The Friedman Doctrine, Revisited.

Reconciling Milton Friedman with corporate social responsibility

In September 1970, The New York Times Magazine published an op-ed by economist Milton Friedman entitled “A Friedman doctrine — The Social Responsibility Of Business Is to Increase Its Profits.“ The article sowed the seeds of neoliberalism, the dominant theory driving corporate decision making and economic policy over the past fifty years. The Friedman doctrine, also dubbed the shareholder theory, has led to disastrous environmental and social consequences: climate change, rising inequality, and social media’s degradation of democracy to name a few.

History almost played out differently. Months earlier in February of that very year, Ralph Nader was advocating for corporate responsibility, launching the Campaign to Make General Motors Responsible. The campaign advocated for three reforms within GM: an expansion of the board to include representatives of the public, a resolution that the company undertake no business activity that “is detrimental to the health, safety, or welfare of the citizens of the United States”, and a shareholder’s committee for social responsibility.

Friedman’s op-ed was a direct response to Nadar and his colleagues’ efforts to make corporations more socially responsible. In the piece, Friedman makes a compelling case that the sole responsibility of the firm should be to maximize return to shareholders.

But, if you examine Friedman’s logic with a more nuanced lens, it’s possible to reconcile his argument with the very case for corporate social responsibility he sought to shut down. This view of the Friedman doctrine provides a new theory of the firm, updated for the urgent needs of the 21st century and compatible with stakeholder capitalism.

First, a quick lesson in economic history…

Classical economics, also known as political economy, arose in the late 18th century with famous economists such as Adam Smith, David Ricardo, and John Stuart Mill. These men were philosophers, concerned not just with economics but also with politics and ethics. Adam Smith’s Theory of Moral Sentiments provides the moral underpinnings for The Wealth of Nations. John Stuart Mill was a proponent of utilitarianism, Jeremy Bentham’s ethical theory around morally superior outcomes optimizing for the happiness and well being of all affected individuals.

Around 1900, classical economics gave way to neoclassical economics; a tectonic shift in economic thinking that served as the foundation for Friedman’s arguments.

It’s important to understand that this same time in history marked profound discoveries for the field of physics. Max Planck discovered the quantum nature of energy in 1900. Einstein published his paper on special relativity and introduced mass-energy equivalence in1905. Inspired by their counterparts in physics, economists at the time sought to make economics a science, rigorizing the field. That is to say, they sought to represent economic theory in terms of mathematical equations that could be solved using calculus. Doing so stripped the field of economics of its moral origins, and radically reduced complex human behavior to simple equations with a handful of variables.

Equations to be maximized, known as objective functions, dictated the decisions of various economic actors. Firms optimized for profit. Employees optimized for economic return on their labor. Investors optimized for return on capital. And importantly, consumers optimized for the utility, i.e. the welfare or happiness, gained from consumption (of a good or service).

Neoclassical economics underpinned Friedman’s mental model when he wrote the Friedman doctrine. Seen this way, his case is compelling. In fact, doing anything other than optimizing for return to shareholders is fundamentally anti-democratic.

Here’s a passage from the article; It’s worth reading it in his own words:

“What does it mean to say that the corporate executive has a ‘social responsibility’ in his capacity as a businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers.

…the corporate executive would be spending someone else’s money for a general social interest. Insofar as his actions in accord with his ‘social responsibility’ reduce returns to stockholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers’ money. Insofar as his actions lower the wages of some employees, he is spending their money.

The stockholders or the customers or the employees could separately spend their own money on the particular action if they wished to do so. The executive is exercising a distinct ‘social responsibility,’ rather than serving as an agent of the stockholders or the customers or the employees, only if he spends the money in a different way than they would have spent it.

But if he does this, he is in effect imposing taxes, on the one hand, and deciding how the tax proceeds shall be spent, on the other.”

Friedman goes on to argue that acting so is tantamount to taxation without representation — levying taxes and spending that revenue for social ends is the role of the state, not the corporation.

“The whole justification for permitting the corporate executive to be selected by the stockholders is that the executive is an agent serving the interests of his principal. This justification disappears when the corporate executive imposes taxes and spends the proceeds for ‘social’ purposes. He becomes in effect a public employee, a civil servant, even though he remains in name an employee of a private enterprise. On grounds of political principle, it is intolerable that such civil servants — insofar as their actions in the name of social responsibility are real and not just window‐dressing — should be selected as they are now. If they are to be civil servants, then they must be selected through a political process. If they are to impose taxes and make expenditures to foster ‘social’ objectives, then political machinery must be set up to guide the assessment of taxes and to determine through a political process the objectives to be served.”

Taken within the context of neoclassical economics, Friedman’s argument is compelling. Firms should optimize for profit — individuals can spend their own money towards social ends. Firms pay taxes that are then allocated based on the preferences of citizens, acting through a democratic state.

But what if we challenge the assumptions of neoclassical economics? What if investors, employees, and consumers have more complex objective functions than simply return on capital, labor, and utility of the goods and services consumed?

This is in fact what we see all around us today. Investors now allocate capital based on social outcomes, not just financial return. Employees care about the values their companies stand for. And increasingly, consumption decisions are based on whether firms have policies in place addressing social justice and environmental responsibilities. Each of these actors is willing to accept a lower return, or pay a premium, to align themselves with their broader societal preferences. They are effectively opting in to be taxed, in order to support firms which embody the social responsibility they wish to see from the private sector.

This update to neoclassical economic thinking supports today’s shift to stakeholder capitalism, where the purpose of the firm is no longer to maximize return to shareholders, but to serve the needs of society writ large. Seen this way, corporate social responsibility is fully compatible with Friedman’s logic. Firms should indeed operate in ways that align with the objective function of their respective stakeholders, taking social outcomes into account.

This, I believe, is the economy of the future: where firms exist to serve social objectives. The shift is nothing short of profound — the many of the functions previously confined to the state and nonprofits decentralize to the firm, externalities internalized.

I’ll elaborate in more detail on such an economy in my next post.