, CalPers, or FRR, to create supply and provide examples for others.
b) Command and control regulation on specific agendas, as the Swedish government is requiring of the AP funds as regards executive pay.
Market and Command and Control Measures for Private Equity Funds and ESG The pension funds, insurers and banks that supply private equity with capital and loans should make the implementation of an environmental agenda a precondition of investment or lending. This could come about through:
1. Voluntary action on the part of the institutional investors. This has not happened to date in any significant way 27, or
2. Government action that would stimulate or require institutional investors to do so; such action could take two forms:
27An exception may be Robeco´s Sustainable Private Equity Fund, closing at $200m in 2006, relatively small compared to usual PE placements.
51
‐ Demand stimulus on the part of government‐controlled funds by making an environmental agenda a condition of getting mandates. Large funds like the NGPF could do this. As could non‐government funds like ABP and life insurers like Swiss Life, SPP, or AXA.
‐ In addition to I., and particularly if i. does not work, command and control regulation could require private equity funds to adopt a defined environmental and social agenda, just as the Swedish government is in the process of requiring for AP funds with respect to executive pay. UK funds that threaten to move to Bermuda, Switzerland, etc. would be told by authorities they will become prohibited from investing in EU regulated pension funds, insurers and banks, thus calling their bluff (Financial Times, 2009).
These two forms could be complementary. Strong Scandinavian style financial regulation is not particular to small countries. Spain has largely avoided the contagion of CDOs (collateralized debt obligations) and derivatives by means of its strong, prudent national banking laws. The size and diversity of its banking system and its regional autonomies are not an obstacle. What we need are the right laws and a strong central regulator. In the US, to help counteract the overwhelming influence of lobbyists and PACs, it is necessary, albeit not sufficient, to have a strong and truly independent NGO watchdog, as well as investigative financial media, to pressure authorities to be harder on business. The New Chicago School of Regulation argues in this direction for non‐legal regulatory tools to help implement law rather than as a substitute for law (Lessig, 1998). The UN PRI could become an effective activist for these causes. Macro Prudential Regulation: Modernizing Fiduciary Duty During the drafting of the UN PRI, the most heated arguments concerned the language of the justificatory preamble. On one side were adherents to the narrow interpretation that sees fiduciary duty as requiring and allowing inclusion of ESG if, and only if, it is “material” to stock price performance. Holders of this view usually believe the overriding objective and fiduciary duty of a fund manager is profit maximization and that ESG considerations should come into play only if they are instrumental to profit maximization; otherwise ESG should be ignored. They also tend to focus on short‐term profit maximization. On the other side were adherents to a broader view that believe: 1) the financial interest of principals cannot be divorced from, nor can it trump their environmental, social and ethical interests; and 2) there is no necessary conflict between good or competitive long term returns and ethical constraints on investment.
52
These disparate views could be bridged if we extend the notion of materiality beyond short‐term equity price expectations (typically from next quarter or the one year price target put forth by the brokers) to longer‐term expectations of price (three to five years, or more, depending on the sector, country, or asset). The meaning of materiality would thus be extended to include its future evolutionary dimension, including the process whereby ESG issues become material, i.e. the recognition that what may not be material today or in the short term may well become important material in the future. As an example, we have the history of materiality of asbestos, tobacco, contaminated land, and, in the making, carbon emissions and climate change impacts28. I argue that fiduciary law needs to be modernized so as to explicitly recognize the likely future materiality of particular ESG concerns and interests. Climate chan e is clearly the paradigmatic concern in this regard. Thus, we may distinguish two types of materiality, short term and long term, and give primacy to long‐term materiality when assessing whether negligence occurs on the part of institutional investors or asset managers that may have negligently or wilfully disregarded an environmental matter they should have acted upon.
g
Wilful or negligent disregard of climate change and other environmental interests that ends up causing investors a loss could then give rise to a legal claim of financial reparation. The potential liability on trustees and officers of institutional investors and their managers would be a far more effective measure than current regulations such as the Pension Disclosure Regulation, which went into effect in the UK in 2000 and requires all UK occupational pension funds to disclose the degree to which they take into account ethical, social, and environmental considerations. The theory that more disclosure results in more accountability, more ESG in portfolios and hence in companies, does not bear out in practice. Transparency is not enough29. The risk of financial consequence is a lot more effective.
28For a state of the art discussion of fiduciary duty, see The legal framework for the integration of ESG in institutional investment (2005), a groundbreaking legal study by Freshfields, Brukhaus, Derringer commissioned by UNEP FI accessible at http://www.unepfi.org/publications . I defined the terms of reference of the study with the following question: “Is the integration of ESG in institutional investment legally permitted, disallowed, or required by fiduciary duty?” Freshfields responded to this question with regard to the following jurisdictions: US, UK, France, Germany, Australia, Japan. The sequel to this study, looking at prevalent practice and suggesting ESG legal language for mandates, has been released in 2009.
29Just Pensions in 2002 said little evidence had emerged that this regulation changed ESG practice.
53
Ethics in Core Strategic Business Decisions The challenge of capitalism is to find a way of more effectively harnessing self‐interested pursuit of growth and profits, as well as resources, for greater alignment with the public good. A point of departure for this is to reformulate the theoretical understanding of the role of the modern, very large corporation, redefine to whom it is accountable and how it should be supervised, and how it fits into the institutional frameworks that create and give form to markets. The prevailing theory of the multinational corporation gives, at least in theory, pre‐eminence of purpose and control to shareholders. In practice, however, shareholders generally exercise little real control. Most boards are beholden to management, and most institutional investors do not act as owners. This needs to be reconsidered in light of the interdependencies between large corporations, hedge funds or private equity funds and the institutional frameworks and permissions that make their operations possible. Examples of the latter include international property rights, the free flow of capital, the weakness of international labor standards and their enforcement, the holes in regulation that allow for very damaging externalizations, and accounting and taxation rules that permit transfer pricing to low tax or no tax jurisdictions. This issue is clearly beyond the scope of this chapter. An aim of this effort would be to give more effective control to civil society (NGOs, labor unions) and government (UN agencies, financial authorities, environmental authorities and consumer rights bodies) over the governance of MNCs. One would explore the scope of representation, the level of representation, status in the company, the minimally required professional qualifications of the representative, the extent of voice and voting power accorded, and so forth. Desiderata for this more democratic governance form include not just improved responsiveness to public interests but also improved corporate strategy and operational efficiency. Care must be taken to avoid lock‐in or lowest common denominator decision making. Thus, one of the key goals of better corporate governance is to avoid costly mistakes in strategy (e.g. Detroit’s fixation with over‐sized gas guzzlers), costly false starts (e.g. third generation mobile networks), wasteful competition (lack of common standards for TVs and other electronics), failure to restrain products that pose huge public health problems in a timely fashion (such as cigarettes and asbestos insulation), or failure to obtain continuing licenses to operate. The idea is to internalize in a MNC´s governing bodies those influences that are currently external to it and therefore have little direct influence on company goals, strategy, resource allocation and control. Robert Boyer offers a very interesting theoretical framework for understanding the interaction between motivations, modes of coordination, and
54
distribution of power. We need to engineer and institutionalize a different balance of power in relations between the state, the public, and the market, in order to favor the public good (Boyer, 2002).
VI. Dematerializing GNP? The regulatory measures proposed in section V. address the immediate issues of SRI and RI in light of the current acute crisis. But they do not speak to the underlying chronic affliction of our society, or our losing battle, despite the rhetoric, to create an ecologically sustainable economic order30. A long term pension fund that wants to act as a Responsible Investor has to step back at some point and ask whether the kind of products being made and marketed by the economies in which it invests are in line with the requirements of Sustainable Development. This is particularly true for the largest pension funds that represent the collective savings of a nation (such as the Norwegian Government Pension Fund) or a very large part of the employed population (such as the Swedish AP Funds the Dutch pension funds). And it involves a much deeper and more ethical assessment than the technical analyses of whether the companies it has as a given within its investment universe are relatively better than others at producing their industry's products. The specific purpose of institutional investors in a well‐ordered democratic society that prizes social and economic justice is the long‐term preservation of capital and income generation. Political stability and security are preconditions for this. But they, in turn, are conditioned by the investment of capital so as to foster society’s goals and values, the most important of which are: low unemployment, a fair distribution of income and wealth, and environmental protection.
The stimulus packages to get us out of the current crisis and create new jobs are all based on strong measures to stimulate consumption. About 30% is budgeted for greening buildings, alternative energy, energy efficiency, modernization of power plants, public transport, and spending on infrastructure for global warming adaptation (containment dikes, seawalls and other flood control). This is good for
30 Johnston, D. (2007) NYT, May 29 reports a study by Emmanuel Saez, University of California, Berkeley, and Thomas Piketty, Paris School of Economics shows that “the top 300,000 Americans collectively enjoyed almost as much income as the bottom 150 million Americans. Per person, the top group received 440 times as much as the average person in the bottom half earned, nearly doubling the gap from 1980.” As to things environmental, WorldWatch Institute report, The State of the World 2009. In short, we treat the globe like we’ve treated home equity— home equity as if it would go up forever and nature as if it can absorb pollution forever. We blew it on the financial front. The consequences of blowing it on the environmental front will be even worse.
55
SRI and RI, and the funds are taking advantage of this in investment strategies for 2009‐2010. It provides attractive investment opportunities. But none of these environmentally responsible efforts eliminate the fact that re‐stimulating material consumption inevitably creates more pollution: a net increase in GHG, waste and toxic emissions. In the long term, then, today’s RI investment opportunities do not necessarily keep us from ending up with an unsustainable future. The basic concepts of sustainable development as we know it need to be revisited. Pollution control measures cannot keep up with the pollution that results from growth during expansionary periods31. We need to think hard about what I call “dematerializing GNP.” In the developed world, once this crisis is behind us, could we create jobs and income by substituting the production and distribution of consumer goods with the production and distribution of experience? By this I mean orienting the economies of rich countries away from consumer products and towards commercial interactions in the fields of disease prevention, health care, care for the elderly, mass transit, arts, science, research, education, participatory sports and nature experiences. This would of course require enormous political, cultural, industrial and attitudinal changes, along with a redirection of what we lend for and invest in. Basic necessities such as energy, clean water, and housing are necessary in developing countries, so radical changes to economic values can be postponed there. This is not a call for a return to a pre‐industrial utopia. Growth is a given, but it should be of a different kind32. Money should circulate and wealth will be generated; but the objects of exchange that would provide the greatest growth and return on investment in the developed world are dematerialized services.
VII. Conclusion CSR and RI are constrained by the systems they are meant to improve. They have fallen short on the issue of economic fairness in the workplace. In the US, UK, and France, where RI assets under management have grown, income and wealth
31Speth, J. (2008) The Bridge to the End of the World , Yale University Press, reports that from 1890s to 1990s the world economy went up 14x, population up 4x, water use 9x, SO2 up 13x, energy use up 16x, CO2 up 17x, marine fish catch up 35x. “Eco‐efficiency is not improving fast enough to prevent impacts from rising.”
32Growth could still be measured as it is measured today, i.e., as GNP, though the things being measured should change (“experiential” goods instead of “stuff”). One dimensional GNP should include measures of distributional fairness, environmental footprint, and life quality, as posited in Le Clezio, P. (2009) Les indicateurs du development durable et l´imprinte ecologique, CER Report, June and Stiglitz, J. (2009) Commission on the measurement of economic performance and social progress, French Government Publications Office, June.
56
inequality have also grown33, and RI has had no appreciable effect. In environmental matters, CSR and RI have not counteracted the fact that GNP growth has caused net pollution growth, despite advances in eco‐efficiency and voluntary efforts by industry that go beyond compliance with existing regulations. In conclusion, industry’s record of environmental improvements is anecdotal rather than systemic. On the whole, environmental conditions are getting worse around the world. If we continue down this path, environmental catastrophe is a certainty, with tragic social and economic consequences. The wealthy will not be able to insulate themselves from this. RI is CSR for pension funds. Risk is reduced and profitability increased when shareholders demand better corporate governance and environmental accountability. However, as this discussion demonstrated, the aim of CSR and RI is not being realized due to conflicts of interest and systemic restrictions along the investment chain. The financial system fails to regulate both itself and the system of production towards sustainability. Given the way banking, environmental, and labor regulations have been weakened in the USA, it is time for the pendulum to swing back. Tough regulation of capitalism is needed to make it pay for the problems it creates as it goes about creating goods, and make it distribute the surplus value created under the protections of limited liability more equitably. If RI and CSR are to live up to their aspirations, government has to get into the act, prescribe standards, control results, and enact macro‐prudential legislation. Only government, acting in response to the demands of civil society and supported by the active pressure of independent NGOs, can civilize capitalism.
33 See footnote number 20.
57
58
References: Boyer, R. (2002) Théorie de la régulation—l´état des savoirs, Postface, diagram p 544, Paris
Financial Times, 6 June 2009.
Johnson, K.L. and de Graaf, F. J. (2005), “Modernizing Pension Fund Legal Standards for the 21st Century”, Network for Sustainable Financial Markets: Consultation Paper No. 2, February accessible at http://www.sustainablefinancialmarkets.net/.../modernizing‐pension‐fund‐legal‐standards‐for‐the‐21‐century/
Johnson, S. (2009) “The Quiet Coup”, Atlantic Monthly, May. Accessed June.1. 2009. Avaialble at: http://www.theatlantic.com/doc/200905/imf‐advice
Krugman, P. (2009), New York Times, April
Lessig, L. (1998) “The New Chicago School”, Journal of Legal Studies, Vol.27
Lorsch, J., Berlowitz, L. and Zelleke, A. (2005) Restoring Trust in American Business, AmericanAcademy of Arts and Sciences, Washington, DC.
Midttun, A. (2008) “Partnered governance: aligning corporate responsibility and public policy in the global economy”, Corporate Governance: an international review, Vol 8, Issue 4
Novethic (2009), Finance Islamic et ISR, Note de travail, May.
Novethic (2009), “Quelles enjeux pour les fonds monetaires ISR?”, Accessed February 9. 2009 available at http://www.novethic.fr
Rawls, J. (1975) A Theory of Justice, Harvard U Press, Cambridge, Ma
Villalonga, B. (2002) “Privatization and efficiency: differentiating ownership effects from political, organizational and dynamics effects”, Journal of Economic Behavior & Organization, Vol.42, pp. 43‐74
Chapter 3
The Icelandic Bank Collapse: Challenges to Governance and Risk Management
Throstur Olaf Sigurjonsson
Introduction The collapse of the Icelandic banks in October 2008 was interwoven with corporate governance issues. The saga begins with deregulation and privatization through the liberalization process of financial markets and capital mobility in the 1990s, along with the EEA (European Economic Area) agreement. These conditions, initiated by the government, created an environment in which the Icelandic financial service industry could thrive, and where risk taking and an adventurous business culture were embraced. Not only was this embraced by government and industry, Icelandic society as a whole also participated. The lack of critical insights into core processes because of the largely laissez‐faire attitude of the government, lack of transparency, and entangled ownership issues within the industry prevented sufficient public debate to prompt reasonable criticism of both government and industry. In October 2008, the three largest Icelandic banks were put into receivership by the Icelandic government. This marked the end of a seven‐year period of unprecedented growth in which the banks had grown from small local banks, serving mostly Icelandic clients, to become amongst the major players in Europe. Only a few days after the collapse, it became evident that a severe crisis could not be avoided and the whole nation would suffer. The supervisory authorities should have stopped or limited the scope of the banks’ acts. The Central Bank of Iceland should have taken firm action on the mounting imbalances occurring over the preceding years. However, this did not occur. Policy makers, as well as practitioners in the financial sector, should bear the Icelandic case, which vividly demonstrates the necessity of particular governance measures, in mind. This chapter is organized as follows: First, the main characteristics of the evolution of the financial industry in Iceland in the 1990s are analyzed, with primary emphasis on the resulting “boom” period. This provides a description of the sowing of the seeds of the crisis. Second, the governance changes within the Icelandic banks are examined—changes that led to a complete change in banking ideology. Third, the downfall of the Icelandic banks is described, highlighting the
59
weak governmental measures taken, including bank privatizations that were treated as a discrete act rather than as a progressive process. Fourth, the findings of multiple governance failures resulting in a society not adequately alert to the increased risk of governance changes are presented. The final section discusses the policy recommendations that can be derived from the Icelandic case.
Financial Evolution on Iceland The Icelandic government implemented a program of market liberalization and deregulation throughout the late 1980s and the early 1990s. The motivation for this program was the need to adjust the Icelandic legislative and regulatory structures to those of the European Union. This was necessary in conjunction with Iceland’s entry into the European Economic Area in 1994. Table 1 shows the financial evolution in Iceland prior to and during the privatization phase.
Table 1: Financial Evolution in Iceland1
Event Year
Financial Indexation Permitted 1979
Liberalization of domestic bank rates 1984‐1986
Iceland Stock Exchange established 1985
Interest Rate Act: Interest rates fully liberalized 1987
Stepwise liberalization of capital movement begins 1990
Treasury overdraft facility in the Central Bank closed 1992‐1993
New foreign exchange regulations marks the beginning of the liberalization of cross‐boarder capital movements
1992
Interbank market for foreign exchange established 1993
Iceland becomes a founding member of the EEA 1994
Long term capital movements fully liberalized 1994
Short term capital movements fully liberalized 1995
Foreign direct investment liberalized in accordance with EEA agreement
1995
Interbank money market 1998
Interbank FX swap market 2001
Privatization of state owned banks completed 2003
1 Source: Central Bank of Iceland
60
61
Part of the evolution was fuelled by an attempt to increase economic efficiency through privatization. This resonates with agency theory, public choice theory and organization theory (Vickers and Yarrow, 1988, 1991; Martin and Parker, 1997; Boycko and Vishny 1996; Bishop and Thompson, 1992; Villalonga, 2000). The privatization of socially important institutions as banks has often been received with reluctance by policitians (Jones, 1985; Kikeri, Nellis and Shirley, 1994; Shleifer and Vishny, 1997; Boyko, Shleifer and Vishny, 1996; Shleifer, 1998; Sappington and Sidak, 2000; and Shirley and Walsh, 2000). A government argument for privatization is that it encourages entrepreneurship, but entrepreneurship involves risk‐taking, which appears to be a factor largely neglected by governments. At the beginning of the 1980s political interference and rigorous restriction of financial markets were creating a crisis in Iceland. Inflation was in the double digits, resulting in high negative real interest rates that led, in turn, to a reduction in bank deposits, essentially halving the banking system. Dramatic structural and legislative reforms were implemented and the financial sector was opened up to international capital. Interest rates and other prices reflected supply and demand, and innovation was both encouraged and rewarded. The taxation system underwent a complete overhaul and tax rates were lowered considerably, becoming among the lowest in Europe (Portes and Baldursson, 2007). During and after the privatization reform era, there was a strong need for new investment opportunities. Liberalization of the financial markets was taking place, providing new opportunities for provisions of securities. The privatization of the public banks stimulated strong growth in the financial system. Landsbanki and Bunadarbanki were privatized in the period between 1999 and 2003 (Bunadarbanki merged with the private investment bank Kaupthing in 2003). FBA, originally a public investment credit fund, was privatized in 1998 and merged with the private commercial bank Glitnir, then Islandsbanki. The Icelandic banking privatization was somewhat different from the process of privatization in other countries. While most countries had privatized their institutions with at least some foreign ownership, the Icelandic government initially decided to encourage foreign ownership, then backed away from that decision. Instead, individual domestic entities gained controlling interests in the banks. These investors had no prior experience in commercial banking (Sigurjonsson, 2010). A wave of consolidation followed closely on the heels of privatization, supplying the banks with the necessary instruments and scale for both domestic and international growth. Figure 1 shows the acquisitions of the Icelandic banks following privatization.
Figure 1 Consolidation Process Post Privatization.
62
In a domestic market of only 330,000 people, the future growth of the newly privatized banks would have to come from abroad. In the interest of seeking further consolidation and growth opportunities, a strategy of international acquisitions was implemented. The diversification of risk was also a significant concern. The banks needed to vary their revenue streams. At the beginning of the first decade of the 21st century, historically low global interest rates and decreased credit spreads brought into existence the ideal platform for fast growth strategies. At the same time, asset growth was strong in Iceland, especially in equity and real estate. The fast growing pension funds also controlled considerable equity (with assets amounting to 130% of GDP), and they searched for investment opportunities (Sigurmundsson, 2009). It was clear that the domestic economy could never provide an investment platform for this capital. The banks also benefited from the expansion of various other Icelandic sectors. Drivers for growth were identical to the ones for the financial industry: favourable international conditions, a mature domestic market and an essential diversification strategy to decrease risk. The banks were inspired to seek out new customers in their international expansion, many of them being Icelandic firms seeking growth abroad. Therefore, the banks not only provided funding for projects but facilitated many of them as well, using what can be called a “package effect”, where the Icelandic banks followed their customers and often created partnerships in ventures. Early, it became evident that partnership had turned into ownership, where major customers had in some instances gained a considerable stake in the banks, and were appointed board positions. However, rapid growth and vast cross‐border expansion could not occur without risk. The Icelandic banks encountered what has been called the Informational Crisis in early 2006 (Portes and Baldursson, 2007). Among others things, this arose from criticism by the Fitch rating firm and Danske Bank (Central Bank of Iceland, 2006; Valgreen, 2006). The criticism centered on the banks’ dependence on the wholesale market for financing, and on the practice of borrowing short term but lending long term, leading the banks to become very sensitive to financial turmoil in international markets. Doubts about governance matters such as cross‐ownership, lack of transparency in strategy, operation and corporate structure drew criticism as well. A Danske Bank analyst wrote:
The economy is clearly overheating, since the labour market is extremely tight, wage pressures are unsustainable, the inflation rate is among the highest in the OECD area despite an overvalued currency, and the central bank is stamping on the brakes (Valgreen 2006).
63
These observed imbalances in the economy led to a downgrade by Fitch Ratings of Iceland’s state from stable to negative. The belief was that Iceland could not escape a crisis when forced to correct the imbalances.
The Icelandic economy has become increasingly dependent on foreign capital and international terms of lending. Iceland seems not only to be overheating, but also looks very dependent on the willingness‐to‐lend of global financial markets. This raises the question of whether the economy is facing not just a recession – but also a severe financial crisis. (Valgreen, 2006).
The Icelandic banks were criticized for their lack of transparency in both their operations and their media relations. The reality was that nearly all Icelandic newspapers and business magazines during this period became indirectly owned by the banks through their largest shareholders. The same largest shareholders were also their largest debtors. An attempt to institute legislation against media monopolies was declined by the president of Iceland who has veto power over parliament (Sigurjonsson, 2010). The international media became suspicious and investor confidence eroded. Dramatic headlines in the major international newspapers appeared and were full of scepticism: “Iceland’s poets of enterprise lose their rhythm” (Fleming, 2006), “Meltdown worries put Iceland’s UK raids under threat” (Padgham, 2006), and “Icelandic charm melts away as debt crisis grips” (Fletcher, 2006). This market suspicion led to a 25% depreciation of the ISK (Icelandic Króna) and the stock index fell comparably. In financing their rapid growth since privatization, the banks had relied heavily on wholesale funding. At the time of this criticism, the maturities of the securities were relatively front‐loaded. The banks had to alter their strategy, limit their reliance on the wholesale markets and raise retail deposits. The banks already had a dominant share in the domestic market, but through their subsidiaries and branches abroad, they managed to raise customer deposits. The privatized banks took the path of globalizing their market positions. Within a few years after privatization, growth was extraordinary, with asset multiples of 8 to 12. This growth, however, was from a small asset base. A broader income base and dispersed risk were intended to soften any setbacks that the Icelandic economy might suffer. On the other hand, large shifts in the values of the foreign assets and liabilities of the banks created problems of how to insulate the domestic economy, which depended on the regular flow of production of goods and services. Over a period of a few years, the Icelandic
64
banks leveraged their capital base to buy up banking assets worth several times the country’s GDP. If the value of these assets (mostly bought in the years of the banking and credit boom between 2003 and 2006) were to be re‐evalued at much lower prices, the financial institutions would become insolvent.
Governance Changes Amongst the players within the finance industry there is no agreement on whether it was the deregulation and privatization or the entrepreneurial spirit of the newly privatized banks that drove their growth. When interviewed, an executive from Glitnir responded that it was based more on the pre‐privatization process and the foundation of necessary infrastructure, than on internal parameters:
It was the privatization itself that unleashed the hidden force within the Icelandic economy. After years of economic growth, after the process of liberalization in nearly every aspect of the society, after extreme growth within the pension fund system and so forth, all this is being released into the privatization of the banks. The state owned banks were privatized in the framework of these circumstances so success was bound to happen (Kristjánsson 2007).
This view is in favor of the government policy and is supported by various elements, as Table 1 demonstrated. The government undertook a very large political commitment to enable the process and was in a good position to do so, as the government was in power for 16 consecutive years, and managed to build widespread public support for the process. A laissez‐faire policy was enacted, in which the newly‐freed market was supposed to take care of itself. Another view is that governance changes within the privatized banks were even more important. The noticeable changes were governance changes within boards and at executive levels, completely new and aggressive compensation systems, stock option plans for employees and flat organizational structures. The CEO of Kaupthing explained:
We have had the same leadership team since 1995, from the time we were a small investment bank prior to merging with the privatized Bunadarbanki. The glue that has kept this crew together rests on friendship, common vision and an aggressive incentive system.
Kaupthing was a pioneer establishing the first true investment banking
incentive system in Iceland. (Sigurðsson, 2007).
65
However, it remains unanswered how the risk profile was altered in response to these governance changes. The strategies and structures of the Icelandic banks began to differ from the other Nordic banks in many ways. The Icelandic banks were neither ordinary commercial banks nor pure investment banks, but somewhere in between. They followed many of their growing customers in cross‐border acquisitions and often would do so more intimately than conventional banks. The Central Bank of Iceland was observing the financial institutions at this time. The governor explained:
There were many young companies in Iceland carrying out to its full extent their international strategy and delivering rapid growth. The Icelandic banks took advantage of that, which led to their own increased international operations. Entrepreneurial spirit was very strong in Iceland at that time, much stronger than it seemed to be in the other Nordic countries, at least on this scale (Gunnarsson, 2007).
Arguments put forward in the agency theory become quite clear in the ownership transactions of the Icelandic banks. As suggested by proponents of agency theory, private ownership eliminated familiar threats from the period of public ownership. This is explained further by the governor:
Managers of the public banks were not thinking too much about profitability. Things went fine if the institutions would show some profits but too much meant political difficulties. Then politicians would want to get that money for other projects. This all changed with privatization. Today there are thousands of shareholders in the banks and to them it is extremely important that the banks are efficient and make profit. There is a complete change in ideology (Gunnarsson, 2007).
This ‘complete change in ideology’ indeed seemed to have driven the vast growth of the Icelandic banks. However, soon the new owners’ ideology raised questions related to classic agency problems. When cross‐ownership was examined, the lack of transparency became evident and corporate governance at the firm level became a real issue. The root of this is traced to the time when the banks began
the beginning of the recent growth period. In a small and fast growing economy,
ownership was more entwined than in a larger economy. The most significant cases involved Kaupthing and Landsbanki. Kaupthing had acquired a stake in Exista (a holding company) when the latter was established. Then, over a short period, Exista became the largest shareholder in Kaupthing. Within a few years,
66
Exista became the largest investment firm in Iceland with huge stakes in some Nordic financial firms. Kaupthing solved the cross‐ownership issue by distributing its shares in Exista to shareholders of the bank itself. Later, the largest shareholders of Exista became the largest owners of Kaupthing and very sizable customers. In the other case, Landsbanki owned a substantial share in one of the largest investment banks, Straumur. Landsbanki aimed to solve the cross‐ownership dilemma by selling its shares in Straumur to Grettir Investments in May 2006. The major stakeholder in Landsbanki and chairman of the board, Bjorgolfur Gudmundsson, owned 28.52% in Grettir through his company Hansa. His son, Bjorgolfur Thor Bjorgolfsson, owned 20.66% in Grettir through his company Opera Investments. Bjorgolfur Thor was the chairman of the board at Straumur. After this transaction, firms under the control of the father and his son managed 37% of Straumur (see Nasdaq’s OMX Nordic news page). Corporate governance issues remained convoluted and opaque. It can be claimed that the responsibility of unsolved cross ownership issues rested with the boards. As anticipated, the composition of the boards of the banks changed after privatization. The board members were practically all new. There was only one member serving on Landsbanki’s board who was there prior to privatization. At Kaupthing, all the board members were new. Board members should be able to exercise an objective independent judgment and have relevant industry experience. But no “fit and proper” person tests were carried out. Board members consisted mostly of self‐made entrepreneurs without any banking or financial experience. They were, on the other hand, the banks’ largest shareholders and debtors. This is unfortunate keeping in mind the specific role of corporate governance within banks. The liabilities of implicit or explicit government guarantee changes the role of corporate governance for shareholders, boards and executives in banks. At the executive level, vast changes were also made. At Landsbanki, seven people at the executive level, out of eleven, were new. Only one executive from the public Bunadarbankinn kept his chair at Kaupthing. None of these executives were foreign bankers with experience, because the government decided to privatize to Icelandic agents only. The very young Icelandic financial industry provided executives mostly in their late twenties or thirties. The banks went from public to private with considerable stock options for executive level managers. A completely new compensation policy was implemented, encompassing an aggressive investment banking style incentive system. This led to excessive risk taking. Glitnir provided employees in Corporate Finance Division bonuses for lending. They received 10% of the bank’s fee, which was normally 3‐4% of a loan (DV, 2009). Kaupthing loaned its top executives some 50 billion ISK to buy shares
67
in the bank. The only collateral was the shares themselves. These were bullet loans, where the debtor pays the principle at the end of the loan period, which in these cases were often extended (Morgunbladid, 2009). Some of the executives and board members of the banks were personally liable for their debts, making them extremely vulnerable to a downswing in the share price. The lending of the banks became excessive. A leak of Kaupthing’s loan book unveils unusual lending
practices1. The highest loans (5.5 billion Euros) were given to companies that
were related to six customers, four of them major shareholders in the bank. Collateral was non‐existent or, at most, partial.
These agency concerns should have been addressed by the shareholders, and there were thousands. Nearly all the Icelandic public had stake in the banks, as the government had successfully established incentives for share ownership. The public was inactive and challenged neither the boards nor the executives. Icelandic media, indirectly owned by the banks, did not provide constructive criticism. Rather, it reacted negatively towards the foreign criticism of the Icelandic banks. The politicians acted in a similar manner and denied any faultfinding (Sigurjonsson and Schwartzkopf, 2010). No institution, whether public or private, provided public protection in terms of informative criticism. From a civil point of view, the public at large clearly had no realistic critical information and was not adequately alerted. The Downfall A period of economic growth had infused leaders with courage. Banks and companies had solid credit, and business opportunities were there for the taking. The privatization era in Iceland had replaced a time characterized by restrictions with one characterized by optimism and risk‐taking. Access to cheap capital appreciated asset prices in whatever form by multiples. Real estate prices doubled and the stock market appreciated seven times in a few years. Assets were bought with the belief that prices would appreciate further, regardless of revenue stream. Then expectations and access to capital became a prime driver for a rise in asset prices. With assets booked at market value, equity appreciated, thus justifying further borrowing. Therefore, an asset bubble was created. This situation applied to most of the Western world in 2007. The Icelandic banks took part in this bonanza, presumably more enthusiastically than most others did.
The assets and liabilities of the Icelandic banking sector (denominated in foreign currency) amounted to ten times the Icelandic GDP within six years of privatization. These assets became extremely vulnerable in the liquidity crisis of
1 see wikileaks: http://wikileaks.org/leak/kaupthing‐bank‐before‐crash‐2008.pdf
68
2008. The Icelandic banks depended heavily on wholesale financing and deposits, resulting in a situation where creditors believed that other creditors would refuse to roll over present loans, and therefore refused to extend new credit. It is in circumstances such as these that banks usually fail.
The months of September and October 2008 were decisive for the Icelandic banks. After the fall of the investment bank Lehman Brothers in September 2008, money markets and interbank lending froze completely. The Central Bank of Iceland was unable to act as an effective lender of last resort to the Icelandic banks. It simply did not hold enough foreign currency to do this. Glitnir bank was hit first. With short run credit lines closed, Glitnir had to request a short‐term loan from the Central Bank of Iceland, which refused. The government put Glitnir into receivership, the first step towards a formal bankruptcy, on October 6, 2008. The bank was not nationalized, as the state would have become responsible for the bank’s huge liabilities. The consequence was a debt downgrade and a sharp fall in the already depreciated ISK. Figure 2 shows the crash of the ISK. Figure 2. Development of the ISK (the Icelandic trade weighted index)2
100,00
150,00
200,00
250,00
05.01.2004 05.01.2005 05.01.2006 05.01.2007 05.01.2008
Short run funding evaporated and margin calls came from the European Central Bank. Landsbanki found itself unable to meet its commitments and was put into receivership on October 7. However, for the moment Kaupthing appeared viable.
2 Source: Calculation by the author
69
Landsbanki had operated the Icesave 1200 billion ISK deposit account out of Iceland as a branch (not as a subsidiary), passing the ultimate liability (the 20,887 Euros liability per deposit owner) on to the Icelandic state. The Icelandic Central Bank made some remarks that were construed to mean that Iceland would not meet these obligations to British depositors. The reaction of the United Kingdom was to seize the UK assets of all the Icelandic banks by invoking anti‐terrorist laws. Kaupthing was ruined by the confiscation of its subsidiary, Singer and Friedlander, as covenants on loan agreements were activated. Kaupthing was then also put into receivership on October 9. Figure 3 shows the evolution of the banks’ stock prices, from privatization to a total collapse in October 2008. Figure 3. Stock Price of the Icelandic Banks, Icex15 and FTSE100.
With the spectacular growth of the banks, their largest owners became highly leveraged. This led to a high level of vulnerability to financial shocks. The dramatic reversal was phenomenal. All the Icelandic banks had recently passed a stress test but, unfortunately, the test did not ask all the essential questions. The Financial Supervisory Authority’s (FSA) stress test did not account for vulnerability to a liquidity crisis. European laws applied (through the EEA treaty), but there was no attempt to adjust the tests towards Icelandic circumstances. The laissez‐faire policy had kept the FSA weak. The institution received only 18% increase in its annual budget and employees increased from 27 to 45 during the years 2001 to 2007. Concurrently the banks grew ten‐fold. An aggressive incentive system
70
encouraged the out of control growth, and risk taking became excessive. There was no regulatory framework preventing Icelandic banks from opening branches (rather than subsidiaries) abroad, therefore they were transferring liability onto the Icelandic state. The privatization of the banks was treated as a discrete act, unfortunately, without necessary regulatory and governance measures taken.
Major Findings In the case of Iceland, the results of the governance of liberalization and privatization are equivocal. The government‘s procedures seem to have bred economic growth. In that sense, the deregulation process led to efficiency gains. On the other hand, governance measures taken post‐privatization seem to have been lax. However, this failure of governance is similar to the process in many countries. Liberalization and privatization have often been treated as discrete acts rather than as parts of a progressive process. An example can be seen in the case of the Scandinavian banking crisis in the 1990s (see, for example, Jonung, 2008, Englund and Vihrala, 2007). In their expansion, the Icelandic banks relied on market funding. As international conditions deteriorated—whether credit markets, equity prices or other factors— vulnerability became much greater than before. Neither the Central Bank of Iceland nor the National Treasury followed the banks’ growth by establishing the necessary reserves, which in the case of a considerable recession or liquidity crisis, leads to extreme difficulties. It was suggested earlier that liberalization and privatization breeds entrepreneurship and greater risk taking. This saga clearly supports the supposition that, where commercial banks turn unhindered into highly risk taking investment banks, encouraged by aggressive incentive systems, they leave the risk to the public. The public gained a false sense of security through both governmental and industry contentment with the development, and became fascinated by all the economic growth, as frail as it was. Critical insights into core processes were lacking. The close ties between banks and media did not encourage transparent and informative reporting. Correct information and critical analyst engagement could have triggered a much more adequate public debate, which would have put pressure on both government and the banking industry. The corporate governance arrangements within the Icelandic banks failed for a number of reasons. A mismatch between incentive systems, risk management and internal control systems appeared to have been unseen by the banks’ boards. Self‐regulatory procedures and mechanisms were not in place. The corporate governance aspect of risk management collapsed. Boards and other stakeholders (including government agencies) were at best ignorant of the risks
71
taken. The evidence supports that boards were aware of the risk but decided to ignore it, expecting greater returns and higher share prices. Kaupthing’s loan book shows appalling practices in which a bank lends enormous amounts to holding companies and individuals so that they can buy shares in the bank. This is a way of appreciating share prices in the bank. The financial supervision had focused on regulatory capital ratios (as Basel I capital requirements). The liquid risk, which is not being measured, is crucial where banks are especially vulnerable towards marketability of securities. The Icelandic banks relied heavily on marketability of their securities for liquidity needs. Apart from the few largest owners of the banks, shareholders were weak and dispersed. They had to cope with the increasingly complicated operation of the banks, where there were new financial products such as credit derivatives, swaps and so forth to decipher. Deregulation made it possible for banks to diversify into related activities like insurance services and mortgages, and to organize a substantial share of their activities in off balance sheet operations (Thomsen, 2009). Hence, shareholders had to rely on corporate governance mechanisms to protect their interests. These mechanisms were lacking. Shareholders were uneducated and did not rebel at annual meetings, elect new board members or elect a hostile raider to clean up the operations. Performance related incentives were to overcome agency problems, but were ill structured. Another governance mechanism is reputational risk. It should motivate executives to perform well for fear of reputational loss, but executives of banks during the boom period were treated like celebrities. Agency problems cannot be eliminated all together (Tirole, 2006). Nonetheless, the Icelandic case shows how fragile governance issues can become. Only a few days after the collapse of the Icelandic banks, it became evident that a deep crisis was unavoidable and the whole nation would suffer. Policy Recommendations Policy makers as well as practitioners in the financial sector should bear in mind the Icelandic case, which demonstrates the governance measures needed to be taken by governments before liberalization and deregulation, as well as emphasizing the increased risk that goes along with it. Some proposals are highlighted below:
1. Public financial education needs to be a priority in the future rehabilitation process complementing governance and regulatory reform. An independent agency, free from uncertainty of financial support, should be established to gather, analyze and supply reliable
72
information for stakeholders, government included. Legislation against media monopolies must be passed. Well‐informed individuals would react more efficiently and critically and would also better understand the need for change in both regulatory and governance practices. Furthermore, consumer protection in respect to financial products must be addressed, although the MiFID decree from 2007 provides some protection. The vast development of credit markets has made the public vulnerable to inappropriate financial products and selling strategies. A redress mechanism in the case of abuse should be implemented.
2. The position of Chief Risk Officer should be established in each bank. A system that allows the incumbent to report directly to the board should be implemented, functioning as internal control and reporting to audit committees. These functions should be independent from management and with sufficient access to relevant information. The risk management role of the CEOs is not to be diminished, rather the boards’ concerns are to be highlighted. In the light of the poor risk management culture of the Icelandic banks, more importance should placed on risk mechanism and the risk management culture itself, and less on checklists of innumerable possible risks. Risk management should be more comprehensive in scope as well. The case of Landsbanki and its Icesave deposit accounts in the UK shows that the legal borders of a bank can become wider than its economic ones.
3. Changes must be implemented in terms of the organizational structure of the banks. The fallen Icelandic banks contained, on one balance sheet, various entities such as commercial banking, investment banking, asset management, an insurance arm, and a pension fund, creating contagion risk. An improved structure should entail a legal separation between entities and thereby separation of balance sheets that a non‐operating holding firm could parent (the OECD is putting forward such suggestions (OECD, 2009)). In this way, the entities become separately capitalized and can be listed or non‐listed. Different reporting obligations can be applied as well as separate governance structures. Transparency for stakeholders should increase, leading to better governance. In times of difficulties, regulators can act firmly, not having to deal with the complexity of the existing structures. The risk of the commercial banks’ balance
73
sheet will become less, an arrangement that would have saved the Icelandic public from a lot of damage.
4. New types of bank owners must be sought, now that the Icelandic government is being given a second chance to create a healthy financial system. A laissez‐faire policy of risk and balanced development issues should be shelved. The sheer enormity of the banking sector in relation to the public resources was an evidence of bad policymaking. The government must demand much lower leverage and a higher equity base in future banks. It should be aiming to bring new capital into the system, by not selling to existing financial institutions, but rather to foreign investors with modest leverage, preferably respectable and reliable major international banks. Once bitten, twice shy, the government should not sell the banks to agents likely to become users of bank credit. As proposed above, a new corporate structure for the future banks should provide for clear and transparent deposit insurance, and guarantee systems. Creditors of financial institutions not covered by explicit systems must realize that the institutions can fall. Risk should become transparently priced.
5. Market conditions will guide how quickly the government can and should sell off the new public banks. A long‐term, government‐owned controlling might be feasible. It then becomes the responsibility of the government to secure changes in corporate governance arrangements within the banks. This responsibility should be given to a new administrative agency that ought to have the autonomy to prepare and implement needed changes. If and when a competitive sales process takes place, a selection criteria should identify the private buyer best suited to guarantee necessary changes. A pre‐qualification process followed by bidding among selected candidates allows for a more careful selection process of preferred groups of investors. The selection criteria should be disclosed and the objectives for post privatization processes demanded. The restructuring of the banks might be necessary to minimize potential dominant market positions and to encourage competition. Anti‐trust regulation should be a part of an adequate regulatory framework where an element of monopoly is likely to persist.
74
6. Financial supervision and regulation were weak and provided the wrong incentives, contributing to excessive risk taking. Neither the boards nor the shareholders seemed to understand the characteristics of a new and complex financial industry, undervaluing the risks the banks were running. The mechanisms to oversee and control management were not in place. A new regulatory agenda will have to be created to address these failures. This agenda should contain an increase in minimum capital requirements and stricter rules on liquidity management. The level of capital required should be increased relative to the risk being taken, keeping in mind how banks financed themselves through money markets that eventually evaporated. In addition to liquidity levels, quality of assets and securities, as well as funding, must be addressed, as these can be constraints on liquidity. Boards, or sometimes managers, did not always properly understand internal risk management models. The “fit and proper” criteria should also be reconsidered. The Icelandic Financial Supervisory Authority had introduced a competence test for CEO’s of financial institutions. It is worthwhile considering whether such tests should be extended to lower level management and to boards, ensuring these agents fully understand complex instruments and methods. Policy makers must also address the remuneration issues. Excessive levels of remuneration became a matter of social and political dissatisfaction, and motivated high risk‐taking and short term thinking which impacted risk management negatively. Full transparency concerning incentives should also be guaranteed. The Financial Supervisory Authority must then oversee the adequacy of the incentive policies. It should be able to step in and get policies reassessed, or to require a bank to provide additional capital. Supervisors should be called upon frequently to inspect banks’ internal risk management systems. These systems must be fully independent within the banks and be made responsible for independent stress testing. The above‐mentioned role of a risk officer should be created and hold a high rank in the hierarchy with a direct access to the board. Supervisory control should be considerable and enforced through frequent inspection regimes.
The reforms proposed above stress governance issues, on a number of levels: at the government level; at the firm level; and at the civil society level. Traditional public government is not sufficient to address a number of critical issues in the
75
modern economy. Government obviously has a need to strike a balance between entrepreneurial growth and risk exposure and balanced societal development. The Icelandic case describes a laissez faire attitude, where risk and balanced development issues were neglected. The sheer oversize of the banking sector in relation to the public resources is an evidence of this. Civil society obviously also cherishes welfare growth, but has lacked critical insight into core processes. Presumably, a critical non‐governmental organization and analyst engagement with good information could have triggered a much more adequate public debate, which would again have put pressure on both government and industry.
76
References Bishop, M. and Thompson, D. (1992), “Privatization in the UK internal organization and productive efficiency”, Annals of Public and Cooperative Economics, Vol.63, No. 2, pp.171–188.
Boycko, A.S. and Vishny, R. (1996), “A theory of privatization”, Economic Journal, Vol. 106, No 435, pp. 309–319.
Boycko, M., Shleifer, A. and Vishny, R.W. (1997), “Second‐Best Economic Policy for a Divided Government”, European Economic Review, Vol. 40, No. 3‐5, pp.767‐774.
Central Bank of Iceland (2006a), “The economy of Iceland”, available at: http://www.sedlabanki.is/lisalib/getfile.aspx?itemid=4689 (accessed 28 December 2008).
Central Bank of Iceland (2006), “Fitch Ratings revises Iceland's outlook to negative”, available at: http://www.sedlabanki.is/?PageID=287&NewsID=1124 (accessed 28 December 2008).
DV (2009), “Fengu bónusa fyrir að lána”, available at: http://www.dv.is/frettir/2009/8/5/fengu‐bonusa‐fyrir‐ad‐lana/ (accessed 15 August 2009).
England, P. and Vihrala, V. (2007), Financial crises in developed economies: The cases of Sweden and Finland, Handelshogskolan, Stockholm.
Financial Supervisory Authority (2008), “Stress test”, available at: http://www.fme.is/?PageID=168 (accessed 24 August 2009).
Fleming, S. (2006), “Iceland's poets of enterprise lose their rhythm”, The Daily Mail, 28 March, pp. 61.
Fletcher, R. (2006), “Icelandic charm melts away as debt crisis grips”, The Sunday Times, 2 April, pp. 13.
Jones, A. (1985), Britain's economy. The roots of stagnation, Cambridge University Press, Cambridge, UK.
77
Jonung, L. (2008), “Lessons from financial liberalisation in Scandinavia”, Comparative Economic Studies, Vol 50, No. 4, pp. 564–598.
Kikeri, S, Nellis, J. and Shirley, M. (1994), “Privatization: Lessons from market economies”, World Bank Research Observer, Vol. 9, No. 2, pp. 241‐272.
Martin, S. and Parker, D. (1997), The impact of privatization. Ownership and corporate performance in the UK. Routledge, London.
Morgunblaðið (2009), “Yfirlýsingin kom frá forstjóra Kaupthings”, avaible at: http://www.mbl.is/mm/vidskipti/frettir/2008/11/05/yfirlysingin_kom_fra_forstjora_kaupthings/ (accessed 20 September 2009).
Nasdaq OMX Nordic (2009), available at: http://nasdaqomxnordic.com/Frettir/. OECD (2009), “Finance, competition and governance: priorities for reform and strategies to phase‐out emergency measures”, available at: http://www.oecd.org/dataoecd/55/47/43091457.pdf (accessed 7 September 2009).
Padgham, J. (2006), “Meltdown worries put Iceland's UK raids under threat”, The Evening Standard, 27 March, pp. 26.
Portes, R. and Baldursson, F.M. (2007), The Internationalization of Iceland’s Financial Sector Iceland Chamber of Commerce, Iceland..
Sappington, D.E.M. and Sidak, J.G. (2000), “Are public enterprises the only credible predators? Who should the courts believe?”, The University of Chicago Law Review, Vol. 67 No. 1;pp. 271‐292.
Shleifer, A. (1998), “State versus private ownership”, Journal of Economic Perspectives, Vol. 12, No. 4, pp. 133‐150.
Shleifer, A. and Vishny, R.W. (1997), “A survey of corporate governance”. Journal of Finance, Vol. 52, No. 2, pp. 737‐783.
Shirley, M. and Walsh, P. (2000), Public vs. Private Ownership: The Current State of the Debate. World Bank, Washington, DC.
78
79
Sigurjonsson, T.O. (2010), “Privatization and deregulation: a chronology of events”, in Aliber, R. (Ed.), forthcoming, Palgrave, UK. Sigurjonsson, T.O. and Schwarzkopf, D. (2010), “ANT methodology study on the Icelandic banks”, working paper, ,School of Business, Reykjavik University, 6. October 2009.
Sigurmundsson, A. (2009), “Ræða Arnars Sigurmundssonar”, available at: http://ll.is/files/bcecdihcbi/Avarp_Arnars_a_adalfundi_LL_15._mai_2009.pdf (accessed 20 August 2009).
Thomsen, S. (2009), “Corporate governance and the financial crisis: an overview”, in Thomsen S., Rose, C. and Risager O. (Eds.), Investment, risk and governance, SimCorp StrategyLab, NY, pp. 98‐109.
Tirole, J. (2006), Corporate Governance, Princeton University Press, Princeton. Valgreen, C. (2006), “Iceland: Geyser crisis”, available at: http://danskeanalyse.danskebank.dk/link/FokusAndreIceland21032006/$file/GeyserCrises.pdf (accessed 3 September 2009).
Vickers, J. and Yarrow, G. (1988), Privatization: An Economic Analysis, World Bank Policy Research Working Paper Series, Washington, DC.
Vickers, J. and Yarrow, G. (1991), “Economic perspectives on privatization”. Journal of Economic Perspectives, Vol. 5, No. 2, pp. 111–132.
Villalonga, B. (2000), “Privatization and efficiency: differentiating ownership effects from political, organizational and dynamics effects”. Journal of Economic Behavior & Organization, Vol. 42, No. 1, pp. 43‐74. APPENDIX. INTERVIEWEES Gunnarsson, B.Í., governer of the Central Bank of Iceland. 30 July 2007 Kristjánsson, T., Vice President at Glitnir bank. 20 June 2007 Sigurdsson H.M., CEO of Kaupthing bank. 20 July 2007 Sigurdsson O., CEO of Stafir Pension fund. 15 August 2007
80
Chapter 4
Managing Sustainability Through the Value Chain
Fritz Balkau and Guido Sonnemann1
Introduction We are living at a time when production and exchange of goods and services have attained global dimensions, with raw materials and finished products, and their imbedded environmental impacts, being transported vast distances across the world to their end‐consumers. While globalization is generally taken to be a positive force in human development, it is not without its social costs. Surveys by UNEP 2and other organizations, such as WorldWatch3, show that our social fabric and physical surroundings are now under significant stress.
But our current environmental policies, many dating from the 1980s and 90s, have difficulty in dealing with the complex causes of the deterioration we are witnessing. In part this is because they continue to deal separately with environmental media such as land, water, air, or are otherwise preoccupied with specific single waste streams. In an attempt to efficiently solve local problems, many actions merely shift the impacts to other places, media or stakeholders.
The World Summit on Sustainable Development in 20024 called for a wider adoption of a ‘preventive’ and ‘integrated’ life‐cycle approach to products and materials, relying on life‐cycle assessment to identify the impacts at different stages in the life‐chain. The technique of Life‐cycle Management (LCM) constitutes such an approach by devising partnerships and procedures to minimize impacts in a holistic fashion.
LCM is still a young science. Different models are being tried in different circumstances, and the factors for success are gradually becoming more evident. This chapter will explore the different models, their strengths and weaknesses, and the synergies that can be created when a cooperative approach is taken.
1 Note: The views expressed in this text are those of the authors, and are not in any way
official policy of their past or present employers. 2 www.unep.org/geo/ 3 www.worldwatch.org/stateoftheworld 4 www.un.org/events/wssd
81
Why Life‐cycle Management? A convenient way of understanding the issues that underlie life‐cycle thinking is through the notion of our ‘footprint’ on the planet. Some footprints such as carbon, water, and energy can be quantified. Other more ‘ecological’ footprints resist calculation although they remain a useful general concept in discussion. A footprint is taken to be the total effect of all the steps in the life‐chain of products and materials we consume5 . A more holistic management of these accumulated impacts is a prerequisite for achieving a sustainable lifestyle that is within the resource capacity of our planet. Most of the environmental impact we see today is due to the surprisingly low resource efficiency of our modern society. Overall, only about 6% of total resource consumption goes into the final manufactured product. The other 94% is discarded as (unwanted) by‐product at various places along the production‐consumption cycle 6. Wasteful technologies and throwaway products are often highlighted as the principal problems. However, the root cause of inefficiencies is also the uncoordinated nature of the value chains. Optimization of individual steps does not necessarily lead to a reduction of the biggest impact, nor does it result in an optimization of the system as a whole. In many cases, impacts are simply pushed along the life‐chain, rather than being mitigated in any real way. A simple example below illustrates this problem in a practical way:
Leather tanners who purchased raw hides from foreign sources for processing regularly found themselves out of regulatory compliance with respect to pesticide levels in their wastewater. Pesticides are added by cattle farmers and slaughterhouses to protect the freshly skinned hides from bacterial and insect attack. The embedded chemicals pass along the entire value‐chain in the leather industry and some end up in wastewater wherever a washing stage occurs. There was no intra‐sector communication and negotiation framework to solve this problem, as each link in the value‐chain acted independently. Ultimately the added cost of sophisticated wastewater treatment at the tanning stage exceeded the value of the product, and contributed to the decline of the industry in the UK. The problem could have been solved if life‐cycle management systems had been in place. An industry‐wide initiative relating to chemical use throughout the product cycle could have been negotiated. Individual tanners could have spent more time managing their supply‐chain. Government regulation could
5 www.en.wikipedia.org/wiki/Ecological_footprint 6 www.sustainer.org/pubs/Seville.Nat.Cap.html
82
have addressed the root causes, i.e. slaughterhouse practice, rather than applying wastewater standards at the tanning end‐point. Lack of appreciation of the life‐cycle management concept and the absence of a life‐chain partnership meant that none of the above were applied at the time.
This type of ‘burden shifting’ situation is common in many industries. To better understand the structure of the possible solutions, we need to briefly look at the foundations of LCM and the principles on which they are based.
Life‐cycle Management Framework and Concepts The various definitions of life‐cycle management often reflect the particular viewpoints of different stakeholders. According to UNEP “Life‐cycle Management (LCM) is a product management system aiming to minimize environmental and socioeconomic burdens … during the entire life‐cycle … [relying on] … collaboration and communication with all stakeholders in the value chain.” This simple notion belies the difficulties in its implementation. Figure 1 from the food sector gives an indication of the challenge involved. It clearly shows the complex materials that flow in our food supply and where various types of environmental impact occur. Figure 1. Life‐chain of food production
Crop production
Livestock/fish production
Processing Packaging Distribution Consumption
Feed Grazing land Water Antibiotics Energy
Water Cleaners/ sanitisers Energy
Paper / cardboard Plastics Glass Metals Energy
Transport fuels Storage air-conditioning
Energy
Soil loss Contamination Harm to non-target species
Greenhouse gas emissions Manure management problems
Effluent Food residues
Solid waste Greenhouse gas emissions Other transport emissions Ozone layer depleting
Solid waste
Soil Water Pesticides/ herbicides Fertilizer Energy Seeds
LCM works with partners at all these points to effectuate both local and system‐level improvements. It is not yet a standardized discipline, but rather it is an umbrella framework for combining and applying other management instruments
83
in a more holistic life‐chain perspective. The advantage of LCM is its ability to more explicitly take into account upstream and downstream impacts, including situations in which they are widely distributed geographically and socially. It can more easily address global issues and system dynamics than instruments designed for individual company use. A particular feature of LCM is the ‘democratization’ of the management exercise through the involvement of different value‐chain partners.
For the present discussion, we group LCM approaches into three broad categories based on their ‘owners.’ We will elaborate further on these later in this chapter.
1. Organization of a holistic form of sustainability management within individual companies using, for example, supply‐chain management and product design7
2. Government life‐cycle policies and regulations to address system dysfunctions or to deal with certain product issues such as chemical contamination
3. Multi‐stakeholder voluntary codes to manage sustainability issues for selected commodity materials and products e.g. the Cyanide Code described below
In practice, there is a good deal of synergy in these approaches, and they are best used in combination, as, for example, when government regulation enables or supports industry codes or multi‐stakeholder mechanisms.
As few tools have been developed specifically for implementing LCM, the partners are currently obliged to draw on the existing set of corporate management instruments and government regulations to see what combination of these can be effectively applied along the entire life‐chain. The more common ones (see Table 1) include supply‐chain management (SCM), corporate social responsibility (CSR), environmental design (DFE), and product‐service systems (PSS). Some organizations have packaged the most useful instruments into a tool box 8.
As a general comment, many of the current instruments also need to evolve further if they are to play a full part in LCM. The expanded range of objectives in a full sustainable development agenda, and the need to consider the entire value‐chain stretches many of them to their limit. For example, while the
7 www.fivewinds.com/uploadedfiles_shared/EnvironmentalSupplyChainManagement040127.pdf 8 www.maplecroft.com/policybank.pdf
84
Global e‐Sustainability Initiative (GESI) has developed an electronic tool for sustainability evaluation of electronics suppliers9 . This tool considers only a part of the life‐chain, often ignoring the impacts of mining the metals that the industry uses. Another example is LCA itself, which is mainly used to assess numerical parameters such as materials and energy flows, whereas the full sustainability agenda includes many non‐quantifiable issues such as biodiversity and social aspects. Partnerships are at the core of LCM. There is no single procedure for identifying partners, and indeed some such as the end‐consumer are frequently left out. There is still a reluctance to expand the LCM partnerships too far up and down the life‐chain, partly out of fear of losing control and partly to keep the management exercise simple. As a counter example, Figure 2 shows ALCAN’s vision on products in a company context. Not all corporations are yet interested in including end‐consumers in their work on LCM.
Figure 2. Life‐cycle management in Alcan
We can usefully illustrate the above analysis through a case study from the mining industry. This is an example of multi‐stakeholder LCM, i.e. item (iii) in the preceding grouping, but the conclusions also have a more general validity.
The gold mining industry uses sodium cyanide to leach gold out of crushed mineral ore. Its toxicity means that careful handling is required at all stages of its life chain. Government safety regulations spell out the standards to be followed. After the widely reported spill of 70 tons of cyanide from a mining operation into the Danube River system in 2000, the industry funded an international multi‐stakeholder steering group to
9 http://e‐tasc.achilles.com/WhatIsETASC/Default.aspx
85
develop a new (life‐cycle) instrument – the ‘International Code for Cyanide Management’ –and a membership‐based mechanism for its implementation10. The Code defines a formal relationship for the key LCM partners: the chemical supplier, the transporter, and the mining company. It thus constitutes a ‘cradle to grave’ management process. The Code incorporates safety objectives, technical standards, and operational procedures to be applied by the LCM partners. Supply‐chain management ensures these standards are applied right up to the original chemical manufacturer. Independent audits and a requirement for public consultation ensure that the entire life‐cycle remains visible to the community.
Many private mining investment decisions and government approvals now require companies to be members of this code. Companies on their side have found that the procedures of the Code also make their operations more cost‐effective. More than 50% of world gold production now takes place by companies that are members of the Code. Safety incidents have markedly decreased. But the Code also has limitations. In particular its character as a voluntary agreement means it suffers from the free‐rider problem (remedied in part by the tendency of some governments to require adherence to the Code as a condition of approval). There is also a problem in application to small operators who have less influence over their supply‐chains. Similar experiences have been observed in natural resources, chemicals and minerals, and other sectors. LCM, when systematically applied, can be a major factor in achieving the goals of sustainable development while keeping the company competitive. Its effectiveness increases when there is a synergy between business procedures, e.g. financing, and government approvals, and is at its best when public interest groups also contribute to the arrangements. However, close management control is needed to ensure meaningful objectives to the exercise and to provide effective operational supervision.
How is LCM applied now? LCM in Business The business sector was the first to make extensive use of LCM, using it as a way of shaping its response to market competition, consumer pressure, product quality assurance, workplace and consumer safety, meeting sustainability targets,
10www.cyanidecode.org
86
and so on. Figure 3 from Unilever illustrates well how companies see the usefulness of LCM in a corporate framework. Figure 3. Lifecycle Management in Unilever
The World Business Council for Sustainable Development (WBCSD) is promoting LCM as a way of improving company CSR programs by, for example, improving their products’ sustainability performance. Below are two examples of life‐cycle management in companies, with emphases on product design and supply chain management respectively.
According to Nokia: “… life‐cycle covers all significant impacts in the life‐cycle of a product and thus constitutes the basis for all environmental activities at Nokia as well as a framework for actions. Based on this approach, we set targets for further improvement of our environmental performance.” The life‐cycle profiles for Nokia's two primary product types, mobile phones and network equipment, are very different. For mobile phones, the extraction of raw materials and the production of components have the largest environmental impacts, while for network equipment, the energy consumption during the use phase is the most important (see Figure 4). This life‐cycle perspective has led to a significant reduction in the material consumption for mobile phones and today several weigh below 100g11. IKEA tries to produce low‐cost home furnishing products that influence the environment as little as possible and are produced in a socially responsible way. IKEA has developed a Code of Conduct that represents minimum demands to its 1,600 suppliers in connection with
11 www.lca‐center.dk/cms/site.aspx?p=5285
87
social, environmental and work‐related conditions. The use of life‐cycle thinking ensures that the company is abreast of development trends and at the same time contributes to ensuring a sustainable development for IKEA itself and for its suppliers. Supply chain management factors include resource use, sustainable forestry practices and training for employees12.
Figure 4. Life‐cycle considerations in electronics manufacturing
These examples show that there are different options for LCM depending on the objectives the companies have set themselves. Nokia is anxious to market a product with lower embedded pollution impacts. But it has not mentioned the social impacts due, for example, to the mining of metals on which electronic circuitry depends, and which has actually led the entire industry participating in the Gesi initiative mentioned earlier. Nokia is thus selectively addressing the value‐chain of its products. As a distributor, IKEA tries to exercise better control over its numerous suppliers, including social impact and bio‐diversity criteria, as well as waste. Sheer numbers suggest that it will, however, have difficulty influencing the suppliers of the suppliers, and so its value‐chains are also rather short. Both of these examples highlight one of the major challenges facing LCM, identifying in a meaningful way the length of the chain necessary to adequately resolve sustainability issues in the life‐cycle of products and materials. Other companies that have a life‐chain approach to their environmental management
12 Three cornerstones in IKEA's environmental work: http://www.lca‐center.dk/cms/site.asp?p=46831. IKEA's demands to their suppliers ‐ environmental and social: http://www.lca‐center.dk/cms/site.asp?p=4683
88
programs include Alcan, Magna International, Siemens, Ford, and Veolia. LC assessment underpins many of these management exercises. Information on materials and energy flows leads to improvements in sustainability performance by reducing waste and pollution, and redesigning products. Now that major distribution chains are also embracing CSR, use of LCA is increasing sharply. For example:
Future shoppers at Wal‐Mart can expect to have not only low prices but also information on carbon and water footprints, and on pollution generated during the product’s manufacture. Wal‐Mart’s ambition is to create a comprehensive indexing system that provides customers with relevant information about the “world behind its products.” Among its more than 100,000 suppliers, big companies such as Unilever and Proctor and Gamble are supporting the initiative. Rival retailers such as Tesco, Target, Costco and others have been invited to cooperate to avoid a proliferation of separate indexing systems. The initiative has major implications for the supply‐chains. Manufacturers and suppliers will need to make sustainability criteria a major aspect of their operation in the future.
While the chief users of LCM in business have so far been individual companies, business associations are catching up. The International Council on Metals and Mining (ICMM) statement on materials stewardship is an example of life chain management advocacy for an entire industry sector13. It promotes an integrated life‐cycle approach to the production and use of minerals to ensure alignment with sustainable development principles. Value‐chain partners are encouraged to pursue responsible design, use, re‐use, recycling, and disposal of materials. Other sectors advocating LCM include the chemicals industry with its Global Products Strategy that is dedicated to improving the responsible handling of chemicals throughout the value‐chain 14. But numerous challenges remain for business. We have seen that the value‐chains being managed are often still quite short, and the sustainability objectives have been reduced to a small number. Many stakeholders, particularly end‐consumers, are still locked out of the LCM exercise. Small companies often have insufficient leverage to manage their supply‐chains or to redesign their products. And coordinating, monitoring, and checking the actions of the various upstream and downstream partners is a major management exercise. The lack of
13 www.icmm.com/page/2043/news‐and‐events/news/articles/icmm‐outlines‐the‐benefits‐of‐materials‐stewardship 14 www.icca‐chem.org/
89
standardization of LCM is thus all too apparent, leading to a diversity of often inconsistent approaches. Companies’ LCM initiatives also depend significantly on the government regulatory framework where sustainability targets may be set, information demanded, and procedures mandated (or forbidden). There are also challenges at the political level. Companies clearly manage (sometimes manipulate) the LCM process in their own interests, rather than attempt to achieve real sustainability improvements. This opens the door for eventual international standardization and/or government regulation. Many governments in emerging economies are deeply suspicious of western corporate attempts to control their supply chains and try to use international forums such as WTO to block such practices. LCM in Government Regulators realized some time ago that the point‐source approach to managing environmental quality has clear limits and that future regulation should try to reflect a more comprehensive life‐cycle approach. This is not an easy task given the complex, interconnected web of government regulation in most countries, much of which is based on single‐media legislation. Nevertheless a number of environmental ministries are now starting to try out more proactive strategic instruments and policies based on life‐cycle approaches; and some national and regional authorities are putting in place holistic legislation that fits into the broad area of sustainable consumption and production (SCP) policies. Leadership has come especially from intergovernmental bodies like the European Union (EU), which has taken a visible stance on upstream approaches through, for example, its Integrated Product Policy15 . ‘Integrated’ action can be general or applied to a specific class of materials or products. The REACH process in the European Union for potentially hazardous chemicals is a relevant recent example16. Another good example of life‐cycle legislation is the Restriction of
Hazardous Substances Directive 2002/95/EC, commonly referred to as the (RoHS). This limits the use of six hazardous materials such as lead, mercury or cadmium in the manufacture of electrical equipment. It is closely linked to the Waste Electrical and Electronic Equipment Directive (WEEE) 2002/96/EC, which sets collection, recycling and recovery targets for electrical goods and is part of a legislative initiative to solve the problem of toxic electronic waste. RoHS has both
15 http://ec.europa.eu/environment/ipp/ 16 www.euractiv.com/en/environment/chemicals‐policy‐review‐reach/article‐117452
90
upstream and downstream components to help reduce health and environmental impacts in developing countries where much of today's high‐tech trash ends up for ‘recycling.’
While individual governments have tried from time to time to incorporate more extended life‐chain management elements into sustainable development policies, they have experienced difficulties in giving them effect through regulations or other obligations. Thus the French parliament in 2008 rejected the minister’s proposal to introduce differential pricing based on accumulated environmental impact. LCM applied to entire value chains touches on too many diverse interests for it to be easily accepted in a political context. There is also the inherent complexity of creating legislative links along extended supply chains, especially as much of the international trade process is effectively beyond national jurisdiction and only amenable to regional or global initiatives. For some priority issues, governments do however practice a form of LCM directly, even if in a piecemeal fashion. Specific high‐profile substances such as radioactive materials, pharmaceuticals, and genetic material may be controlled through a set of independent but interlocking regulations right along the life‐chain, often under the oversight of specific coordination bodies on which interested government departments (and even civil society bodies) may be represented. Road (and air) safety is another issue often subject to a systems approach where vehicles, road infrastructure, user permits, driver behaviour, alcohol sales, medical services, etc. are all incorporated into a type of life‐chain process where each component is optimized in relation to the others. This approach has, in some countries, succeeded in dramatically reducing the road toll, demonstrating that effectively managed holistic approaches can deliver good results in addressing complex problems. In most cases, however, the political and logistic challenges have led national governments to choose the ‘coordination’ option over integrated regulation. Faced with the extended LCM constraints mentioned above, they emphasize the assessment stage (i.e. LCA), promoting research and data collection, and then bringing this knowledge into product legislation. In effect this focuses on the consumption end of the value chain rather than on the production cycle. Fortunately, governments also have some other options. Softer forms of actions such as product labelling, product awards, and consumer information have increased consciousness of the ‘world behind the product,’ and thereby provoke more fundamental product rethinking by manufacturers. For example,
91
the EU Energy Label for most white goods, light bulbs, packaging, and cars have been particularly effective in improving the energy efficiency of key products. There are also major opportunities that are being missed. Government is arguably society’s single biggest consumer of goods and services. A more serious attempt to incorporate life‐chain performance criteria in public purchasing and tendering would send a strong signal to suppliers that the more extensive use of LCM could also have commercial advantages. At present, political and cost factors still dominate in most government supply contracts. Overall, apart from the major political constraints, governments’ role in LCM is constrained by the fact that it is not clearly positioned at a definable point along the value‐chain. Being in a sense ‘everywhere,’ its chief role is to provide an enabling framework that obliges the various life‐chain partners to adopt LCM. Cooperative Life‐chain Management In some circumstances, as with many commodity products, for example, no single company dominates the value‐chain, nor is it possible for governments to legislate due to the nature of the global marketplace. Here a different model of LCM can be introduced, one of cooperative action through a formal management structure and agreed performance codes. Rather than the LCM exercise being based on a single company initiative (as in the case of the Wal‐Mart example), this approach relies on a multi‐stakeholder coalition to drive the process forward. In addition to the direct supply‐chain partners, civil society groups, intergovernmental organizations, and consumer groups may be represented in these coalitions. The prominent examples are mostly in the natural resources area, mining, forestry, and fisheries, where intense consumer and NGO activity has focused attention on upstream and downstream issues in addition to the direct impact of operations. The cyanide code discussed earlier also adopted such a cooperative multi‐stakeholder process. Unlike corporate LCM, there is a formal life‐cycle management framework that brings all stakeholders together to formulate the sustainability objectives. As a group, they elaborate on performance standards, introduce monitoring and verification processes, and engage in open communication with end‐users for quality assurance purposes. Among the best‐known examples of LCM partnerships for sustainable resource exploitation are the Forest Stewardship Council and the Marine Stewardship Council.
The production and supply of sustainably harvested timber embraces life‐cycle management through the certification process put in place by an
92
international instance, the Forest Stewardship Council (FSC)17. The multi‐stakeholder FSC was created after UNCED in 1992, when it became clear that only a collective management agreement would reduce the confliction situation concerning timber harvesting. Under the instrument, both forest operations and the timber product are subject to strict conditions with regards to independent auditing and certification, including public reporting. The sustainably‐produced timber is marketed as such by retailers who have targeted a major consumer segment interested in such products. Some forest product companies claim similar ‘sustainable’ practices outside such formal agreements, however, little independent auditing usually takes place. As evidence of the effectiveness of the FSC instrument, the WWF reports that 1.2 million hectares of forests in the Congo Basin achieved certification in 2008. The aspect of the consumption side is taken more clearly into account in the fishing sector, under the Marine Stewardship Council . This is also based on a certification procedure but has a mission to inform and educate (but not exert obligations on) consumers of the product. The life‐chain issues for marine fisheries are well summarized by Ecotrust18.
The FSC and MSC are practical management initiatives that bind various partners along the value‐chain under common objectives and procedures. The key partners have the opportunity to participate in the governance of the instrument. This management approach is in contrast with the International Tropical Timber Agreement, an intergovernmental treaty established under the UN to encourage governments to implement sustainable harvesting practices, but which has no binding procedures, targets, obligations or monitoring 19. Implementation of the above approach depends on the same instruments as those already used by individual companies, e.g. audits, product specification, certification, etc. and may also rely on complementary regulation by governments to give it additional strength, e.g. approvals, product standards, labeling. In a sense then, cooperative LCM, by focusing on building strong, formal partnerships, is simply a further development of the individual LCM initiatives already in place in business and government. It is the nature, strength and influence of the partnership coalition that sets it apart from other LCM models. These coalitions have undoubted advantages in situations where no individual company or government is able to exercise leadership. In the case of the cyanide code
17 www.fsc.org/ 18 www.slideshare.net/ecotrust/adventures‐in‐lca/ 19 http://untreaty.un.org/English/notpubl/XIX_46_english.pdf
93
mentioned earlier, a full life‐cycle control of the substance has been achieved, and safety performance has markedly improved. The role of government in such cooperative LCM is limited to product and process endorsement or occasionally to approval as a condition of permission. A more powerful influence is now exercised by financial institutions that have become interested in the certification aspects of such LCM exercises as a way of orienting their project funding. But the cooperative process is not without its difficulties. It is costly and time‐consuming to manage. In a diverse partnership there are often stakeholders who wish to control the process, thereby reducing the commitment of other partners. The Green Lead project20 suffers from this problem. Reducing the exercise to only a few steps in the life‐chain is the most common weakness of life‐cycle coalitions (as it is in most LCM exercises), since the joint interests of a diverse group of partners is likely to be concordant only for a limited number of issues. Finally, binding standards – never popular with business – and compliance mechanisms are essential for a broad coalition to act in a coherent fashion. Here, the weakness of the Tropical Timber Agreement, which has no standards at all, is noteworthy in comparison to the clear procedures of the FSC.
Implementation of LCM The diversity of LCM methods seen above is a reflection of the growing complexity of life‐chain issues as international trade expands. Implementation approaches depend on the purpose of the exercise. In the case of product optimization within a single company, as promoted by the WBCSD, for example, the parameters of the LCM exercise will be dominated by internal corporate factors such as CSR. Conversely, in the case of the cyanide code, LCM is used to bring about a global improvement in chemical safety throughout the entire industry. Here CSR is one of the subordinate tools for implementing LCM. It is clear that LCM is at its most effective when business, industry and community work together, each bringing additional value to the implementation. Government provides a clear regulatory framework and standards that business depends on to implement company initiatives. Public bodies contribute to the articulation of agreed sustainability targets, and to information exchange. This partnership basis to LCM has its strongest expression in the cooperative model we saw above. The partnership model is also the one best able to work towards broader community outcomes on sustainability. Business LCM is still too often focused on achieving narrow corporate outcomes of improved image, marketing, and cost, without explicitly and visibly factoring broader global and societal goals into the
20 www.greenlead.org
94
exercise. And we have seen that governments have reduced ability on their own to make LCM work due to the complexity of the political factors. Through a multi‐stakeholder LCM coalition the aspirations and objectives of all the social partners can more easily be taken into account. LCM has thus been effective in a number of circumstances. But what is likely to bring about such success? While much depends on the situation, a number of common factors stand out:
1. Shared perception of the need for action on sustainability issues. This is often accomplished through the media, writings, conferences, and consultation;
2. Neutral forum to bring the partners together initially; 3. Formal process to link the stakeholders. This could be through internal
directives, contractual arrangements, partnership agreements or membership of joint initiatives;
4. Mechanism to agree on issues, priorities and process. In most cases this would be a Board, a Steering Group or equivalent, as was the case for FSC and the cyanide code. For corporate SCM it is usually the contract management process;
5. Capacity for compiling and interpreting technical data, and developing action plans, management protocols, contracts or regulations. Many LCM initiatives have a special unit or secretariat to undertake the technical work;
6. Process to ensure implementation, auditing and monitoring; 7. Communication system to keep stakeholders informed.
Where these conditions are met, LCM is likely to work well. But there are also some problems that delay a full implementation of LCM. The first is a lack of awareness in many sectors that LCM is an appropriate response to their situation. The UK tanners, for example, did not have the necessary vision to engage with upstream suppliers. Their traditional independence and ingrained perception that downstream government regulations were the only possible form of environmental management led to inaction until it was too late. Next is the complexity of dealing with all actors across all sections of the value‐chain, and perhaps addressing all issues (as Wal‐Mart is trying to do). While influence over immediate suppliers through standard SCM is straightforward, the inclusion of the suppliers of the suppliers greatly multiplies the points needing coordination or surveillance. We have already seen that the Gesi initiative
95
excluded metals mining from its program, even though mining is one of the controversial areas of the sustainability agenda. Likewise, the Nokia and Ikea examples illustrated the current tendency for companies to consider only short sections of the supply chain. On the government side, we also noted that life‐cycle legislation is both complex and politically sensitive due to the number of vested interests (both in and out of government). But there is no way around this. If we want a life‐cycle approach to optimize sustainability issues for the community rather than the company, we will have to learn to deal with extended life‐chains and multiple partners. Finally, we have to acknowledge that as for other radical changes in procedure, management resistance is a key factor in slowing down implementation of LCM. Traditional approaches die hard, as we already noted in the still ongoing application of outdated environmental pollution policies. The higher degree of transparency and the sharing of responsibility required for LCM are not always welcomed by corporate managers. LCM is inevitably an exercise in partnership building. Corporate SCM identifies partners after the issues have already been defined. In the collaborative approach, the partnership is formed first around a generalized problem. The partners then develop more precise objectives and goals as a subsequent step, as was done by the FSC and the Cyanide Code. Even integrated government policy and regulation depends on consultation. However, partnership building is an inexact science, depending on human insight as much as on formal procedures, and the subsequent achievement of unity of purpose along the supply‐chain is no easy feat. It is no wonder that the negotiations on common objectives and procedures sometimes take several years. The above, together with a lack of standardization of the LCM technique, have led to a diversity of views about what LCM actually is, and how to do it. Along the way the notion of a complete life‐cycle sometimes becomes lost. There is also confusion about its relationship with other environmental management tools. The end‐result is that LCM has for the moment the standing of an umbrella concept for applying established environmental management tools, rather than as a rigorous standardized procedure in its own right. There is still much to do to promote and improve LCM at the level of individual value‐chains, and this has been the purpose of this chapter. Eventually a more fundamental issue to address will be the optimization of the entire production‐consumption system, the most complex life‐cycle management challenge of all. This is beyond the ability of the current LCM players to achieve individually given that it requires redesigning simultaneously a wide array of products, services, infrastructure and marketing procedures, and the resource
96
base upon which they rely. It will, in particular, require a much stronger consensus about our common sustainability goals. Building a new global production‐consumption system would necessitate more sophisticated LCA processes to identify the key factors at play. While Dfe and PSS would continue to play an important role, such system optimization will be impossible without new tools and instruments, making it important to develop additional LC management models that could function at this scale.
Synthesis and Conclusions As the global economy continually touches more countries, our environment is under increasing stress. Environmental management approaches too frequently look only at individual points of our (inefficient) production‐consumption chain, and many pollution abatement actions merely displace the problem to another section of the value chain. Sustainable development requires more widespread application of prevention‐oriented life‐cycle thinking, and more emphasis on optimizing the system as a whole. Life‐cycle assessment remains the most important analytical tool to pinpoint the key areas that need attention. Much effort by companies, governments and consumer groups has gone into standardizing and promoting its application. Life‐cycle management is not yet a standardized discipline; rather it is for the moment an umbrella framework for applying existing instruments and procedures in a more holistic way and creating management partnerships between upstream and downstream actors. A number of different models of LCM can be identified, each suitable for a particular type of situation. The most successful outcome occurs when a broad, multi‐stakeholder partnership with a formal management framework is established. Business and government need to make mutually complementary contributions to such a coalition, and ideally to all LCM initiatives. Until specific tools are developed for LCM, implementation still depends on the current set of environmental management tools that were originally developed for corporate use as, for example supply‐chain management, environmental management systems, and ‘green’ purchasing. The application, re‐orientation, and sometimes redevelopment, of these tools in a new LCM framework are major challenges for the current generation of managers who have grown familiar with a more limited range of applications. While company action on LCM currently has the most widespread application, it also depends on government life‐cycle policies and the setting of sustainable product standards. For the moment, most corporate LCM is aimed at improving individual products and company image. It does not have the mandate
97
to address the global situation of unsustainable production and consumption, nor the value‐chains of common commodity products in a global market. Governments have been slower to incorporate LCM aspects into their policies and regulations. Their limited geographical jurisdiction makes it difficult for them to address global value chains. Governments also face difficulties in reconciling different political interests along the life‐chain of products when they attempt to adopt a life‐cycle approach to regulation. Accordingly, they have focused more on information and coordination approaches. That said, there remain large, unrealized opportunities, as for example, in official procurement and purchasing policies. While not practising LCM as such, consumer groups are increasingly aware of life‐cycle impacts, the so‐called ‘world behind the product.’ They act mainly on a limited product‐by‐product basis, disseminating information and promoting consumer boycotts. This mechanism has nevertheless stimulated corporations to review more closely the life‐chain impacts of their entire range of products as a way of avoiding future adverse publicity or legal liability. Consumer and environmental NGOs also play a major role in cooperative LCM initiatives by helping to influence the sustainability objectives. Taken together, the above approaches have generally given encouraging results in improving the management in a number of clearly identified value chains, even if much remains to be done. Overall, we can see a growing acceptance by society that a more holistic life‐cycle approach is necessary to manage our global production‐consumption system. Different approaches are now being tried by various stakeholder groups, both independently and in the context of LCM partnerships and coalitions. While LCM is not yet a standardized discipline, it has undisputed value in guiding the application of current environmental management tools to arrive at results that cannot be achieved through the fragmented application we have seen in the past. Further work to enhance the effectiveness of LCM, including its eventual standardization, will add momentum to this encouraging trend.
98
99
Annex 1 Life‐Cycle Management instruments 1. Building LCM partnerships 2.Value‐chain analysis 3. Defining objectives and developing performance codes 4. Environmental management system (EMS) as framework for LCM. 5. Corporate social responsibility (CSR) 6. Supply‐chain management (SCM) 7. Product stewardship, or Extended producer liability (EPR) 8. Design for environment (Dfe) 9. Regulations, technical performance codes and Life‐cycle policies. 10. Technical assistance
This can be based on formal contracting procedures in SCM, or through a voluntary management coalition. End‐consumers are still often under‐represented. Provides the basis for prioritizing action and identifying key points in the value‐chain. Uses existing methodologies e.g. LCA, risk assessment etc. applied along the life‐chain. Provides direction and guidance to various LCM actions. Implies also monitoring, auditing and certification. EMS used to structure LCM actions, but also to assist in implementation as, for example, when used in accrediting partners and suppliers. Use community outreach procedures as a means of engaging with LCM stakeholders. SCM is already an established practice. To address sustainability issues comprehensively it needs to be applied further along the life‐chain, i.e. to ‘suppliers of suppliers.’ Procurement, purchasing, eco‐labelling, recycling, product advisory services etc. are among the actions directed toward the consumption end of the life‐chain. Enhances total performance of products, including supply chains. Product service systems (PSS) is a concept of providing services as alternatives to products. Not so far extensively applied as a life‐chain tool. Product liability legislation and integrated pollution and product policies are emerging but not yet binding. Not usually considered a ‘tool,’ but vital in assisting all the actors in the value‐chain to play their part and take effective supporting action (ref Responsible Care21).
21 The need for technical assistance to weaker partners was already acknowledged when the chemical industry’s worldwide Responsible Care program was launched (www.responsiblecare.org/). In their words, “mechanisms to
ensure an effective and robust Member Support network are fundamental to the further development and future success ……”
100
Chapter 5
Sustainable Palm Oil: The Promise and Limitations of Partnered Governance
Jordan Nikoloyuk, Tom R. Burns, and Reinier De Man
Introduction The rapid destruction on the world’s tropical rainforests has been an issue on the agendas of policy makers and NGOs for a long time. One strategy for saving the forests has focused on the link between tropical forests, and tropical timber and timber products. Unfortunately, forest and timber certification has only a very limited effect on protecting tropical forests. The main threat to tropical forests is not forestry but the conversion of forest to agricultural land, in our case case here, for the production of palm oil. For this reason, nature conservation organisations gradually widened their focus from promoting ‘sustainable forestry’ to fighting ‘forest conversion.’ In the late 1990s, the WWF developed its “Strategic Action on Palm Oil and Soy.” These two crops appeared responsible for the rapid conversion of the world's major virgin tropical rain forests and dry savannah forest (‘cerrado’). For the WWF, the connection between everyday consumer products (such as margarine and fats, found in thousands of products) and the destruction of the rainforest made palm oil a useful case study for focusing public attention. In 2002, the WWF (with the engagement of consultant de Man, one of the co‐authors of this chapter) mobilized industry actors to form the Roundtable on Sustainable Palm Oil (RSPO). The RSPO's sustainability aspirations were high from the outset: RSPO is an association created by organisations carrying out their activities in and around the entire supply chain for palm oil to promote the growth and use of sustainable palm oil through co‐ operation within the supply chain and open dialogue with its stakeholders1. The explicit vision and mission of RSPO became, respectively: 1) RSPO will assure that palm oil contributes to a better world, and 2) It will advance the production, procurement and use of sustainable oil palm products through:
1 http://www.rspo.org/Our_Aspirations.aspx
101
• the development, implementation and verification of credible global standards and,
• engaging stakeholders along the supply chain
The RSPO is an example of an emerging new governance model intending to further sustainable development. Government intervention was absent from deforestation caused by oil palm expansion. Attempts at international regulation faced possible World Trade Organization (WTO) action against improper trade barriers. The RSPO developed as consumer‐oriented businesses partnered with civil society organizations and palm oil producers to address a perceived long‐term threat to their financial interests. This chapter extends our earlier multi‐level analysis and critical assessment of partnered governance to develop the conceptualization and practice of sustainability governance (see De Man and Burns, 2006). It reviews several of the basic principles of the partnered governance model, outlines the case of RSPO in detail, and assesses that initiative’s accomplishments and disappointments. It concludes by suggesting ways in which partnered governance forms might be developed and made more effective.
Conceptual Framework Partnered Governance Sustainability implies a long‐term focus, in the sense of the sustainable development concept originally developed by the Brundtland Commission [1987]. Social and ecological development goals refer to the public rather than the private domain, entitling partnerships for sustainability to claim contribution to public goals, even where the partners are primarily private sector companies and NGOs. Partnered governance (also known as collaborative, or cooperative governance) refers to governance involving the cooperation of diverse social actors in regulation – in particular various private agents and sometimes public agents. These concepts became established in the new millennium. Glasbergen (2006) refers to a new partnership paradigm for governance2, “a project as well as a process.”3
2See Carson et al (2009) on the theory of public policy paradigms and their relation to the emergence and development of new governance forms. 3 Early developers of the concept of partnered governance in the USA were Zadek (2001, 2006), Radovic, Zadek, and Sillanpaa (2005), Donahue and Zeckhauser (2006); and in Europe, Balloch and Taylor (2001), Jonathan Greer (2001), Pieter Glasbergen (2005, 2007), and Atle Midttun (2008).
102
Increasingly, one observes partnerships involving companies and other agents in one or more sectors, for example, along a ‘supply chain.’ Examples of supply‐chain partnerships are found in several industry sectors; these include fisheries through the Marine Stewardship Council, forestry through the Forest Stewardship Council, and paper and wood suppliers to publishing companies, as examined by de Man and Burns (2006). Non‐governmental organizations (NGOs) often play a role in these partnerships, either as external watchdogs or auditors, or as full partners. Partnerships developing on multiple levels Partnership governance refers to an organizational form (or forms) of cooperation among different business players (enterprises) and other stakeholders in a sector or several sectors, e.g., a supply chain. Increasingly, there are environmentally or socially motivated NGOs who represent the ‘interests’ of ecology, workers, affected populations, etc. Such partnerships for sustainability imply that there is not only a business interest for the business partners, but also a gain in terms of the goals of the NGO partners, e.g. realizing social or ecological aims and standards. There are at least two levels and distinct forms of partnerships for sustainability:
1. The business to business (B‐to‐B) partnership, possibly with NGO involvement, in which different companies work together for producing a sustainable product, such as sustainable fishing or socially responsible paper or clothing production.
2. The industry to industry (I‐to‐I) partnership, in which groups of companies and/or industry associations from different sectors, e.g., phases of a supply chain, work together to realize (minimum standards) for sustainable products. Good examples are the Forest Stewardship Council (FSC, see [Cashore et al, 2004]) and the many different initiatives for ‘sustainable coffee’ (Potts, 2003) as well as our case study here, the RSPO.
Although this chapter examines only a particular case, the phenomenon of partnered governance is widespread and rapidly evolving. Why Partnered Governance? What are the Driving Forces? The growing number of ‘partnerships for sustainability’ may be explained by several distinct driving forces. In the first place, there is a general tendency towards diverse forms of cooperation, in particular, in supply chains (from very loose ad‐hoc coalitions to formalized joint ventures). A key force is the globalization of business activity and a tendency to outsource anything that is not
103
core business. While globalization and specialization contribute to lower costs and higher flexibility, they also create risks of a loss of control and a resulting weak quality control and an insecurity of products and supply. Examples can be found in many industries, including the food industry, where a lack of control over inputs (e.g. meat from BSE‐infected cows) produced significant health risks for consumers and a major loss of trust in the food industry (Carson et al, 2009). Different forms of cooperation between companies may be initiated in order to minimize such risks. Companies also increasingly face reputational risks (and decline in public trust), even if the end product is of irreproachable quality. Reputational risks may relate to issues of ecological or corporate social responsibility. Ecological and social NGOs know that large international companies and owners of top‐level brands are particularly vulnerable to criticism and they tend to target their campaigns towards these companies. The problems addressed may be upstream in supply chains and concern practices for which the companies do not have formal liability. Nevertheless, they are held accountable for these upstream operations and are driven to develop strategies to correct the behaviour of their suppliers. Often these problems occur in third world countries with weak (or weakly implemented) social and environmental policies. NGO criticism is often the trigger for action on the part of brand owners and consumer product manufacturers. The latter initiate cooperation with their suppliers and even form partnerships for solving environmental problems and establishing corporate social responsibility. Self‐Regulation through Cooperation In many cases, the role of government is either absent or indirect. It is not unusual that partnerships for sustainability are needed precisely because of a lack of government regulation, or extremely weak controls (see also Cashore et al., 2004). Supply‐chain partnerships try to independently establish their ‘license to operate’ by voluntary self‐regulation within the supply chain, seeking endorsement from respectable stakeholders. Currently, minimum standards for ‘sustainability’ of raw materials have been or are being negotiated in many different ‘I‐to‐I’ supply‐chain partnerships, as shown above in the section above. Setting up a Partnered Governance Structure: The Case of RSPO The RSPO was launched by WWF, engaging palm oil processing and trade companies, financial players, NGOs, and retailers and food manufacturers as well as consultants, among them: Aarhus United UK Ltd, Karlshamns AB (Sweden),
104
Golden Hope Plantations Berhad, Migros, Malaysian Palm Oil Association, Sainsbury's and Unilever (Netherlands). These actors were brought together by WWF in 2002,mediated by one of the authors of this chapter, Reinier de Man. Other active agents eventually (e.g. serving on the eventual RSPO's Executive Board) were Loders Croklaan (Netherlands), Pacific Rim Palm Oil Ltd (Singapore) and The Body Shop (UK). After several preparatory meetings, the First Roundtable meeting took place in Kuala Lumpur, Malaysia on 21 ‐ 22 August 2003 attended by 200 participants from 16 countries. On 8 April 2004, the Roundtable on Sustainable Palm Oil (RSPO), was formally established as a not for profit Swiss association. Initiators Within the WWF organization, WWF Switzerland was given the responsibility of developing concrete strategies for implementing the ‘Strategic Action on Palm Oil and Soy’.4 Reinier de Man, one of the authors of this chapter, who had already worked with WWF Switzerland on forestry and cotton issues, was asked to explore the possibilities for WWF‐private sector cooperation on setting a standard for sustainable palm oil. The Definition Phase The original idea of RSPO was to create a demand‐side coalition for sustainable palm oil. The Swiss supermarket chain ‘Migros’ had already defined their own standard and were sourcing ‘sustainable palm oil’ from Ghana. Unilever had laid a basis for their own sustainability criteria. Retailers could pressure suppliers to conform to a cross‐industry consensus on criteria and standards for sustainable palm oil. A retailer and manufacturer user group would dictate standards to producers. Divergence in Perceptions and Judgment Subsequent discussion revealed a number of divergent opinions, perceptions and strategies, evidently linked to differences in interests.
There was no consensus about the causal link between palm oil production and deforestation. According to Unilever’s analyses, oil palm could not be
4 WWF had already gathered substantial experience with implementing the Forestry Steward Council (FSC) (founded in 1993) and promoting FSC products through the so‐called Global Forest Trade Network (GFTN). There were some ideas to link the Palm Oil activities to the GFTN and to set up a certification scheme for palm oil according to the tried and tested FSC methodology. Others thought this would be too complicated and that GFTN would not have the capacity to do this.
105
held responsible for more than 10 to 15% of total deforestation in Indonesia. As the link between palm oil and deforestation was at the centre of WWF’s position, it was not possible to have an open discussion on this issue.
Unilever, as one the world’s largest palm oil consumers, became the most influential player during early stages of this initiative. From the outset, Unilever questioned the idea of a demand‐side coalition (‘palm oil user group’). They argued for carefully involving palm oil producers and producing countries in defining criteria and setting standards. Unilever’s approach was more or less followed in further roundtable development.
From the beginning of the initiative, the question arose, as to whether the goal should be to produce a separate ‘sustainable’ palm oil grade. There was a general feeling that there should be no substantial additional costs, for which consumers would be unwilling to pay (RSPO Executive Board minutes, late 2002).
By early autumn 2002, the character of the Roundtable on Sustainable Palm Oil had been largely defined. Setting up RSPO As a finalization of the different bilateral discussions and first step towards establishing RSPO, a meeting was held in September 2002, during which the Roundtable's ideas were discussed among retailers, manufacturers, banks and the WWF. There appeared to be sufficient support for setting up a roundtable. It had become clear then that the Roundtable should include both the demand and supply sides and that it should not be focused on a single issue (such as deforestation). It is to be noted that this initial, critical compromise was made in order to secure the support of major players, most notably Unilever. After the meeting in September 2002, the initiative was further developed in bilateral contacts between Unilever and the WWF with the involvement of consultant, de Man. The latter had developed the idea of setting up a so‐called Organizing Committee, responsible for setting up the first Roundtable on Sustainable Palm Oil and provide the necessary financial resources. It was agreed that all players in the supply chain, from oil palm growers to retailing outlets should participate. The participation of NGOs was also anticipated. The first meeting of the Organizing Committee took place at Heathrow Airport on January 30, 2003. Organizations present were, apart from Unilever and the WWF, two retailers (Sainsbury and Migros) and two consultant organizations (de Man & ProForest). It was regretted that participation by the palm oil
106
producing and processing industry had not yet been realised, though steps to include their interests had been made: contact was established with the Malaysian Palm Oil Association (MPOA), Malaysian palm oil company, Golden Hope, and Anglia Oils. MPOA and Anglia Oils joined the Organizing Committee not long after this meeting. During the process that followed, the involvement of the palm oil sector (both Malaysian and Indonesian) remained a main discussion topic and contact established with several key players. An outline for the August 2003 Roundtable meeting was in preparation. A Charter was cautiously formulated according to the goals and principles of the Roundtable, and did not contain any demanding obligations apart from a general commitment to a trajectory of continuous improvement. In the draft Charter, the Roundtable was presented as a business initiative of Unilever, Migros, Sainsbury’s, Anglia Oils/United Plantations, MPOA, and Golden Hope Plantation in cooperation with the WWF. Differences of opinion, already clear during the Autumn 2002 meeting, were not resolved in 2003. There was still no consensus about the character of the problem, particularly the quantitative link between oil palm development and deforestation. The Inaugural Roundtable Meeting and Setting up a Formal Structure The first Roundtable meeting took place in Kuala Lumpur on August 20‐21, 2003. It was organized by de Man in close cooperation with the Malaysian Palm Oil Association (MPOA) on the basis of the decisions made by the Roundtable Organising Committee. The Roundtable was attended by more than 200 people from 16 different countries. The program contained key‐note speeches by key players such as MPOA and the WWF. Break‐out sessions were held on several issues. Two issues were at the centre: a discussion of the so‐called Statement of Intent (the earlier “charter”) and studies conducted by the UK‐based consultancy ProForest that would lay the basis for development of future sustainability criteria. Following the First Roundtable, there was pressure from the MPOA and WWF to formalize the Roundtable and its governance structures. Contentious negotiations showed that palm oil industry representatives could not accept any model that would give or appear to give NGO’s a majority on an Executive Board. Finally, a compromise was reached, by giving producers and NGOs equal representation. The WWF had stressed the need for consensus decision‐making on the board. The proposal was accepted. Ironically, the majority issue, as stated by MPOA, was practically unimportant: any vote could block any future decision in the model that was adopted.
107
After the January 2003 meeting, the next steps were relatively straightforward. The RSPO was registered as a charity under Swiss law and set up its secretariat in Kuala Lumpur. Subsequently, the first board meeting took place. Unilever’s leading position was reaffirmed in the choice of the President (Jan Kees Vis from Unilever's top management). Other board members included representatives from the WWF, MPOA, palm oil companies and retailers (including Migros Switzerland). The Roundtable Meetings 2 ‐ 6 / Formulating the RSPO Criteria The work after the first Roundtable meeting was carried out during and between five subsequent Roundtable meetings. Working groups and committees were set up for defining principles and criteria for sustainable palm oil, for solving verification and certification issues and for discussing a number of technical issues, including the role of smallholders in the production of sustainable palm oil. The number of participants increased to 500+ from more than 25 countries and almost 100 members representing a third of all palm oil development. Important NGOs such as Oxfam, Conservation International and Indonessian NGOs participated (see Figure 1). At the 3rd meeting in November, 2005, the Roundtable adopted the “Principles and Criteria for Sustainable Palm Oil Production”: 8 Principles and 39 Criteria encompassing the economic, environmental, and social aspects of sustainable palm oil production. Saving the Forest Principle 7 addressed the “responsible development of new plantings.” Apart from requiring the necessary impact assessments before developing a new plantation, Criterion 7.3 explicitly forbade development of new plantations on primary forest or forest with high natural values. The main agenda for the years to come focused on the technical process of criteria definition and verification issues (including logistics and chain‐of‐custody issues). Although the Roundtable was diplomatically executed, the Principles and Criteria were speedily adopted, which was only possible by skating over details and could easily have led to serious conflicts and delays in the implementation process. Notable among such details were two issues: first, how to define whether a forest has ‘high natural value,’, and second, how to design a system that takes into account the special problems related to smallholders.
Figure 1. Participants in 5th RSPO Roundtable (Source: RSPO Summary of RT5 Results and Next Steps)
108
At the General Assembly after the 6th Roundtable, two significant resolutions were made to address early challenges. The first responded to NGO criticisms of the certification process, specifically the Greenpeace campaign discussed below.), by requiring RSPO members to demonstrate and publicize their criteria for compliance with new plantings before commencing any expansion. A second resolution addressed producers' concerns for the development of a market for certified oil, by requiring members of the RSPO to submit, and make public, their plans for sourcing sustainable palm oil, as well as the certification of plantations. By April 2004, the main principles for the RSPO’s development had been set, and the organizational arrangements made operational. These principles and rules corresponded roughly with many of the partnered governance arrangements established in other supply chains. A consistent set of game rules was emerging. Multi‐stakeholder participation was essential, with key players from the entire supply chain involved together with major social and environmental NGOs (global ‘cooperative’ brands including the WWF, CARE, and Oxfam) as partners. Elaborate governance structures and procedures emphasized norms of consensus rather than coercion; the stress was on negotiating differences and finding common positions and standards. Typically, a standard‐setting organization worked as a technical organization under the multi‐stakeholder umbrella. Variations between initiatives mainly concerned (a) the involvement of supply‐side agents, (b) the involvement of particular NGOs and other stakeholders, and (c) the governance rule systems. With respect to the RSPO, it may be concluded:
109
• Unilever holds the central position in the initiative. The WWF is leading on the part of NGOs. As a result of Unilever's strong position, palm oil interests became more prominent than in the original WWW model.
• The Malaysian and Indonesian palm oil industries hold a strong position in the initiative. Without their cooperation, no effective decisions can be reached.
• Rules for discussion and decision‐making were set: in addition to norms of consensus and balancing NGO and industry interests, game rules were diplomatic and process‐driven, rather than problem‐focused or driven by outcome.
• The process of constitution and operationalization has been slow. This is mainly a result of the consensus rule in decision‐making and bureaucratic forms of technical advisory work. High‐conflict issues are hidden in cautious formulations or postponed until a future date.
• The focus of the initiative is on palm oil as a food, rather than a source of energy. The bio‐fuels discussion gained currency after 2006 within as well as outside of RSPO.
• The supply‐chain issue focusing on the extent to which “sustainable palm oil” should be physically separated from the bulk commodity, remained on the agenda. Several options were open: segregated sustainable palm oil, different mass balance systems, and a system of certificate trading (not unlike the system for trading ‘green’ electricity).
How well is RSPO doing? Accessing and analyzing RSPO The RSPO was created to promote sustainable palm oil and to prevent the production of non‐sustainable palm oil. The reason for a private sector‐driven initiative was the weakness of local policies and their implementation. Had there been stronger laws and regulations in palm oil producing countries, and had these been implemented, then there would have been little need for the RSPO. Thus far, the RSPO has been an apparent success. It was established in a relatively short period of time. At the 3rd Roundtable Meeting in November 2005, Principles & Criteria (P&C) for Sustainable Palm Oil Production were adopted by RSPO. Programmes were initiated to provide a framework for verification, and certified palm oil is now available on the world market.
110
Partnered governance related to global commodity chains is emerging in other sectors and around other issues as well. Examples include child labour and consumer products from Asia, sustainability of timber; human rights issues surrounding metals produced in the Democratic Republic of Congo, coffee from Nicaragua, etc. A major factor favouring such new forms of governance is the weak or uninterested government in countries where these commodities are produced. Still, general questions must be asked about the strengths and weaknesses of such partnerships. As discussed earlier, major questions concern the effectiveness, efficiency, and legitimacy of ‘new forms of self‐regulation’, as discussed below (also, see De Man and Burns, 2006)). 1. Effectiveness Our first question is: how well are the principles and criteria, which have been created under the umbrella of RSPO, regulating the market? The first palm oil certification was awarded by the RSPO in August 2008, and eleven plantation companies have certified their operations in the past year. These companies produce a combined total of approximately 1.5 million tonnes of crude palm oil (CPO) annually, as well as a significant volume of palm kernel meal (PK) and palm kernel oil (PKO) used in industrial chemical production. Table 1: Certification of Palm Oil by Country and Company
Company Country Mills CPO (mt) PK (mt) PKO (mt)
United Plantations Berhad Malaysia 6 185,324 50195
New Britain Palm Oil PNG 4 257,338 62,181
Sime Darby Malaysia 5 209,444 51,46
Kulim Bhd Malaysia 3 88,914 24,943
Wilmar/PPB Oil Palms Malaysia 3 122,9 27,4
PT Musim Mas Indonesia 2 135 31,25 IOI Corp Malaysia 1 63 14,85
SIPEF/Hargy Oil Palms Ltd PNG 2 78,158 0 5,83
Cargil/PT Hindolie Indonesia 2 51,344 12,122
Kuala Lumpur Kepong‐KDC Malaysia 2 92 22
PT London Sumatra Indonesia 4 169,48 30,017 2,772
Total 34 1,452,902 326,42 8,602
Certification requires some of the largest plantation companies to set aside significant areas for conservation, sometimes through consultation with the NGO members of the RSPO. Sime Darby and Wilmar, for example, have each preserved
111
approximately 10% of their total planted areas (500,000 ha and 200,000 ha respectively). In most plantation companies, HCVA assessments, with the assistance of NGOs, have begun or are ongoing.5 Despite these successes, RSPO has faced a number of serious challenges to its effectiveness, in both the short and long‐terms.
o Some criteria, despite the thousands of man‐hours spent in meetings, are still weak, since they lack clear operational meaning.
o There are serious problems with implementing the criteria on the ground due to lack of knowledge, lack of motivation and often lack of good governance inside companies.
o Unfortunately, non‐certified palm oil can be sold without much difficulty, as there are sufficient food and energy markets (India, China, etc.), which will absorb any production.
Two of the major reasons for limited effectiveness are: (a) the criteria are weak and lack much precision, since they are the result of consensual negotiations; (b) the problem of market fragmentation. The most important political processes, which ultimately led to the RSPO as we know it today, took place between 2002 and 2004. The working process between 2004 and today was based on a stable agenda and a clear definition of roles. The process can be defined in terms of a multi‐stakeholder consultation process on “Principles & Criteria” and the technical instruments needed to implement the criteria both at the plantation level and in the supply chain. This formulation underlines the technical character of the initiative, leaving little space for discussion of its mission and underlying principles. It also suggests a reassuring degree of stability that may not be justified in the light of the serious legitimacy problems RSPO finds itself at the moment (see later discussion). The peace accomplished during the process between 2004 and
5 Perhaps most significant in the long‐term will be the effect that RSPO certification can have on yield improvement. The current average yield for palm oil on Malaysian and Indonesian plantations is between 3.0‐3.5 tonnes/ha. It is possible to more than double this, by adopting agricultural practices suggested by the RSPO principles and criteria (as well as other guidelines on efficient fertilization and pruning). Yields on some plantations are as high as 8.0 tonnes/ha. The standard can also reduce long‐term labor costs by providing better community relations and a more stable workforce. The benefits of improving management practices can therefore potentially mitigate the drive to expand plantations.
112
2008 may have been bought at the price of postponing rather than solving a number of serious interpretation and implementation problems. Criteria remain difficult to implement and audit. The RSPO has been able to introduce and strengthen transparency, long‐term planning, environmental responsibility, and good agricultural practices and labour management in many plantations. The commitment of producers to transparency and annual reporting alone has led to the constructive engagement with NGOs in numerous cases of potential issues. For example, in the case of the IOI Group’s planned expansion in Central Kalimantan, NGO participation in environmental assessments helped identify areas to preserve. Social criteria, though, have proven more problematic, as have those related to the development of new plantings. So far, the plantations that have certified have been mature and established ones. When companies have concessions to develop in forested areas, they have not been persuaded by the appeal of future RSPO certification. Changing the areas in which concessions are granted is beyond the power of the RSPO, and requires assistance from local and regional governments. The RSPO, and individual plantation companies, are unable to guarantee the long‐term state of land that is preserved. District heads can, and do, exclude forested land from concessions if the company is not adequately developing it. In addition, implementing the RSPO criteria in a relatively small part of the global market limits its impact considerably. These private sector initiatives for self‐regulation in the supply chain share an additional problem, given the complexity and heterogeneity of palm oil markets: how to avoid free‐riding. In the case of sustainable palm oil, for example, the standard for it may be accepted by a majority of the companies operating on the European market, but this is no more than 20% of world demand. Unsustainable plantations developed on freshly cut primary forest land can continue to supply growing markets in China and India. Price premiums are expected to drop as the supply of certified palm oil increases, and this can be seen currently.6 However, even with decreasing costs, the market for certified oil may not be sufficiently significant. Part of the problem for increasing demand is caused by the complexity of the certification system and the RSPO’s failure to effectively communicate about and market its certified product. The presence of technical experts in the Executive Board and on working groups has allowed the development of the principles and criteria to proceed
6 Currently, the RSPO can supply 100,000 tonnes of certified palm oil per month, and has certified approximately 1.5 million tonnes. According to WWF, however, only 15,000 tonnes have been traded as certified oil so far. This is partly due to the current price premium of about 20 USD/tonne, which is a barrier in an economic climate where any cost increases are to be avoided.
113
without much contention, but it has also meant that issues like marketing and branding, even in a business‐to‐business manner, have been ignored. The value of RSPO certification is simply not apparent to many demand‐side actors. Even if marketing and communication can make ‘sustainable palm oil’ more mainstream, the long‐term solution generally proposed is to introduce the standards, which are the result of private sector initiatives, into national legislation. In the case of palm oil, this implies that the main exporting countries, Malaysia and Indonesia, implement the RSPO standards into their national legislation. The RSPO ‘I‐to‐I’ supply chain initiative with NGO participation may then be seen as a precursor to legislation rather than as an alternative to government regulation. 2. Efficiency The efficiency problem must also be considered with respect to the implementation of the RSPO principles and criteria. Although the process of consensus rule and conflict avoidance has been slow, it has been endorsed by a significant proportion of actors in the palm oil chain. The slow development process has respected the fact that participants need time to become comfortable with the ideas being proposed. The collaborative dialogues that took so long have dramatically increased producer support of the system and helped the different actors feel some ownership of the criteria. While the process of creating criteria alone could perhaps have been done over a long weekend, creating a widely accepted global standard for an extensively traded commodity is a very different challenge. But it has led to years of delay, 6 years from the first discussions in WWF. 3. Legitimacy External and internal legitimacy must be distinguished. External Legitimacy The weaknesses of some of the criteria, the difficulties of implementation, and the perceived inefficiencies in the RSPO process (especially regarding deforestation) have led to the RSPO losing some credibility among NGOs. External NGOs, especially Greenpeace and Friends of the Earth, have launched campaigns against the RSPO process and individual RSPO members for their participation, including several of the NGO participants such as WWF and Oxfam. Greenpeace was one of the NGOs drawing attention prior to 2002 to the issue of deforestation in South‐East Asia, and remains critical of the RSPO process. It has published reports that especially target Unilever and Unilever suppliers, and
114
in 2008 investigated United Plantations, to determine the impact of the first RSPO certification. It concluded, for instance, that “United Plantation may have their RSPO certification of Malaysian plantations but continue with business as usual in their Indonesian concessions.” 7 Friends of the Earth, an international NGO, follows the double strategy of stressing the need for RSPO certified palm oil as a minimum standard and criticizing the RSPO for setting standards too low and for not sanctioning its members. FoE has also targeted the individual members of RSPO, such as Wilmar, for failing to follow their own internal standards. These criticisms caused problems for many individual members, as well as the RSPO project as a whole. The problem may have been compounded by the early failure of RSPO to constructively engage with external NGOs. The technical mindset of the RSPO members predisposed them to respond to this critique in a very technical manner and to dismiss their validity or relevance. Such technical responses from industry were not effective in building credibility in relation to “campaigning” NGOs taking a very strong stance against RSPO. The attacks from environmental NGOs are not seen as problematic by all members of the RSPO. The internal NGOs, such as Oxfam and WWF, see a very complementary role for external NGOs. The Greenpeace campaign against United Plantations was based on clauses in the RSPO system that internal NGOs negotiated, and the campaign helped WWF push for the creation of the new plantings working group, which may significantly resolve many issues of forest and HCV conservation, among other ways, by ensuring that proper documentation is in place before new plantings commence. A Greenpeace campaign against Dove has led to a similar result. Although Dove, through Unilever, has arguably done more than most other brands to promote sustainability in palm oil, the emotional nature of its brand advertising makes it very vulnerable to external criticism. In response to the campaign, Unilever joined several other companies in calling for a moratorium on Indonesian deforestation, signalling that it did not consider the current forest conversion and greenhouse gas criteria to be sufficiently strong enough (at least for purposes of legitimization).
7 In 2007, Greenpeace published a report called “Cooking the Climate” in which the role of RSPO was described in a very negative way, highlighting the negative role of oil palm plantations in destroying biodiversity and the climate. In the chapter “The RSPO Group of Friends”, the leading role of Unilever and its suppliers (Cargill, ADM‐Kuok‐Wilmar, Golden Hope, Sinar Mas) was critically assessed.
115
Internal Legitimacy The campaigns of external NGOs have been at least partly responsible for advancing the development of RSPO. The producers who helped found the RPSO in 2002 did so largely because of NGO campaigns about fires and deforestation in Southeast Asia. Now that the certification system of the RSPO is established, these negative campaigns may be seriously damaging the RSPO’s legitimacy among its members. Producers who largely joined the initiative to combat negative publicity now see the leading certified companies becoming targets for further attacks. Rather than the shelter they expected, RSPO has begun to be perceived as a way to be singled out for not complying with specified criteria. The problem is compounded by the lack of communication from the RSPO about its work. Negative NGOs dominate the discussion about palm oil. For producers not able to secure higher prices, and at the same time being subject to targeting by NGO campaigns, the payoff from RSPO certification is unclear. Those producers who have not joined the RSPO, or who have not yet certified their plantations, may be reluctant to do so. The legitimacy of the RSPO from the perspective of producers is being challenged. The resolution introduced at the sixth Roundtable, requiring time‐bound sourcing plans from members, may make the market more predictable and show explicit benefits. However, the RSPO must also begin communicating more about its product to increased legitimacy of and demand for it.
Conclusions: Power Aspects of Partnered Governance We may conclude that RSPO is effective in establishing minimum standards for growing palm oil, i.e. regulating plantation management. However, as argued above, there are a number of problems of effectiveness, efficiency, and legitimacy. A major argument for new forms of governance such as partnership governance has been an extremely weak or uninterested government in countries where many commodities such as palm oil are being produced, and there is in effect a “regulatory vacuum.” Increasingly, civil society organizations in consuming countries are mobilizing pressure for alternative means of regulation such as partnered governance along supply chains. As suggested by some of the discussion under legitimization, there are a number of power aspects: Power in the founding phase, differential power and marginalization conditions in given governance arrangements, and, in general, the role of power in the evolution of partnered governance.
116
Power Factors in the Founding Moments: The acute structural problem with such partnerships for sustainability is that their emergence and development depends typically on powerful players (de Man and Burns, 2006). These actors tend to search for partners that are highly organized and can play a decisive role in regulating the relevant supply chain(s). Results achieved are based on cooperation among large companies in coalition with typically large NGOs. Also, the start‐up transaction costs of dealing with many small partners are high. The successful development of supply chain partnerships for sustainability tends to involve then a high concentration of powerful agents and the marginalization of smaller and less powerful agents ( de Man and Burns, 2006). Generally speaking, this type of private governance can more readily be established when there are a few powerful agents who can take cooperative initiatives and shape the governance arrangements and their evolution (that is, exercise meta‐power (McGinty et al, 2009). Correspondingly, small or weak actors – whether businesses, NGOs, or other actors such as local communities – are effectively excluded from the development of partnered governance, though they may be recruited into the organization Power in RSPO’s Modus Operandi The unequal power distribution from the founding moments through the phases of consolidation and development operate to the disadvantage of weak or marginal groups – a form of “organizational bias.” This is clearly indicated by, RSPO’s inability to recognize or address smallholder issues. Thus, new sustainability standards tend to burden and to further marginalize many smallholders. Part of the delays in addressing smallholder issues are attributable to the fact that many of the large producers were not as interested in empowering individual growers as they were in addressing high‐public relations (PR) value issues like the death of the orangutan. At the same time, the involvement of NGOs in the RSPO process helped to legitimize it at the same time that many voices and opinions remained outside the process. During the development of RSPO, power structures changed as the markets for palm oil shifted drastically, mainly as a result of the rapid increase of demand from emerging countries such as China in particular, increasing oil prices, and bio‐fuels policies in a number of countries in the EU. With the soaring oil prices after 2000, bio‐diesel from palm oil became increasingly competitive, and consumer‐oriented organizations such as food manufacturers lost some of their
117
bargaining power, as fuel‐oriented companies came into, or assumed more prominent roles in the game. The power conditions and dynamic of partnered governance leave the system to a certain extent at the mercy of power drivers and developments; although there are potential normative countervailing powers (see below). Limitations and Potentialities While the RSPO’s system of partnered governance has many limitations, there are few real alternatives that have been nearly as successful in addressing this type of sustainability issue. Compared to some other partnered governance initiatives, the RSPO has been remarkably successful. The FSC, with its reliance on the demand‐side establishment of standards, has been unable to realize significant producer participation. The Roundtable on Responsible Soy has been divided by the issues of compensation and opportunity cost, which cannot be addressed by industry initiative alone. If the RSPO is among the most successful examples of this emerging model of governance for sustainable development, analysis points out that there are serious limitations of such stakeholder network governance. Compared to other sectors, the palm oil commodity chain is very concentrated, and smallholder interests can be and are typically neglected. In the meantime, private governance arrangements like that of RSPO contribute in several ways to the development of a normative order or type of normative power oriented to sustainability (as contrasted to purely economic or administrative power). The normative order gains in influence and effectiveness as more private and public stakeholders acknowledge it, join it (in its diverse forms), and participate in its various elaborations and developments.
118
References: Balloch, S. and Taylor, M. (eds.) (2001). Partnership Working. Bristol: The Policy Press. Brundtland, G. H. (ed.) (1987). Our Common Future: The World Commission on Environment and Development. Oxford: Oxford University.
Carson, M., T. R. Burns, and D. Gomez Calvo (2009) Public Policy Paradigms: The Theory and Practice of Paradigm Shifts in the EU. Frankfurt/Berlin/New York: Peter Lang Publishers.
Cashore, B, G. Auld and D. Newsom. (2004). Governing through Markets– Forest Certification and the Emergency of Non‐State Authority. New Haven: Yale University Press. Donahahue, J.D. & R. Zeckhauser (2006) "Collaborative Governance" In: Oxford Handbook of Public Policy. Oxford, NewYork: Oxford University Press. De Man, R. and T. R. Burns. (2006). “Sustainability: Supply Chains, Partner Linkages, and New Forms of Self‐Regulation.” Human System Management, Vol. 25, No. 1: 1‐12. Glasbergen, P. (2005). Partnerships for sustainable development. Promoting public goods through private actions. In S. van den Burg, G. Spaargaren & H. Waaijers (eds.), Wetenschap met beleid, beleid met wetenschap (pp. 207‐212). Wageningen: Swome/Gamon. Glasbergen, P. (2007). "Setting the scene: the partnership paradigm in the making." In P. Glasbergen, F. Biermann & A.P.J. Mol (eds.), Partnerships, Governance and Sustainable Development. Reflections on theory and practice (pp. 1‐27). Cheltenham, UK: Edward Elgar. Greer J, (2001). "Whither partnership governance in Northern Ireland?" Environment and Planning C: Government and Policy 19(5) 751 – 770 Midttun, A. ( 2008). "Partnered governance: aligning corporate responsibility and public policy in the global economy." Corporate Governance. Vol. 8, No. 4: 406 – 418
119
120
Groenenberg, R. (2001). "Environmental partnerships in sustainable energy." Journal of European Environmental Policy, 11(1), 1‐13.
McGinty, P., T. R.Burns, and P.M. Hall (2009) “Meta‐Power.” In: G. Ritzer (ed.) Blackwell Encyclopedia of Sociology. Oxford: Blackwell.
Midttun, A. ( 2008). "Partnered governance: aligning corporate responsibility and public policy in the global economy." Corporate Governance. Vol. 8, No. 4: 406 – 418 Potts, J. (2003). Building a Sustainable Coffee Sector Using Market‐e Role of Multi‐stakeholder Cooperation, IISD and UNCTAD, Geneva, Radovich, S., S. Zadek and M. Sillanpaa, (2005) Guidelines for Effective Partnership Governance and Accountability. London: AccountAbility Zadek, S. (2001) Endearing Myths, Enduring Truths: Partnerships between Business, Civil Society Organizations and Governments. Washington, D.C.: Business Partners for Development Zadek, S. (2006) "The logic of collaborative governance: corporate responsibility, accountability, and the social contract." Corporate Social Responsibility Initiative working paper No. 14. Cambridge, Ma.: Kennedy School of Government, Harvard University.
Chapter 6
Governing from the middle: the C40 Cities Leadership Group
Mikael Román
Introduction Both problems and solutions regarding climate change originate in the world's urban centers. Around the world, cities are developing municipal networks to meet the challenges of global warming. While different networks vary in both scope and purpose, together they challenge the notion that a global governance process, like the one pursued through the United Nations Framework Convention for Climate Change (UNFCCC), is required for efficient climate change policies (Betsill and Bulkeley, 2007). The situation is complicated as city networks use neither the top‐down policy of major international climate change negotiations nor the bottom‐up processes of social movements. Quite the contrary, municipal governments are established, formal authorities within their respective boundaries, which is a unique position, as they operate in close cooperation with the private sector and other interest groups. This creates the possibility for what we will call ‘governance from the middle’: city networks mediating complementary activities between a diverse set of actors. City networks govern in both the vertical and horizontal senses. They connect cities within established formal governance structures, such as regional and national governments (vertical). They also link the member city governments with other non‐state actors (horizontal). How does this operate de facto? What are the characteristics of ‘governance from the middle’? What are the potential prospects for and risks of such an arrangement? These are the two central questions that this study seeks to address. Our argument first discusses the characteristics and operation of the C40 Cities Climate Leadership Group (originally called the Large Cities Climate Leadership Group). The C40 network was created in October 2005 when Ken Livingstone, the mayor of London at that time, invited representatives from 18 cities to discuss collaborative measures to combat global warming. The meeting concluded with a joint declaration to take action in a number of areas, notably creating procurement policies for climate‐friendly technologies. Shortly thereafter, the C40 Group partnered with the William J. Clinton Foundation to use
121
the newly‐created Clinton Climate Initiative (CCI) as the implementing partner of the C40 Group. Through the CCI, the C40 Group engages in activities, including the following: expert assistance and technical help for cities; the development of tools to measure greenhouse gases; the sharing of best practices; and the creation of financial instruments to increase access to climate‐friendly technology. The C40 Group maintains several innovative characteristics, particularly the use of a third‐party implementation partner and the procurement policies. We will explore some premises of ‘governance from the middle’ both broadly, by applying our initial questions to the operation of the C40 Group, and specifically, by looking at its collaboration with the CCI. This analytical approach has some methodological problems. Most importantly, there is still a shortage of empirical data from and analyses of the C40 Group. We have thus extensively used newspaper articles, interviews, and Internet resources. We have also benefited from comments and conversations with representatives of the CCI. This exchange has been most useful and improved the discussion. Needless to say, the final, scholarly interpretation remains that of the author. In conclusion, this chapter cannot give a complete picture of the C40 Group’s activities or those in which it is involved. Instead, this chapter has the scholarly ambition of exploring questions of the circumstances in which this new governance structure emerged in response to new societal issues. In this case we are concerned with city networks and climate change. What are the characteristics of ‘governance from the middle’? What are the potential prospects and risks of such an arrangement? The central themes of this debate might provide important insights into the mechanisms of governance in networks of cities, which have long remained uncharted territory (Schreurs, 2008).
Theoretical Framework The notion of ‘governance from the middle’ rests on the view that city networks operate according to two different governance models. The first is the intergovernmental model of international policy, which focuses on national agreements between governments, and suggests top‐down policy implementation (Ruggie, 2004). This has been the dominant paradigm within climate change policy – and the one that the C40 Group has set out to challenge. This model can be contrasted with the grassroots mobilization model, which utilizes bottom‐up mobilization for policy change (Tilly et al., 2009, Ghai and Vivian, 1992, Castells, 1983). The latter model applies to the evolution of municipal networks insofar as it illustrates the direction in which certain initiatives
122
evolve. In its most elementary form, the city networks are ‘in the middle’ of these two processes. Yet, to establish what ‘governance from the middle’ means in practice, we have to raise three additional sets of questions. A first concerns state transformation and change. When cities engage in networks, they not only redefine their role as public actors but, by extension, also challenge the role of government as sole governing institution in society (Rosenau and Czempiel, 1992). Three analytical perspectives describe similar processes. One is multi‐level governance, which defines state transformation as either a vertical relocation of power between different levels of government or a horizontal transfer of political authority between state and various non‐state actors (Büchs, 2009, Betsill and Bulkeley, 2007, Hooghe and Marks, 2003). City networks have a unique position to govern from the middle by effectively operating in both vertical and horizontal directions. The second is policy network theory, which dismisses the traditional views of governance and emphasizes cities as strategic nodes in global networks. Through a concentration of knowledge, infrastructure and services, these networks manage, control and service global processes (Castells, 2002, Sassen, 2001). In contrast to multi‐level governance, this theory looks at governance from the middle as mediating between a diverse set of societal actors pursuing complementary activities. A third perspective is the scaling literature that raises critical questions regarding both the scope of the suggested state transformation and the role of cities in both global economy and state. The latter seems particularly relevant to climate change, which has transborder impacts and creates new spheres of governing authority (Bulkeley, 2005). A second critical aspect of municipal networks is how they govern de facto in areas related to urban climate policy. According to Bulkeley and Kern, there are four different governance modes (Bulkeley and Kern, 2006). First is to govern by authority through the use of traditional instruments, such as regulation and planning procedures. Second is self‐governance, which emphasizes the city as consumer to influence the city’s ability to address global warming. Similarly, cities can, as service providers, also govern by provision. As majority shareholders in local public services companies governments can influence decisions on large infrastructure investments. Finally, cities also govern through enabling, by cooperating with non‐state actors, which encourages voluntary activities among businesses and citizens. The C40 Group provides cities with additional leverage on each of the three last items. The critical instrument is the procurement process that allows the C40 Group to govern from the middle organizationally and
123
qualitatively. Consequently, this procurement model will be given particular attention in our discussion. Finally, there is the question of what activities municipal networks effectively govern. The suggested procurement process provides important insights by stressing a variety of distinct activities. Analytically, this can be described with a perceived value‐chain (Thai, 2009, Brickman and Ungerman, 2008).
The C40 Cities Leadership Group The emergence of the C40 Group is a story worth exploring. It provides an example of how cities are organizing themselves to confront global warming. Cities are gaining interest in climate change due to the growing awareness that cities as livelihoods, comprising the capabilities, assets and activities required for a means of living, are both contributing to and affected by global warming (Cahn, 2002). Local governments are critical political actors in the climate policy arena because they have considerable de facto authority over activities such as land use planning, public transportation, waste management and energy consumption, all of which affect GHG emissions (Betsill, 2001, Dodman, 2009). Similarly, city governments can initiate innovation and create sizable markets within a limited space (Rabe, 2002, Victor et al., 2005, Dodman, 2009). Thus they can take an active stance on both mitigation of and adaptation to climate change (Satterthwaite et al., 2007, IPCC, 2007, UNHABITAT, 2008). Organizational Structure Since its initial summit in 2005, the C40 Group has evolved in size and substance. The network currently has 40 official member cities from six continents,1 in addition to 16 observer cities attending most major meetings,2 representing more than 300 million people from industrialized and developing countries. It has the organizational structure of a traditional cities network: core members that meet regularly; a general assembly and board; and a small administrative unit for daily operations (Kern and Bulkeley, 2009). The main events are large, biennial summits (London 2005, New York 2007, and Seoul 2009). Between these meetings, the
1 The member cities are: Addis Ababa, Athens, Bangkok, Beijing, Berlin, Bogotá, Buenos Aires, Cairo, Caracas, Chicago, Delhi, Dhaka, Hanoi, Hong Kong, Houston, Istanbul, Jakarta, Johannesburg, Karachi, Lagos, Lima, London, Los Angeles, Madrid, Melbourne, Mexico City, Moscow, Mumbai, New York, Paris, Philadelphia, Rio de Janeiro, Rome, São Paulo, Seoul, Shanghai, Sydney, Toronto, Tokyo and Warsaw. 2 The observer cities are: Amsterdam, Austin, Barcelona, Basel, Changwon, Copenhagen, Curitiba, Heidelberg, New Orleans, Portland, Rotterdam, Salt Lake City, San Francisco, Seattle, Stockholm, and Yokohama
124
network also organizes workshops and conferences on specific topics. This work is led by the Group’s elected chairman (David Miller, also Mayor of Toronto), and the steering committee of nine representatives from member cities. Their work is supported by the C40 secretariat in London. It meets the criteria for a transnational city network by having: autonomy of member cities and voluntary membership; polycentric, horizontal and non‐hierarchical organizations; and decentralized cooperation between member cities (Kern, 2001). What distinguishes the C40 group from other city networks is an idea which goes straight to the heart of network theory. After the C40 Group realized that its ambitions exceeded its organizational capacity they partnered with the CCI, which became the implementing partner of the C40 Group (William J. Clinton Foundation, 2009a).3 The CCI works with partner cities on large‐scale projects for improving energy efficiency and reducing greenhouse gas emissions. The C40 Group assumed the role of coordinating member cities to govern by enabling. In this sense, the network promotes a horizontal re‐allocation of power between actors across national borders. Through its own network of corporate actors and different interest groups, the CCI extends the C40 network beyond the public realm. Activities and Content Politically, the C40 mayors advocate the role of cities in combating climate change. Practically, they take action within their cities to reduce GHG emissions. Through the C40’s own secretariat, they approve and organize workshops, conferences and summits and develop new work programs in areas such as adaptation and carbon finance (C40 Cities Climate Leadership Group, 2009). The Energy Efficiency Building Retrofit Program (EEBRP), first presented in May 2007 at the C40 Group’s Second Summit in New York, exemplifies the ambitions and rationale of the C40 Group. This program was designed to increase the global market for building retrofits (Revkin and Healy, 2007). Its underlying rationale, building largely on the business model the Clinton Foundation used for AIDS/HIV prevention, is to stimulate contracting, financing, and technology diffusion through a global procurement effort. The EEBRP operates largely as a matchmaking consortium managed by the CCI. On the demand‐side, assistance is provided to cities to procure services for large‐scale retrofit projects of buildings, provided they explicitly plan for emission reduction. On the supply side, large
3 The other initiatives are: Alliance for a Healthier Generation; Clinton Economic Opportunity Initiative; Clinton Giustra Sustainable Growth Initiative; Clinton Global Initiative (CGI); Clinton HIV/AIDS Initiative (CHAI); and Clinton Hunter Development Initiative (CHDI).
125
service providers and technology producers supply this potentially huge market of cities, provided they agree to follow global best practices and, in direct technology procurements, cut their prices substantially for climate‐friendly technologies. The cities and building owners are under no obligation to employ the services of companies introduced by the CCI, and final technology decisions are made independently. The exact terms for corporations’ participation in agreements with the CCI differ in each case, but the ambition is to create the necessary market conditions for new contracting models and products. Global Procurement as a form of Governance The EEBRP is instructive insofar as it illustrates how global procurement processes serve as a critical instrument for any effort to govern from the middle. Interestingly, it is also the centerpiece of another city network, ICLEI ‐ Local Governments for Sustainability, which even developed manuals for green procurement in areas of climate change (ICLEI ‐ Local Governments for Sustainability, 2009; Clement, 2007). One key way that the procurement process influences behavior in a system can be seen in the case of the EEBRP. Global procurement has the potential to link and thereby promote several distinct activities in a perceived policy process, or value‐chain. In this case, the procurement process is intended to support five different efforts. First, it helps cities to utilize a process called energy service performance contracting intended to identify and implement practical efficiency gains. For this purpose, the CCI collaborates with many of the world’s largest of energy service companies, or ESCOs, including (Honeywell, Johnson Controls Inc, Siemens and Trane (Kugler, 2007). Second, the EEBRP assists cities and ESCOs to find a financing model that allows them to undertake the implementation of large‐scale retrofit projects. CCI works with a number of commercial banks, institutional investors, international financial institutions and other capital providers to design financing programs and source capital. Third, the EEBRP administers a purchasing alliance, in which cities have access to CCI‐negotiated terms and prices from relevant technology producers. The EEBRP is currently developing projects in 16 of the C40 cities and with more than 30 different companies.4 The point here is that the procurement process becomes a tool to pursue certain activities. The suggested procurement effort is, in many respects, the centerpiece of the C40 group’s effort to govern from the middle. What is important to stress, though, is that for this to take place, procurement must be understood as a multi‐
4 The cities include: Bangkok, Chicago, Houston, Johannesburg, London, Melbourne, Mexico City, Mumbai, New York, Rome, São Paulo, Seoul, Tokyo and Toronto.
126
step process (i.e. selection of service provider, financing, purchasing and measuring) rather than a simple arrangement for purchase. By forging the horizontal and vertical links between various activities, the C40 Group can create this mechanism to govern from the middle. Building on this logic, it is an explicit ambition of the CCI to create standardized models and packages for procurement, contracting, project implementation, financing and measurement, which can be replicated and expanded into other mitigation areas, as well as climate change adaptation more generally (William J. Clinton Foundation, 2009d). The C40 Group in Relation to other Cities Networks and Processes The C40 Group is not the only cities network. Nor is it isolated from other top‐down governance structures. It is positioned within this context, which constitutes yet another aspect of ‘governance from the middle. There are several similar networks at all levels of global society. Some of these are intended for a particular national context, such as the National League of Cities in the US, while others, like the Asian Cities Climate Change Resilience Network, have a regional scope. In many cases, discussions regarding environmental governance are now also brought up in networks originally set up to serve broader objectives, such as the International Council for Local Environmental Initiatives (ICLEI). In other cases, concern about climate change has spurred the creation of new institutions specifically intended to meet the challenges of global warming. One example is the C40 Group; others include the World Mayors Council on Climate Change and the Cities and Climate Change Initiative (CCCI). One critical task of the C40 Group’s ambition to govern from the middle is how to relate to these other city networks. In some instances, this involves concrete collaborations around specific projects, such as the joint effort with the ICLEI to develop a web‐based emissions tracker tool (Project Two Degrees) (William J. Clinton Foundation, 2009e). On other occasions, it implies the coordination of activities and positions with other governance processes.
Prospects and Risks in Governing from the Middle
This discussion has provided several insights into how city networks govern from the middle. Our focus on the C40 Group does not tell the whole story, yet it allows us to make some critical observations. The first is that the ambition to govern from the middle probably requires some form of hybrid governance system that puts additional emphasis on market mechanisms, which may create new opportunities to involve non‐state actors in a collaborative effort. Second, it
127
emphasizes the need for a new type of coordinating role and, potentially, new organizational features of the network itself. The C40 Group has opted to have an independent foundation as an external implementation partner, but there may be other solutions. Finally, this new logic of governance also requires new procedures. The critical element in the case of the C40 Group is the comprehensive procurement process, which brings market logic more actively into the governance process, and potentially links various activities and actors together. The new set of societal challenges, in this case climate change, calls for new forms of governance. The process of developing and implementing new procedures and processes resembles a societal experiment in some ways, with both advances and occasional setbacks. This requires continuous, constructive rethinking of particular procedures on the part of the participants. To the scholar, it raises a new set of questions and issues.
In the following pages we discuss the daily operations of city networks. What are the potential prospects and risks facing city networks as they govern from the middle? Again, we use the C40 Group as an illustration of a more general phenomenon. The ambition is not so much to discuss the operation of the C40 Group itself, as to identify generic areas of interest that are critical for the effort to govern from the middle. Within the identified areas there are synergies and conflicts in practice that, for the scholar, generate further research questions. This exercise is a first step in the pursuit of a larger academic goal.
Managing the Relationship between Mitigation and Adaptation A critical issue that every city network will have to address is how to prioritize between activities aiming at the mitigation of GHG emissions and adaptation to the climate change that has already occurred. This decision is often pursued with great uncertainty and lack of prior knowledge. The CCI has, for its part, tried to make the most out of this situation by turning it into a learning process. Consequently, it began by focusing primarily on mitigation and energy‐related issues. The rationale is clear. Energy use is often directly linked to other local issues, such as air quality and human health. Hence the idea that working with energy efficiency would provide opportunities for learning once the network started to address more complex issues such as transportation and land‐use. According to CCI staff, the combination of project implementation and learning has been successful for the most part. There are, however, potential risks with this strategy. Most importantly, a one‐sided focus on energy efficiency, and other mitigation efforts, may alienate members in the network who see adaptation as their principal concern. A city government’s decision about pursuing energy‐efficiency policies will always be
128
contingent on other local needs. Nowhere is this more evident than in developing countries, where public officials, in addition to struggling with poverty and unemployment, have traditional local environmental concerns and must also address global warming (Holgate, 2007, Romero Lankao, 2007). Under these circumstances, climate change adaptation, rather than mitigation, is usually the overriding concern (Satterthwaite et al., 2007). Governing through markets: the global procurement process The second item in the effort to govern from middle is a mechanism that promotes action through markets. This is a critical component for achieving horizontal collaboration with the private sector and other non‐state actors. Although other city networks make this more or less explicit, it is a centrepiece of the C40 Group’s agenda. Procurement operates as a governance mechanism with an integrated view of sustainable planning and also establishes a baseline price that will have an impact on local purchase procedures. Yet, there are also several questions regarding the use of global procurement processes as a general strategy to confront climate change. In short, they seem to be effective in some situations but counter‐productive in others. I have highlighted five areas of concern related to procurement. The first is that some procurement processes may alienate member cities with specific technology needs. The focus on energy efficiency illustrates the point. While energy use and GHG emissions are often higher in industrialized countries, European and North American cities have more to gain from pooling demand for retrofit technologies than cities in developing countries (UNHABITAT, 2008). In light of this, the CCI has extended its activities into other areas, such as transportation and waste management where, according to representatives, it continues to have a varying degree of success, depending on technology and location. Second, there is a potential conflict between the suggested procurement process and individual cities’ desire to support local industry. Local producers are thereafter invited to participate in procurement where the Purchasing Alliance is playing a convening role. This is intended to create a dynamic in which CCI partners, who represent more expensive technologies, can compete at a price point more in line with their local counterparts. The owner of the building to be retrofitted is then free to analyze quality, price and local production through a matrix that gives equal weight to all three, as CCI plays no role in the final decision‐making process. The process might produce the effect of giving de facto preferential treatment to multi‐national corporations (MNCs) that already benefit
129
from economies of scale. In spite of open contracting procedures local industry, because not involved in the technology‐development process, might be made subject to a circumstantial penalty. The counter argument is that local companies are often able to “out‐price” global firms, because their means of production are closer to hand, significantly reducing costs of selling in local markets. The issue, it seems, needs further empirical analysis. Third, similar concerns can also be raised about how the suggested procurement process influences global competition between MNCs. The purchasing alliance is made up exclusively of Western – primarily North American – companies. Does the purchasing alliance have the tendency to reduce competition in this respect? More importantly, it also emphasizes the criteria by which companies are selected, and to what extent there may be a potential overlap of interests between Clinton Foundation donors and corporations participating in the CCI. It is noted, however, that the CCI is financially independent of the Clinton Foundation. Fourth, there are several important questions related to the procurement process as a vehicle for financing. Many of them reflect the evolving nature of the process itself. When the purchasing alliance was launched in May 2007, it started off with a set of standardized contractual models for commercial bank loans and money provided by five different banks (ABN AMRO, Citi, Deutsche Bank, JP Morgan Chase, and UBS) that each committed USD 1 billion as liquidity for the necessary investments (Bell et al., 2008, 2007). Since then, the number and types of financial partners for individual projects have expanded considerably to also involve local and regional banks, and non‐profit loan and grant providers, as well as development banks. Unclear is how exactly this dynamic works. What is the added value of procurement processes suggested by C40 Group in comparison to other financing modes, such as IMF‐backed bonds or various special‐purpose bonds? Fifth, it is not clear that procurement procedures are equally appropriate to support climate change adaptation. Mitigation and adaptation policies differ considerably. While mitigation concerns the protection of a global public good, adaptation is a more localized activity that does not lend itself to global targets. In practice, mitigation is better suited for top‐down policies, whereas adaptation more often requires a bottom‐up process (Klein et al., 2007). There are several actors outside the control of the procurement process itself that influence its effectiveness. One set of issues refers to the differences in local legal frameworks and their application. Many countries do not have clear environmental criteria in their procurement processes, and costs may therefore
130
be inferred on a short‐term gains rather than life‐cycle analysis. A similar argument goes for the design of budget systems. These observations emphasize the need to examine the qualitative aspects of procurement processes. One important distinction lies between procurement as a market‐based mechanism, incentivizing action, and its role as an organizing principle for a purchasing process more generally. Regarding the former, procurement processes are not always able to respond to the varying degree of market incentives in different policy areas. Instead, it seems particularly suited to incremental changes in technology, especially in areas where markets are clearly defined and co‐benefits easily discernible. The Unintended Consequences of Assessment and Evaluation A third issue that any city network operating in the area of climate change will have to address is the question of assessment and evaluation. The C40 Group is currently developing a web‐based emissions tracker tool called ‘Project Two Degrees” through the CCI, and in collaboration with ICLEI and corporate actors such as Microsoft and Ascentium (Project Two Degrees, 2009). The effort complies with the emphasis given to science as a basis for sound climate policies (Broder and Wald, 2009, Holgate, 2007). This measurement system will enable comparisons regarding the efficiency of different local policies and thus support both educational programs and accountability. There are, though, serious considerations related to the use of assessment data as a basis for policy‐making. In fact, quantifying greenhouse gas emissions at the urban or local scale is an exercise fraught with methodological and technical difficulties, principally related to ‘boundary problems’ and issues of scale. Cities’ contribution to global anthropogenic GHG emissions is, for example, often overstated (Dodman, 2009). Rather than making up for 75‐80 per cent of global emissions, cities probably emit between 30 and 40 per cent. Similarly, aggregate data miss the large variation between and within cities. The latter observation is particularly disturbing since consumption patterns, rather than any regional variation, are what really drive climate change (Satterthwaite, 2008). A focus on second and third tier data alters some of the basic assumptions regarding cities and climate change with considerable implications for policy. Industrial production, for example, more often occurs outside cities, as do energy and food production. Similarly, urban residents actually spend less energy per capita in transportation than their rural counterparts. These observations do not in any way reject the role of cities in meeting the challenges of global warming. However, they emphasize the need for more thorough socio‐economic analyses regarding the causal pattern driving GHG emissions. The point here is that a
131
single‐handed focus on aggregate emissions may generate misunderstandings about local drivers for action as well as the various co‐benefits that may occur for both mitigation and adaptation (Satterthwaite, 2008). The Independent Implementer: the Role of the CCI One particular trait of the C40 Group is the choice of the CCI as an external implementing body responsible for coordinating the network’s activities. This arrangement, with a high‐profile, non‐profit organization operating as a third‐party broker for a global procurement process, is critical to the network’s ability to govern from the middle, and has provided several opportunities for both networking and increased legitimacy. Most importantly, the CCI has been able increase visibility and therefore the network’s ability to act overall. Moreover, through the CCI’s flexible organization, including a highly motivated and competent staff, the network has avoided many problems of administrative inertia. There are, though, some potential problems with the CCI’s position, including the potential clash between various organizational agendas. The CCI is the ‘implementing partner’ of the C40 Group. Though linked to the Clinton Foundation, it is financially independent. The CCI has its own climate agenda that emphasizes clean energy and forestry as strategic areas, in addition to the cities agenda. There is also an implicit intention to extend these efforts. The CCI also works with cities outside the C40 Groups (William J. Clinton Foundation, 2009c). In its role as implementing partner, the CCI retains considerable de facto influence over several decision‐making processes. This is not necessarily a bad thing; indeed, it could be a precondition for action within highly complex governance structures involving numerous interests, such as those of the C40 Group. Yet, there remains a potential conflict between different organizational agendas. A more complicated issue relates to the influence of carrying a high‐profile name. Clearly, acting in the name of a former US President holds both advantages and problems. On the positive side, it allows CCI to act with a clear agenda and considerable clout. At the same time, it may also limit the selection of partners. An initiative backed by a ‘Clinton Foundation’ is probably more likely to engage US companies than an ‘Angela Merkel Foundation’ that would be more interesting to European firms, for example. Finally, the administrative arrangement with a third‐party implementer for a global city network raises questions about transparency. There is relatively little documentation available to the outside world from the CCI and C40 regarding commercial activities. Most of the material is comprised of general presentation of the agenda and presentations from workshops. This is largely a
132
function of the regulatory tradition guiding non‐profit organizations in the US. The CCI states that it has never received any money from organizations it has negotiated with. Managing the Structural Asymmetries between Member cCties ‘Governing from the middle’ also implies close collaboration between member cities. This relationship operates in both directions and involves both opportunities and risks. On the one hand, cities are critical for network efficiency, providing administrative resources or policy implementation. However, the ability of individual cities to assist the network is often hampered by institutional mismatches, a shortage of human resources, or the lack of financial resources (Betsill, 2001, O’Meara, 1999). Given circumstances such as financial resources and administrative corruption, the C40 network may play a positive role by supporting internal processes, providing informational support and bringing in financial resources and sounder business practices (Motta, 2004). On the other hand, such structural asymmetries within the network may adversely affect the efficiency of the governance system as a whole.
Conclusion This chapter began with the goal of discussing ways in which cities across the globe have begun organizing themselves in networks to meet the challenges of global warming. This emerging trend is both practically and conceptually intriguing: It suggests “governance from the middle” that challenges many of the conventional ways of implementing policy. In order to understand what this entails in practice, we raised two questions: What are the characteristics of ‘governance from the middle’? What are the potential prospects for and risks of such an arrangement? Our discussion has analyzed the experiences of the C40 Group, an emerging global network of cities specifically created to meet the challenges of global warming. Our observations have given some generic requirements for governing from the middle. First, it probably requires a hybrid governance system that puts emphasis on market mechanisms. Second, this calls for a new coordinating role for the network itself. Finally, the new logic of governance also requires new procedures that put this market logic into operation, and facilitate networking. In the case of the C40 Group, the CCI as an external implementation partner and the integrated procurement process fulfil the latter two requirements. Some of the C40 Group’s recent achievements vouch for the network’s success. Within just a few years, the CCI has managed to initiate more than 250
133
energy efficiency building retrofit projects in 20 cities; develop waste management programs in Delhi, Lagos and Houston; support renewed transportation systems in Johannesburg, Mexico City, and São Paulo; and develop Clean Energy and Forestry programs in Australia, the United States, Kenya and Indonesia (William J. Clinton Foundation, 2009b). However, experience also reveals potential problems related to capacity problems, the potential lack of transparency in certain areas, as well as clashing judicial frameworks. What makes governance from the middle as implemented by the C40 Group so compelling is the ambition to promote the ‘drivers for action’ rather than focusing on meeting specific needs. This is where the ‘governance from the middle’ model makes its most important conceptual contributions. There are also considerable practical consequences. Apart from stimulating local action, the procurement process provides also an integrated view on sustainable planning, by providing analytical, technical and informational support throughout the process. Yet, as our analysis has indicated that the critical task ahead is to identify under what circumstances it is a viable option. Similar market‐oriented procedures may provide the necessary link between global and local levels, often missing in transnational city networks (Keiner and Kim, 2007). These final observations also set a course for future discussions on what ‘governance from the middle’ means in practice. Recently, partnerships between public and private actors have been recognized as critical in the fight against global warming. The question now is how to support and expand these efforts.
134
References
(2007) "President Clinton announces worldwide retrofit initiative". Engineered Systems Vol. 24, No. 7, pp. 62.
Bell, W., Buckley, D., Fong, I., Frere, T., Karrer, L., Reddy, Y. K. S., Sun, W., Vishwakarma, B. & Yu, R. (2008) Financing energy‐efficiency building retrofits on campus: A menu of options for New York City schools In the PlaNYC 2030 Challenge, School of International and Public Affairs, Columbia University, New York, NY.
Betsill, M. (2001) "Mitigating Climate Change in US Cities: opportunities and obstacles". Local Environment Vol. 6, No. 4, pp. 393‐406.
Betsill, M. & Bulkeley, H. (2007) "Looking Back and Thinking Ahead: A Decade of Cities and Climate Change Research". Local Environment Vol. 12, No. 5, pp. 447‐456.
Brickman, C. & Ungerman, D. (2008) "Climate change and supply chain management". The McKinsey Quarterly. July 2008. Available from http://www.mckinseyquarterly.com (accessed 29 july, 2008).
Broder, J. M. & Wald, M. L. (2009) "Big Science Role is Seen in Global Warming Cure". NY Times, New York, 12 February 2009. Available from http://www.nytimes.com/2009/02/12/us/politics/12chu.html?ref=science (accessed 13 February, 2009).
Büchs, M. (2009) "Examining the interaction between vertical and horizontal dimensions of state transformation". Cambridge Journal of Regions, Economy and Society, pp. 1‐15.
Bulkeley, H. (2005) "Reconfiguring environmental governance: Towards a politics of scales and networks". Political Geography Vol. 24, pp. 875‐902.
Bulkeley, H. & Kern, K. (2006) "Local Government and the Governing of Climate Change in Germany and the UK". Urban Studies Vol. 43, No. 12, pp. 2237‐2259.
C40 Cities Climate Leadership Group (2008) "C40 Tokyo Conference on Climate Change ‐ Adaptation Measures for Sustainable Low Carbon Cities". C40 Cities, Available from http://www.c40tokyo.jp/en/ (accessed 6 June 2009).
135
C40 Cities Climate Leadership Group (2009) "Initiatives". C40 Cities, Available from http://www.c40cities.org/initiatives/climate‐positive.jsp (accessed 30 October 2009).
Cahn, M. (2002) "Sustainable Livelihoods Approach: Concept and Practice". Paper presented at the Devnet Conference 2002 ‐ Contesting Development: Pathways to Better Practice, Palmerston North, New Zealand, 5‐7 December.
Castells, M. (1983) The city and the grassroots: a cross‐cultural theory of urban social movements, University of California Press, Berkeley.
Castells, M. (2002) "Local and Global: Cities in the Network Society". Tijdschrift voor Economische en Sociale Geografie Vol. 93, No. 5, pp. 548‐558.
Clement, S. (Ed.) (2007) The Procura+ Manual: A Guide to Cost‐Effective Sustainable Public Procurement, Freiburg, ICLEI – Local Governments for Sustainability.
Dodman, D. (2009) "Blaming cities for climate change? An analysis of urban greenhouse gas emissions inventories ". Environment & Urbanization Vol. 21, No. 1, pp. 185‐201.
European Environment Agency (EEA) & United Nations Environment Program (UNEP) (2007) Sustainable consumption and production in South East Europe and Eastern Europe, Caucasus and Central Asia: Joint UNEP‐EEA report on the opportunities and lessons learned, EEA, Copenhagen.
Ghai, D. P. & Vivian, J. M. (1992) Grassroots environmental action: people's participation in sustainable development, Routledge, New York.
Holgate, C. (2007) "Factors and Actors in Climate Change Mitigation: A Tale of Two South African Cities". Local Environment Vol. 12, No. 5, pp. 471‐484.
Hooghe, L. & Marks, G. (2003) "Unravelling the central state, but how? Types of multi‐level governance". American Political Science Review Vol. 97, No. 2, pp. 233‐243.
ICLEI ‐ Local Governments for Sustainability (2009) "EcoProcura 2009: Climate Neutral through Procurement". ICLEI ‐ Local Governments for Sustainability, Available from www.iclei.org/ecoprocura2009 (accessed 4 June 2009).
136
IPCC (2007) "Summary for Policymakers". In PARRY, M. L., CANZIANI, O. F., PALUTIKOF, J. P., VAN DER LINDEN, P. J. & HANSON, C. E. (Eds.) Climate Change 2007: Impacts, Adaptation and Vulnerability. Contribution of Working Group II to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge.
Kamal‐Chaoui, L. (2009) "Competitive Cities and Climate Change: an Introductory Paper". Paper presented at the OECD Conference "Competitive Cities and Climate Change", Milan, Italy, 9‐10 October, 2008 2009.
Keiner, M. & Kim, A. (2007) "Transnational City Networks for Sustainability ". European Planning Studies Vol. 15, No. 10, pp. 1369‐1395.
Kern, K. (2001) "Transnationale Städtenetzwerke in Europa". In SCHRÖTER, E. (Ed.) Empirische Policy‐ und Verwaltungsforschung: Lokale, nationale und internationale Perspektiven. Leske + Budrich, Opladen.
Kern, K. & Bulkeley, H. (2009) "Cities, Europeanization and Multi‐level Governance: Governing Climate Change through Transnational Municipal Networks". JCMS Vol. 47, No. 2, pp. 309‐332.
Klein, R. J. T., Huq, S., Denton, F., Downing, T. E., Richels, R. G., Robinson, J. B. & Toth, F. L. (2007) "Inter‐relationships between adaptation and mitigation". In PARRY, M. L., CANZIANI, O. F., PALUTIKOF, J. P., VAN DER LINDEN, P. J. & HANSON, C. E. (Eds.) Climate Change 2007: Impacts, Adaptation and Vulnerability. Contribution of Working Group II to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change. Cambridge University Press, Cambridge, UK.
Kousky, C. & Schneider, S. H. (2003) "Global climate policy: will cities lead the way?" Climate Policy Vol. 3, pp. 359‐372.
Kugler, S. (2007) "16 Cities to Get Financing to 'Go Green'". Associated Press Online, 17 May 2007. Available from LexisNexis (accessed 14 December, 2008).
McEvoy, D., Lindley, S. & Handley, J. (2006) "Adaptation and mitigation in urban areas: synergies and conflicts". Municipal Engineer Vol. December, No. ME4, pp. 185‐191.
Motta, R. S. d. (2004) "Analyzing the Environmental Performance of the Brazilian Industrial Sector". Rio de Janeiro: IPEA.
137
O'Meara, M. (1999) Reinventing Cities for People and the Planet, Worldwatch Institute, Washington DC.
OECD (2007) Improving the Environmental Performance of Public Procurement: Report on Implementation of the Council Recommendation (ENV/EPOC/WPNEP(2006)6/FINAL), OECD, Paris.
Project Two Degrees (2009) "Project Two Degrees". Available from http://www.project2degrees.org/Pages/Default.aspx (accessed 30 October 2009).
Rabe, B. G. (2002) "Greenhouse & Statehouse: The Evolving State Government Role in Climate Change". Washington, DC: Pew Center on Global Climate Change.
Rabe, B. G., Román, M. & Dobelis, A. N. (2005) "State Competition as a Source Driving Climate Change Mitigation". New York University Environmental Law Journal Vol. 14, No. 1, pp. 1‐53.
Revkin, A. C. & Healy, P. (2007) "Coalition to Make Buildings Energy‐Efficient". NY Times, New York, 17 May 2007. Available from http://www.nytimes.com/2007/05/17/us/17climate.html?_r=1&scp=1&sq=Coalition%20to%20Make%20Buildings%20Energy‐Efficient&st=cse (accessed 14 March, 2009).
Romero Lankao, P. (2007) "How do Local Governments in Mexico City Manage Global Warming?" Local Environment Vol. 12, No. 5, pp. 519‐535.
Rosenau, J. & Czempiel, E.‐O. (Eds.) (1992) Governance without Government: Order and Change in World Politics, Cambridge, Cambridge University Press.
Ruggie, J. G. (2004) "Reconstituting the Global Public Domain — Issues, Actors, and Practices". European Journal of International Relations Vol. 10, No. 4, pp. 499‐531.
Sassen, S. (2001) The global city: New York, London, Tokyo, Princeton University Press, Princeton, N.J.
Satterthwaite, D. (2008) "Cities’ contribution to global warming: notes on the allocation of greenhouse gas emissions". Environment & Urbanization Vol. 20, No. 2, pp. 539‐549.
138
Satterthwaite, D., Huq, S., Pelling, M., Reid, H. & Romero Lankao, P. (2007) Adapting to Climate Change in Urban Areas: The possibilities and constraints in low‐ and middle‐income nations, IIED, London.
Schreurs, M. A. (2008) "From the Bottom Up: Local and Subnational Climate Change Politics". The Journal of Environment Development Vol. 17, No. 4, pp. 343‐355.
States News Service (2008) "Highlighting urban dimension at global climate change talks". States News Service, Nairobi, 27 November 2008. Available from LexisNexis (accessed 18 February, 2009).
Thai, K. V. (2009) International handbook of public procurement, CRC Press, Boca Raton, FL.
Tilly, C., Wood, L. J. & Tilly, C. (2009) Social movements, 1768‐2008, Paradigm Publishers, Boulder.
UNDESA (2008) "Public Procurement as a tool for promoting more Sustainable Consumption and Production patterns ". Sustainable Development Innovation Briefs, No. 5.
UNDESA (2009) "The Marrakesh Process: Sustainable Public Procurement". UNDESA, (accessed 30 October 2009).
UNHABITAT (2008) State of the World’s Cities 2008/2009: Harmonious Cities, Earthscan, London.
Victor, D. G., House, J. C. & Joy, S. (2005) "A Madisonian Approach to Climate Policy". Science Vol. 309, pp. 1820‐1821.
William J. Clinton Foundation (2009a) "About The Clinton Foundation". Available from http://www.clintonfoundation.org/about‐the‐clinton‐foundation/ (accessed 8 October 2009).
William J. Clinton Foundation (2009b) "Clinton Climate Initiative Accomplishments". Available from http://www.clintonfoundation.org/what‐we‐do/clinton‐climate‐initiative/what‐we‐ve‐accomplished (accessed 7 October 2009).
William J. Clinton Foundation (2009c) "Combating Climate Change: Clinton Climate Initiative". Available from http://www.clintonfoundation.org/what‐we‐do/clinton‐climate‐initiative/ (accessed 25 March 2009).
139
140
William J. Clinton Foundation (2009d) "Our Approach". Available from http://www.clintonfoundation.org/what‐we‐do/clinton‐climate‐initiative/our‐approach/ (accessed 7 October 2009).
William J. Clinton Foundation (2009e) "Project Two Degrees". Available from http://www.project2degrees.org/Pages/default.aspx (accessed 29 October 2009).
Chapter 7
Governance Arrangements for Sustainability: A Regional Perspective
Philippe C. Schmitter
Introduction At the time the Brundtland Report on Sustainable development was published (WCED; 1987), the obvious assumption was that this was the task of politicians acting in the name of sovereign national states who would enter into intergovernmental treaties with each other. Since the scope of most of the problems being addressed was global, it was further assumed that these treaties should be as comprehensive as possible and this implied a privileged role for the United Nations and its specialized agencies. And, indeed, the Report seems to have served as a stimulus for the convocation of a number of global conferences at which such treaties were drafted—and it continues to do so, (the latest being the Cop 15, the United Nations Climate Change Conference in Copenhagen in December 2009). The signatories to these draft conventions were supposed to ratify them promptly and implement them faithfully according to the well‐established doctrine of pacta sunt servanta. The ensuing 20 years have demonstrated that this strategy is flawed. Some countries sign treaties, but do not ratify them – including major countries like the United States. Others do ratify, but do not comply with their obligations. And not a few just sit on the fence until the treaty outcome has become clearer. Global summits and treaty negotiations continue to be held, but with reduced expectations. Fortunately, world politics have changed dramatically since Brundtland. Features that were barely discernable in the mid‐1980s have become major trends. A large number of autocratic governments have collapsed and been replaced by democratic ones. Non‐state actors have grown in importance and now routinely transcend national confines; domestic publics have become aware of and are being mobilized around foreign issues as never before (Ruggie 2004); globalized corporations have acquired resources superior to all but a few sovereign states and are operating simultaneously and relatively autonomously in many of them; trans‐national scientific communities have formed around a multitude of specialized issues and are exerting more influence on policy‐making
141
at all levels of territory; the cost of international communication and transportation has fallen precipitously; massive flows of persons across national and continental boundaries have revealed how difficult it has become for governments to control even a core element of their sovereignty; a permissive ideology of laissez‐faire and laissez‐passer in goods and services (but not people) has proliferated far beyond its previous Anglo‐American liberal heartland. Finally, the multiple and complex issues involving sustainable development have become more salient to mass publics – and better supported within and across scientific communities. In other words, the generic argument in Brundtland that sustainability should be considered an urgent concern that transcends existing national borders and overwhelms present state capacities has been won. What is needed is a common strategy that takes into account the complexity of the problem and the momentous political changes of the past twenty years. When proposing such a strategy, we should not be under the illusion that all will agree with it just because, ultimately, all will benefit from it. Achieving sustainable development in the future will be a struggle, if only because existing unsustainable development generates very unequal costs and benefits in the present and will continue to do so during any foreseeable transition period. And those who benefit the most are frequently those who are best entrenched in national and sub‐national political units. Europeans have acquired additional reasons for being optimistic about political sustainability during this same period. The Single European Act in 1987 set a deadline of 1992 for the completion of the internal Market and increased the number of policy areas in which qualified majority voting would apply within the (then) EC. It also explicitly declared for the first time that “environmental protection requirements shall be a component of the Community’s other policies” (Art. 130R) greatly strengthening the role of the Commission’s Environmental Directorate (DG XI) and the treaty notably provided a specific “backchannel” for deciding on such measures by qualified majority (Art. 100A). Admittedly, the EU had already been active in setting standards in this field – it began to do so as early as 1967 and by the mid‐1980s 120 such directives had been agreed upon – but its formal incorporation provided a new momentum among member governments and secured the legal basis for action by both the Commission and the European Court of Justice. According to one accounting the EU had produced no less than 450 environmental regulations by 1992. Public opinion data from the Euro‐barometer survey in all member countries has consistently demonstrated
142
that protecting the environment is considered by mass publics to be one of the most important objectives that they expected the EU to tackle.1 Perhaps, even more important from the perspective of political sustainability, has been the much less formal development of a method for dealing with the inevitable interest conflicts surrounding the setting of such standards. The EU is not – and may never be – a sovereign national state. Its government, the Commission, cannot call upon its own monopoly of organized and legitimate violence to enforce its decisions, much less rely upon its coincidence with a distinctive and over‐arching identity. It lacks the elementary financial resources derived from the power to tax and it has only very limited human resources given the small number of its employees. The sustainability of its decisions depend, first, upon the reasonableness of these decisions and, second, upon the willing cooperation of national civil servants, police officials and judges in implementing and monitoring them. In other words, the EU cannot govern in the traditional sense of the hierarchic application of authority and punishment of violators .2 The European Union (EU) offers an interesting arena for sustainability oriented governance entrepreneurship. The EU cannot govern in the traditional sense of the hierarchic application of authority and punishment of violators, like a consolidated nation state. To overcome this deficit, it has developed an elaborate practice and a normative justification for itself as a “multi‐layered and poly‐centric system of governance” that may contain interesting lessons for international governance for sustainability going forward. None of the world’s other regional institutions – MERCOSUR, ASEAN, CIS, OAS, AU and over a hundred other acronyms – deserve this label. At best they are instruments for regional cooperation, not integration. EU’s multi‐layered and poly‐centric system of governance has several characteristics: it is governance rather than government; it is partial rather than comprehensive, and it is regional rather than global.
1 According to a Eurobarometer survey published in March 2008, two thirds of all respondents preferred that policy decisions about the environment be taken at the European level. http://env‐health.org/a/2861/ accessed on 22 July 2009. 2 "Examining the Present Euro‐Polity with the Help of Past Theories", in Gary Marks, Fritz Scharpf, Philippe C. Schmitter and Wolfgang Streeck, Governance in the European Union, (London: Sage Publications, 1996), pp. 1‐14.
143
Governance rather than Government Governance works not through formal monopolistic institutions exercising ultimate authority over a specified territory, i.e. states, but through informal arrangements of actors exercising some degree of control over diverse functions, i.e. networks. Such arrangements are open to participation by different types of actors – public and private, profit and non‐profit, national and trans‐national, expert and amateur, producer and consumer, large and small – who have been identified and have accepted each other as “stakeholders.” What these actors have in common is an enhanced awareness of interdependence. They have conflicting objectives, but depend sufficiently upon each other so that no one can simply impose a solution on the other; and all would lose if no solution were found. They know that their respective contributions are needed to varying degrees if some problem is to be solved or some public good is to be produced. Moreover, they also know that the solution cannot simply be bought in the market or commanded by the government. These other two mechanisms of distribution would normally be preferred on practical or ideological grounds, but thanks to either market failure or state failure (or both), “second best” more complex governance solutions becomes the best ones. It is precisely their informality in both composition and operation that makes governance arrangements so much more appropriate as a starting point for tackling sustainability issues. They can be “chartered” initially by virtually any level of government or even set of private institutions, but what is especially important is that membership in them is not contingent on the formal (and illusory) equality of inter‐governmental organizations and decision‐making proceeds by negotiated consensus – not by unanimity or voting. Moreover, actors in such arrangements can collectively set standards and set up monitoring systems without having to go through formal processes of ratification. Ideally, such arrangements should be ‘self‐enforcing’, but in the real world their role is always circumscribed by both market and state mechanisms. In order to reach consensus in the first place, ‘stakeholders’ often depend on their mutual fear that, if markets were to distribute goods or states were to impose solutions, they would all be worse off. The implementation of choices made by governance may be even more problematic. Markets can offer powerful incentives to defect from them and, thereby, gain short‐run competitive advantage. Lack of official support from governments can mean that monitoring devices will be weak and sanctions impossible to apply. In other words, governance arrangements in Europe may fit the political conditions of a world “Post‐Brundtland” that has lost its clear demarcations of
144
national sovereignty, that has to cope with problems cutting across entrenched functional specializations, that has generated a wide variety of actors insisting on their right to participate, and that has not yet produced a regional system of government. They are not, however, the definitive response to the challenge of sustainable development. For the foreseeable future, such arrangements will still ultimately have to face the test of market competition and to rely ultimately on the legitimate coercion of national state authorities. They cannot stand alone.
Partial rather than Comprehensive Sustainable development demands nothing if not comprehensiveness. It requires that multiple and relatively autonomous domains of human endeavour have to be coordinated. The problem is that governance arrangements work best when they are partial, i.e. when the stakeholders involved are relatively few in number and highly dependent upon each other. These arrangements may be useful in overcoming the ‘intergovernmental’ limits imposed by national sovereignty, but how effective can they be in bridging the differences in knowledge and interest embedded in distinct functional domains? The simple answer is that we do not know. Only innovation and experimentation will inform us. Can stakeholders in one domain – owners, employees, experts, interest representatives and civil servants – learn from what others have accomplished? Will participants engaged in solving their problems of sustainability even perceive the positive and negative effects that their efforts have upon others? Will entirely new scientific specialties emerge to deal with the interstices between different governance arrangements? Can one even imagine something like ‘mergers and acquisitions’ in the future in which initially separate governance arrangements combine to deal with more comprehensive issues? History at the national level in most developed societies suggests that this was possible. ‘Spill‐Overs’ routinely occurred across scientific specialities and administrative functions. Some policy arenas proved more strategically important than others and incorporated less innovative or weaker ones. What made an especially significant contribution to these processes of diffusion and expansion was the existence within each national state of something called a ‘civil society.’ The participants in most governance arrangements have not been individuals but organizations. And these scientific societies, business and professional associations, trade unions, social movements, community organizations, and so forth have to relate to each other across levels and arenas. They often compete for member affiliation and financial support, and have to form alliances for broader purposes. One special peculiarity of this process at the national level, however, is virtually absent at the trans‐national level – namely, the existence of a
145
system of competing political parties. With their ideological appeals, electoral campaigns and comprehensive role in forming governments, these parties ‐ in the context of a nation state ‐ provided a powerful incentive for connecting the “partialities” embedded in separate policy domains. As we shall see below, only in a very few trans‐national regions does anything equivalent to this yet exist. Relying on the governance of functionally differentiated policy domains to accomplish sustainable development is definitely paradoxical. It proposes to use a partial instrument to reach a comprehensive objective. At best, it offers the promise that dispersed efforts at functional problem‐solving by isolated groups of stakeholders will not only not interfere with each other, but eventually lead to a more encompassing approach. However, un‐sustainability is increasing at rapid pace and something has to be done sooner rather than later. Of course, a more comprehensive multi‐sectoral system for assessing risks and allocating responses would be preferable. Alas, it will not be available in the foreseeable future.
Regional rather than Global Not only should sustainable development be comprehensive in functional substance, it should also be global in territorial scope. Its most basic principle is that the world has become one. There exists only one eco‐system and an increasingly integrated economy. Awareness of this has grown, but the world is no closer to possessing a political mechanism at the global level for identifying policy priorities, setting relevant standards, raising necessary resources, supporting collective efforts and, when all else fails, punishing defections from the common good. National states still try to do this and they necessarily do so in a highly unequal and self‐regarding way. But they are no longer alone. One of the most significant of the changes that have occurred since Brundtland has been the emergence of ‘trans‐national regions.’ Between the global and the local in some parts of the world – and nowhere more so than in Europe – there now exist complex ‘multi‐layered’ political systems in which the responsibility for using public authority is shared across different territorial levels and the implementation of policies requires constant cooperation among them. We are convinced that, given the disappointing results of trying to reach global agreements and empower global intergovernmental organizations, this intermediate ‘regional’ level provides us with another ‘second‐best’ strategic alternative. And the fact that the European Union – now expanded to include 27 countries – is in the vanguard of such developments is especially encouraging. This world region has the collective resources – material and human – to make a highly significant contribution on its own. The existence of a supra‐national
146
organization with a proven capacity to generate benefits for all of its members and of a population that is more aware than almost any other of the costs involved in ‘un‐sustainable development’ are more than coincidental. The citizens of the EU uniquely expect their regional organization to do something about these risks (Schmitter, 1996). Another significant factor is that Europe – within and beyond the EU – already possesses the key elements of a continent‐wide civil society that can play a crucial role in identifying priorities, diffusing best practices, and pressuring for ‘spill‐overs’ from one domain to another. This region does not yet have a distinctive supra‐national party system, but such a system could emerge in the near future and sustainability issues could well determine its configuration. Students of international relations have long recognized that voluntary and peaceful change at this macro‐level requires the exercise of leadership (they call it “hegemony”). Some actor has to take the initially greater risks and pay originally higher costs. Empire allows for the imposition of such changes by force; major policy shifts within national polities typically follow from changes in the party or alliance in power. Regional organizations are in a unique position to play this role constructively, precisely when they are not simply a façade covering domination by the most powerful national state, the largest private firm, the momentarily hegemonic political party, or the best funded NGO. The European Union has repeatedly demonstrated its independence from the hegemony of its largest member states and its capacity to exert influence outside its own territorial sphere. No other trans‐national regional organization can (yet) make that claim, which is why at this point in time the European Union offers to the world its best strategic alternative for advancing politically sustainable development. While it is conceivable that other world regions might eventually imitate its institutions (in fact, the EU has dedicated considerable resources to efforts to clone itself and meets regularly with its “counter‐parts” in Asia, Latin America and Africa), the best one can expect in the near future is that individual national states will chose to adopt the regulations and standards developed by EU governance arrangements. Needless to say, this is most likely in “neighbouring” states to its South and East where such “Euro‐compatibility” may enhance their prospects for eventual membership.
Combining Governance and Legitimacy in the European Union Governance arrangements must ultimately combine performance with legitimacy. With its White Paper on Governance, (2001) the EU literally proclaimed its intention to stake its future legitimacy on the successful application of governance
147
arrangements to solve interest conflicts among its member states and to satisfy normative expectations across its national publics. In so doing, it also implicitly recognized that it could not compete on the standard criteria of legitimacy with national democracies. Whatever modifications might be introduced in its rules and practices – including those in the draft Constitutional Treaty and its abridged Lisbon Version – they would not suffice to convince most of its citizens that the EU could function as a ‘real‐existing’ liberal‐representative‐parliamentary‐electoral‐constitutional‐democratic regime. Something else had to justify why the decisions of this unavoidably complex and remote trans‐national regional polity were legitimate and worthy of being obeyed. And ‘governance’ was chosen to fill this bill of particulars. However, much of what is happening within the EU on a regular basis is more the result of expediency, pragmatic tinkering, time pressures, the diffusion of ’best practices,’ ad hoc and even ad hominem solutions than of shared principles and explicit design. It is still my (untested) presumption that, if the EU were to elaborate and defend a number of clear principles and to design its governance arrangements accordingly, this would improve the legitimacy of their decisions in the long run and, just maybe, convert the EU from a consumer of national legitimacy into the producer of a new type of supra‐national legitimacy that could be applied to the tasks of ensuring ecological and social sustainability at the regional level.
The following sections outline some core design principles for governance arrangements, with a focus on both legitimacy and efficiency. This includes chartering, composing and decision‐making.
Design Principles for Governance Arrangements If one accepts the following generic definition: governance is a method or mechanism for dealing with a broad range of problems or conflicts in which actors regularly arrive at mutually satisfactory and binding decisions by negotiating with each other and cooperating in the implementation of these decisions, then there are three tasks that should be accomplished if such arrangements are to be regarded as legitimate by those who are going to be affected by their decisions: (1) they have to be established by some recognized and pre‐existing authority and be given a specific mandate within which to operate (chartering); (2) the actors who regularly participate in them and who are presumed to represent wider publics have to be chosen (composing); and (3) these actors have to be instructed how they are to negotiate, reach consensual agreements on policies and go about implementing them (decision‐making). What is critical about these three
148
dimensions is that the solutions they require do not correspond to the norms that prevail in most ‘real‐existing’ liberal democratic governments. Governance arrangements are not self‐established “by the will of the people;” they are not open to the participation of all citizens, but only to a selected and privileged sub‐set of them; and they do not make their decisions on the basis of majority voting, or even voting at all. Even more unconventional is the fact that these regional governance arrangements can be poly‐centric and, therefore, not be subject to the hierarchic or sovereign control of a single institution such as the parliament or the executive power.
Chartering Governance Arrangements First, one should start with the notion of chartering, i.e. of how a governance arrangement (hereafter, a GA) gets established at the regional level to deal with a particular task. This question of “why are these actors making decisions on this issue?” should be resolved through an explicit delegation of authority from a legitimate pre‐existing institution, i.e. by means of a charter. This notion of a charter rests on the presumption that a particular issue or policy arena is ‘appropriate’ for such an arrangement, ergo, it is not better handled by good old‐fashioned market competition or government regulation, and that (subsidiarité oblige) it should be tackled at the supra‐national level. What has to be demonstrated and defended is the notion that some particular set of actors, each acting autonomously, is thought to be capable of making decisions that will resolve the conflicts involved and provide the resources necessary for dealing with the issue pre‐designated by its charter. Moreover, these decisions once implemented will be accepted as legitimate by those who did not participate and who have suffered or enjoyed their consequences. And, if this were not enough, a successful GA would also have to demonstrate that its capacity to resolve conflicts and provide resources is superior to anything that a national or sub‐national arrangement could have done. Looked at from this perspective, there may not be that many policy arenas that should acquire “their” respective GA’s. Six Principles for Chartering GAs: 1. The principle of ‘mandated authority’: No GA should be established that does
not have a clear and circumscribed mandate that is delegated to it by an appropriate institution. Any EU institution should be entitled to recommend the initial formation and design of a GA, i.e. its charter, its composition and its rules, but (following the provisions of the Treaty of Rome) only those approved by the Commission should be actually established, whether or not
149
they are subsequently staffed, funded, “housed” and/or supervised by the Commission. Those who do not participate but are affected by a GA should be confident that it has been established by an authority they recognize as legitimate and its mandate is publicly proclaimed and justified.
2. The ‘sunset’ principle: No GA should be chartered for an indefinite period,
irrespective of its performance. While it is important that participants in all GA’s should expect to interact with each other on a regular and iterative basis (and it is important that the number and identity of participants be kept as constant as possible), each GA should have a pre‐established date at which it should expire. Of course, if the EU institution that delegated its existence explicitly agrees, its charter can be renewed and extended, but again only for a definite period. Again, citizens who are at best indirectly and unevenly represented should be confident that these arrangements among privileged decision‐makers will not perpetuate themselves in power beyond the period necessary for accomplished their mandate. Moreover, since GAs often arrogate to themselves a role in monitoring the subsequent implementation of their decisions, the temptation for self‐perpetuation can be especially strong.
3. The principle of ‘functional separability’: No GA should be chartered to
accomplish a task that is not sufficiently differentiated from tasks already being accomplished by other GA’s and that cannot be feasibly accomplished through their independent deliberation and decision. Here, in Europe, the issue is that of ‘poly‐centriciity.’ The European Union has no constitution or democratically accountable mechanism for preventing the proliferation of its GA’s (Banchoff, Thomas and Smith, 1998). Indeed, with so many “sovereign” member‐states and so little centralized authority, there is an inevitable tendency to resolve conflicts through compromises that produce additional institutions to be distributed accordingly. Some principle has to be inserted to resist this temptation, although how it can be enforced and by whom is not evident.
4. The principle of ‘supplementarity’: No GA should be chartered (or allowed to
shift its tasks) in such a way as to duplicate, displace or even threaten the compétences of existing regional institutions. European governance arrangements are not substitutes for European government, but should be designed to supplement and, hence, to improve the performance of the Commission, the Council and the Parliament. Again, the root of the matter is
150
that the EU is not a state and does not (yet) have a constitutionalized regime and therefore it lacks the legal means for sanctioning the intrusion of governance arrangements upon governing institutions. Moreover, in an established national democracy, competing political parties might be expected to raise such issues of intrusion – especially upon the prerogatives of parliaments – but the EU lacks such a system and the European Parliament has virtually no powers to regulate or limit the powers of its GA’s.
5. The principle of ‘requisite variety’: Each GA should be free – within the limits
set by its charter – to establish the internal procedures that its participants deem appropriate for accomplishing the task assigned to it. Given the diversity inherent in these functionally differentiated tasks, it is to be expected that GA’s will adopt a wide variety of distinctive formats for defining their work program, their criteria for participation and their rules of decision‐making – while (hopefully) conforming to similar principles of general design. One of the most compelling arguments of early functionalist thinkers such as David Mitrany is that the representatives and experts who are made responsible for resolving the particular problems that transcend national states should be autonomous in choosing the organizational means and strategies for doing so – within the mandate given to them initially. It, therefore, follows from the variety of issues that have to be dealt with at the regional level that the rules and resources for doing so should be correspondingly varied.
6. The ‘high rim’ or ‘anti‐spillover’ principle: No GA should be allowed by its
mandating institution to exceed the tasks originally delegated to it. If, as often happens in the course of deliberations, a GA concludes that it cannot fulfil its original mandate without taking on new tasks, it should be required to obtain a specific change in its mandate in order to do so. According to the neo‐functionalist theory of regional integration, one has every reason to suspect that the functionaries, experts and interest representatives that cluster around a given GA will make every effort to expand its tasks, both in scope and, as we have seen above, in time. If they did not, the process would stagnate into a set of “self‐encapsulated” institutions making little or no contribution to the general process of integration. Paradoxically, for the sake of legitimacy, the design of GA’s should resist these efforts at ‘log‐rolling’ and ‘package‐dealing.’ Decisions involving the negotiation of such tradeoffs across circumscribed issue areas should be the purview of other regional institutions, i.e. the Commission, the Council of Ministers, the European Council and,
151
hopefully in the future, the European Parliament in the case of the EU – not a highly specialized GA.
Composing Governance Arrangements Now that the GA has been chartered, it must be composed, i.e. those who are to entitled to participate in it must be selected (and not elected). Whether specified ex ante in the charter or chosen ex post by some authoritative body, these persons (or, better said, organizational representatives) should have some justifiable reason for being included in the negotiations and deliberations and for entering into the (anticipated) consensus. This code‐word in the present discussion surrounding the concept of governance is stakeholders. Unlike democratic government where all citizens are presumed to have an equal right to participate, in governance arrangements only some subset of these citizens, i.e. those who have expressed a greater concern or are deemed to be more likely to be affected, can participate. The calculation seems to be that if stakeholders can reach a consensus on what is to be done and, even more, if they can continue to agree on how to implement what has been chosen, their fellow citizens will conform as if they themselves had had the opportunity to participate. Four Principles for Composing GA’s
1. The ‘minimum threshold’ principle: No GA should have more active participants than is necessary for the purpose of fulfilling its mandated task. It has the autonomous right to seek information and invite consultation from any sources that it chooses. However, for the actual process of drafting prospective policies and deciding upon them, only those persons or organizations judged capable of contributing to the governance of the designated task should participate. Decision by consensus requires, at a minimum, three things: (1) a restricted number of participants since agreement becomes exponentially more difficult to reach as the number of participants increases; (2) those who do participate should possess some type or degree of ‘asset specificity’ which means material, intellectual or political resources that are apposite to the tasks to be accomplished; and (3) as persons or organizations, the participants should have the capacity not just to represent relevant categories but also to deliver their conformity to whatever decisions are made. Restricting their number is a prerequisite for the other two.
2. The ‘stake‐holding’ principle: No GA should have, as active participants,
persons or organizations that do not have a significant stake in the issues
152
surrounding the task assigned to it. Knowledge‐holders (experts) specializing in dealing with the task should be considered to have a stake, even if they profess not to represent the interests of any particular stakeholder. This follows from the discussion above about ‘asset specificity.’ Needless to say, defining what degree or type of asset constitutes ‘a stake’ and who controls that stake is bound to be politically contested since ‐‐ thanks to the growing interdependence of policy domains ‐‐ the number of representatives and experts who can make such a claim is potentially unlimited. As an approximate guideline, a relevant stake‐holder could be defined as a person or organization whose participation is necessary for the making of a (potentially) binding decision by consensus and whose collaboration is necessary for the successful implementation of that decision. In practice, this is likely to be determined only by an iterative process in which those initially excluded from the governance arrangement make sufficiently known their claims to stake‐ and knowledge‐holding so that they are subsequently included.
3. The principle of ‘European Privilege:’ All things being equal, the
participants in a governance arrangement attached to the EU should represent Europe‐wide constituencies. Granted that, in practice, these representatives may have to rely heavily on national and even sub‐national personnel and funding and may even be dominated by national and sub‐national calculations of interest, and granted that the larger the constituency in numbers, territorial scale and cultural diversity, the more difficult it may be to acquire the asset specificity that provides the basis for stake‐holding, nevertheless, the distinctive characteristic of a European governance arrangement is contingent on privileging this level of aggregation in the selection of participants. This follows from the initial argument that only regional rather than global governance arrangements are viable at this point in time. Given the ‘unfinished’ nature of European integration, there may be significant stake‐ and knowledge‐holders in prospective member‐states and even in those that have explicitly chosen not to join the EU but are strongly affected by its policies.
4. The ‘adversarial’ principle: Participants in a GA should be selected to represent constituencies that are known to have diverse and, especially, opposing interests. No GA should be composed of a preponderance of representatives who are known to have a similar position or who have already formed an alliance for common purpose. In the case of
153
‘knowledge‐holders’ who are presumed not to have constituencies but ideas, they should be chosen to represent whatever differing theories or paradigms may exist with regard to a particular task. To respect this principle, it may be necessary for the designers of such arrangements to play a pro‐active role in helping less well‐endowed or more dispersed interests to get organized and sufficiently motivated to participate against their ‘privileged’ adversaries. This element of ‘sponsorship, while intended to encourage a greater balance in adversarial relations, can conflict with the subsequent principle of ‘putative’ equality of treatment and status. It can also generate serious questions concerning the autonomy of such ‘sponsored’ organizations. What is crucial, however, about this aspect of GA composition is that non‐participants are confident that its deliberations and negotiations include a sufficiently wide range of actual participants and opinions. Only then will these outsiders believe that they have been represented vicariously in its activities and accord legitimacy to its decisions.
Decision‐Making in Governance Arrangements Now that the GA has been chartered and composed, it must take and implement decisions. As we have seen above, the usual rules dominating inter‐governmental organizations (unanimity) or democratic federations (simple or qualified majority) are not appropriate. Rather, a deliberately vague “meta‐rule” should apply, namely, consensus. But what are the operative principles that frame this process of consensus formation? Seven Principles for Decision‐Making in GA’s
1. The principle of ‘putative’ equality: All participants in a GA should be considered and treated as equals, even when they represent constituencies of greatly differing size, resources, public or private status, and ‘political clout’ at the national level. No GA should have second and third class participants, even though it is necessary to distinguish unambiguously between those who can participate and those who are just consulted. GA’s are not ‘democratic’ – at least, not as conventionally defined. They do not have competitive party systems, regular elections or voting mechanisms – but there is one way in which they can acquire something approximating democratic legitimacy. If their participants treat each other as equals – as quasi‐citizens – this should improve the quality of their deliberations by encouraging a more honest expression of preferences and the development of relations of mutual trust among
154
them. If and when an eventual consensus is reached, it will be much more likely to be respected voluntarily by both insiders and outsiders.
2. The principle of horizontal interaction: Because of the presumption of
equality among participants, the internal deliberation and decision making processes of a GA should avoid as much as possible such internal hierarchical devices as stable delegation of tasks, distinctions between “neutral” experts and “committed” representatives, formalized leadership structures, deference arrangements, etc. and should encourage flexibility in fulfilling collective tasks, rotating arrangements for leadership and rapporteurship, extensive verbal deliberation, along with a general atmosphere of informality and mutual respect. Here, the logic is similar to that for presumptive equality. The weaker a given stakeholder is in the society or polity, the stronger should be his or her role within the GA – at least, relatively speaking. In the EU, this has been resolved through the systematic over‐representation of small member states in such arrangements and the demonstrated willingness of the larger ones not to assert their hegemony.
3. The principle of consensus: Decisions in a GA should be taken by
consensus rather than by vote or by imposition. This implies that no decision can be taken against the expressed opposition of any participant, although informal mechanisms usually allow for actors to abstain on a given issue or to express publicly dissenting opinions without their exercising a veto. In other words, consensus need not mean unanimity. Needless to say, the primary devices for arriving at consensus are deliberation (i.e. trying to convince one’s adversaries of the bien‐fondèe of one’s position), compromise (i.e. by accepting a solution somewhere between the expressed preferences of actors) and accommodation (i.e. by weighing the intensity of the preferences of actors). Regular and iterative interaction among a stable set of representatives is also important, since this would allow for the making of “trade‐offs” across a succession of controversial issues. Perhaps, the most important aspect of consensus formation is the prevention of cumulative domination that might emerge within a GA via repeated votes in which the same participants are regularly on the winning side. Moreover, decision‐making by consensus is a powerful incentive for actors to ‘stay in the game’ rather than defect after losing.
155
4. The ‘open door’ principle: Any participant should be able to exit from a GA at relatively modest cost and without suffering retaliation in other domains – either by other participants or by national or regional authorities. Moreover, the ex‐participant has the right to publicize this exit before a wider public (and, the threat to do so should be considered a normal aspect of procedure), but not the assurance that, by exiting, he or she can unilaterally halt the process of governance. This provides the complement to the incentive noted above to stay in the game. If a single stakeholder or a minority of stakeholders persistently disagrees with the decisions that have emerged consensually among the others, low cost exit can be an important alternative to what Albert Hirschmann (1970) has called ‘voice’ or ‘loyalty.’ This prospect of exercising this option should keep the dominant group in line – with, however, completely impeding its capacity to move ahead on a given issue.
5. The proportionality principle: Although it would be counter‐productive for
influences to be formally weighed or equally counted, it is desirable that across the range of decisions taken by a given GA there be an informal sense that the outcomes reached are roughly proportional to the specific assets that each participant contributes (differentially) to the process of resolving the inevitable disputes and accomplishing the delegated tasks. A more orthodox way of grasping this principle would be to refer to “reciprocity” – although this seems to convey the meaning of equal shares or benefits across some set of iterations. “Proportionality” is similar, but allows for the likelihood that stable inequalities in benefit will emerge and be accepted as legitimate on the grounds of differential initial assets and contributions. In the EU context, this notion is supplemented by that of ‘convergence,’ namely, that over time and across a range of issues, the performance of participants should become increasingly similar to that of the one with the best performing assets.
6. The principle of ‘shifting alliances’: Over time within a given GA, it should
be expected that the process of consensus formation will be led by different sets of participants and that no single participant or minority of participants will be persistently required to make greater sacrifices in order to reach that consensus. Another way of describing this condition is ‘pluralism.’ Provided its composition is properly ‘adversarial,’ even the most specialized GA should have multiple and rival interests within it. Ideally, these lines of cleavage should cut across those of national
156
interest, opening up possibilities for the formation of trans‐national coalitions. But even if that is not the case and representatives of the same ‘monolithic’ countries face off against each other time and again, it is to be hoped that the same ones always win or lose. And, if this becomes the case, there is still available the relatively low cost ‘open door’ option to prevent the appearance of domination or hegemony by the better endowed participants.
7. The principle of ‘checks and balances’: No GA should take a decision
binding on persons or organizations not part of its deliberations unless that decision can not be explicitly disapproved by another institution that is based on different practices of representation and/or of constituency. This one of the main reasons why GA's are so unlikely to be successful in other regions or at the global level where there exists no such higher order authoritative institutions. In the Europe, the EU performs this function and it normally and in the first instance will be that EU institution which “chartered” the GA initially that will serve as an external check on its decisions. Eventually, one can even imagine that the European Parliament through its internal committee structure could be accorded an increased role as co‐approver of GA decisions. Checks and balances are a very important legitimating feature of the territorial units in all federalist and de‐centralized polities and their activities is usually overseen by yet another layer of decision‐making, namely, an independent Supreme or Constitutional Court such as the European Court of Justice.
Concluding with some Doubts Establishing a set of governance arrangements to deal with functionally differentiated issues related to ecological and social sustainability at the level of Europe is no panacea. It will not work to resolve all of the policy issues surrounding sustainability and it will not work unless it is firmly based on political as well as administrative design principles. And that means that difficult choices involving their charter, composition and decision‐rules cannot be indefinitely avoided or finessed. Unless the GA’s within the EU are ‘properly’ designed, there is no reason to be confident that their decisions will be more sustainable or more innovative than those taken by national governments or embedded in international treaties. And, as emphasized above, governance arrangements never work alone but only in conjuncture with community norms, state authority and market competition.
157
Two key dilemmas must be addressed – even if progress is made on the difficult choices involved in designing GA’s:
(1) The proliferation of regional GA’s tends to occur within compartmentalized policy arenas (and even more so in the EU than in its member states) and leaves unresolved the large issue of how eventual conflicts between their decisions are going to be resolved. Multiple ‘governance arrangements’ at the micro‐ or meso‐levels no matter how participatory, innovative and sustainable on their own, may end up generating macro‐outcomes that were not anticipated and that no one wants!
(2) The criteria for the inclusion of participants and the making of
decisions in regional GA’s are not generally compatible with the standards for democratic legitimation used within national and sub‐national polities – although experimentation with governance arrangements is occurring at all levels of aggregation. Before GA’s can be reliably deployed and generate a sense of obligation among broader publics, it may be necessary to spend a good deal of effort in changing peoples’ notions of what democracy is and what it is becoming.
At the present moment only the European Union offers a politically sustainable alternative to the environmental policies of national states and to treaties between them. The twenty or so years since the Brundtland Report have revealed the limits to reliance on national and international politics, at the same time that the EU has issued an impressive number of directives on these issues. It has reached these decisions through very complicated; little understood and often improvised processes of ‘governance.’ Despite a good deal of grumbling about the legitimacy of the EU itself, these decisions have by‐and‐large been accepted by European citizens and implemented by European governments – and there are more in the offing. There is no equivalent trans‐national regional organization in rest of the world. If my speculations about design principles are correct, it is even less likely that some arrangement for ‘global governance’ would produce legitimate and, hence, politically sustainable decisions. The best one might hope for would be the adoption of EU directives by national governments and, eventually, their implementation in other world regions – but only once these regions had built up an institutional capacity for dealing with other common economic and social
158
problems. One cannot completely discard the possibility that national governments will be driven by dire necessity or impending catastrophe to endow some ‘global governance instrument’ with the powers to make and implement binding resolutions, but at the present moment and for the foreseeable future solutions to our global ‘un‐sustainability’ are largely in the hands of competing private producers, unevenly distributed across national polities, variable according to industry and sector, and still in dispute between different technologies. The only viable political strategy that I can foresee is to proceed incrementally (and insufficiently) at the partial and regional levels according to relatively simple principles of chartering, composing and deciding within governance arrangements.
159
References Communication from the Commission of 25 July 2001 "European governance ‐ A white paper" [COM (2001) 428 final ‐ Official Journal C 287 of 12.10.2001]. Eurobarometer (2008): survey published in March 2008, two thirds of all respondents preferred that policy decisions about the environment be taken at the European level. http://env‐health.org/a/2861/ accessed on 22 July 2009. Hirschman, Albert O (1970): Exit, voice, and loyalty : responses to decline in firms, organizations, and states. Cambridge, Mass. : Harvard University Press
Keohane, Robert (1984) After hegemony: Cooperation and Discord in the World Political Economy. (Princeton: Princeton University Press). Schmitter (1996):"Examining the Present Euro‐Polity with the Help of Past Theories", in Gary Marks, Fritz Scharpf, Philippe C. Schmitter and Wolfgang Streeck, Governance in the European Union, (London: Sage Publications, 1996), pp. 1‐14. Ruggie, J. (2004), “Reconstituting the Global Public Domain‐Issues, Actors, and Practices”, European Journal of International Relations, Vol. 10 No. 4, pp. 499‐531.
World Commission on Environment and Development (WCED) 1987: Our Common Future, Oxford: Oxford University Press. Oxford.
160
Chapter 8
Montesquieu for the 21st Century: Factoring Civil Society and Business into Global Governance
Atle Midttun3
Introduction Following three decades of predominantly neoliberal orientation, the late 20th and the early 21st centuries have seen increasing economic globalisation in the form of both globally extended capital markets and large‐scale outsourcing of production in global supply systems across the world. International governance of social and environmental concerns has not advanced at the same rate, reflecting the lack of both resourceful engagement from powerful, committed actors and pressure from self‐interested nation states. As also indicated in previous chapters in this report, there are no clear solutions to the challenges facing global governance. The intergovernmental negotiation model, which has traditionally been used for international governance, has the built‐in tendency to sacrifice global welfare while prioritising national interests. The sole political accountability of state governments to domestic electorates tends to turn them into “egoistic” international actors that overvalue immediate gains and only respond to longer term collective needs with the least common denominator. Global democracy has been proposed by some scholars (The Commission on Global Governance 2005; Rosenau 1997; Ikenburry 2001) to overcome the global welfare deficit through establishing representative democracy beyond the boundaries of the nation state, and generalizing its norms and institutions around the world. Others, such as Held (2002) have argued for building international governance in a bottom‐up mode based on collective movements. However, the global democracy model lacks a credible account of how it could come into power and acquire authority, constitutional legitimacy and accountability across national and cultural divides. Corporate social responsibility (CSR) has also been deployed to overcome the global governance deficit by using
3 I am grateful to Hilde Nordbø for assistance with interviews and preparing much of the EITI material, and to Jonas Moberg and Anders Tunold Kråkenes; the EITI secretariat, Sefton Darby; former DFID and World Bank and Alan Dethridge; former VP External Affairs, exploration and production, Shell; for comments to the final version
161
multinational industry as a vehicle to impose a social and environmental agenda on the global economy (Elkington 2001; Zadek 2004; Midttun 2008). However, the credibility of CSR suffers from its conflict with core elements of corporate law that focus on limited liability and systematically shield corporations from responsibility beyond their invested capital. Furthermore, many of the incentives to show corporate responsibility have limited credibility without third party verification. The weaknesses of all three models require us to rethink global governance. Rather than inventing yet another model, we argue for the establishment of balances between existing institutions, based on Montesquieu’s idea of checks and balances of the state powers. However, globalization has led to the erosion of exclusive government control and we need to revitalise governance as a more encompassing approach that also involves other parts of society. Now the three powers that need to be balanced are the state, industry/markets, and civil society. We argue that these three domains with varying interests form important complementary arenas for addressing global governance, just as the legislative, executive and judicial powers did in Montesquieu’s analysis of the state. Furthermore, we wish to advance the idea of balance of power in a dynamic way, treating governance as an emerging enterprise with parallels to the idea of the product cycle in innovation theory. We will support our conceptual analysis with examples from the Extractive Industries’ Transparency Initiative (EITI), a major new governance initiative to lift the “resource curse” from countries with an abundance of natural resources.
Montesquieu’s Theory of Balance of State Powers4 Montesquieu’s doctrine of balance of state powers has its roots in 17th and 18th century political philosophy. In his Second Treatise of Civil Government, English philosopher John Locke (1632‐1704) noted the temptations to corruption that exist:
( … ) And because it may be too great temptation to human frailty, apt to grasp at power, for the same persons who have the power of making laws to have also in their hands the power to execute them, whereby they may exempt themselves from obedience to the laws they make. And suit the laws, both in its making and execution to their own private advantage (…) (Locke 2004).
Locke’s views were part of a growing English radical tradition, but it was French philosopher, Baron de Montesquieu (1689‐1755), who articulated the foundations
4 Based on Spindler (2000)
162
of the separation doctrine after visiting England from 1729 to 1731 (Spindler 2000). In The Spirit of Laws (1748), Montesquieu argued that English liberty was preserved by its institutional arrangements. He saw not only separations of power between the three main branches of English government, but within them, such as the decision‐sharing power of judges with juries; or the separation of the monarch and parliament within the legislative process.
The ideas of Locke and Montesquieu were put into practice during the American Revolution in the 1780s. Motivated by a desire to prevent the abuses of power they experienced under English rule, the founders of the Constitution of the United States adopted and expanded doctrine of the separation of powers. To help ensure the preservation of liberty, the three branches of government – legislative, judicial, and executive – were both separated and balanced. Each had its own personnel and there were separate elections for executive and legislative politicians. Each had specific powers over the other two and some form of veto.
Translation into the 21st Century There is a parallel between for the 18th century concept of division of power and our current need to engage and balance the powers of the state, industry/markets and civil society in governance for global sustainability. In both cases, complementary and somewhat adversarial power bases can be used to increase transparency while minimising monopoly and dogmatism. In both cases, pluralism of powers may lead to inherent conflicts that keep all powers alert and creative, thereby preventing stagnation. Given their different memberships, organisations and functions, state, business and civil society have diverse governance capabilities that allow them engage in global governance in complementary ways. The presence of competing governance arenas implies that governance initiatives can advance even if they are blocked in one arena. For instance, governance initiatives that do not find state support may be adopted by the market, or pushed forward by civil society. The three powers and their respective and complementary arenas can thereby be used to address global governance, just as the legislative, executive, and judicial powers were in Montesquieu’s analysis of the state.
A Dynamic Extension Extending Montesquieu’s idea of the balance of powers from the state to a societal level is, however, only a first step. His doctrine can also be developed beyond static checks and balances into more dynamic innovation, drawing on the product‐cycle model. The product‐cycle model (Figure 1, lower half) highlights the
163
complexity of innovation with the need to foster different types of entrepreneurial initiatives at different stages of the cycle (Utterback and Abernathy 2000; Vernon 1966; Midttun and Ørjasæter 2009). The initial stages of the product‐cycle are characterized by entrepreneurial exploration and experimentation (March 1991). The analogy is often made to natural selection models, where an important precondition is a “variety creation mechanism” to allow selection at a later time. In many cases new ideas emerge from entrepreneurs outside the established industrial actors, although intrapreneurship (within existing firms) is also a major source of innovation. In some cases, the firm may choose to promote creativity in a rather open manner to encourage new ideas in a way that resembles “blind variation.” However, most firms use systematic procedures in order to identify and examine new opportunities before they focus on the most promising ones. When the product has proven its viability it moves into the next phase of the product cycle, stabilization and growth. This stage involves a significant increase of production volume, new capital inflows and creation of strategic alliances, especially those that increase the capacity of the distribution system, extend the market share, and develop customer relations. Due to scarcity of resources, increased demand on managerial capacity and cost, only a few innovations can be advanced at that point in time. With deployment and early growth, experience improves the innovative product or service – the so‐called learning curve (Henderson 1984). For every new batch of output, the innovator will be able to increase labour efficiency with a variety of measures including standardization, specialization, improved technology, and better use of equipment. All of these factors improve performance and bring down costs. As a result of repeated improvement under the growth phase, the technology matures and becomes standardized. In this mature phase of the product cycle the focus is on efficiency, productivity and full exploitation of innovation. Stability, in terms of demand, technology, and competition, characterizes maturity. Strong market leaders should enjoy strong profits and high, positive cash flows. The company is now able to cover all of the costs of development as well as provide the shareholders with a return on investment. Innovations at this stage are usually incremental. These life cycle extensions are variously characterized by product modifications as well as improvements to the product, technology, the business model, or even the organization itself. We may speak of a first early mature phase, where market still expands, and a late mature phase, when markets are saturated and starts to decline.
164
Finally, the product cycle ends with a phase‐out. Labour and capital resources are reallocated to new activities. Uncertainty is evident. Efficient and constructive transformation at the end of the product cycle is amongst the greatest challenges of management. From a marketing point of view, the stages of the product cycle indicate particular marketing challenges and target groups, which range from innovators via early adapters to early and late majorities and even laggards (Kotler, 1991).
Drawing the analogy from the product cycle model to governance, we may see governance as a dynamic process where new governance initiatives emerge in early experimental forms and – if successful – are diffused, scaled up, and gradually consolidated into broadly accepted formal governance arrangements (Figure 1, upper half). In parallel with commercial innovation, we may therefore speak of early explorative governance entrepreneurship, where governance entrepreneurs work to set new agendas and re‐frame our understanding of current issues and the governance approaches needed to solve them. When this understanding resonates in broader segments of society, common framing can emerge. Figure 1. The Product Cycle Model: Technological and Governance Application
With an analogy to the stabilization and growth phase, governance entrepreneurship may succeed in establishing new norms and rules, as well as to initiate monitoring to evaluate compliance. As the new governance initiative stabilizes and grows, old normative frameworks may be supplemented or even
165
replaced by new frameworks that reshape available options for commercial and political actors.
Governance entrepreneurship is also shaped by communication in modern, media‐driven societies. When seen as credible voices for “just causes,” governance entrepreneurs may gain moral support in the public media and use this to scale up new governance initiatives by leveraging stronger actors in markets and politics. The threat of media exposure may have significant consequences in a brand‐oriented, commercial context where negative media exposure could cause serious damage to reputations. The same goes for politics when political prestige is at stake.
Successful agenda setting, as well as the re‐framing of norms and values, can lead to institutionalization and increased capacity. At this mature stage, the entrepreneurial governance initiatives become part of the establishment and are factored into mainstream business and political practice. This process also provides financial support and incentives to encourage large‐scale changes of conduct.
In product cycle thinking, economic organization varies significantly from stage to stage (from early entrepreneurial initiatives to growth firms and to mature commercialization). By analogy, there would be a need for similar shifts in the organization of governance as governance innovations move from early exploration to standardization, growth and mature institutionalization. Civil society, the state, and markets represent governance arenas that can play important complementary roles as drivers of governance entrepreneurship during different phases of the product cycle. Each has strengths, such as early innovation in civil society and the formal organization of business and state governments coming in at later growth and maturing stages. Montesquieu’s argument for balance of powers between civil society, markets and the state now figures as an important element in the dynamics of governance at the societal level.
The EITI Case We have selected the Extractive Industries’ Transparency Initiative (EITI) as an illustration of governance innovation. This study is based on a series of interviews with representatives of the EITI secretariat as well as civil society representatives and former employees in British Petroleum and the British Department for International Development (DFID) who were involved in critical phases of the Initiative’s development. The interviews were supplemented with written sources.5
5Interview with Jonas Moberg 12.06.09 (Head of EITI secretariat), Sefton Darby 30.09.09 (Former DFID and World Bank), Graham Baxter 14.10.09 (Former VP Corporate
166
EITI represents a governance process initiated by civil society with a subsequent “buy in” from industry and established political institutions to address a gross governance and market failure in extractive industries – the “resource curse” – particularly in developing countries. In the worst cases the resource curse involves huge flows of money from natural resources fuelling political corruption, with multinational corporations as significant players. The result is that money gets diverted to secret bank accounts while civil society remains poor. The EITI case illustrates the dynamics of governance entrepreneurship and the interplay between the state, business and civil society with both critical controversy and supportive collaboration (figure 2). It illustrates how civic engagement may trigger policy innovation, and factor into national policy‐making both in developed and developing countries. It can also engage international institutions and change business practices in both extractive and financial industries. It exemplifies how transparent accounting may evolve under active public scrutiny and auditing from leading auditing firms. Figure 2. The Product Cycle Model: Governance and EITI Applications
The EITI governance innovation can be seen as a process in several phases, where actors and arenas shift, as the process proceeds from early stage civic initiatives
Responsibility, BP), Alan Dethridge 19.10.09(Former VP External Affairs, exploration and production , Shell), Mona Thowsen 22.09.09(PWYP Norway)
167
to later stage commercial and political engagement. We shall present the core events, main actors and arenas in a sequence of four phases. The first phase, set in motion by civil initiatives, also includes early commercial engagement. In the second phase, after early commercial engagement has reached its limits, the civil sector re‐engages, which then activates early political engagement. The third phase sees the mainstreaming of political institutionalization, which precipitates the fourth phase of institutionalization of commercial engagement leading up to the present state of affairs.
Early Civic Governance Entrepreneurship The EITI started with NGO initiatives, led by Global Witness, focussing on Angola and the resource curse. In a series of critical articles, they pointed to the fact that Angola was one of sub‐Saharan Africa’s largest oil producers at a time when the 1999 UN Human Development Index (HDI) placed Angola close to the bottom (160 out of 174 countries), according to social indicators. While Angola should have been a country with a thriving economy, it was a country at war, with the majority of its national wealth unaccounted for.
The report “A Crude Awakening,” released by Global Witness in 1999, formulated central premises for initiatives that followed. It presented a critical examination of corruption placing blame on both the Angolan government and the petroleum industry. The report pointed out that a significant portion of Angola’s oil‐derived wealth was pocketed by elite individuals. Power centered around the presidency and was generating vast profits for top‐level generals as well as for international arms dealers, while the Angolan people suffered. Rather than contributing to Angola’s development, the oil revenue was directly contributing to further decline. The report emphatically blamed the oil industry. As the main generators of revenue to the government of Angola, it argued, the international oil industry and financial world needed to acknowledge their complicity, change their business practices, and create new standards of transparency. The oil industry initiative was based on a similar initiative for diamond mining, known as “The Kimberley Process,” which imposed “conflict free” certification of shipments of rough diamonds to prevent the diamond trade from financing wars in developing countries.
Global Witness then proceeded to mobilize stronger civic power through Publish What You Pay (PWYP), a campaign organisation founded in June 2002 along with the CAFOD, Open Society Institute, Oxfam GB, Save the Children UK, and Transparency International UK. The founding coalition of NGOs was soon joined by others such as Catholic Relief Services, Human Rights Watch, Partnership Africa Canada, Pax Christi Netherlands and Secours
168
Catholique/CARITAS France, along with an increasing number of groups from developing countries. In the wake of A Crude Awakening, PWYP was contacted by civil society and community groups from countries who faced the same challenges described in the Angolan report6. As a result, PWYP established a co‐coordinator role to facilitate its work. This further contributed to the global spread of the movement for transparent accounting.
The campaign linked itself to western policy concerns regarding good governance, corporate accountability, and poverty reduction and could thus count on basic acceptance from Western political elites, in spite of the fact that these ideals were not always adhered to in political and commercial practice. The report and active NGO campaigning then mounted pressure on the oil industry – in the UK – in particular, to act on principles to which they were committed. The media gave more attention to both corruption and NGO initiatives, which compelled politicians to put their ideals into practice (Figure 3). As momentum increased inside Western oil companies, NGO’s also lobbied for revenue transparency, in both their home countries and oil‐rich countries. Figure 3. Corruption issues in the media7
Human Rights Watch (HRW) added another dimension to the already complex case of transparency in countries suffering from the resource curse: the link to human rights. This put additional pressure on western firms operating in oil rich countries in the developing world. A report published by Stratfor Global
6Interview with PWYP 22.09.09 7The search was done using Factiva, with the search term corrupt* ranging from 01.01.1995 until 31.12.2008. Sources were major UK news and business publications in English.
169
Intelligence (2004) focused on human‐rights issues facing oil, gas, and mining companies. The report addressed government security forces and security arrangements around their operations, as well as companies’ impact on the economy and environment of communities.
Early Commercial Engagement Pressured by NGO initiatives and extensive media debate, the PWYP initiative provoked industry engagement and British Petroleum (BP) – with a strong influence from public opinion, but also prompted by US regulatory pressure – prepared to disclose its payments to the Angolan government. The following release from the Guardian (2002) describes the event:
In a regulatory filing in the United States, BP revealed it had paid $111m to the Angolan government as its share of a “signature bonus” to win the rights to operate Block 31 off West Africa. This was picked up by the media and resulted in an almost immediate attack from Sonangol in a letter signed by Manuel Vicente, president of the administrative council of the Angolan oil group. "It was with great surprise and some disbelief that we found out through the press that your company has been disclosing information about oil‐related activities in Angola, some of which have a strict confidential character," wrote Mr. Vicente in the letter last year. He went on to warn: "Given the seriousness of the situation, if the provision of information by your company is confirmed and we observe moral or material damage thereof, we reserve the right to take appropriate action.
BP recognized the commercial implications of unilateral disclosure and backed down. Global witness, which supported BP’s efforts to match rhetoric with concrete action, soon turned critical and pressed for more resolute action. In an interview (Global Witness 2003), Erin Wakes and Gavin Hayman of Global Witness blamed BP for copying the letter from Sonargol to all the other oil companies in the country, and thereby implicitly warning against disclosure. They also blamed US companies for treating contracts as sacrosanct and declaring that they would not be breaking contracts unless required by law. Furthermore, US companies were criticized for generally taking a critical attitude to extra‐commercial engagements, as indicated in a letter from Chevron stating, “If we did this we'd have to do everything everyone else asks of us.”
170
The NGOs realized from the Angola/BP case that they could not force Western‐based multinationals to abandon their contracts. Nevertheless, the Western companies are more likely to engage in dialogue with NGOs than, for example, state‐owned companies from developing countries, as they feel less compelled to maintain the “social license to operate” that NGOs or community groups can endorse. In parallel with BP’s engagement with Sonargol in Angola, Shell was involved in promoting transparency in Nigeria, but with a close alliance with President Obasanjo, whose main goal was to fight corruption. He was already a member of the advisory board for Transparency International as well as the board of the Ford Foundation. This made it easier for Shell to disclose its payments in Nigeria to help to fight corruption at the local level.
Early Political Engagement Following A Crude Awakening, UK Minister for Africa; Peter Hain convened a series of meetings with NGO’s and oil companies to discuss the recommendations presented in the report. In parallel with their engagement with industry, Global Witness and later the PWYP campaign also mobilized pressure on policy‐makers. This campaign was met with considerable support in the UK DFID. At the time, reports from several UK Embassies in oil rich developing countries also expressed concern about the transparency and corruption associated with the oil industry and potentially also affecting British firms. Following BP’s problematic experience with unilateral company initiatives and the expectations for strong British multi‐stakeholder initiatives at the Johannesburg Summit in 2002, the British Government decided to launch the Extractive Industries’ Transparency Initiative. The British Prime Minister stated in Johannesburg that he wanted to initiate a dialogue about the issue of revenue transparency that would bring together not only oil, gas and mining companies, but also NGOs, the ‘Publish What You Pay’ campaign, and relevant host and home country governments.
The forum met for the first time in February 2003, and brought all the big players in the industry to the table, including the oil, gas and mining sector companies and also some host country governments. The initiative was then officially launched on the 17th of June 2003 at the first EITI plenary conference8. While the PWYP campaign supported the initiative, it had hoped for a mandatory framework rather than the voluntary solution that was reached. They also expressed disappointment in the lack of a concrete plan of action.
8 The conference had 140 delegates; 31 governments, 12 NGOs, 18 companies, 4 intergov. org
171
It was, however, hard to reach a consensus on the Western side. According to Global Witness activists (Global Witness 2003) the USA and France had been pulling in different directions over EITI. The US stance was that this was an issue for government to government dialogue, not their companies. An even stronger factor for the US government at that time was access to resources, particularly in countries outside OPEC. The French stance, on the other hand, was that corruption in another country only concerned companies and had nothing to do with the French government. The French Government, however, soon turned around at the EITI and was willing to move forward.
Initiatives were also taken by British parliamentarians to bring about EU legislation to promote transparency in extractive industries. Richard Howitt MEP, responsible for organizing the European Parliament’s Annual Public Hearings on Corporate Social Responsibility, worked hard to help. He pointed out that while both BP and Shell were in favour of transparency, they admitted to difficulties, fearing the loss of lucrative contracts. The only way to stop companies from being played against each other and realize the good intentions was, according to Howitt, the introduction of binding EU legislation: “With new EU‐wide transparency rules currently before Parliament, he said, there is a real opportunity for the people of desperately poor countries to stop seeing their oil income embezzled and squandered with the complicity of our European oil companies.”
The EITI emerged from the political process with quite a few of the PWYP campaign’s goals, but stopped short of its stronger policy measures that PWYP campaigned for. While EITI took a voluntary approach, the NGO initiative had focused on mandatory regulation. They had hoped to make mandatory transparency rules a precondition for listing on the stock exchange. They also wanted rules and accounting standards to be imposed on extractive industries in their home countries. Lastly, they wanted similar criteria for the World Bank, the IMF and anyone else who loans money, such as the export credit agencies who fund infrastructure developments. The PWYP coalition nevertheless continued to support and monitor the EITI process as a collaborating body in spite of the soft approach.
The successful engagement of British policy makers in promoting transparency in extractive industries was also due to a network of individuals, who played specific roles in the formation of EITI and the buy in from companies and governments. Global Witness and the PWYP campaign found support from DFID, which had a number of engaged individuals who believed in the cause and who were sympathetic towards the NGOs. This included the head of the Business Alliances Team in DFID, Ben Mellor, and its Secretaries of State, Hillary Benn and Clair Short. Also, the UK Africa Minister, Peter Hein, made use of his strong ties to
172
the region as well as his particular interest in Angola. Prime Minister Tony Blair was influenced by George Soros, the founder of Open Society Institute, and supporter of both Global Witness and PWYP. The Nigerian President, Obasanjo, worked closely with Shell because of his position at the Transparency International advisory board and the Ford foundation. Nigeria also hired a former World Bank employee as finance minister to help fight corruption. This network was committed to the initiative’s values and did not want to see EITI fail once it was established.
DFID's Secretary of State Claire Short fought hard for EITI to be a development program rather than an “international agreement.” One of the successes of EITI was that the negotiations process at the international level was generously backed up by donors supporting actual implementation processes in certain countries.
Diffusion and International Institutionalization Following the UK initiative, EITI has received extensive international support. The World Bank pioneered pressure for structuring revenue transparency in several high‐profile extractive industries projects in the first years of the 21st century, including its official endorsement of the EITI on December 9, 2003. A number of Western governments – including Australia, Belgium, Canada, France, Germany, Italy, the Netherlands, Norway, Spain, Sweden, the United Kingdom and the United States – support the EITI. The EITI has also been endorsed by the United Nations (UN), the European Union (EU), and the Organisation for Economic Co‐operation and Development (OECD). One may therefore conclude that EITI has enjoyed remarkable success in creating an institutional framework for revenue transparency among Western nations. In 2007, the International EITI Secretariat opened in Oslo, under the leadership of former Swedish diplomat Jonas Moberg, again indicating an internationalization of the initiative within the West. Developed countries that are home to the major trans‐national oil companies (TNC’s) have also sought legal solutions to this issue. On March 30th 2004, the EU parliament became the first parliamentary institution to pass legislation dealing with the issue of revenue transparency in mainstream financial services legislation. An amendment to the “Transparency Obligations Directive” reads, “EU states should promote public disclosure of payments to governments by extractive companies listed on European stock exchanges.” Also in March 2004, the “Publish What You Pay Act” was launched in the U.S. House of Representatives, with the goal of using stock market disclosure rules to mandate the disclosure of payments to foreign national governments by American extractive companies. This bill never passed, but there have been
173
several attempts later at launching similar Acts, with the most recent being The “Energy Security through Transparency Act of 2009. If passed, the bill would require energy and mining companies to reveal how much they pay to foreign countries and the U.S. government for oil, gas, and other minerals (Publish What You Pay 2009).
The EITI has also managed to mobilize considerable financial support. The Multi‐Donor Trust Fund (MDTF) for the EITI was established in August 2004 through an agreement between the United Kingdom’s Department for International Development (DFID) and the World Bank. In 2005, the governments of Germany, the Netherlands, and Norway joined. France joined in 2006 and Australia, Belgium, Canada and Spain followed in 2007. The US Government and European Commission joined in 2008, and Finland and Switzerland in 2009. The fund is also supported by oil, gas and mining companies, institutional investors, and to a lesser extent foundations and NGO’s. A Memorandum of Understanding (MoU) was signed between the MDTF and the EITI International Secretariat in early 2008.
EITI has also managed to attract a number of resource‐rich southern countries, particularly in Africa, in addition to the support of the African Union (AU). However, except for Azerbaijan and Liberia, no other countries have taken the step from candidacy to full compliance, which would require extensive scrutiny and verification by designated auditors. Many countries will, however, have to do this in 2010, as EITI Candidate countries must become compliant within two years of candidacy.
The institutionalization of EITI in global governance has also had its limitations. As noted by the EITI secretariat itself, few major emerging economies have shown interest in EITI so far. South Africa did attend the 2005 London conference as observers, but no progress has been achieved in subsequent dialogue. Russia also attended the 2005 London Conference as an observer – their companies are signatories to the Kazakhstan and Azerbaijan MoU – but there has been no unequivocal support for EITI from either the Russian Government or companies. Petrobras has up until 2009 been a member of the EITI International Board, but there was no Brazilian representation at the 2005 London Conference. Neither India nor China sent representatives to the Conference, although the EITI has worked hard on networking and lobbying embassies, foreign ministers, country representatives, and Western oil company headquarters.
174
Challenges Ahead As 2010 draws closer, the EITI is torn between pressures to show results and diffuse the initiative to additional regions.
With respect to performance, there are now critical voices emerging, impatiently demanding tangible results. In a discussion paper Ölcer (2009), for instance, argue that the government’s public endorsement of EITI principles does not, on average, improve corruption as measured by the corruption perception index. They argue that the EITI needs to be stricter on the quality and consistency of accounting reports. But this critique has also met with opposition. Bauchowitz (2009) commented that the data upon which Ölcer’s critique is based is a composite index that takes sources from up to two years prior to its publication into account. Given the relative recentness of EITI, one would have to wait to see effects. An additional critique is that the date of public endorsement, or candidacy, of the EITI initiative was used as the reference point. This announcement of the intention to adopt a transparency policy is, however, not equivalent to policy action. It is only when the country moves to become EITI Compliant that one may start talking about real commitments, and so far only two countries – Azerbaijan and Liberia – has done so.
The true test of EITI therefore will come with the validation process in 2010 and beyond. A new phase in EITI’s governance will begin and tangible results must emerge. However, this raises a delicate issue. The performance test in the West and South comes at a time when the initiative also needs to spread to developing economies in not only the East, but remaining southern regions – particularly Latin America. The simultaneous pressure from two fronts constitutes a real challenge, as one can easily imagine a scenario in which the effort to meet one challenge reduces the possibility of meeting the other. If the bar is set too high for existing members – in order to achieve tangible results – the model may fail to spread. However, if the expansion of a weakened EITI is prioritized, it may never attain its objectives.
Concluding Discussion Given the limitations of conventional governance models, this chapter set out to explore the governance potential in complementary interplay between governance arenas. Taking Montesquieu’s theory of checks and balances between state powers as a point of departure, we have argued for combining the power of civil society, the state, and the market as a way to advance governance in the global economy when these three powers fail individually. Furthermore, we have argued that this interplay may facilitate dynamic governance entrepreneurship,
175
where the three powers/arenas play complementary roles in different phases of the product cycle.
The EITI case illustrates this well. Through gradual build‐up of normative power, appealing to norms that are formally ascribed to, but badly implemented, the civic initiative Publish What You Pay sought to mobilize normative power to pressure actors with implementation capability: industry and government. Much of EITI’s remarkable success in building institutional support is indeed due to actors expanding from their traditional domains into new complementary roles. Each of the three powers, civil society, business and politics have exploited their comparative advantages in bringing the governance project forward, yet at the same time changing traditional practices. While starting out in a critical activist mode, civic initiatives engaged extensively with industry and government to push the initiative onto the agenda of the establishment. When early engagements between civil society organizations and industry proved too weak, there was swift mobilization to bring the third power – government – on board.
The flexibility of engagements between actors in all three channels proved essential to further governance entrepreneurship. In particular, this case indicates the potential for evolution from soft to hard law (Brown Weiss 1999). Civic initiatives highlighted discrepancies between commercial and political practices and generally accepted norms. Through strategic alliances with selected established political and commercial actors, civil society gradually succeeded in having these norms institutionalized and diffused.
With engagement of actors across arenas also came changes in policy content. Civil society organizations found themselves having to compromise on mandatory legislation in order to participate in supervisory functions on the national EITI boards. Neither industry nor home governments were willing to unilaterally implement transparency through hard law. However, Industry and Governments had to accept extraordinary institutionalization of supervisory functions on the top of traditional decision‐making and include civic engagement to promote new transparency ideals. Governance entrepreneurship across arenas therefore also serves to attune actors to opinions and perspectives that are viable across the board and, thereby, more easily diffused.
However, while the EITI has been a case of highly successful institution building, it still remains to be seen how it will succeed in operative practice. The “soft” beginnings of EITI remain a delicate point. While it is obviously an important element in EITI’s successful expansion, it remains a challenge for the initiative as it moves forward. To maintain its momentum, the EITI needs both recruitment and performance. A critical point is thus the next step, in 2010, when a large number of countries have to move into “compliance” mode. If the
176
initiative does not then show results, it will begin to lose its reputation. However, if EITI becomes too demanding, it will lose members and remain only for the chosen few. Here lies a delicate balance, which must be reached carefully. The relationship with emerging economies remains a major challenge to EITI’s ambition to develop a truly global standard while maintaining support from the existing signatories. The Indian and Chinese companies’ mandate to deal with weak and resource‐rich states in traditional “Westphalian” style, with no questions asked about revenue flows, gives an advantage to the elite in bargaining. One of the core elements of the EITI case was the bargaining power of Western multinational companies that played a vital role as technological and managerial gatekeepers. When they loose their exclusive positions, a crucial element EITI’s leverage on weak, resource‐rich governments may erode.
Just as the hegemony of the Western model of de‐regulated markets and corporatization of the economy has met serious opposition, so have Western norms and standards in general. The normative basis for civically‐initiated governance entrepreneurship therefore remains more challenging in a multipolar world. Nevertheless, the capacity of civic movements to spread and design common policy platforms should not be underestimated. Neither should one underestimate the incentives for new global corporations with roots in developing economies to take on cosmopolitan values and behaviour as expand and must present their brand and reputation to the global media.
Although far from perfect, governance entrepreneurship engaging the three powers of society in new and creative ways seems to be a necessary innovation in a world with great need for collective action but only imperfect solutions. We live in a multipolar world with widespread intergovernmental egoism and bleak prospects for global democracy. Just as Montesquieu saw the potential for a healthy state in the critical rivalry between the three state powers, the critical balance between government, business markets and civil society organizations remains a crucial ingredient in maintaining global order.
177
References Bauchowitz, Stefan (2009), Measuring EITI'S Success, accessed 1. September 2009, available at http://www.voxeu.org/index.php?q=node/3088 Brown Weiss, E. (1999), “The Emerging Structure of International Environmental Law” in Vig, N. J. and Axelrod, Regina (eds) The Global Environment. Congressional Quarterly, Washington D.C. Commission on Global Governance, (1995), Our Global Neighbourhood, Oxford University Press, Oxford. EITI (2006), “Report of the International Advisory Group”, accessed 1.September 2009, available at http://eiti.org/files/document/eiti_iag_report_english.pdf Elkington, J., (2001), The Chrysalis economy : how citizen CEOs and corporations can fuse values and value creation, Capstone, Oxford Ikenberry, G. J. (2001), After Victory, Princeton University Press, Princeton. Global Witness, (1999), “A Crude Awakening”, accessed 16.June.2009, available at http://www.globalwitness.org/media_library_detail.php/93/en/a_crude_awakening Global Witness, (2003) Interview with Global Witness, Joe Schumacher http://www.monitor.upeace.org/archive.cfm?id_article=58 Last Updated: 07/28/2003 Henderson, B., (1984), “The Application and misapplication of the Experience Curve”, Journal of Business Strategy, Vol. 4 Issue 3, pp3‐7 Kotler, P. (1991) “Ch.13 Managing Products through their Product Life Cycle”, in Kotler (1991): Marketing Management: Analysis, Planning, Implementation, and Control," 7th edition, Prentice‐Hall: Englewood Cliffs, N.J Locke J. (2004) “Chapter XII; The Legislative, Ececutive and Federative Power of the Commonwealth; Second Treatise of Government; p 86; Barnes and Noble Books; Originally published in 1690 “partnered governance”
178
Midttun, A., (2008), “Partnered governance: aligning corporate responsibility and public policy in the global economy”, Journal of Corporate Governance. Vol.8, Issue,4, pp406 ‐ 418 Midttun, A and Ørjasæter, N.O. (2009)”The firm as a Nexus of Product Cycles: Organising Intrapreneurship in the Innovative Firm” in Arentsen, M. and van Rossum, W. (eds) Governance of innovation. Edward Elgar, Cheltenham. Also previously published in Norwegian: Selskapet som et knippe produktsykluser: organisering av intraprenørskap i det innovative foretak; I Tor Hernes og Anne Louise Koefoed (red): Innovasjoners odyssé: Innovasjonsledelse fra idé til marked. Fagbokforlaget 2007 ) Montesquieu, Charles de Secondat baron de (1989): The spirit of the laws / translated and (edited by A. M. Cohler, B. C. Miller, H. S. Stone). Cambridge texts in the history of political thought Cambridge : Cambridge University Press (French: L'esprit des lois) first published anonymously by Charles de Secondat, Baron de Montesquieu in 1748 with the help of Claudine Guérin de Tencin. Publish What You Pay (2009): http://www.publishwhatyoupay.org/en/resources/energy‐security‐through‐transparency‐act‐2009 Rosenau, J. (1997), Along the Domestic‐ Foreign Frontier, Cambridge University Press, Cambridge. Spindler, G (2000): “Separation of Powers: Doctrine and Practice” (This article, suitable for Year 11‐12 Legal Studies, originally appeared in the publication Legal Date in March 2000.) http://www.parliament.nsw.gov.au/prod/parlment/publications.nsf/0/E88B2C638DC23E51CA256EDE00795896 , 10 october 2009 Stratfor Global Intelligence, (2004), Human Rights a New Lever for Angolan Oil Transparency?, accessed 15 september 2009, available at http://www.stratfor.com/memberships/84157/human_rights_new_lever_angolan_oil_transparency Utterback, J. M. and Abernathy, W. J. (1975/ 2000): A Dynamic Model of Process and Product Innovation; The political economy of science, technology and
179
180
innovation, 2000, pp. 386‐403, Elgar Reference Collection. International Library of Critical Writings in Economics, vol. 116. Cheltenham, U.K. and Northampton, Mass Vernon, Raymond (1966) ‘International Investment and International Trade in the Product Cycle’, The Quarterly Journal of Economics, vol. 80, Issue, 2 Macalister, T. (2002), “'Ethical' BP linked to Angola claims, The Guardian, Wednesday 27 February 2002, accessed August 1. Available at : http://www.guardian.co.uk/business/2002/feb/27/oilandpetrol.bp Zadek, Simon (2004) “ The Path to Corporate Responsibility” Harvard Business Review, Vol. 82 Issue 12, pp 125‐132, Ölcer, Dilan, (2009) “Extracting the Maximum from EITI“ OECD Development Centre Working Paper No.276 , February