The myth of the “invisible hand” – On ethics, decency and the governmental framework of the economy

The Swiss pharmaceutical company Lonza is making headlines these days: In 2017, their engineers discovered that their factory in Visp in the canton of Valais had been emitting immense amounts of nitrous oxide (laughing gas) for decades. This has a greenhouse effect of about 600,000 tons carbon dioxide of per year (the greenhouse effect of nitrous oxide is 300 times stronger than that of CO2), more than one percent of the total greenhouse gas emissions in all Switzerland, and this from a single factory! Thus, a leading global chemical company, which has been a self-declared pioneer in a green industry in recent years, has not noticed for years that it is blowing hundreds of thousands of CO2-equivalent extra tons of greenhouse gas into the air. After this embarrassment, one would think that Lonza would quickly stop the emissions after all. This would be possible by installing a catalyst that converts the nitrous oxide into nitrogen and oxygen, literally dissolving it into air. Well, that is not what happened. Instead, the company decided to play cat-and-mouse with the Swiss authorities, as research by the Swiss daily newspaper Tagesanzeiger has shown. This involved financing the catalyst plant at a cost of 12 million Swiss francs, a paltry sum for a company that in 2019 had almost six billion in sales and well over a billion francs in profits. Lonza is not only demanding that the Swiss government covers the 12 million Swiss francs cost. Suddenly the managers smelled money. They demanded that the construction of the catalyst be recognized by the Swiss government as a CO2 compensation project. Each ton of CO2 reduction (or the equivalent) could bring the company 95 Swiss francs. All of a sudden, tens of millions of Swiss francs in extra profits instead of just the 12 million costs being covered by the government. In all this time of negotiations (more than three years have passed since the company discovered the nitrous oxide emission), the company is blowing large quantities of climate gas into the air, even though it would be so easy to prevent this. Neither public nor Lonza’s shareholders were informed of this emission until two years later, and the catalyst is not expected to be installed until spring 2022. In terms of costs, however, the company has long been off the hook.

It is clear from such examples that the concept of the “invisible hand”, introduced by Adam Smith in 1776, hardly works in reality the way economists like to imagine in their models (it is debatable whether Smith himself meant by this expression that if all actors are oriented to their own well-being, self-regulation of economic life leads to optimal production quantity and quality and to fair distribution. But this is how this metaphor entered economic theory). An important aspect that prevents unconditional, pure market-based competition from leading to socially acceptable conditions is that costs are externalized. For example, the emission of greenhouse gases such as CO2 or nitrous oxide is still associated with very low costs for the polluters; the real costs are largely booked into the future – and then paid by everyone. It is like throwing garbage out of a car window. This is the least costly and therefore the most economical form of disposal for oneself. The fact that the general public is burdened with the garbage, and/or must pay for its disposal, is not considered. It is the well-known problem of the “tragedy of the commons”, which already Aristotle described in his work “Politics”: “The good that is common to the greatest number is given the least care”. Market dynamics offers no mechanism that would prevent this all too human behavior. The companies under cost pressure cannot afford the competitive disadvantage if they voluntarily paid the actual price for the production, usage, side costs and also disposal of their products when their competitors do not.

Concrete calculations of globally externalized climate costs arrive at very large figures:

• In 2013, the International Monetary Fund (IMF) put the externalized costs of fossil energy production, i.e. those not included in the price, at around USD 4.9 trillion per year. That is about 5.8 percent of global gross domestic product.
• Nicholas Stern, Head of the UK Government’s Economic Service and former World Bank Chief Economist, also estimated the direct annual costs of climate damage in 2006 at 5 percent of global GDP. If the costs of environmental and health damage are also considered, Stern estimates that the direct annual cost of climate damage is as high as $17 trillion, or 20 percent of global GDP. Converted to the approx. 37 billion tons of CO2 emissions emitted in 2019, this means damage costs of approx. 450 dollars for each ton of emitted carbon dioxide.

Can one blame the companies, which are in enormous economic competition with each other, not only for costs and customers, but also for investors and shareholders? The maxim of “shareholder value” optimization from the late 1980s states that it is not enough to be competitive, but that the company value must also be increased as much as possible. Of course, external constraints only interfere with this. Business ethicists are increasingly questioning this very paradigm and are calling instead for an ethical foundation for economic activity, e.g. in the form of a sense of purpose that goes beyond profit maximization.

There are many examples of ethical misconduct by companies beyond Lonza. A particularly striking one is the Swiss company Glencore, which has repeatedly drawn attention to itself through scandals in recent years. Allegations of corruption, breaches of environmental regulations, exploitation of land and people in third world countries, controversial business deals in Congo and Venezuela, for example, which have led to investigations by the US and Canadian judicial authorities, complaints by shareholders for improper management – the list of complaints brought against this company is long. And yet the company is thriving, its dishonest management including many of the richest Swiss. “I am a businessman, not a politician,” its boss once said, justifying this statement by saying that it was perfectly okay to do business with corrupt, violent and racist governments and to violate environmental regulations.

There is no “invisible hand” that can change things for the better all by itself. The approach that politics should simply let things run in order to achieve the best possible result for all people is fundamentally wrong, as ethical misconduct is not punished sufficiently by the market. As long as major companies such as Glencore and Lonza, or Exxon and Koch Industries, do not set limits for themselves and prefer to brutally serve their own profit without any consideration for the common good, these limits must be set from the outside. This is primarily the role of politics. Consumers and shareholders can set certain signals, but only the legislator can bring about a safe and lasting change of maldevelopments like the ones above. The following examples show that this is possible:

• In the pharmaceutical industry, strict procedures apply in most countries of the world for the approval of new drugs. They ensure that corporate interests do not lead to excessive risks for society. In Germany, not least the thalidomide scandal in the early 1960s sensitized politicians and citizens to the issue.
• In the case of nuclear power, there are clear government regulations regarding safety and disposal. Nuclear power plants are thus subject to strict regulations.
• After many years, the American judiciary finally acted against the tobacco industry’s decades-long unspeakable lies about the health damage their products cause and sentenced them to pay hundreds of billions of dollars.

In Switzerland, a referendum will be held on November 29, 2020, demanding that Swiss companies be held fully responsible for violations of legal requirements abroad. Companies should then comply with the legal regulations abroad, just as they have to at home. A matter that one should believe should be taken for granted. But this is what is currently raging a fierce political battle in Switzerland in which the companies are lamenting the loss of their competitiveness. It could not be more telling.