So what’s that title about anyway?

I know I said that the next post would be about contacting the IFC, but I’ve realised that I forgot to explain why the project is called ‘Governance by Contract?’. So, herewith an explanation of sorts.

One of the most interesting things about the social sciences is that there’s always more than one way of looking at the same question. Last time I was talking about the project from a perspective that focused on the steps that the IFC had taken to ensure that its client businesses were respecting human rights, but you could equally well look at the IFC’s performance standards system as a means of filling the ‘governance gap’ that has opened up as a result of the globalization of the economy.

OK, so now I have to explain ‘governance gap’. On the grounds that ‘governance’ is more difficult to explain than ‘gap’ let’s start with that.

Governance

When people talk about governance, what they mean is simply the process of deciding what is to be done and making sure there is an appropriate degree of responsibility and accountability for those decisions. What it comes down to is a mixture of goals, incentives, rules and institutions. So corporate governance is about boards of directors, markets, contracts, management systems, accounting standards, labour law, community engagement, environmental law and so on. Although you don’t need governments to have governance and many aspects of governance are independent of the state, laws and other types of government regulation obviously do loom fairly large in all of this.

The whole idea of governance is particularly resonant when we’re talking about capitalism. Business decision-making necessarily involves striking a balance between factors that pull in different directions. On the one hand there are market factors — the need to be able to compete on price and quality. On the other there are the social and environmental limits that have to be put on where we let markets take us, and the incentives needed to ensure that businesses do certain important things they might not do (or do enough of) if markets were their only point of reference, like training young people or investing in research and development.

For us as consumers and investors, whether individual or collective, what’s important is to be sure that our money is being used by businesses that consistently strike a reasonable balance between the interests of workers, shareholders, suppliers, customers, the community and the environment. More than anything else, we want to be sure that the international financial relationships that arise as a result of trade and investment are making the lives of the affected workers and communities better and not worse.

Business leaders and pro-business lobbies are always keen to insist that corporate executives are able to recognize and maintain a reasonable  balance between interests without any external intervention or oversight, but unfortunately the history of capitalism strongly suggests that this is not the case. We’ll come back to the debate on business regulation in a moment, but for now let’s just recognise that most people would agree that we can’t just let corporations, large or small, do exactly what they like and that corporate governance has to involve a substantial element of regulatory compliance together with public accountability for decisions made and action taken.

So what’s the gap?

Globalisation has left a governance gap simply because although the importance of international trade has grown enormously in recent years and although production systems increasingly involve contractors, sub-contractors and sub-sub-contractors in multiple countries, governance systems are still almost exclusively national. Certainly there are lots of international treaties and conventions that say what everyone has agreed to do (for example) to protect workers from exploitation or reduce pollution, but the international organizations that administer these treaties and conventions have no direct jurisdiction over individuals and corporations. They rely on national governments to enact laws and regulations that will put the agreements they have signed into effect.

There are two problems with this. First of all, the capacity of governments to produce and enforce regulation is wildly variable. Simply because some government has signed up to an international convention to protect the orange tree lobster (or whatever) doesn’t in itself guarantee that no companies under the jurisdiction of that government will ever harm an orange tree lobster and that from the moment the convention is signed we can trade with them with a clear conscience. Second, and perhaps more seriously, the willingness of governments to regulate is in itself affected by the importance of international trade. There is no international governance system that can limit or balance the commercial pressure that economically powerful brands and retailers based in the Global North are able to apply along their supply chains in the Global South. The need to accommodate these foreign customers and investors may in turn lead the  governments of poorer countries to be less than assiduous about implementing existing social and environmental agreements and to resist the development of new ones.

Closing the governance gap

There are two obvious ways we might go about trying to close this governance gap. On the one hand, we could increase the capacity of international organizations (IOs) to monitor compliance with the rules and to provide funding and concrete technical assistance to governments to get effective regulation up and running at the national level. More radically, we could also give IOs more power to sanction countries that are not doing enough to ensure that international law is being effectively put into practice. This is attractively simple on paper, but startlingly complex, expensive and politically difficult in practice. On the other hand, national governments could simply ban trade with foreign businesses that are unable satisfactorily  to demonstrate that (for example) their production processes are harmless to orange tree lobsters. This brings us back to the question of business regulation.

Many people would argue that it is unfair to developing world businesses to have to comply with regulation and standards developed in the Global North and responding to the needs and demands of consumers and corporations there. The regulation of products and production processes has even been equated with protectionism on the grounds that since Global North businesses find it easier to comply with this regulation, it has the effect of keeping Global South producers out of northern markets. This argument has even been given institutional expression in the rules produced by the World Trade Organization, which forbid governments from introducing regulation that has a substantively different effect on products from domestic and foreign producers.

Whatever else we may think of this kind of unilateral action, it certainly raises a number of difficult questions to do with democracy, accountability and sovereignty. If global governance of markets and businesses is to be legitimate, one set of nations can’t simply be excluded from the development of the regulations that make capitalism liveable. But including them would require an international institutional apparatus that doesn’t currently exist and whose establishment looks next to impossible. Does that mean, though, that we should simply abandon those who are suffering from the consequences of international trade? These questions are so difficult and so intractable that at the moment the preferred solutions are those that simply get around them by putting the emphasis on voluntary or private governance.

Private governance systems

By virtue of being voluntary, private governance systems avoid the problems of principle arising from compulsory regulation. They are independent of government and as such do not have the power to impose sanctions for non-compliance with regulation. Instead, they operate on the basis of incentives to comply. In most cases, these incentives are tied up with the projected market advantage that comes with persuading customers that a business respects certain rules or principles. Whether through corporate reputation built on the basis of compliance with internal codes of conduct or through participation in certification and labelling schemes, the idea is that if a business is able to produce some sort of evidence that it has behaved properly it will attract more customers. Something over 400 different ‘ethical’ labels currently exist that claim to certify that producers have gone about their business in a way that is appropriately respectful of the environment (eg orange tree lobster friendly), the rights of indigenous peoples, the rights of workers and so on. The various fair trade and organic labels are undoubtedly the best known of these.

Whether private governance is an acceptable, durable and/or effective solution to anything at all is a question that is entirely unresolved, but if we try to get into the issues here this post will never get finished. We’ll try to come back to it in the future, though.

Back to the IFC and that title again…

The IFC’s performance standards system falls somewhere between private and public governance. The IFC is a public (i.e. intergovernmental) international organization, but it does not itself produce or administer international agreements or rule systems. On the other hand, it has a much greater capacity to change the behaviour of businesses than either the private certification/labelling organisations or those IOs that do produce international regulation because what it has to offer is the incentive of an injection of cold hard cash. Insufficient compliance equals no investment, and since continuing compliance is a condition of the investment contract, failing to resolve problems or falling out of compliance equals withdrawal of investment.

The more attentive among you will have noticed that I have finally explained the title of the research project: the IFC performance standards system is a kind of regulatory scheme that is enforced via the inclusion of compliance as a condition of an investment contract. Hence, ‘governance by contract’. It’s not private because the IFC ‘belongs’ to governments and the regulation that it tries to enforce is largely derived from existing international conventions and treaties. On the other hand it’s not public because the incentive to comply is contained in a private investment contract.

So it’s really interesting, but does it work? No idea, but watch this space if you want to see if we can make a stab at an answer.

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