By Dr. Aneel Karnani, Ph.D., Professor of Strategy at the Michigan Ross School of Business.
India is the only major country in the world that by law requires firms above a specified threshold size to spend 2% of their net profits on corporate social responsibility (CSR) projects. This law came into effect in April 2014 and was significantly amended in 2021.
The general reaction in the Indian press has been positive and suggests that the CSR law has been a success. However, the CSR law is only apparently successful: compliance with the law is not a good measure of its success. What matters is not the amount of money spent, but rather the outcomes achieved. In fact, the law mandating CSR expenditures is harmful to achieving the nation's goal of inclusive development.
The compliance numbers overstate the effect of the law. It is not clear whether firms have really increased their CSR spending after the law compared to what they were spending voluntarily before the law, because CSR spending was not well reported historically. Based on a study of the 100 largest Indian firms, Professors Dhammika Dharmapala and Vikramaditya Khanna find that while firms that were initially spending less than 2% increased their CSR activity, but those that were initially spending more than 2% reduced their CSR expenditures. It is possible that the 2% level intended as a threshold becomes an unintended focal point (or an anchor), both a floor and a ceiling.
Societal interests and private firms profits are not perfectly aligned, of course. The CSR law and its mandated expenditures will lead to lower net profits. The CSR law can be viewed as a 2% tax, albeit spent by the firms rather than collected by the government. This is a hidden way to increase corporate taxes. It is not surprising that the Indian business community strongly opposed the CSR law. The corporate tax rate in India is 30 percent (about 35 percent including some surcharges) —already one of the highest compared to a global average of about 25 percent. Empirical research suggests that following the first announcement of mandatory CSR in August 2010, the stock market value of firms subject to the law decreased by about 3%. This negative effect should not be surprising; if CSR spending benefitted firms, they would already have been doing it voluntarily. This proves that the Indian stock market perceives the mandatory CSR expenditures as a tax. What is interesting is that the estimated decrease in market value of 3% is even larger than the mandated expenditure level of 2%. This could be due to additional costs of compliance and reporting.
Given the current emphasis on economic liberalization and economic growth, it is unlikely that the Indian polity desires an increase in the corporate tax rate. This certainly will not help to make Indian firms more globally competitive nor attract more foreign investment into India, and is not conducive to economic development of India.
What India needs is not just economic development, but inclusive development. Even to the extent that there has been a real increase in socially beneficial expenditures, the spending has not gone to democratically determined priorities, but rather to whatever the companies prefer to emphasize. The CSR law works like a centralized tax with decentralized expenditures undertaken by private, and importantly unelected, parties according to their own priorities. This is clearly contrary to the fundamental logic of democratic governance. It is in effect taxation without representation. It is the government's responsibility to determine high-priority needs of society and target public expenditures in these areas to achieve the nation's goal of inclusive economic development. Given the high and growing level on inequality in India, the Indian political economic system needs to further emphasize egalitarian development. With the CSR law, the government has abdicated one of its primary functions and responsibilities.
Inequality in India has several dimensions; an important one is geographic inequality. Some parts of India enjoy significantly higher levels of industrial development and per capita income than other parts. It is the responsibility of the central government to help achieve a geographically more egalitarian society. Perversely the CSR law helps entrench the current geographic inequality in development. Five states: Maharashtra, Delhi, Karnataka, Gujarat, and Tamil Nadu account for 79% of all CSR contribution. Towards the bottom of the list are Nagaland, Mizoram, Tripura, Sikkim and Meghalaya, all from the northeast. A similar asymmetry is also observed in the beneficiary states; the top contributing states also being the top recipient states. This, of course, reflects the inclinations, interests, and priorities of the business sector.
It is impossible to have true responsibility without accountability. In a private company, if the managers behave irresponsibly, the shareholders hold the managers accountable and can fire the managers. In a democracy the citizens hold the government officials accountable and can 'fire' them at the next election. But, under the CSR law, if the managers do not spend the CSR funds in a responsible manner, nobody holds them accountable. It is significant that the focus of the CSR law is on money spent, not results achieved. It is somewhat like shareholders rewarding managers for how high are their costs rather than profits achieved.
CSR is a controversial idea with many executives, academics and officials on both sides of the issue. According to two researchers at the United Nations, Peter Utting and Jose Carlos Marques, "CSR thinking is largely ahistorical, empirically weak, theoretically thin and politically naive." Nobel Prize economist Milton Friedman argued that discussions of CSR are notable for their "analytical looseness and lack of rigor" -- apparently not much has changed since that observation in 1970. It is a symptom of the poor theoretical foundation of CSR that the field cannot even agree on a definition of CSR.
Thus it is not surprising that the Indian law does not clearly define CSR for the purposes of expenditures. The law lists only a few genres of CSR activities: “eradicating extreme hunger and poverty,” “promotion of education,” and “social business projects.” This is much too vague to work as a legal definition.
Some supporters of the CSR law have argued that CSR contributes to governmental resources and delivery mechanisms to provide public goods such as education, health care and infrastructure. CSR helps to fill a 'governance gap' especially when governments are weak, corrupt, inefficient and under-resourced. Even if the Indian government is characterized by these negative traits, the solution is to improve the government, and certainly not to have the government outsource its core responsibilities.
The CSR law is inherently contradictory. CSR is fundamentally an inspirational exercise, and it is very difficult to legislate aspirations. Laws only set minimum standards, but do not create an impetus for positive action. For example, it would be difficult to require that companies build ‘excellent’ schools; the legal requirement can be met merely by spending money on education. The CSR law by its very nature cannot be a catalyst for societal change.
Inequality in India, which was already high, has increased even more. The CSR law does not go far enough in reducing inequality and helping the disadvantaged. Without an emphasis on accountability of results achieved (not funds spent), it is very unlikely that the law will result in real effectiveness. But it does give the illusion of progress. This is ‘greenwashing’ on a national scale!
About the Author
Dr. Aneel Karnani, PhD is a Professor of Strategy and International Business at the Michigan Ross School of Business. Professor Karnani's interests are focused on three topics: strategies for growth, global competition, and the role of business in society. He studies how firms can leverage existing competitive advantages and create new ones to achieve rapid growth. He is interested in global competition, particularly in the context of emerging economies. He studies both how local companies can compete against large multinational firms, and how multinational firms can succeed in these unfamiliar markets. Karnani researches poverty reduction and the appropriate roles for the private sector, the state and civil society. He is interested in how society can strike the appropriate balance between private profits and public welfare in tackling major societal problems.