Jul 24, 2019
Welcome to Finance and Fury, the ‘Say What Wednesday’
Edition.
We recently had an awesome email from Zoe about a potential
market solution following the ‘Solution for pollution’ episode last
week;
“We sort our cans from our mixed recycling in our Sydney CBD
office building to donate the 10c return to charity. We collect 50
cans per week on our floor which is on level 22 of a 23-level
building.
Staff are incentivised to sort their waste through the small
charitable 10c donation. However, it is difficult to return cans in
the city as there is no spare space to hold sorted recycling. This
could be fixed if we could hold sorted recycling in our office
buildings. Rather than sending mixed and often contaminated waste
to large holding areas outside of the CBD, we could send clean
product directly to appropriate recycling facilities.
There are hundreds of office building across the country holding
contaminated recycling then paying waste companies to remove their
rubbish. With a small 10c donation to charity for each recyclable
product we have a great incentive for our office buildings in the
country to hold sorted recycling in their basements which can be
sent directly to the correct recycling avenue.
I’m a long-time listener, first time writer. Thank you for such
an interesting podcast.”
That sounds like a great program that you are all participating
in! Really awesome to hear and is definitely a great effort to help
the pollution problem.
How can this become a more popular thing? not just with cans –
with bottles, paper, food, plastics.
In today’s episode we will go deeper into this topic
- Talk about policy decision making – how to expand this sort of
program and also, why policy makers are likely to stuff it up
- We have to operate this way due to the influencing factors such
as share values, costs, Government intervention, etc.
- All incentives based – you can lead a horse to water but you
can’t make it drink. Policy may end up drowning it.
- Then also we’ll run through why simply regulating that
companies have to be a part of the supply chain would result in a
pretty bad outcome, not only for companies but also us as the
consumer.
First, I want to explain a few concepts behind policy decision
making and issues I see with the current regulatory environment
- Common practice - Things defined by ‘hoped-for’ results, rather
than the actual mechanics of decision making
- ‘Profit making’ businesses often fail to make a profit and
become extinct – economist Thomas Sowell calls them ‘residual
claimants to the company’s income’ – they get what is left.
- There’s no more reason to expect a drug prevention program to
reduce drug use, or public interest law firms to serve public
interest, than there is to expect a company make a profit.
- You have to look at what they do – not what they intend to do.
This is the trouble with regulation and legislation – set out with
what you intend to do, but regulations aren’t a dynamic system and
the information feedback loop is almost non-existent
- Government makes a blunder with regulations and it takes a
while for them to concede (if ever)
- Do you ever hear them turn around and say ‘we got it wrong’ –
instead they say, ‘this policy will work, if we have more
money’
- Doubling down. It’s politicians’ jobs to stay in power – saying
you are wrong doesn’t give voters confidence and you may not get
re-elected – could be career suicide if they try to correct
something that they have done wrong
- It takes years to have the studies conducted on the effects
anyway – there’s time to ride it out and still retire
- Let’s compare this to a company – Can a company afford to
double down if it is wrong? If it does, it is no longer a company.
This is part of an instant (quick) feedback of information about
your decisions. Not making a profit shows that you’re doing
something wrong (sales, costs, consumer wants) – need to find out
ASAP and correct the model.
- That is where the incentives lie – how effective they are is
based around the level of consequences – pros and cons
- But still need the information feedback loop as part of the
system – allows to adjust course midstream – rather than just wait
and crash – incentives aren’t worth anything if you have no
information on what is working, and what isn’t
- Policy has to have two key components – correct incentives –
quality information feedback loop
- Issues – how do you collect all of the information needed to
enforce regulations? – use Recycling as example
- Gov – how does it know best how to collect rubbish – or
transport, store, process, recycle, price, get it to the companies
– this is the main issue of any centrally planned system –
- information is limited and inability to adjust decisions to the
individual level, rather than collective – farms under economic
authoritarians like Stalin, Mao – weather and crop differences
couldn’t be managed –
- people forced into collective farming – people starved, even
though you had a massive increase in number of workers in one
project, if you don’t know what you are doing or only are able to
use what you are given, hard to farm well
- This is why I am not a massive fan of a lot of regulations –
not built in incentives but enforcement, and no feedback loop
- Throwing darts blindfolded and hoping you don’t hit anyone
Example - Banking regulations – we will be back to another royal
commission in 3-4 years on banks
If I was a betting man - derivative transaction reporting not
being fulfilled – so APRA and ASIC just double down on similar
policy - Could go on and on – but back to the core of designing a
policy – never leaves the method up to companies, punishes them if
they don’t meet the quotas
- Incentives are incredibly important – any policy should be
designed to provide incentives to achieve the intended outcome –
not a policy designed to enforce the intended quotas
- The name of a policy means nothing – Think about any company
that is run privately and for a profit
- ‘for profit company’ – what if it is running at a loss? Still
call it a for profit as that is the intention
- Problem – when things are named and designed around the
intended outcome we are more willing to accept it
- Policy to remove all inequalities in the world – only way it
can be done is to remove every choice you have
- When there are freedoms, there tends to be ranges of inequality
due to choices – distributions over ranges
- With the right incentives, companies would willing adopt
programs – but the collection/storage/transport of recycled goods
is a costly process, companies would need to be incentivised to
participate in these activities beyond it just being the right
thing to do.
- What incentives will get companies attention?
- nature of any company in a modern economy requires incentives
to be a financial incentive
- Even efforts that are taken for 'good will' are still
financially motivated - doing these activities is intended to
provide marketing and awareness of the company and the
products/services they sell – social media posts
- How the 'brand' of a company is viewed by potential consumers
is one of the biggest factors in determining their long term
success. If they are seen to be doing good, consumer are more
willing to support them and therefore, profits will go up. On the
other side, when consumers find out that they have been doing the
wrong thing companies get heavily punished.
- A recent example is Volkswagen emissions scandal back in 2015
where their share price halved, going from over €200 to €100 in a
month
- world's largest automaker by sales – installed software to
deceive the CO2 emissions tracking software – people bought the
cars thinking they were helping – but then the market punished
them. As it should – it is a market of regulations and consumers
that drives business decisions
- We are consumers – why can’t we just force companies to do
this? Boycotts etc. – we are myopic, and cost sensitive (cost in
time, effort, money, all factors)
- Boycott may last a few days, weeks, months – but will 100% of
consumers participate? And how long?
- May have a minimal effect if company does capitulate – as long
as they are seen to do something – minimal
- What about our short-term natures? Another barrier in having a
company adopt an ongoing recycling model
- Events of providing 'good will' are short lived benefits to the
brand - consumers soon forget
- We are bombarded with information constantly - companies need
to constantly come up with a new campaign to grab public attention
again
- Implementing an ongoing program that would increase their
operating costs isn’t an attractive option
- Brand goes up, but effects of activity fades over time – we
adapt or forget – but costs remain
What may make companies willing adopt the responsibility of
being part of the recycling supply chain
- Incentive for them - either tax credits or other form of
regulatory benefit would need to be provided
- on the surface this sort of policy wouldn’t look popular -
giving the fat cat companies tax cuts –
- But if the Gov can cease doing this, then the costs they incur
goes down, meaning less tax needed
- Worried about those large multi-national companies avoiding
more tax still?
- They are only paying the level of tax that they view as
'socially acceptable', again to preserve the brand.
- Massive banks like Citi-group, they could all pay 0% of tax
using profit shifting but choose not to as that would decrease
their brands value in the eyes of the consumer.
- This isn’t true for any small to medium sized business though -
don’t have access to the same profit shifting schemes
- SME's are also where almost half of the population is
employed
- providing incentives to companies based around what will best
incentivise them would be needed
- also allow the greatest range of benefits to be provided when
compared to blanket regulations enforcing the participation in the
same activities
- large companies could absorb the costs while SME's would
struggle to keep up with these over time
- No idea what the right level of incentive would need to be –
don’t think it should be a blanket – something to meet each
industry needs
- Let them figure it out over time – thousands of companies
trying different things – some will stick, become adopted –
different things will work in smaller business, compared to large –
allows for flexibility
- Know that it cant be a blanket enforcement – speaking of which
- Still reading through the UNs Circular Economy – holy moly
there is a lot of additional proposals that massively increase
global regulations – Global price controls, quotes, enforcement of
methods – conjunction with non-profits: part of project mainstream
(actual name) – Looking at the list of partners –
- Danone – food processing multinational – Google – Unilever -
H&M Group –
- Intesa Sanpaolo – massive bank – 800bn euros – 25% bigger than
CBA
- They are taking care of the money (5bn euro credit facility)
plus designing lots of legislation:
- Quote - circular economy principles not only for the
international corporates and large companies but also for the small
and medium-sized enterprises - the main focus of our Group
commitment. The circular economy is one of the most
important new development frameworks, enhancing companies’
resilience and changing their business models.
- This is who the circular economy would really benefit – either
absorb the cost of participating (they are designing it based on
what works for them), or pay the fines for breaking the new
regulations that they championed into the market place
- SMEs suffer – can’t source (access to supply chain), afford
(increased cost of goods), sell (restrictions on what product
reused content is, or not legal to sell) etc under the new
regulations
- All massive companies – revenues in the billions –
- This form of enforcement style policy just ends up digging the
consumer into a hole
- The circular economy does sound good though – it sounds like a
great thing to work towards – but that is because they are stating
the intended goals again – but mechanisms are more important than
the stated goal – Say I am going to lose weight, but if I super
size myself, I wont be successful
- This will be part of a bigger series - companies backing the
circular economy and why will be part of the series
Thanks again for the question Zoe! And if you have a question or
a topic you'd like to explore on the podcast, hit me up on the
Finance and Fury contact page!