The Unintended Consequences of India's CSR Law

India is showing corporate leadership on the world stage. Since 2013, large, profitable companies are required to pay 2 per cent of their net profits to improve Indian society. The money is to be spent on important societal issues, such as poverty, education, and the empowerment of women. To my knowledge, no other government has stepped up to legislate corporate social responsibility (CSR).

Most governments do not legislate CSR. Rather, they tax companies and reallocate the funds themselves. In that way, governments can prioritise social issues, rather than leaving them in the hands of corporations. One has to wonder if India's approach is visionary or whether it is short sighted.

CSR Legislation is Visionary

Legislating CSR clearly has its benefits. The most obvious benefit is that it will generate a significant amount of money for social causes. Charitable contributions are expected to grow from $600 million to $2 billion annually. The number of schools that can be built, teachers hired, and mouths fed with this amount of money is significant. This legislation will lead to a direct transfer of wealth from the owners of capital to people who have never had the opportunity to acquire capital.

As well, this policy is likely to build a culture of CSR among corporations. By requiring corporations to give to charitable causes, companies will build the corporate processes and relationships that will facilitate CSR. This will force companies to think more deeply about their role in society, rather than just paying more taxes to government. Charitable giving will become part of the corporate DNA. Furthermore, recipients of the CSR funds will start to see businesses as partners and not just part of an elite capitalist class.

This is the story that the government is likely hoping will occur. There is a darker side that could create unintended consequences.

CSR Legislation is Short-Sighted

In 1962, Milton Friedman wrote in his seminal book, Capitalism and Freedom, that "there is one and only one social responsibility of business-to use its resources and engage in activities designed to increase its profits ..." He argues that corporations are tasked to make money. They cannot be responsible, as this is the domain of individuals. The only responsibility of business is to make money and to distribute this money to their shareholders.

Friedman also argues that corporations do not have the skills to know how to alleviate poverty, educate the uneducated, and empower women. Instead, they know how to produce goods and services at the lowest cost possible, and sell them for the highest price possible. In many cases, these very activities are at odds with CSR, such as paying people low wages on temporary contracts with poor long-term benefits.

It is hard to reconcile the idea that corporations will disburse funds to the underprivileged, while at the same time profiting from low paid labor. Although some corporations may be benevolent, the corporate framework has been established to foster short-term self-interests.

Social problems, however, do not require handfuls of money to resolve them. Many problems are systemic and require long-term sustained commitment. Money can sometimes exacerbate these issues, rather than resolve them.

For example, building schools and providing teachers are often seen as the solution to the lack of education. In fact, these activities are among the most favored among Westerners, as it captures their hearts, minds and pocket books. However, poor education and illiteracy are often not the result of poor schooling; they are often a result of poverty so that children are needed to work at home or in a factory. Education is often symptomatic of other issues and cannot be resolved by quick fixes.

Changing mindsets and changing systems take time. Yet, the CSR legislation requires funds to be distributed annually and companies look for immediate results. They want to see their changes quickly. Building schools and staffing teachers provides corporations the visible artifacts that reward their CSR efforts. The CSR law could likely lead to window dressing or green washing.

Should Business be Determining Social Priorities? 

But, there is a deeper, more philosophical question that should be asked. Should corporations be determining social priorities? It is widely assumed that the role of government is to protect the social good. Even Milton Friedman would agree. If government abdicates that responsibility to business, then will business become government. Do we want business to determine who should receive affordable housing, where schools should be built, or which communities to police and protect.

How Business Can Do the Most Good through CSR

India is experiencing a natural experiment. The legislation is enacted, so the consequences of the policy will be revealed over time. The success, I believe, is now in the hands of business. They can use their money for tackling some of India's most deeply rooted social concerns, or they can use their money to advance business interests. If they choose the former, I have a few suggestions.

1. Do what you know. Whereas CSR can be seen as philanthropy, it is likely to have the greatest impact if the money spent accords with current business activities. Food businesses can help feed the poor. Construction companies can hire local labor or build affordable housing. Telecom companies can provide free cellular airtime. By sticking with what you know, you are likely to have more positive impact, while building your reputation as a community-based organisation.

2. Work with research institutions. Universities house people who are entrenched in data and care deeply about social issues. Researchers can provide evidence and insights in the best ways to address social issues and serve as objective arbiters in mediating between partners with competing interests.

3. Engage the recipients. It is much easier to hand people money than actually hear their issues. When corporate employees sit with target communities, they will build empathy and find creative solutions to addressing problems.

4. Collaborate with NGOs. Programs are best delivered by on the ground, who can see the impact of the new programs. Find legitimate NGOs who will work with you, speak candidly with you, and execute the program. Businesses should do what they do well and make money; social enterprises can do what they do well and fix social problems.

The author is Professor and Canada Research Chair in Business Sustainability at the Ivey Business School, Western University, Canada.

(An earlier version of this column had inaccuracies and was erroneously uploaded.)

Here is why you need to take social responsibility seriously

On April 1, 2014, the new Companies Act, 2013 came into force—and India became the first country to legally require companies to “give back” to society.

On April 1, 2015, the government will start finding out if any of that actually happened, and if not, why not, as the legal reporting framework requires.

The law made it mandatory for companies that have an annual turnover greater than Rs1,000 crore, or net worth greater than Rs500 crore, or net profit greater than Rs5 crore, to spend 2% of their three-year average annual net profit on corporate social responsibility (CSR) activities starting last year.

But Indian companies largely spent 2014 awaiting regulatory clarity on several unclear provisions in the law, while also preparing to comply.

 CSR is actually much more exciting than all this regulatory talk. 

Critics argue mandatory CSR is oxymoronic, and a bad idea at a time when economic growth driven by the private sector has been ostensibly pulling millions out of poverty.

Moreover, they add, India’s inherent government corruption and “tick box” tokenistic compliance behaviour could make it nearly impossible for CSR to have substantial positive social impact.

Now there is speculation that the Narendra Modi government’s move towards improving ease-of-business might do away with the 2% requirement, but the Companies Amendment Bill 2014 passed by the Lok Sabha late last year doesn’t officially seem to deal with this (pdf).

Nonetheless, minister of state for finance, Jayant Sinha, last month recommended that corporates engage in CSR. And, although the CSR clause might eventually be watered down for ease-of-business reasons, it is very unlikely to be removed entirely. 

But CSR is actually much more exciting than all this regulatory talk.

As economic growth gets back on track—and if as expected the next decade produces unprecedented corporate successes in India—the size and scale of CSR will expand since it is effectively a proportion of corporate profits.

Which brings us to a key question: Whether compliance-driven or responsibility-driven, can CSR be transformational in India?

Organising force

In 2009, India had 3.3 million non-governmental organisations (NGOs), about one for every 400 Indians.

Most are tiny organizations that deal with specific local issues. And while the social sector in India is recognized for its big heart and solid commitment to social justice, it is equally well known for lacking professionalism, efficiency, transparency and accountability.

 CSR can bring fresh life into this situation and unlock the sector’s value by organizing it. 

NGO leaders will typically treat these traits as good-to-haves, but lack the resources—and often, the will—to implement them. That’s understandable. Consulting firms offer pro-bono consulting services for NGOs, but that too has limited impact.

Larger companies start their own foundations or NGOs in the hope of both doing good and being seen as such, but often end up creating somewhat professional but tiny silos, having little impact in organising the sector as a whole.

But if the social sector remains unorganised, much of its value will remain untapped. And that significantly reduces possible mission-level benefits for both NGOs and government institutions, and the communities they wish to serve.

CSR can bring fresh life into this situation and unlock the sector’s value by organizing it.

CSR funds can be used to create and run high-impact, transparent NGO projects. These high efficiency, technology-driven projects—co-created by corporate donors, NGOs, research organisations and local government agencies—can be transformational in their legitimacy, reach, funding, impact and sustainability.

To ensure maximum impact for every rupee spent, these projects can aim to improve the implementation of often flawed and leaky government programmes, and help create sustainable livelihoods.

Under the law, CSR funds are directly proportional to corporate profits, which are driven by market forces. Therefore well-managed collective CSR efforts will effectively create an elaborate, market-led NGO performance measurement standard, without any added government regulation or cost.

Through this, NGOs get to have social impact; companies enjoy impact and branding; the government receives help in development works; research organisations get access to subjects and data; and, most importantly, the served communities benefit tremendously.

In India, it would be a near miracle if all these happen as described, but the larger point is that CSR does have the potential to create and administer effective development projects. 

Philanthropy and government 

The past half-a-century of proliferating NGO activity has certainly done some degree of good for India’s poor and marginalized, but it has also added to government jadedness at the local level, by opening up what is often called a parallel development sector.

NGOs feel they are filling in for governments that aren’t doing their part. Unfortunately very often they have been right. But NGOs are often just as ineffective themselves. Companies doing CSR can change that by incentivising both sides to work together.

The central government’s many flagship schemes for the urban and rural poor need a lot of professional deployment assistance from the outside. Assistance coming from CSR-funded, professional NGO projects can improve the effectiveness of such programmes significantly.

Teams of consultants, development practitioners, researchers, academics and technologists, hired by think tanks that are funded by CSR money, could provide a major boost on the ground.

These experts can help local NGOs and government bodies implement programmes with precision and speed towards pre-negotiated common goals. If it is done right, such a controlled operation will likely demonstrate on-going positive development impact.

But that’s only a good idea. If not executed professionally, this can fall by the wayside just as easily.

Incentivise companies

A third way CSR funds can be transformative is if companies understand the real marketing, communications and brand value in properly executed CSR projects. This is not a novel idea, but it hasn’t been done right—yet.

Just about every new study on perceptions of business responsibility reveals that today’s consumers—including in India—aredisproportionately more willing to buy from companies perceived as “caring” for people, communities and social issues.

 CSR funds spent in the right places can easily qualify as marketing funds. 

Unfortunately, what we currently have is a large numbers of companies engaging in “feel good,” mostly pseudo-philanthropic marketing campaigns.

Some of it may be going viral now but these trends will be gone in five years. Instead, what will last is real concern, real care and real impact on the ground—all communicated well.

CSR funds spent in the right places can easily qualify as marketing funds, and if sufficient numbers of Indian companies begin to see this, it can result in significant cost savings and social impact for companies.

And that’ll help the bottom-line.

You can follow Ravi at @ravinarain. We welcome your comments at ideas.india@qz.com.