Argument

India’s 2 Percent Solution

By mandating corporate social responsibility, Narendra Modi is helping the government shirk its most basic obligations.

Indian Prime Minister Narendra Modi delivers his speech during the 46th Indian Labour Conference in New Delhi on July 20, 2015.  Prime Minister Narendra Modi inaugurated the 46th Indian Labour Conference as well as dedicated the National Career Service (NCS) portal to the nation and launched health reforms of the Employees' State Insurance Corporation of India (ESIC) in New Delhi.    AFP PHOTO/ PRAKASH SINGH        (Photo credit should read PRAKASH SINGH/AFP/Getty Images)
Indian Prime Minister Narendra Modi delivers his speech during the 46th Indian Labour Conference in New Delhi on July 20, 2015. Prime Minister Narendra Modi inaugurated the 46th Indian Labour Conference as well as dedicated the National Career Service (NCS) portal to the nation and launched health reforms of the Employees' State Insurance Corporation of India (ESIC) in New Delhi. AFP PHOTO/ PRAKASH SINGH (Photo credit should read PRAKASH SINGH/AFP/Getty Images)

How do you compel corporations to do some good? New Delhi thinks it has the answer. On April 1, 2014, an unprecedented law went into effect in India — one designed to mandate virtuous behavior by businesses operating across the country. It requires them to direct at least 2 percent of their pretax profits toward corporate social responsibility (CSR) each year, making India the first and only country in the world to mandate CSR. That sounds great, in theory. In practice it’s much more complicated.

Originally passed in 2013 by the Congress-led, left-of-center government, the mandate applies to both private and publicly owned firms with an annual turnover of 10 billion rupees (or about $160 million), a net worth of 5 billion rupees, or a net profit of 50 million rupees. This past May, the Indian Institute of Corporate Affairs, a government-established think tank, estimated that it will affect some 6,000 Indian firms and could result in CSR spending of as much as $4.2 billion at the current exchange rates.

Oddly, the enforcement provisions of the law are quite thin. The only penalties it exacts are for failing to report CSR spending. In fact, news reports suggest that at the end of the first year of the CSR mandate, some two-thirds of the companies it covered had failed to meet the 2 percent threshold. That may be in part because firms were uncertain of how strongly the Modi government — elected in May 2014, not long after the start of the first full fiscal year covered by the law — would enforce a law passed by a predecessor it had soundly defeated.

More than a year in, it’s clear that Modi takes the CSR mandate quite seriously, viewing it as a way of kick-starting funding for some of his signature programs — most notably the Swachh Bharat (Clean India) initiative, which aims to build toilets in India to help end the scourge of open defecation and institute a culture of cleanliness in a society not especially known for sterling public hygiene. Ever the pragmatist, the ostensibly business-friendly Modi has gone so far as to exhort businesses to direct their CSR funding toward the building of new toilets, either by contributing to the government program or by investing directly through their own activities. Recently, Modi also urged firms to devote CSR spending to an apprenticeship program to help workers find jobs, another one of his pet projects. “I want industrialists to hire more apprentices,” he said. “Never mind if your profit margins fall. It is your social responsibility.”

In an emerging economy like India, one with a limited state capacity to deliver public goods and services, CSR could theoretically provide a complement to government programs. But allowing the government to lean on the private sector in this way may not work as intended, especially if the government expects CSR spending to bear the brunt of the cost and implementation for a range of new policies aimed at improving the quality of life for Indians.

If all goes as planned, the mandate will raise a major chunk of change. The money that the mandate will raise amounts to just under 0.2 percent of India’s GDP, compared with the roughly 1.7 percent of GDP the government spends on welfare programs, as estimated by the Asian Development Bank in 2013. Given that this amount is relatively low even among emerging economies (China spends 5.4 percent of its GDP on social welfare), the extra kick from CSR spending could make a huge difference.

The mandate allows firms to give money to a wide range of social causes, either by funding such activities directly through their own foundations or trusts or by funneling money to nongovernmental organizations. In the case of Swachh Bharat, it appears that firms prefer to build toilets because of their greater visibility, rather than focusing on fixing municipal sanitation systems. The latter would require greater time and financial commitments, would require coordination with municipal authorities, and doesn’t tend to lend itself to high-profile photo opportunities.

The mandate also raises the possibility that the new funds won’t reach those who need them the most. Richard Rossow, a senior fellow at the Center for Strategic and International Studies in Washington, has argued that the CSR requirement may actually exacerbate regional inequalities. That’s because large firms are more likely to spend their CSR funds where the bulk of their operations and markets are based, and not where they’re most needed. And as it turns out, large firms tend to be headquartered in relatively prosperous states, leaving India’s most-impoverished behind.

What’s more, those firms that don’t manage their CSR through an in-house foundation or trust are more likely to invest a good chunk of the cash in India’s bloated NGO sector. It may be hard to believe, but there is one NGO for every 600 Indians. The global consulting firm Bain & Company’s annual India Philanthropy Report for this year notes that “donor apathy and a mistrust” of nonprofit organizations permeate the system. Given the proliferation of private firms and NGOs involved with the CSR mandate, it’s unlikely that there will be any kind of cooperation among individual actors, economies of scale to bring down costs and increase efficiency, or measures to avoid redundancy among thousands of competing programs.

Yet another danger is that the law’s vague, opaque compliance norms, which lack any specific penalty for noncompliance, may allow unscrupulous firms to game the system. They might, for instance, try to direct CSR funding to cronies, somehow siphon it off themselves, or pay it out only to engineer its return in the form of kickbacks. None other than veteran Indian industrialist and philanthropist Ratan Tata alluded to this danger before the new law came into effect. He reiterated his warning in June at the Indian Merchants’ Chambers annual meeting in Mumbai, acknowledging that while some companies would make substantial contributions, “there would be some companies which would be either wasting the money or siphoning [it] in some form.” Tata certainly has the moral authority to speak on the subject: Several companies in the large business conglomerate he headed until only recently gave well above the mandated 2 percent requirement even before the law went into effect.

Indeed, though the law is still too new to have produced any malfeasance, CSR scams had already surfaced before its passage. The in-house auditors of the state-owned National Aluminium Company, for example, have alleged that the company mishandled its CSR spending in 2012 by steering its contributions to one favored private university. Ironically, this same company went on to receive an award for best CSR practices in 2013.

Broadly speaking, the CSR mandate poses two dangers: first, the possibilities of cronyism and corruption that Tata highlighted, thanks to its tough-to-enforce compliance norms; and second, the possibility that the government may react to such scams by creating a new, costly layer of bureaucracy to enforce the rules. In an economy still saddled with too many leftover socialist-era rules and regulations, mandatory CSR is a move in the wrong direction. Modi himself has publicly declared his wish for India to improve its abysmally low rank in the World Bank’s Ease of Doing Business ranking, and it’s hard to see how forcing charitable activity onto companies in an opaque and poorly regulated business environment would help.

This perverse effect on the private sector is what makes Modi’s embrace of the CSR requirement so dissonant. But it’s also disappointing. By encouraging the private sector to spend its CSR money in basic areas like sanitation, he’s implicitly acknowledging that all levels of government are failing to provide basic public goods and services. Voters swept Modi into power with a big majority on a mandate to fix poor governance — not to force the private sector to fix a broken government system of substandard and creaky public infrastructure.

Of late, the abdication of responsibility has reached tragicomic proportions. Rather than owning up to the government’s failure to provide public goods and services, one minister even chided a group of business leaders for not doing enough to help the government achieve its social welfare goals. And apart from the outspoken Tata, few if any major business leaders have spoken out against the CSR mandate.

As I argued earlier, Modi has supposedly been trying to break the nexus between big business and government by cutting off the cozy access to the prime minister and senior politicians that business leaders once enjoyed. Unfortunately, a murky mandatory CSR rule is only likely to foster cronyism and corruption rather than reduce it.

Photo credit: Prakash Singh/AFP

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