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6 March 2000

Why it pays to be good (eventually)

Focus on business ethics - Though social responsibility does not help short-term profit, it

By Charles Leadbeater

When four Chicago bankers decided in 1973 to buy the ailing last bank in South Shore, Chicago, their colleagues thought they were mad. This was one of the city’s poorest areas, where commercial life was draining away and the mainly black community of 80,000 was on its knees.

Capital was flowing out, homes falling into disrepair, property values plummeting, store-owners leaving. Ron Grzywinski, one of the bankers, described it as “a disinvested community” where, because there were so few opportunities for work, people did not think it worth investing in education and work skills. But disinvestment, argued Grzywinski, was a market phenomenon that could be reversed only by reinvigorating local markets.

He and his team set out to build investors’ confidence in the community. What they have created is one of the most impressive models of how to break through the outmoded divide between charity and commerce, social purpose and profits. The bank, Shorebank, invests in social capital creation and, by doing it well, makes a financial return that can compare with any bank in the US.

It started with the belief that people in distressed communities such as South Shore have the same aspirations as everyone else. They lacked conventional collateral or credit histories, but they were credit-worthy. Grzywinski’s team also held fast to the principle that renewal would be self-sustaining only if it were supported in a disciplined and business-like fashion. Charity would not work in the long run. Local markets for jobs, property and retailers could be restored only if there were strong, local social institutions. Communities declined through a complex, compounded process, which required an equally complex and comprehensive response. Renewal needed to be all- encompassing, improving the apartments people lived in, the stores they shopped in, the quality of their schools and transport.

To cut short a long and inspiring story, Shorebank has helped to transform the area, by lending to local rehabbers who have improved apartment blocks, brought residents back to the area and created local wealth. The bank has assets of $725 million: a 15-fold increase over 25 years. In 1998-99, it made a record profit of more than $5 million and its return on equity has averaged more than 25 per cent for most of the past 20 years. And in the same year Shorebank lent more than $61 million to 13 distressed neighbourhoods in Chicago. The bank has done this without calling on direct subsidies to its borrowers.

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Why is there no equivalent bank in the UK? Shorebank has shown how financial and social capital can be grown together. But, all too often, shareholder interests and social needs seem to be in conflict. The scope for socially responsible business seems to be closing down in a world in which managers are increasingly driven to meet the demands of shareholders and financial markets.

The companies that do involve themselves in local communities or good causes usually do so as a boost to their reputation or brand, or perhaps as a political add-on which salves the conscience and gets invitations to dine with Prince Charles. Social responsibility rarely seems fundamental to the business; and, in any case, social responsibility doesn’t seem to pay.

Take the case of Levi Strauss, the jeans manufacturer. Hailed as one of the most socially responsible businesses in the world, Levi Strauss long resisted pressures to outsource its manufacturing to low-cost factories in South America, the Far East and Eastern Europe. Closing factories in the US, it was argued, would damage Levi’s standing with the minority communities that provided most of its workforce and many of its consumers. Gains in lower production costs would be lost in lower sales.

But that was before the advent of own-brand jeans such as Armani and Calvin Klein. They had no scruples about making their jeans in low-wage countries and consumers had no scruples about buying them. Levi’s market share began to erode and about three years ago it could resist the tide no longer. It closed US factories, outsourced production and wrote down some of the commercial value of social responsibility.

If social responsibility cannot be made to pay for a sophisticated company such as Levi Strauss, what chance is there for other companies? Here are six compelling reasons for business to take trust and ethics seriously.

First, we live in a knowledge-driven economy, in which companies increasingly compete on their ability to create new products and processes. That depends on bright, young, mobile, intelligent staff and such people do not want to work for a company with a poor social reputation, as Shell found out to its cost in the wake of the Brent Spar fiasco.

Second, public trust is also vital to the exploitation of knowledge. Innovation carries risks. The more radical the innovation, the greater the perceived risk. The outstanding current case is the controversy over genetically modified foods. Monsanto’s ability to exploit its innovations depends not on the quality of its science but on its standing with the public, on how far it is trusted. Trust is difficult to build up and easy to lose. The BSE crisis that hit the British beef industry in the mid-1990s exemplifies its value; its loss will cost the industry, according to a National Audit Office study, at least £4 billion. Most of that was spent on the disposal of cattle, but the longer-term effects of loss of faith in the industry are almost incalculable.

Third, many companies find themselves in an uncomfortable no-man’s land between the public and private sector. Take gas. A ruthless, profit-driven, laissez-faire approach would say that British Gas should focus on its most profitable consumers and largely ignore the poorer ones. But if the company followed this logic, it would be accused of reneging on an implicit public service undertaking that is still part of our background assumptions about utilities such as fuel and water. Companies, especially large, regulated companies in quasi-public markets, risk the loss of their licence to operate if people think they are acting irresponsibly. As the line between public and private blurs, more companies will find themselves in this position. For example, oil companies such as BP-Amoco are becoming as much part of the political process of decision-making over the environment as government.

Fourth, as the global economy becomes more integrated, more businesses will find themselves facing ethical dilemmas. Drawn to low-cost production sites around the world, they may well, as with Nike, find themselves facing angry, affluent consumers in their domestic markets, unhappy with their labour practices. The immediacy and power of modern communications makes it easier for critics to expose apparent double standards. Only companies with clear, consistent standards will avoid these pitfalls.

Fifth, as the character of the economy continues to shift towards the global production and trade of intangible services, using intangible assets, so trust will become more important. Trust is vital to most exchanges between buyers and sellers. As the international division of labour expands so we increasingly depend on goods we barely understand, made by strangers, in factories many thousands of miles away. We will buy more goods by telephone or over the Internet and take it on trust that the people on the other end of the line will supply what we have paid for. Knowledge-intensive products, akin to specialist services, are difficult to test in advance. You cannot test-drive a divorce lawyer. So corporate brands that can be trusted will become ever more important.

Sixth, social engagement can help to spur innovation within a company. Take IBM’s Reinventing Education programme, involving 21 schools across the US in an attempt to deliver education digitally. The schools benefit from the new techniques, IBM from the stimulus to new development. For example, in Charlotte, North Carolina, IBM has developed a tool that allows parents to view their children’s marked work from home or from a community centre and to compare it with academic standards in the rest of the community. In Philadelphia, IBM has helped to create new voice-recognition packages for children, while in Florida and Cincinnati cutting-edge “data warehousing” and tracking computer software is being developed to help with scheduling lessons in a year-round high school. Its subsequent commercial potential could be considerable.

British business likes to defend its freedom from the “red tape” of social regulation that binds many of its European competitors, particularly in Germany. It is less willing to compare itself with the US, the torch-carrier of flexible working, low taxation and light regulation. US companies are characteristically far more socially engaged than their British counterparts. If corporate Britain wants the freedoms enjoyed by US business, the government should demand that it shoulders similar social responsibilities.

The paperback edition of the writer’s “Living on Thin Air: the new economy” is published by Viking Penguin this month

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