Regulating Your Morals with Your Money

Do Australians want an army of social engineers to control their investments?

Clearly some do, as shown by the existence of so-called ethical funds.  But then, most do not.

Well, we are about to lose our choice and be forced into the hands of the social engineers.  The Financial Services Reform Act, passed in the dying hours of the last Government, imposes disclosure requirements on all funds managers which will, in effect, force them to inquire into the labour, environmental, social and ethical standards of the Australian corporate sector.

At first sight, the legislation appears relatively innocuous.  Who could object to disclosure on labour, environmental, social and ethical matters?  No doubt the Minister was persuaded that the amendment was harmless and would even aid "transparency".  Upon closer examination however, the legislation is much more intrusive than it seems.  The transparency is more apparent than real.  In practical terms, disclosure requires the institutions to formulate and express attitudes and practices on four matters which range from difficult to impossible to define.

Institutions will be forced to decide what is an ethical activity.  Ethical funds have for example commonly declared armament manufacturers such as Boeing to be unethical.  Yet these funds have frequently invested heavily in the computer manufacturers that provide the guidance systems for Boeing's missiles.  They also over-looked the fact the missiles manufactured by Boeing protect the lives of many innocent people.

The funds will be forced to decide what constitutes good labour standards, for example, whether it is adequate to follow the laws of the land or follow the dictates of the union movement.  They will be forced also to decide and measure environmental standards -- not just those required under law, but above-the-law pushed standards.

In theory, businesses could state that they do not take these matters into account, thereby avoiding scrutiny and the subsequent paper chase.  In practice, however, no institution will state that it does not take such matters into account, in part because if it did, pressure groups would label it as unethical or anti-social.  Silence would be treated as guilt.  In any case, it is a reality of business that those matters are almost always "taken into account" to some degree.

Contrary to the claims of the ethical lobby, these provisions will cost investors.

The provisions will not only impose extra reporting requirements but require funds to hire social engineers, ethicists, environmental scientists and labour market analysts to screen for good behaviour.  Of course the cost of these services will be borne entirely by investors.  Many funds managers actually like the extra work, as it means more money to them.  Judging from existing ethical funds, the reporting requirement could force management costs up by as much as 45 per cent.

Moreover, there is no reason to believe that an ethical screen will compensate for higher management costs through higher yields or lower risks.  Indeed, if anything, the evidence points in the other direction.

Forcing unnecessary and costly investment criteria on investors is not only a breach of their rights, but a serious threat to their future.

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Power to the People: Privatisation and Deregulation of the Electricity Industry in Australia

An address delivered at
Johannesburg, 18 September 2002

"Until self-trained economist Edwin Chadwick came along, 19th-century Britain had a huge problem with its convicts bound for Australia:  most were dying before they reached the "fatal shore" down under.  Chadwick, however, proposed a solution as effective has it was simple.  Instead of paying sea captains by the number of convicts that boarded their ships, he suggested paying them for the number of convicts who disembarked from their ships -- under their own power.  It worked.  Soon after Chadwick's policy was implemented, convict survival rates surged to over 90 percent."

"Entrepreneurial Economics for Fun, Profit, and a Better World",
by Alex Tabarrok (May, 2002)

BACKGROUND TO PRIVATISATION IN AUSTRALIA

THE AUSTRALIAN POLITICAL ENVIRONMENT

Private ownership uses those same insights that Chadwick discovered two centuries ago.  It is based on incentives and, harnessed with competition to meet market needs, is the most powerful means of promoting efficiency and high living standards.

Fifteen years ago, following a century of increasing government ownership, it was a new concept and Australians, like most people, are conservative and suspicious of radical new approaches that might impose risks of severing rights that have evolved.

Australia's political structure also makes it a difficult country in which to embark upon reform.  A federation of nine jurisdictions, a bicameral parliamentary system and the fact that the Federal Government of the day seldom controls both Houses of Parliament means change is normally gradual.  That served us relatively well in resisting the vast wave of nationalisations and increased government ownership that swept Britain, France and much of Europe fifty years ago.  It may be a liability in pursuing the modern ideological perspective of reform to downsize government based on a greater confidence in the market place.

Nonetheless, change does come about.  As for deregulation and market reforms, Australia followed general global trends.  Something similar also occurred in the case of privatisation but in that case it was assisted by another midwife, financial crisis.

Over the past dozen years, well in excess of $100 billion of previously owned government businesses have been sold to the private sector.  In terms of industry sector these were dominated first by the government's half float of Telstra and secondly by the electricity and gas industry.  The Figure below illustrates the industry shares.

Figure 1

The sums raised from privatisation understates the magnitudes involved since, concurrent with and subsequent to it, there has been considerable new private investment in areas formerly reserved for government.

IMPETUS TO AUSTRALIAN REFORM

Reforms in Australia were spurred by three different but associated factors:

• seeking improved management efficiency,
• neutrality in the dealings of SOEs with other parties, and
• privatisation of assets both to better meet these goals and to relieve budgetary pressures.

It was in fact the Hawke Labor Government that, initially in the mid-1980s, first embarked on some rather tepid movements in the direction of deregulation.  Because many in the Labor Party cut their teeth on the need for more, not de, regulation, once the process got underway a euphemism was required.  In Australia, the moniker was "micro-economic reform", which progressively became more serious, especially in the early 1990s following a report on competition policy chaired by businessman/academic Fred Hilmer.

As well as attempting to dismantle layers of government restraint of business, deregulation had three other dimensions:

• placing government business entities on a footing similar to private businesses and at arms length from the political process;
• ensuring "open access" by users of and suppliers to natural monopoly facilities like electricity lines and rail tracks;  and
• terminating as the exclusive preserve of government entities, certain activities including infrastructural facilities.

Privatisation in Australia was sparked by the Thatcherite revolution.  In Australia and elsewhere this was derided by Labor Governments when they were out of office but adopted in part when such governments became sufficiently established and able to carry their constituents in a shift from ideology to pragmatism.  For the conservative side of politics, the path followed was observation of successful privatisation measures and then mollifying its more curmudgeonly elements who worried about "selling the family silver".  Privatisation however was never electorally popular in Australia and remains unloved even though service outcomes of the privatised entities show demonstrable improvement over their predecessors.

Although the Federal Labor Government–in power for 13 years from 1982–moved towards privatisation, the areas it chose were those where government business entities were heavily involved in a competitive business environment.  The entities included the Commonwealth Bank, Qantas and a pipeline business.

Massive impetus to privatisation was given by a collapse of State Government financial instrumentalities in the early 1990s.  Not only did this reveal mismanagement that shook the confidence of those championing State owned business, but the consequences also placed the State Governments that had presided over these businesses in a parlous financial position.

The most serious was that of Victoria and a Liberal Government was elected in 1992 with a privatisation platform.  The electricity industry was the prime target and this program brought a melding of the deregulation, pursuit of business efficiency and privatisation strands.

ELECTRICITY REFORM AND PRIVATISATION

Privatisation

The vigorous process of privatisation which the Victorian Liberal Government embarked upon following its election in 1992 radically transformed the Victorian economy.  Following many years during which the State was among Australia's worst performers with low income growth and fiscal mismanagement, the post 1992 period saw it converted to enjoy rapid growth and a sound budgetary position.

Asset sales were a major feature of the policy both as a means of restoring the State's low credit rating position and allowing lower levels of taxation, and as a means of injecting greater competitiveness into the State's economy.  Privatisation of the Victorian electricity assets accounted for the lion's share of the State's asset sales in a process which was among the most notable in the world.

Some $23 billion was earned from the Victorian privatisations of electricity and a further $5 billion from gas.  From the electricity privatisations alone, the Auditor-General put the annual savings net of expectations from dividends etc. at $760 million per annum, equivalent to about 9 per cent of the State's own taxation raisings.

By the time of the Government's fall in 1999, as well as electricity, the state owned gas, rail, bus services, trams and ports had been privatised.

In addition, the Government had brought in private ownership to build its major urban road development, City Link and had introduced private ownership of prisons and hospitals.  The success of the Victorian privatisation, especially of electricity, brought other State Governments to pursue that same policy.

Nonetheless, only in Victoria and South Australia was the privatisation of electricity complete.  Union opposition in NSW, the largest state, has meant very little privatisation, even though the Labor Government is keen to sell its electricity assets.  The NSW Liberal Opposition, having lost an election on a platform that included electricity privatisation is now ostensibly even more against its privatisation than the Labor Government.  In Queensland, a gradual privatisation may be taking place as several new generation facilities are being built largely by private enterprise.

In Western Australia, the State Government has privatised its gas business but both the State's major parties oppose privatising electricity.  Western Australia is a stand-alone jurisdiction not linked with the rest of the Australian grid.

The following Figure illustrates that Victoria (which comprises about 30% of the Australian market) dominated Australian privatisation with South Australia (comprising about 8% of the Australian market) also fighting above its weight.

Figure 2

Structural reform and issues emerging

The basis of the Australian reforms and privatisations, in line with those in other jurisdictions, was a disaggregation of the previous monopoly over electricity supply into generation, long distance transmission, local distribution and retailing.  Generation Transmission Distribution Retailing

This disaggregation was planned in Victoria concurrently with the privatisation but other states also embarked on a disaggregation of the industry.  Privatisation in Australia, leveraging off the mistakes made in the UK, was set in train to allow for a maximum role of competition as the discipline to promote efficiency and prevent price gouging.  In Victoria and South Australia, generation was disaggregated to the maximum–essentially seven separate Victorian suppliers and five in South Australia.

It was intended for generation and retailing to operate in a totally deregulated market with distribution and transmission, which were viewed as "essential facilities" or natural monopolies, to be regulated.

At the onset, generation, transmission and distribution/retailing were to be structurally separated but there were no specific long-term measures to prevent re-aggregation.

Although retailing and distribution were sold as combined units, they were to be "ring fenced" to prevent the distribution business favouring its affiliate.  In the event all five of the original Victorian host distribution business/retailers now have separate companies handling the two activities.  What has surprised some is that all the privatised retailers and some of those remaining in government hands have moved to acquire some generation of their own.  This is a function of the need that retailers see for some control over their supply, particularly in view of the wholesale price shifts to which electricity is now subject.

Retail was a part of the electricity industry envisaged as being contestable and requiring no more regulation than is required of other retail activities.  In fact, although commercial supply is now largely deregulated, governments have been cautious about deregulating household supply.  Both in NSW and Victoria, retail competition at the household level has been accompanied by safety nets that make it unattractive for retailers to poach customers.  This on-going regulation of retail supply has resulted in some market confusion and is reported to have been the straw that resulted in two of the five original owners of Victorian retailers exiting the market.  Commercial customers have seen a churn rate from their host retailer of about 40% but the regulations in place have meant that very few households have switched retailer.

Other developments have not followed the path that was expected.  In the case of transmission, a centrally planned provision was envisaged.  However, a situation recognised from the outset is that transmission and new generation are alternatives.  If transmission is provided free or at regulated prices this may discourage a more rational and lower cost development of new generation.

This led to provision being made for entrepreneurial interconnects in the National Electricity Law.  And Transenergie, a subsidiary of Hydro Quebec, has started building these entrepreneurial links.  This has in turn given rise to issues concerning the circumstances under which a regulated augmentation of links should be permitted.  The danger is that links which are financed by a compulsory charge on the customer, might lead to incentives to site generation in places that are distant from major markets.  If someone else is paying for transmission, the rational generation business will take its profits and socialise its losses.

Australia's electricity market no longer comprises several internal market supplied by monopoly firms.  It is now a multiplicity of bilateral contracts between generators, and retailers strongly underpinned by a "gross pool" through which virtually all electricity has to be bought and sold.  The four states that are in the National Electricity Market (NEM) are connected by transmission links though the different states all comprise regions that sometimes have constrained interconnects.

Essentially the NEM is a one-way market with the demand emerging from whatever end-users require and with supply being offered by generators at different price levels.  All supply is paid the same price, that of the highest bid plant that is loaded.  In the short term, generators are relatively indifferent to the price of that part of their supply for which they have contracts (probably 90% plus of the market) and will often bid close to their marginal costs for this part of the load.  Compared to a price norm of about $30 per MWh, at present prices can rise to as much as $10,000 per MWh which makes retailers especially keen to be fully contracted.

A rather complex National Electricity Code controls the rules under which generation and transmission are placed on the market.  And the fact that the price has oscillated has contributed to unease in certain quarters that there is price manipulation.  Of course, the price oscillations have always been there but were masked in the past because the monopoly provider called in higher merit order plant without this actually being specifically priced.

PRICE OUTCOMES

WHOLESALE PRICES

The overall outcome has been much lower average prices than most people expected.  Over the past four years the average wholesale price in the two largest sub-markets, NSW and Victoria has been below that required to justify new baseload capacity, a price commonly estimated to lie between $34 and $45 per MWh depending on the State.  Compared with a pre-reform intra-company price of $38-44 per MWh in NSW and Victoria the price outcomes have been as shown in Table 1 and Figure 3.  By and large, contract prices have reflected these spot prices.

Table 1
Average Prices in Major National Electricity Markets ($)

Year	NSW	VIC	QLD	SA
1999 July-June	23.7	25.1	55	49.7
1999 -- 2000	28.9	26.1	45.3	60.6
2000 -- 2001	38.4	45.4	42.2	57.3
2001 July-December	27.4	26.7	28	26.4

Figure 3

These wholesale price outcomes are very much the telescoped outcome of prices that have ranged from near zero levels to needle peaks of $9000 per MWh.

The very high price excursions cause political difficulties especially where major customers allege generators are abusing market power.  The effect of the high price excursions on average prices is not inconsiderable.  Even though the prices above $1,000 prevail less than one third of one percent of the time in all jurisdictions, they have an affect in raising prices by between 12% and 25%.

Table 2
Effects of High Price Excursions

	Number of hours	% of time	affect on average price
NSW	24.5	0.19	18%
Vic	30.5	0.23	12%
SA	40.5	0.31	25%
Qld	24.5	0.19	14%

The high price incidences occur in all jurisdictions that have a market in place.  They are not due to private ownership–indeed the price peaks have led to claims that generators are exercising market power and it is the NSW generators who have been most strongly accused of such abuse.  NSW has the most highly concentrated supply, with essentially only three portfolio generation businesses.

That said, the competition authority, the ACCC, has recently issued a report that says abuse of market power by generators is not occurring.  In many respects the best evidence of this is the much lower aggregate prices that we have seen and the evidence of generator financial distress.  In this respect only one of the generators is publicly listed, the 2000 MW Loy Yang.  Since that plant was sold in 1997 for $4.8 billion, in spite of the business since markedly improving its productivity and availability, its value is now at least $1billion less than its sale price as a result of very low wholesale prices.

As Table 1 showed, prices in Victoria have risen as demand has gradually increased.  But it has been the peak prices that have brought this about.

The price developments in Victoria and other states have led to predictable new investment responses.  South Australia and Queensland were short of capacity, saw high prices and have experienced a surge of new investment.  Victoria has a surfeit of baseload power but a shortage of peaking capacity and again the market has responded.  NSW was relatively comfortable in both respects.  These capacity augmentations are summarized below.

Table 3
New Generation Investments

State	Committed Projects (MW's)
South Australia	1,130 MW baseload since 2000
NSW	220 MW peak since 2000
Queensland	2,496 MW baseload since 2000
Victoria	856 MW peak since July 2001

DISTRIBUTION AND RETAIL

Distribution and transmission profits are largely controlled by government regulation.  In the case of transmission, price reductions required by regulation have resulted in considerable marking down of value.  For distribution, even though the businesses have complained about regulators' price setting, the outcomes have left values unchanged.

With retailing, an activity that was thought to have little value at the time of privatisation, recent sales of a stand-alone retailer and the implicit price of the retailing arm of a retailer/distributor, have demonstrated rather more value.  Electricity retailing has upside potential because of the other retailing opportunities it offers through levering off its developed customer relations.

POST-PRIVATISATION ASSET RESALES

Prices resulting from market forces and regulatory decisions have been major factors in establishing the value of the privatised businesses.  A further factor has been global trends and perspectives.  In this respect many British and American energy businesses during the later part of the 1990s when the privatisations took place had decidedly different business strategies than they now have.  The euphoric attitudes to the prospect of capitalising on overseas energy opportunities are now more subdued.

In some cases this has resulted from a new realism in assessing earning prospects due to changed perceptions about regulatory risk or more sober market forecasts.  Broader events like the collapse of Enron have also played a role.  The general view is that the prices for the Victorian and South Australian energy assets would be somewhat reduced today.  Nonetheless, new buyers have emerged and the assets continue to command good prices.

The following table summarises the available information on post privatisation asset price movements.

Table 4
Estimated Changes in the Asset Values of On-Sold Victorian Electricity and Gas Businesses

Sector	Business	Approx Change in Value
Retail	Pulse (2002)	+ 40%
Distribution	Citipower (1998) Powercor (1999) Citipower (2002)	+ 5% + 5% - 6%
Transmission	Powernet (2000) GasNet (2001)	-17% -20%
Generation	Loy Yang (2002)	-25%

OUTCOMES IN PERFORMANCE OF THE ELECTRICITY INDUSTRY

DISTRIBUTION

Victorian distribution businesses since privatisation have shown marked increases in productivity and in customer service.  This is probably better relative to the government businesses but fully documenting the productivity performance of the distribution businesses is difficult.

On the available data, between 1994/5 and 2000/01 all states achieved substantial labour productivity gains.

In comparative terms, in 2000/01 labour productivity in NSW and Queensland, though showing considerable improvements, remained only 78 and 63 per cent respectively of Victoria's level.  South Australia, post its privatisation, appeared to have leap-frogged Victoria labour productivity, while Western Australia (which covers only the South East interconnected system) was also well ahead.

Figure 4

ESAA

The above measure of efficiency levels, labour productivity, excludes the important component of capital productivity.  Energy businesses themselves attempt to determine their relative efficiencies to set internal targets (and, in the regulated environment in which distribution operates, to deter regulators from seeking excessive price reductions).

Benchmarking one of the Victorian distribution businesses against 104 US utilities, the Pacific Economics Group (PEG) found that the Company's computed overall cost is 44% of that of the average U.S. firm.  The study's findings would have placed United Energy close to the frontier of efficiency.

The following table shows United Energy compared with the average in the sample compiled by PEG.

Figure 5
AVERAGE VALUES OF VARIABLES IN THE BENCHMARKING STUDY

Variable	Units	US Sample Average	United Energy	United Energy/ Sample Average
Total Cost	Thousands of $(US)	377,782,714	171,158,503	0.45
Price of Capital Services	Index Number	1.00	1.07	1.07
Price of Labor Services	$1,000(US) per Employee	51.75	36.59	0.71
Price of Materials	Index Number	1.12	1.08	0.97
Total Customers	Customers	695,777	538,000	0.77
Retail Deliveries	MWh	17,358,000	6,448,605	0.36
Miles of Distribution System	Miles	20,480	3,387	0.36
% of Distribution System Electric	Percent	89%	100%	1.12

Source:  Pacific Economics Group, Kaufmann, L., Lowry, M.N., and Hovde, D., United Energy Performance, Results of International Benchmarking, November 1999, p. 39

Reliability of distribution in Victoria has improved considerably since privatisation.  The ORG sets targets for each of the businesses, targets that are far less controversial than those covering prices.

A steady improvement in reliability, as measured by minutes off supply, has been experienced in the years since 1995 as illustrated below.

Figure 6

Source:  Essential Services Commission

The improvements have been seen in all five distribution businesses as illustrated in Figure 7 below.

Figure 7

Source:  Essential Services Commission

A small increase was recorded in minutes off supply in the first half of calendar 2001.  This was ascribed to more normal storm situations following a very benign first half year in calendar 2000.  The Office of the Regulator General noted that the distribution businesses remained on track to the target reductions in minutes off supply that had formed part of the 2001 rate re-set.

In respect of reliability, the Victorian outcome has shown relatively more improvement than that in other jurisdictions.  Figure 8 illustrates this.

Figure 8

Figure 8 shows that improved performances have been logged by Victoria (outages down 64 per cent) and NSW (outages down 24 per cent).  Queensland showed 47 per cent increased outage times and in South Australia an increase of 36 per cent was logged.

GENERATOR PERFORMANCE

As with distribution, it is rarely possible to assemble simple benchmarks allowing state by state comparisons between generation businesses.  Using simple labour productivity is difficult.  For example, output per employee, as well as having definitional problems with employees following a greater use of contract labour, also compares Victoria's brown coal generators with other states' black coal generators which employ less labour partly because they do not own and mine their own coal.  Similarly, gas generators and hydro-electric generators require fewer staff.

In addition, as with distribution businesses, profit figures are now not readily available because the privatised businesses' profits are normally consolidated into parent company accounts and not separately identified.

The available data shows that productivity in all state systems has experienced marked improvements.  The comparative performance of five states is shown in Figure 9 below.

Chart 5

Source ESAA

Part of the improved productivity of the generators is their greater availability.

Not only did the pre-1992 generation sector exhibit gross over-manning but the generators were available for less than 80 per cent of the time.  Having generators available to run at short notice allows an ability to meet unexpected changes in demand, thus bringing about lower prices at such periods and allowing higher earnings by the generators.  The improvement in Victoria's generators has been outstanding as Figure 10 illustrates (perturbations in the last two years in South Australia and Victoria reflect new capacity coming on line).

Figure 10

Source:  ESAA

PRICES TO CUSTOMERS

While Australian prices do not compare favourably to those in the lowest cost supply system in the world, that of Eskom, they are low by world standards (see appendix).  The shift to a competitive market means it is no longer possible to discover prices in the traditional way by dividing revenue by energy usage and subdividing this into different customer classes.  The historical data remains useful for the regulated customers, where energy price is determined by governments and the customers are captive.

Comparisons of consumer prices are also complicated because of very different usage profiles–Victoria tends to have peakier, and hence more expensive, demand than the other states.  The data is shown below.

Figure 11

Source ESAA

Nor is it possible to provide directly comparable numbers for contestable customers.  However around 40% of customer load is supplied by non-host retailers.  Prices fell considerably where the customers were free to shop in NSW and Victoria, though reflecting a more recent tightening of supply, they have tended to rise somewhat, though are still well below pre-deregulation levels.

Figure 12

Source:  ESAA

PRIVATISATION VERSUS CORPORATISATION

All Australian electricity supply businesses are now either privatised or state owned but operating under corporations law with more-or-less independent directors.  This is a development over the last ten years and there is no reputable body that advocates returning the operations of electricity supply firms to the public service.

Corporatisation itself meant a considerable improvement in productivity and customer orientation.  Further improvements followed with privatisation and, by and large, the government owned firms in Australia have lifted their performance and match those of the private firms.  All suppliers have, as shown in the earlier tables, exhibited much greater efficiency in terms of labour productivity, and supply security.

Nonetheless, corporatisation remains a half-way house.  Privatisation remains a preferred approach.  It does so for reasons over and above the advantages it brings in releasing the government from capital expenditure obligations and consequent improvement in debt levels.

Privatisation allows a more enduring improvement in efficiency for several reasons.

• The government ownership makes expansion and pursuit of synergies more difficult.  The firm would need to obtain ministerial approval for such measures and this is likely to be more difficult (especially where there have been histories of ill-advised government business expansion) than is the case with private shareholders.  In the electricity and gas industries, where market development appears to be favouring some limited re-aggregation of retailers and generators, such inflexibility is likely to adversely impact on the GBEs.
• There may also be some residual areas where private ownership and the improved incentives inherent in it will prove beneficial.  In this respect, the one serious business error of an Australian electricity firm since the reform program has been one of the NSW generation businesses which entered into very poor contracts and lost a sum close to its net worth.
• Irrespective of intentions, Governments will meddle in the behaviour of the firms they own.  Some examples in Australia have been:
• The board appointments, which have occasionally been political, as when the NSW placed the ex leader of the Trade Union federation on the board of one of its generators.
• State governments have made known their preferred form of labour management to those charged with business management;  managers in such circumstances feel obliged to follow ministerial preferences even where they entail costs.
• In NSW, the government has put in place a mandatory insurance scheme between the state owned retailers and generators.  While stabilising prices, this seriously impedes the development of risk markets and would not be possible if there was major private ownership.
• Finally, government ownership leaves no market for the firm itself.  Other firms can sell parts of themselves off or face takeovers from entities that consider they can manage their assets more effectively.  Australian privatised energy businesses have seen a number of second round sales.  Government ownership can do little more than change the team.

OUTCOMES THAT MIGHT HAVE BEEN IMPROVED

The foregoing indicates that the Australian development is incomplete.  The supply industry in the largest State is almost exclusively government owned.  Aside from this, the privatisation program has been remarkably successful.  It has raised far more than was expected and has brought an enhanced level of efficiency.  Much was learned from the mistakes in the UK experience.

The disaggregation prior to privatisation has had some deficiencies.  These include leaving South Australia with only one host retailer, a situation that may have led to higher prices because of the difficulties new rivals without a local base have experienced in establishing themselves.

A further criticism concerns the NSW disaggregation its generation three portfolio businesses when six or more separate businesses could have been created.  There are claims that this brings the risk of UK style market power.

A further more insidious issue is the dividing line between governments and business.  Governments, especially when they do not own assets, want to see prices as low as possible.  But "free beer" cannot be supplied indefinitely.  There is a risk in some of the interventions that governments have made or threatened that some new investment will be deterred with a low price in the short term resulting in higher prices at a later stage.  Short-termism is an enduring problem with government decisions and a major reason for privatisation.

Establishing market governance that is immune to political intervention in something with as high a public profile as electricity is a major challenge in all jurisdictions.  We have not yet got it right in Australia.

LESSONS FOR SOUTH AFRICA

While I have no detailed knowledge of the South African power industry, I understand generation, transmission distribution and retailing is dominated by the government owned business, ESKOM.  Your industry, which is comparable in size to that of Australia, is corporatised, with transmission, distribution and generation all separated, though there is little private sector participation.

While generation is considered to be managed to a high degree of technical efficiency, the Australian experience indicates that further cost savings and benefits from improved flexibility are found once ownership is changed and incentives to discover these are in place.

Competition in spot bidding and for contracts also sharpens efficiency levels, though this does require retailing and distribution to be separated or ring fenced from each other.  Full separation also makes it difficult to have the government impose cross-subsidies on the business, perhaps to facilitate system extension.  Although a political disadvantage, requiring subsidies to be clearly visible and on-budget rather than obscured is a major benefit to sound governance.

The disaggregation and privatisations in Australia are important beacons for South Africa.

One approach to be avoided is the experience of Indonesia. ⁽¹⁾  Indonesia left the electricity supply under a monopoly (Perusahaan Listrik Negara, PLN) but, starting in 1990, it invited private supply of generation into the monopoly business.  Some 26 plants were constructed on a build-own-operate basis, amounting to about one third of total capacity.  The government accepted take-or-pay contracts with prices denominated in US dollars (in addition the state owned enterprise was not permitted to raise prices to take account of its own cost increases as a result of Indonesia's currency falling to one fifth its previous $US rate and to the reduced demand.).  The outcome has been ruinous losses.

---

ENDNOTES

1.  See Ross H. Mcleod, Second and Third Thoughts on Privatisation in Indonesia, Agenda Vol 9, No. 2, 2002

APPENDIX

Regulation Thwarts Market Growth

Superficially, NSW Treasurer, Michael Egan's letter Owning up to facts on electricity, (AFR Letters, 11 September) is correct in saying that the NSW Government is not the State's price regulator.  However, the comprehensive ownership of both the generation and the retail firms in the industry has allowed the government to require its businesses to participate in a form of compulsory price insurance.

Covering half of demand, this has suppressed market signals and prevented the growth of risk alleviation products that respond to the market views of participants rather than those of the Government.  This regulatory intervention is also thwarting the ability of the NSW electricity businesses to acquire sophisticated risk management skills, thereby jeopardising the growth of a mature market that can operate free of central planning.

Mr Egan is also playing fast with the truth on energy prices in NSW.  In fact, NSW wholesale prices last year were higher than those in both Victoria and South Australia.  While the Government-owned NSW electricity industry has performed creditably over recent years, on a range of measures its privatised counterparts in Victoria, and more recently South Australia, have performed better.  The likelihood of this outcome was, of course, a major factor in Mr Egan himself fostering the privatisation of the NSW industry.

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The action is being funded by these law firms on American-style no-win, no fee basis.  In other words, the law firms are funding the action and will only be remunerated if they win.  According to BRW Magazine, the lawyers will, if they win, receive their costs plus a 25 per cent premium.  The claimants do not have to pay any money up front.  The action is a no-loss arrangement for them.

The claimants could number in the millions, legal costs could reach $100 million and, if awarded, damages could be as high as $500 million.  This could easily be Australia's largest class action case ever.

The case is hardly clear cut.  While the Victorian Supreme Court has ruled that Esso was responsible for the Longford explosion and therefore the cessation of gas supplies, this does not mean that it should be liable for all downstream effects.  Firstly, Esso did not have contracts with consumers.  Esso's contract of supply was with the government owned Gascor.  Second the contract between Esso and Gascor expressly considered the possibility of disruption and includes a clause exempting Esso from any liability for loss of profit or consequential loss.  Third, Esso had no ability to ensure alternative gas supplies;  these powers lay with the Government.  Fourth, many consumers knew of the risk, took out insurance and have received compensatione for their losses.

If the court rules against Esso, it will dramatically increase the cost of, and risk to, suppliers and users of essential facilities from airlines and other public transport to electricity.  It would undermine the ability of parties to apportion risks and liabilities through contracts.  It would provide a disincentive to people to take appropriate precautions like insurance and back-up systems.  It would open up an almost unlimited horizon of activity to ambulance-chasing lawyers.

The process illustrates the needless costs imposed on us by lawyers, both in diverting the consumer's dollar in their direction and in undermining the ability of firms to offer goods and services.

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Regulating Your Morals with Your Money

Do Australians want an army of social engineers to control their investments?

Clearly some do, as shown by the existence of so-called ethical funds.  But then, most investors -- over 99 per cent -- do not.

Well, they are about to lose their choice and be forced into the hands of the social engineers.

The Financial Services Reform Act, passed in the dying hours of the last Government, imposes disclosure requirements on all funds managers which will, in effect, force them to inquire into the labour, environmental, social and ethical standards of the Australian corporate sector.

At first sight, the legislation appears relatively innocuous.  Who could object to disclosure on labour, environmental, social and ethical matters?  No doubt the Minister was persuaded that the amendment was harmless and would even aid "transparency".

Upon closer examination, however, the legislation is much more intrusive than it seems.  And the transparency is more apparent than real.  In practical terms, disclosure requires the institutions to formulate and express its attitudes and practices on four matters which range from difficult to impossible to define.

Institutions will be forced to decide what is an ethical activity.  Ethical funds have for example commonly declared armament manufacturers such as Boeing to be unethical.  Yet these funds have frequently invested heavily in the computer manufacturers that provide the guidance systems for Boeing's missles.  They also over-looked the fact the missiles manufactured by Boeing protect the lives of many innocent people.  The funds will be forced to decide what constitutue good labour standards.  For example, whether it is adquate to follow the laws of the land or follow the dictates of the union movement.  They will be forced to decide and measure environmental standards -- not just those required under law, as every firm does that, but above-the-law standards.

In theory, businesses could state that they do not take these matters into account thereby avoiding scrutiny and the subsequent paper chase.  In practice, however, no institution will state that it does not take such matters into account, in part because if it did, pressure groups would label it as unethical or anti-social.  Silence would be treated as guilt.  In any case, it is a reality of business that those matters are almost always "taken into account" in some degree, so a nil return would, in most cases, be misleading.  The normal investment selection processes involve winnowing out unethical or high risk actions.

In short, the legislation gives the pretence of voluntarism but not the reality.  And it goes well beyond mere reporting.

If proof were needed of the likely impact, we can turn to the UK where similar but milder, legislation came into effect two years ago.  Over 50 per cent of UK pension fund trustees are now pursuing on-financial objectives, not because they believe that they are interest of their unit-holders, but rather to protect their good names from attack by activists.

Contrary to the claims of the ethical lobby these provision will cost investors.

The ethical lobby's sales pitch is that investors can "do well by doing good".  That is thery can pursue non-financial goals at no financial cost.  Indeed some even claim to have the secret to beating the market by being clean, green and union friendly.

Over the 1990s ethical investments were often able to match the market.  Some even were even able to beat the market.  This is now, however, proving to be another mirage of a bubble economy.

Ethical funds have tended to invest in blue chip companies, in growing industries which, in the 1990s, tended to be socially "acceptable" industries, such as dotcoms, telcoms, and services.  In short, they have tended to invest in the leading firms in the fastest growing segments of the market.

The leading firms of the 1990s are now leading the market down and the old economy stocks are the stars.  As a result most ethical funds are struggling.  Ironically despite their ethical screens, ethical funds have been some the largest losers from recent corporate collapses including Enron, WorldCom, Ansett and HIH.

Ethical funds are also more costly to manage.  They not only need a team of financial analysts, but a team of social engineers, ethicists, environmental scientists and labour market analysts, to screen for good behaviour among the stock chosen by the financial people.  Recent research found that ethical funds have expense ratios (management costs as share of funds invested) of between 1.5 and 2.5 per cent which compares very poorly with the average expense ratio of non-ethical funds of about 1 per cent.

In short, ethical funds cost more to manage, adopt higher levels of risk and yield lower returns than funds that adopt strictly financial criteria.  This should surprise no one.

Forcing unnecessary and costly investment criteria on the investors is not only a breach of their rights but a serious threat to their future.

The Government needs to go back to the drawing board and give us our freedom back.

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Calpers, a Lesson in Hypocrisy

Asian investors were in shock earlier this year when the California Public Employees' Retirement System, or Calpers, announced plans to withdraw its investments from Malaysia, Thailand, Indonesia and the Philippines.  While it subsequently reversed its decision on the Philippines, it has reconfirmed its intention to withdraw from the other countries.

Calpers is not just the largest pension fund in the world (it has assets of $149 billion), but one with a reputation as a leader in corporate governance and in the corporate social-responsibility movement.  While Calpers' investment in Thailand, Malaysia and Indonesia only amounts to $219 million, the concern has been that other investors would follow suit.  Well, relax.  Commercial investors were never going to follow Calpers' lead, as it was a clear route to losing money.  And now, its reputation as an investor and leader in corporate governance is in free fall.

However, its decision, particularly in regard to Malaysia, is instructive of the activist role funds like Calpers have taken on.  Calpers' decision was based on commissioned research that not only concluded that these Asian countries were bad risks, but that Argentina was the most promising of the emerging markets.  Since this research was completed in December 2001, the Thai and Indonesian markets have done well and the Malaysian market has held steady, while the Argentine market has collapsed (down 66% in dollar terms as of mid-July).  Moreover, these trends were well-advanced and known in February when Calpers made its decision to divest.

Why would any fund pursue such a strategy?  The answer, in a word, is politics.  Calpers is fundamentally a political organisation.  It is the monopoly provider of pension services to California's state public servants.  Its board is composed overwhelmingly of political types:  elected officials and political appointees.  And it has close union links.

A political orientation naturally leads to activism.  But for a long time Calpers restricted its activism to improving standards of corporate governance, not only in companies it was invested in but in the corporate sector as a whole.  However, from 1998 on Calpers broadened its activism to include non-corporate aims;  it jumped into social activism.  Since then, it has joined shareholder resolutions promoting higher spending on alternative energy, reductions in greenhouse gases, free AIDS drugs and country boycotts.  Calpers has also coordinated its corporate-governance resolutions with union campaigns.

Calpers crossed the rubicon by divesting from profitable investments.  In 2000, at the insistence of Phil Angelides, the state's treasurer and Calpers trustee, it withdrew its investments from tobacco firms.  This decision was made despite warnings from consultants and staff that it would cost at least $30 million in transaction costs.  From the time of the vote to the end of May this year, tobacco stocks outperformed the S&P 500 Index by 90%.  Calpers is now considering another demand from Mr. Angelides to divest from companies that operate in "offshore tax havens".  The rationale is that these firms "are avoiding taxes" and are "more difficult to sue".

Calpers' decision to divest from Asia followed similar logic.  In early 2000, Mr. Angelides, with union support, announced that Calpers should take into consideration labour and other human-rights standards in its emerging-nation investments.  Other members of the Calpers board and staff initially strongly disagreed.  According to the San Francisco Chronicle:  "Opponents ... warn that if fund managers start mixing social activism with their investment decisions, the funds will lose money".  At the end, the board gave in to Mr. Angelides' demands and altered its selection methodology.

Previously, Calpers had employed Wilshire and Associates to develop a selection process that incorporated the use of a range of commercially focused indexes, gathered from reputable published sources.  These indexes measured market volatility, regulation and legal system, investment restrictions, settlement proficiency, transaction growth and growth of technology.  The previous methodology also included indexes on the level of economic development and political stability.

In 2001 it eliminated the growth of technology index, augmented the political stability index and added two new indexes:  transparency and labour standards.  The transparency index measures monetary and fiscal policy, accounting standards and stock-market listing.  These are commercially relevant issues and the measures are compiled by reputable independent sources.  The political-stability index measures civil liberties, judicial independence and political risk.  A strong argument can be made on commercial grounds for their inclusion and they were also derived from reputable sources.

Politicisation came with the measure of labour standards.  Calpers hired the consultancy arm of an arguably union-friendly non-governmental organisation, Verite, to compile the measure.  Verite adopted the standards promoted by the U.S. union movement.  As for its methodology, it made assessments largely based on interviews with labour activists and research on newspaper articles (which in turn were largely generated by these activists).

Thailand was excluded from the Calpers list largely on market as well as transparency factors.  Indonesia was excluded on the basis of a number of factors.  Malaysia, however, was excluded in the end based on a labour-standard assessment.  As in the past, Malaysia ranked high on market-related factors and would have remained on Calpers' list except for its low ranking on labour standards (the fifth lowest of 27 countries).  Malaysia was also ranked poorly on civil liberties and some transparency issues, but it was the low ranking on labour standards that pushed it off the list.

In reality, the performance of the Malaysian labour market has been excellent, with high job growth, low unemployment and a doubling of real wages over the last decade.  Moreover, it has absorbed two million migrant workers from surroundings countries whose labour standards the Calpers study surprisingly rates more highly.  And in contrast to the Calpers study, Malaysia's labour market was this year rated by the World Competitive Index as number two among emerging nations in terms of attractiveness to investors, and the seventh across the world.

Malaysia has long been on the bad books of the U.S. union movement.  It has been the leading critic of attempts to include labour standards in trade and investment deals and of the labour standards promoted by the union movement.  And it has been highly successful in attracting investment away from the U.S.

It is important that Asian policy makers and investors see through the corporate social responsibility rhetoric of Calpers and understand the political agenda that drives this fund and others like it, for they are growing in number and influence.

Corporate Social Responsibility: A Threat to Shareholders

An address to the Australian Shareholders Association,
Melbourne, 3 September 2002

The Conscientious Investor

Triple bottom line:  noun.  A business principle that measures corporate performance along three lines:  profits, environmental sustainability, and social responsibility.

One of the unsung achievements of the federal government is that it has succeeded to some extent in rolling back the Orwellian concept of political correctness, or PC, in public discourse.

Consequently, I was surprised to discover only last week that the government has, with seeming insouciance, institutionalised a most pernicious form of political correctness in the nation's savings system.  My background paper outlines the implications of amendments accepted by the government from the Labor, Democrats and Greens parties and incorporated in the Financial Services Reform Act.

The bill, some 600 pages long, was presented to parliament by then-financial services minister Joe Hockey and became law in March, although full implementation will take up to three years.  Under the provisions of the new law, Australian superannuation, life insurance and managed funds will have to follow a form of triple bottom line (TBL) accounting.

As with most PC mantras, the triple bottom line sounds innocuous, almost motherly in character, but it has come to disguise a political agenda.  In its original formulation, TBL was employed as a voluntary framework for measuring and reporting corporate performance against economic, social and environmental parameters.  Even in this narrowest of definitions, it is apparent that it is impossible to come up with a standardised measure of environmental and social outcomes that would apply across all corporations.

But there is a good public relations case and sometimes a compelling economic case to be made that TBL is a worthwhile exercise and some companies have recognised this.  There is quite an international consulting industry involved in pushing TBL.  Highly active in this lucrative and competitive business are many different interest groups.  A web search on Google of TBL threw up 334,000 references, many of which identified it with the anti-globalisation lobbies.  Not surprisingly, these interest groups have been pushing for TBL to become compulsory so that the rights of "stakeholders" will be treated equally with those of shareholders.  When stakeholders are defined in the widest possible terms to include people with no financial exposure either directly or indirectly to a company's operations there is almost inevitably a conflict between the "stakeholders" and "shareholders".

The federal government, courtesy of Hockey, has gone further than anyone else down this path of creating a legal framework that offers the practical prospect that stakeholders will be in a position to demand equal, even superior, rights to shareholders.  Under provisions of the act, the custodians of a significant proportion of Australia's household saving will be obliged to report the labour standards, environmental, social or ethical considerations they take into account when they invest those savings.  Responsibility for defining the standards to be applied has been handed over to the Australian Securities and Investment Commission.  That's a real hospital pass for ASIC.

Just think of the vexed question of labour standards, ranging from unionised or non-unionised workplace to specifics such as paid maternity leave, before you get to the far fuzzier area of environmental and social standards.  The potential writ of the TBL extends way beyond the financial institutions covered explicitly in the bill.  Would, for example, it be socially responsible for a superannuation fund to invest in a tobacco company, a casino or a farming operation that used genetically modified seeds?  Theoretically, it would be possible for the super fund to simply say it did not take non-financial factors into consideration;  that it was fulfilling its mandate to maximise investors' returns.  In practice, that would invite yourself to be targeted by special interest groups and the media.

Even if the required data is given in the most general of terms, the act provides a degree of legitimacy for "stakeholders" to argue that this falls short of the community service requirements implied by the law.  The government has provided the ideal avenue for activist interest groups to leverage their case by providing soft targets in financial institutions that trail the pack in terms of non-financial performance.  The savings institutions covered by the legislation have more than $600bn under management.  They represent the single most important source of external investment capital for Australian industry.

There is a danger that application of this law will distort the pattern of investment in a deleterious fashion.  This conclusion is backed by the Good Reputation index published by The Sydney Morning Herald and Melbourne's The Age last year.  The criteria employed were based largely on the views of interest groups that compete for the claim to be the most environmentally or socially active and sensitive.  The newspapers looked at Australia's top 100 companies and found not one of the top 10 in the index ranked in the top 10 in terms of financial performance.  Only one, Foster's, made it into the top 20.

The impact of this act will be to further reduce the retirement benefits going to Australians through compulsory super.  Not only has super become a cash cow for the tax system, it has become an arm of social engineering.  The tragedy is that it is beyond repeal.  The critical amendments were written and supported by a coalition of Labor, Democrats and Greens, who are destined to retain a majority in the Senate and be in a position to block any return to sanity on the part of government.

Trade Matters

Australia and the Global Trade System:  From Havana to Seattle
by Ann Capling
Cambridge University Press, Victoria, 2001);  pb $A39.95 (260 pages)

This history of Australia's participation in international trade negotiations over the past 50 years is detailed and comprehensive.  It draws on careful research into official files and interviews with key participants in these seemingly unending negotiations.  This study pays tribute to these "trade warriors", though in retrospect many of the policies pursued were dubious.

The conclusion of this study, that "Australia has been a deeply influential player in the multilateral trading system since its creation" (page 7) overstates the evidence offered.

• Australia took a high profile in the 1946-48 ITO negotiations, when it argued on behalf of under-developed countries that full employment and economic development should be included.  But "the negotiating skill and expertise demonstrated" (page 35) also contributed to the US Congress rejecting the Havana Charter.  A hollow victory!
• During the difficult early years of the GATT, Australian governments' propensity for trade preferences and protectionism threatened to undermine the fledgling institution.  In the McEwen era (1947-71), these policies also imposed severe costs on the Australian economy.
• The brief period of economic reform under Whitlam, which included the 25 per cent across-the-board tariff cut, was reversed with the return of the Fraser Coalition Government.

When the Hawke-Keating Governments adopted economic reform in the mid-1980s (symbolised by floating the Australian dollar and reducing trade barriers unilaterally), this philosophy was absorbed into the tool-box of trade negotiators just embarking on the Uruguay Round negotiations.  Convening the Cairns Group and undertaking some "honest brokering" in services' trade enabled Australia's negotiators to influence outcomes and to mediate among the major players (the EU and the US), as well as engaging important non-OECD members.  This contribution to the multilateral trading system is justly acclaimed.

At the beginning of her book, Ms Capling defines her purpose, "to provide a political analysis ... of trade policy and trade diplomacy" (page 7).  Yet on the next page, she claims to examine "the role of the State in Australia's political and economic development", and "the inter-play between competing economic and political interests in policy-making".  The absence of any economic analysis of trade and the linkages between the domestic economy and international trade and capital flows leaves serious gaps in this story-line.

For example, trade negotiations under fixed exchange rates were quite different from those after 1983, when the Australian dollar had floated and capital flows were deregulated.  The grudging recognition of comparative advantage and trade theory (page 114) does little to fill the economic vacuum, and probably weakens the relevance of political determinants of trade policy.  Any policy has both costs and benefits that have to be evaluated.  References to reciprocity, non-discrimination and transparency throughout the volume need explanation.  Without an understanding of the economics behind these three founding principles of the multilateral trading system, there is no standard against which to assess the political outcomes.  The political inclination towards preferences in Australia until the mid-1960s -- now reappearing in the preoccupation with "free trade" agreements -- indicates more interest in reciprocity than in multilateralism.  Usually, large economies (US, EU, Japan) show most interest in reciprocity because they have the bargaining power to influence their terms of trade.

Not only trade negotiators have promoted Australia's profile in the multilateral trading system.  Academic economists such as Corden, Swann and Lloyd advanced trade theory, as did Garnaut, Snape and others who do get passing reference in the volume.  The "power of (economic) ideas" to influence policymakers is not addressed, while the "essentialism" of politics is rampant.  The role of the Tariff Board (and its successors) in changing attitudes is surely relevant to the politics of trade policy.

Another strange imbalance in this book is its undisguised dislike of all things American.  All US motives are regarded as malign and no recognition is granted for US success in establishing and sustaining the multilateral system of trade and payments after the chaos of the 1930s and World War II.  US trade polices -- like Australian -- are also the product of its domestic policies.  Western Europe's self-centred and discriminatory trade policies, on the other hand, are largely ignored or condoned here.  Only in references to agricultural trade is the European Commission criticised, although Australia's trade relations with the Commission have been poor throughout.

The book closes with an assessment of the future of the WTO, besieged as it is from many directions.  Satisfying developing-country interests while keeping the major players (US and EU) in "the club" will not be easy, especially with increasing resort to preferential trade agreements, which break all three of the founding principles of the multilateral trading system.  Overcoming these difficulties depends on commitments by governments to engage with civil society at home and to pursue genuine multilateralism in WTO meeting rooms.  This volume provides much advice on how Australia should proceed -- and many traps to be avoided!

No Nuggets Here

Nugget Coombs:  A Reforming Life
by Tim Rowse
Cambridge University Press, 2002 $59.95 (419 pages)

Back in 1984, Hugh Stretton, whose word is law in such matters, described Dr H.C. ("Nugget") Coombs as one of Australia's premier "Social Democratic Intellectuals".  Beginning in the dark years of the early 1930s, Coombs set out "to improve the world" using a network of national institutions, including the Commonwealth and Reserve Banks, the federal public service and the Australian National University, as his springboard.

Coombs' career as a reformer is clearly of great interest to the Australian reader and yet Tim Rowse has ended up writing an exceedingly dull book about him.  The reader's heart sinks as earnest summaries of the deliberations of impersonal bureaucratic committees in which Coombs was involved alternate with a succession of paraphrased policy statements.

Rowse has unwisely succumbed to the cult of impersonality which was a deliberate part of Coombs' modus operandi.  A commitment to seeking reform through committees and institutions placed a premium on "amiable impenetrability".  The best way to further social democratic change in Australia was by damping down confrontation of any kind, whether personal or ideological.  For his part, Rowse was never going to do anything that would disturb the calm as indicated by his willing compliance with a ban placed on interviews with Mrs Coombs.

Reading Rowse's account can, in truth, only be persevered with because of a prior knowledge of the important events making up Coombs' life and times.

The Great Depression of the 1930s was, for Coombs, "the most significant event" he ever experienced.  An important reason why the Scullin Labor Government failed to cope with the Depression was because it lacked advice from sympathetic experts who understood precisely how complex economic and financial mechanisms operated.  Labor always seemed to prefer simple views and solutions.  The Depression confirmed its atavistic distrust of the banking system (dismissed as "the Money Power"), making it vulnerable to crackpot remedies peddled by Jack Lang or Major Douglas.

The challenge was serious and Coombs' response was suitably bold.  He enrolled at the London School of Economics where a doctoral thesis on central banking was intended to train him up as an expert who would solve technical problems for a reforming government without arousing hostile conservative passions.

Coombs joined the Commonwealth Bank after he returned to Australia, but his agenda was effectively stymied, the ALP still stubbornly equating university-educated economists with deflationary orthodoxy.

The Second World War, when government control of the economy foreshadowed an eventual Hayekian road to serfdom, was Coombs' salvation as a reformist.  He was summoned to Canberra where he advised the Treasury on the conversion of the banking system into a publicly regulated wartime utility.  After 1942, the Labor Government appointed Coombs to administer its schemes of wartime rationing and post-War reconstruction.

When peace came, government intervention turned to the task of overcoming poverty through full employment.  Coombs sought to counteract Labor's nativist economic outlook by seeking to link the creation of more liberal post-War international trading arrangements to this mighty objective.

Coombs adapted Sidney and Beatrice Webb's strategy of "permeation" to suit Australian circumstances.  He was not wedded to a single party, although Liberal party hotheads insisted he was.  Worthy aims were best achieved by forging and maintaining agreement among key policy-makers and then getting their priorities rubber-stamped by elected politicians.  Polarisation was, for Coombs, a dirty word.  He did not support Chifley's attempt to nationalise the private banks because it was controversial and divisive.  It hindered the development of a cooperative understanding between private and public bankers.

Menzies defeated Labor in 1949, but Coombs stayed on as Governor of the Commonwealth and then the Reserve Bank until he retired in 1968.

The presence in the Menzies cabinet of a rural socialist rump in the form of the Country Party provided Coombs with enough leverage to continue to peddle, if ever so discreetly, a social democratic line.  Until the Reserve Bank was created in 1960, the private banks were subject to a regime of semi-voluntary regulation administered by the Commonwealth Bank which, at the same time, was active in offering "socialist competition" in the market for financial services.

Coombs opposed the eventual splitting-off of the Reserve Bank from the Commonwealth Bank for as long as he could.  He also sought, although without success, to outflank rivals in Treasury by implanting like-minded economists in the Australian National University.  Such setbacks were indicative of a broader unfavourable trend.  Coombs could delay, but not prevent, the historic transition from a Chifley-style guided economy to a Hawke-era market mediation.

The Keynesian apparatus of 1945 was in truth fatally flawed.  Australia's full employment policy, despite its inflationary potential, did not rest on stable institutionalised wage restraints.  Its nemesis came in the 1970s when wage pressures spiralled out of the control of the Arbitration Commission.

Coombs, as an adviser and consultant to the Whitlam Government, was fated to witness the destruction as well as the creation of Australia's post-War settlement.  His 1972 appointment as a high-powered economic adviser highlighted Labor's continuing shortage of technical expertise.

The failure of the Whitlam experiment marked a crisis of faith for Coombs.  He was bent on using public-sector institutions to foster social change and yet the collapse of the Keynesian paradigm made this approach seem passé.  Coombs sought to re-energise policy-making by pressing for a more "responsive" style of public administration.  Bureaucrats, he insisted, needed to take account of a range of new lobby groups, including women, arts practitioners, Aborigines and the conservation movement.

The painful split between ministers and career public servants that occurred when Whitlam was Prime Minister troubled Coombs deeply.  As a remedy he recommended the creation of a Cabinet Office to promote "rapport".  This proposed body was to be fully amenable to the ministry of the day.  It was to be composed "for a particular government predominantly of persons sympathetic with their general political philosophy".  It is likely that such an arrangement would have served to further speed up the promiscuous mingling of lobbyists, advisers and career bureaucrats in Canberra.

Rowse's coverage of Coombs' post-Whitlam years is too patchy to allow us to judge in detail if these notions of responsiveness and rapport were as inimical to good governance as any policy of "relevance" tends to be.  It is clear, though, that Coombs caused needless heartache as Chancellor of the Australian National University when, in an effort to get rid of confrontation by caving in to it, he opted for appeasement when faced with a demanding group of modish New Left students.

Coombs was active as a policy advocate, concentrating in his latter decades on indigenous issues and the environment, up until he suffered a serious stroke two years before his death in 1997.  He never experienced a period of idleness mixed with good health in which to reflect calmly on whether any of the changes he was busy forging might have consequences other than the ones he intended.  This is an important question for reformers, past and present, and the stages of Coombs' career are directly pertinent to it, but sadly Rowse's lifeless account seems almost deliberately intended to stifle rather than stimulate ongoing interest in his reforming aspirations.

The Financial Services Reform Act: A Costly Exercise in Regulating Corporate Morals

Backgrounders

Until the advent of the Financial Services Reform Act, ethical investment had been a matter of free choice.  Investors were free to choose those products that suited their values, and indeed their financial needs.  This is no longer the case.

The new Act imposes disclosure obligations on superannuation, life insurance and managed funds which will, in effect, force them to inquire into the labour, environmental, social and ethical standards of the Australian corporate sector.

Those obligations will impose values on investors and the industry to the detriment of financial return.  The values to be applied are vague and not of a kind that can or should be enforced by government in a liberal society.

The Act will provide a means for intrusion by numerous political and anti-business interest groups into the already heavily regulated operations of Australian companies.

The rights of shareholders will be diminished at the behest of groups that are self-appointed and bear no risk of loss.

The Act is a threat to the future of the majority of Australian investors.  Most Australians now look to funding their retirement from the savings invested in superannuation.  The Act, by inducing trustees and other fiduciaries to pursue non-financial goals and the interests of people other than the unit-holder, can be expected significantly to undermine the returns in superannuation funds.

The Act is a thoroughly bad piece of legislation and the parts that pertain to reporting labour, environmental, ethical and social standards should be repealed.

---

"It is a general popular error to imagine the loudest complainers for the public to be the most anxious for its welfare"

Edmund Burke 1769

INTRODUCTION

On 27 September 2001, Parliament passed the Financial Services Reform Bill into the Corporations Law.

New disclosure provisions now apply to any offer of financial products, such as superannuation, managed investment and life insurance.  Those provisions are very extensive and are designed to give prospective investors sufficient financial information to decide whether or not to invest.

Late in the process of drafting, a disclosure requirement of an unusual kind was added to the Bill.  This covered matters unrelated to the financial and contractual terms of the products.  It imposed reporting obligations for labour standards and environmental, social and ethical considerations -- that is, general behavioural standards.

If these obligations could be limited to those funds that freely choose without coercion to apply them, there would be no concern.  Indeed it would make a substantial contribution to a better informed investing public and offer protection from fraud and potential loss of money.

However, it will not, and probably cannot, be quarantined and will extend beyond its immediate legislative ambit.  It has potentially far-reaching effects on the corporate sector as a whole through the allocation of the funds managed by financial institutions.  Moreover, it is a manifestation of a much wider movement, whose aim is to force acceptance of activist agendas by business -- at the expense of business and their shareholders.

The provision applies particular disclosure requirements to all superannuation, life insurance and managed investment products.  It is thus imposed on approximately $650 billion of Australian savings, including the principal government-enforced form of savings -- superannuation.

This is the first codification of the so-called "triple bottom line".  For the first time, the Government is helping to enforce the political agendas of the multitude of activist and essentially anti-capitalist Non Government Organisations (NGOs).  Few of these NGOs are concerned with the financial health of the funds or of the business sector, nor are their goals aligned to those of shareholders or the majority of Australians whose future depends upon returns in superannuation funds.

THE ACT

The Financial Services Reform Act 2001 is almost 600 pages long and covers vital areas of licensing and conduct of financial institutions.  It also places extensive obligations on providers of retail financial products to make product disclosure statements for such products (Section 1012A). ⁽¹⁾

While prudential regulation is appropriate for a sector which controls a significant proportion of the savings of the general public, the regulations imposed by the Act are excessive.  It not only seeks to cover every eventuality, but greatly enlarges the exercise of bureaucratic discretion and the uncertainties and risks of investing.

Nowhere is this more evident than in the novel provision relating to disclosure of non-financial considerations.  Regulations accompanying the Act oblige the financial institution to state whether it takes the specified non-financial matters into account.  "If the product has an investment component (the Act requires a statement of) the extent to which labour standards or environmental, social or ethical considerations are taken into account in the selection, retention or realisation of the investment" (Section 1013D (1).

THE PRACTICAL IMPLICATIONS FOR BUSINESS

At first sight, the legislation might appear relatively innocuous.  Who could object to disclosure on labour, environmental, social and ethical matters?  No doubt the Minister was persuaded that the amendment was harmless and would even aid "transparency" -- a key policy buzzword.

Upon closer examination, however, the legislation is much more intrusive than it seems.  And the transparency is more apparent than real.

In practical terms, disclosure requires the institution to formulate and express its attitudes and practices to four matters which range from difficult to impossible to define.

In theory, businesses could state that they do not take these matters into account in their investment decisions and avoid scrutiny and the subsequent paper chase that will accompany disclosure.  In practice, however, no institution will state that it does not take such matters into account, in part because if it did, pressure groups and the media would label it as unethical or anti-social.  Silence would be treated as guilt.

In any case, it is also a reality of business that those matters are almost always "taken into account" in some degree, so a nil return would, in most cases, be misleading.  The normal investment selection processes will involve winnowing out from corporate practices fraudulent (that is, unethical) propositions or those with high risk exposures.  "Taking into account" is vague enough to embrace even the most casual process, let alone normal vigilance.

It is also theoretically open to institutions to be selective among the four matters and choose or discard one or more of them.  For the reasons outlined in the preceding paragraphs, this is not a real option.  Moreover, omitting any matter would involve a lengthy explanation of the omission, equivalent to that accompanying the product statement for those matters left in.  There would be no point.

In short, the legislation gives the pretence of voluntarism but not the reality.  And it goes well beyond mere reporting.

If proof were needed of the likely impact, we can turn to the UK where similar, though much milder, legislation came into effect two years ago.  According to studies, "pension fund trustees had little real interest in SRI [Socially Responsible Investment] from a performance or moral perspective, but were primarily interested in protecting their own reputations and deflecting criticism".  However, "90 per cent considered CSR [Corporate Social Responsibility] to be already a key element in corporate reputation and brand and thus market values.  More than 50 per cent thought that CSR would be a significantly important part of investment decision-making within three years". ⁽²⁾  In short, the UK trustees are being forced in large number to pursue SRI, not by the commercial logic of SRI itself or by the interest of their unit-holders, but rather by the desire to protect their good names from attack by SRI activists.  Additional costs are being generated for internal and external advice and monitoring.  Despite this, funds are being criticised for poor practice and inadequate measurement of performance before the legislation has had time to bed down.  The threat of more intrusive regulation is already being made.

THE EXTENSION OF STATE AND THIRD-PARTY
CONTROL AT FOUR LEVELS

The Act extends state control and third-party interference at four levels.

First, the Act requires the Australian Securities and Investment Corporation (ASIC) to produce regulations that define extra-legal social, environmental, labour and ethical standards.  ASIC will be required to spell out performance standards on a wide range of issues which go far beyond the standards currently deemed appropriate by the Australian parliaments.  In short, ASIC rather than Parliament will be required to write law, something that is profoundly undemocratic.

Second, trustees and managers of investment funds will be required to define and then disclose the extent to which they take into consideration the non-financial interest of third parties in their investment.  This goes expressly against the legal obligations of trustees and other fiduciaries.

At a third level, the disclosure obligation will extend to all those companies in which the institutions invest, thus spreading its influence, creating more red tape and spawning new interest groups throughout the economy.

At a fourth, deeper level, the new rules have significant practical implications for all businesses.  The intent is not only to oblige institutions to describe their attitudes, but also to determine those attitudes and to direct their behaviour.

As summarised in Insert 1 and Insert 2, the amendments were seen by their proponents as a means of exerting leverage on business operations, through the allocation of capital, to advance the agendas of labour, environmental, social and ethical pressure groups.  The amendment was also supported by a number of "progressive" businesses including Westpac (the largest provider of ethical funds in Australia) and BP Australia (the leading proponent of corporate engagement) which see commercial advantage in the regulation of their competitors and other investors.

Insert 1:  "Funds for Workers" by Paddy Manning It was just a couple of lines among hundreds of pages in the Financial Services Reform (FSR) Bill that passed the Senate in August 2001. A small amendment designed to promote ethical investment, based on a similar law introduced a year earlier in the UK, and pushed by an unusual coalition of green NGOs and trade unions on the one hand, and some more "progressive" companies like BP Australia and Westpac on the other. After lobbying led by Michael Kerr of the Australian Conservation Foundation and the Ethical Investment Association, Democrats Senator Andrew Murray and Greens Senator Bob Brown were both ready to move and support an amendment that all super funds and fund managers disclose:  "the extent to which, if at all, ethical, social or environmental considerations are taken into account during the selection, retention and realisation of investments". Proponents stressed this was not a requirement for fund managers to take new things into account, or change their investment practices at all.  It was just a new reporting requirement.  But the motivation was clear to all sides:  the new reporting would lift awareness of ethical investment, and funds' reluctance to publicly disclose that ethical concerns were "not considered at all" would prod them into greater consideration of the triple bottom line.  Once financial institutions start taking more account of the triple bottom line, the thinking went, so must the companies that depend on the financial markets for capital. It was not an amendment welcomed by the Government, but nor was it strenuously opposed.  By comparison the FSR Bill was a big deal.  Since being first recommended five years ago as part of the Wallis Financial System inquiry, the Bill had caused the Government a degree of political pain.  In particular the Bill's proposals for an integrated licensing system for investment advice-giving had struck trenchant resistance.  New training, disclosure and remuneration rules had put financial planners -- part of the sensitive small business constituency still smarting over the GST -- offside. At the time the office of then Minister for Financial Services Joe Hockey, indicated tacitly the Government would not allow this drawn out financial services reform to fail on account of a relatively obscure ethical investment amendment. This acquiescence was tested somewhat at the last minute when, out of left field, Labor's Financial Services Spokesperson Senator Stephen Conroy moved his own crude two-word amendment to the Democrat's amendment:  as a condition of crucial ALP support, "Labour standards" must be added to the list of things that would be reported upon. Being so explicit, it stuck out like a sore thumb from the woollier triple bottom line provisions.  It is now law, and became effective (subject to a two year transition) on March 11th along with the rest of the FSR Act.  As a result, suddenly, our banks, fund managers and super funds are put in the unlikely position of judging corporate Australia's labour standards. The irony is not lost on Conroy.  Point out how this labour standards agenda must rankle with inherently conservative financial institutions and Conroy is blunt:  "Great, isn't it?" Clearly when it came to drafting the FSR Regulations, Conroy's wording caused the Government some heartache.  They are structured in such a way that "labour standards" will be reported separately from "ethical, social, or environmental considerations." Reading between the lines, the FSR Regulations say, "this is the Labor Party bit -- handle with care.  The rest is safe, fluffy, triple bottom line stuff -- do what you like". From Ethical Investor Magazine, Issue 11, May 2002 www.ethicalinvestor.com.au

Insert 2:  The High Cost of Ethical Funds While the promoters of Socially Responsible Investment (SRI) funds maintain that there is no trade-off between financial returns and the pursuit of social and other non-financial goals, their claims are based on outdated, overseas research and fail to consider the extra management and screening costs associated with SRI funds. US research does, on the whole, show that during the 1990s, (5) SRI funds were generally able to achieve gross returns on a par with the equity market as a whole.  This is really not surprising, given the investment strategy employed.  Most SRI Funds in the US have tended to invest in blue chip companies, in growing industries which, in the 1990s, tended to be socially "acceptable" industries, such as dotcoms, telcos, and services.  In short, they have tended to invest in the leading firms in the fastest growing segments of the market. There are clear signs that this strategy is now failing and with it the relative returns earned by SRI Funds.  Over the last few years, many of the firms in which the US SRI funds invested heavily, including Enron, WorldCom, Global Crossing and many dotcoms, have seen their share prices collapse, in part, ironically, because their managements behaved unethically.  At the same time, the old, socially "incorrect" industries such as tobacco, mining, oil and gas are now the market leaders.  While there is no detailed research which compares the relative performance of SRI funds during the last few years, there is some evidence that many SRI funds are haemorrhaging and leading the market in decline. (6) The US research also shows that the SRI Funds have high management costs.  SRI funds will, of necessity, have higher costs.  They not only need a team of financial analysts to pick the pool of stocks, but also a team of social engineers, ethicists, environmental scientists, and labour market analysts, to screen for good behaviour among the stock chosen by the financial people.  Recent research in the US substantiates this.  It found that SRI funds have expense ratios (management cost as share of funds invested) of between 1.5 and 2.5 per cent which compares very poorly with the average expense ratio of non-SRI Funds of about 1 per cent. (7) The high expense ratio means that in order for SRI funds to match non-SRI funds in terms of benefits to unit holders, they must achieve higher gross returns than non-SRI funds.  And there is no evidence that they have been able to do so -- even during the dotcom bubble. It also means that the additional costs associated with SRI consume a sizeable proportion of unit holder earnings.  Based on US research, the decision to invest in an SRI fund, as opposed to a non-SRI fund, will consume, on average, 14 per cent of expected lifetime earnings of a superannuation investment, which is an unacceptably high cost, particularly given the dubious benefits of the SRI process in the first place. (8) Given the fundamental differences in the composition and performance of US and Australian stock markets, great care should be taken when using US research to make decisions about SRI funds in Australia.  In Australia, the old, socially incorrect industries such as uranium mining, gambling, electricity generation and, up until recently, tobacco production, make up a larger share of the Australian market than in the US. Ali and Gold (9) provide the first independent examination of the performance of SRI funds in Australia.  They found that excluding "sinful" industries -- such as alcohol and gambling (which the majority of Australian SRI Funds do) -- between 1994 and 2001 would have resulted in a performance shortfall of 0.70 per cent per year, reducing the broad market return from 12.7 per cent to 12 per cent.  They also found that "investors in Australian SRI Funds generally face additional fee imposts, compared with investors in mainstream Australian, managed investment schemes or superannuation funds.  This is largely attributable to fund managers passing on to investors the development and marketing costs for SRI funds and the fees paid to external service providers (primarily, index vendors and SRI research providers)." (10) In summary, the available evidence indicates that SRI funds impose a significant cost on, and yield a lower net return to, investors than non-SRI funds.  To the extent that the Act forces funds managers to undertake non-financial screening activities, then it will undermine the well-being of most Australians without adding much, if any, benefit. Of course, the high costs of SRI Funds are one of main benefits, from their perspective, of SRI promoters, as to them it means income.  However, the livelihood of activists and promoters should have no bearing on the use of other people's funds.

In practice, groups will undoubtedly exert pressure for highly detailed disclosure statements under each of the four headings and will seek to supervise the behaviour of the institutions concerned against these written statements.  Draft "best practice" statements have already been drawn up, and a long line of consultants await the riches offered by the Act.  ASIC will be pressured to produce compulsory guidelines which reflect the wishes of the groups.  There will be a persistent pressure for all funds to become, in effect, ethical funds.

Funds and corporations will not be able to get away with the equivalent of vision or mission statements.  There will be targets, monitoring, hectoring and punishment for perceived failure.

Nor will small business be immune from the effects of this provision.  Such businesses have to raise capital through financial institutions and may then fall under the same strictures or find their funding restricted.  Pubs, farms, and tobacco retailers are obvious candidates, but there are few limits once the moral censors are out.

In the end, this is an attempt, by indirect and stealthy means, to impose new and poorly defined community service obligations and prescribed behaviours on business generally.  By means of legislation and mandatory guidelines, the corporate sector will be obliged to undertake actions (and report on them) that may adversely affect its profitability and that it would not necessarily undertake voluntarily.

If the community and governments wish companies to take on additional social responsibilities, then these ought to be funded through the public sector so that their costs are not concealed and so that their burden is equitably distributed.

THE ECONOMIC EFFECTS

In practical terms, the legislation opens a Pandora"s Box.  It has far-reaching effects for that important group of financial institutions which control our savings, and for all the businesses in which they actually and potentially invest.

At 30 December 2001, $654 billion was held in what are described as Managed Funds (see Table 1).  This effectively comprises the categories covered by the Act's disclosure provision.  As can be seen, the bulk is held in life insurance and superannuation.

Table 1:  Managed Funds -- Consolidated Assets
December Quarter 2001 ($billion)

Life Insurance Offices	176.6
Superannuation Funds	303.3
Public Unit Trusts	130.9
Other	43.6
Total	654.4

Source:  ABS 5655.0, December Quarter 2001.

Managed Funds have grown very rapidly, almost doubling in nominal value in the last five years. ⁽³⁾

The growth in Managed Funds is perhaps the major financial reflection of our national saving effort.  It should be said that our national saving effort has been nothing short of dismal in the last decade.  In particular, the government sector only ceased dissaving a few years ago and slipped back into it again in 2001-2002.  The corporate sector saving effort has also been patchy.  The result is that only the household sector has had a uniformly positive, though still weak, saving performance.  At 2.5 per cent of GDP, household saving is nothing to celebrate.

Total national net saving in 2000-01 was estimated at $18.5 billion ⁽⁴⁾ and was almost all saving by households.  The growth in Managed Funds was $40 billion, which would incorporate a substantial proportion of household saving and would be a significant support to total net capital formation of $37.7 billion.

National aggregate figures such as those quoted above are subject to qualification and are not fully comparable.  What they do demonstrate, however, is the vital importance of the managed-funds sector to our domestic savings and investment effort.  They also suggest that we should be extremely cautious in developing new policies for the sector -- in particular, policies which might impede the flow of the savings of individual households to their most fruitful and efficient use.

The disclosure provisions of the Act are intended to influence the allocation of those funds and thus have unmeasurable but potentially significant effects.  Most markets in Australia are imperfect and the financial markets are no exception.  Subject to normal prudential limits, however, there is a strong case for allowing institutions to allocate their investments according to commercial advantage.  In this way, savings will be allocated to their most productive use.  The extent to which other considerations are taken into account should be subsidiary to this.  Investors who favour these considerations are already able to give expression to that preference by selecting ethical funds.

The Act will encourage significant distortion of investment decisions and place pressure on management to placate critical and hostile groups which have little financial stake in the institutions or businesses affected.  There is no doubt that at the very least, the Government should have consulted the wishes of the millions of savers whose money they have put at risk.

The weakening of the link with shareholders has many implications, not only for the financial soundness of companies but also for the property rights of all shareholders.  Insofar as the government confers rights on other "stakeholders" that affect the return to shareholders, it erodes the rights of those shareholders which they purchased in good faith.  When the government does this, there is a clear justification for some form of compensation to shareholders.  It is implications like these which would have been revealed if there had been proper consultation with those affected.

THE ACT IN ITS BROADER CONTEXT

The disclosure provisions of the Act were not drafted in a vacuum.  In Australia and overseas, interest groups of many kinds have exerted public, financial and political pressure to modify corporate behaviour to suit their own specific agendas.  Many corporations and international institutions have already made a significant response to these pressures.

The Act is another manifestation of this process, albeit with an important difference.  It is based in law, rather than through public pressure.

Insert 3:  Threat to Trustees and Other Fiduciaries SRI funds, and more generally the Act, impose significant risks on trustees and others who have a fiduciary responsibility to manage funds. Under the so-called "prudent investor rule", trustees and other fiduciaries have a responsibility to unit-holders to maximise the financial return on the funds invested.  Under the rule, trustees cannot sacrifice gains to unit-holders for gains to others, nor can they give priority to non-financial objectives over the financial objective of optimising the return on the fund assets. What this means is that trustees of SRI funds are not allowed, by law, to sacrifice financial returns in the pursuit of social, environmental, ethical or labour standards.  If they do, they expose themselves to the risk of legal action by unit-holders. The existence of the "prudent investor rule" no doubt helps explain the vigorous denial by advocates that the returns are lower and the costs higher for SRI funds.  In a court of law, the views of advocates will, however, count for little, and both logic and the available evidence indicate that SRI funds do entail a financial cost to unit-holders and therefore pose a risk to the trustee. The Act, by encouraging wider adoption of SRI Funds, will increase the level and spread of these risks and place trustees in real dilemmas.

THE MULTIPLE BOTTOM LINE

One means by which the various social interest groups have tried to exert pressure on companies is through adoption of the "triple bottom line", where the financial reports and goals are put on a par with reports and goals on environmental and social outcomes.

It is in the nature of movements of this kind that, once the bandwagon gets moving, others will jump aboard.  As well as requiring environmental and social reports, the trend is to take on other passengers, such as labour standards and ethics.  As a result, the triple lines have evolved into the "multiple bottom lines", and again the Act reflects this.

THE EXPANDING STAKEHOLDER LIST

Business has long recognised the need to take into consideration the concerns and interest of "stakeholders".  It is obvious that people and groups, such as lenders, employees, customers and suppliers, are to a degree integral to the success of a business and often invest or put at risk things of value to advance the business.  Lenders put their money at risk.  Suppliers often provide goods on short-term credit.  Employees invest in firm-specific skills.  The local community often shares the air, land and water with the business.  To a degree, it is only reasonable for business to take into consideration the interest of these stakeholders and doing so is not necessarily incompatible with the primacy of shareholders.  Indeed, traditional stakeholder theory argues that systematic consideration of stakeholders' interests enhances the firm's viability and therefore adds to shareholder value.  Traditional stakeholder theory also makes no extra demands about business ethics or corporate social responsibility.

The multiple bottom line process is based on an entirely different stakeholder theory -- one which is explicitly antithetical to maximising shareholder value.

First, the new stakeholder theory greatly broadens the range of permissible stakeholders, to include "any group or person who can affect or be affected by the achievement of the organisation's objectives". ⁽¹¹⁾  In practice, this translates into anyone who voices an opinion about the business and can attract the attention of the media, regulators or politicians.

Second, the new theory changes the status of stakeholders.  Under the traditional theory, stakeholder interests are taken into consideration by management.  Under the new theory, stakeholders are entitled by virtue of their self-proclaimed stakeholder status to directly influence the operation of the business.

Third, the new stakeholder theory erodes the primacy of shareholders and the accountability of business to shareholders.  Traditionally, stakeholder interests are considered because, in the end, doing so will advance the interests of shareholders.  Traditionally, management accountability is not to stakeholders but to shareholders.  The new stakeholder theory explicitly repudiates this type of accountability;  indeed doing so is one of the defining features of the new stakeholder doctrine. ⁽¹²⁾  As described by Elaine Sternberg, the central tenet of the new stakeholder theory (which she defines as stakeholder entitlement) is:  "that organisations, and particularly businesses, must do more than just take their shareholders into account.  It maintains that organisations must instead be accountable to all their stakeholders, and that the proper objective of management is to balance their competing interests".

The stakeholder entitlements approach has a number of direct and serious practical implications for investors and business.

First, it will cost shareholders and traditional stakeholders.  Of necessity, there will eventually be trade-offs between the extra-legal social, ethical, environmental and labour goals sought by the new stakeholders on the one hand and returns to shareholders and traditional stakeholders on the other.  Additional performance targets don't come free, but since only the traditional stakeholders have something at risk, they will in the end bear the costs.  And, as discussed in Insert 2, this is what the research shows.

Second, scarce managerial resources will be consumed in the compilation of multiple reports and pandering to the new army of non-riskbearing stakeholders.  This again will be at the cost of shareholders and traditional stakeholders (see Insert 2).

Third, it will accentuate the agent-principal problem and thereby undermine accountability of the corporations and confidence in the market.  One of the greatest challenges to business is to ensure that management (the agent) acts in the interest of shareholders (the principal) rather than in their own interest or some other party.  Overcoming the agent-principal problem has been the focus of recent corporate and accounting reforms and ostensibly even of the Act.  While some gains have been made, particularly in countries such as Australia, the recent demise of OneTel, HIH, Enron and WorldCom, indicates that the problem remains.  Indeed, these recent corporate collapses and scandals show that accountability of management to traditional shareholders remains one of the significant issues facing corporate Australia and the community at large.  By introducing diverse new demands, which dilute the rights of shareholders, the triple bottom line will actually weaken the accountability chain and hence the ethical response and social contribution of corporations to the owners, to real stakeholders and ultimately to the community at large.  The new stakeholder capitalism will consume scarce management time and resources and will provide succour and comfort for management to pursue non-shareholder goals.  It will provide multiple excuses for poor or even fraudulent management practices.  It will also offer the thinning ranks of corporate headquarters' staff a new and expanding, but counterproductive, career path.

Fourth, the multiple bottom line processes promote destructive rent-seeking behaviour.  Since the new stakeholders put nothing at risk except maybe the resources they expended in lobbying (which in turn are mainly paid for by someone else), they will push their goals beyond a level that is beneficial to shareholders, traditional stakeholders and the economy as a whole.

Fifth, the process promotes false prophets and destructive tactics.  Most of the new stakeholders, in the final analysis, obtain their status, not by reference to their expertise, representative or ethical status, but rather by their ability to be heard in the media and to threaten the reputations of corporations and individuals.  Greenpeace, for example, has no scientific expertise, is a tightly controlled multinational club run from Europe with next to no Australian input, and has a long history of stretching the truth and abusing people's rights.  Yet it is regularly accorded stakeholder status by corporations and governments.  Indeed, it is currently campaigning to become a stakeholder to investment managers under multiple bottom line provisions of the Act, and recently published a guide to socially responsible behaviour for businesses. ⁽¹³⁾  A quick perusal shows that this new stakeholder plans to act against the interest of Australia investors.

The Good Reputation Index of the Fairfax Press provides ominous indications of things to come under the Act.

The Good Reputation Index published in The Sydney Morning Herald and The Age attempts to measure the social, environmental, labour, and ethical as well as the financial and public relations reputations of the 100 largest companies operating in Australia and New Zealand.  It is designed as a tool for the corporate social responsibility industry and as a guide to firms in their deliberations about corporate social responsibility, and is being used as such.

In constructing the index, the Fairfax Press adopted what is now the standard methodology in the corporate social responsibility industry -- that is, basing the index on the views of high-profile pressure groups.  And it included the views of most of the leading lights of the corporate social responsibility industry.

As such, the Good Reputation Index provides a good indication of how corporate Australia will be rated by multiple bottom line provisions of the Act.

Table 2 lists the top ten firms ranked according to the overall or multiple bottom line reputation as well as their ranking (out of 100) on financial performance.  Table 3 lists the top ten firms ranked according to financial performance and contrasts this with their multiple bottom line ranking.

Table 2:  Top Ten Companies -- Multiple Bottom Line

	Multiple Bottom Line	Financial Bottom Line
Australia Post	1	24
Westpac	2	21
Foster's Corp	3	19
Holden	4	32
Queensland Rail	5	46
Alcoa	6	28
IBM	7	54
Ford	8	54
Telstra	9	39
ING	10	31
Average		35

Source:  Good Reputation Index 2001, Sydney Morning Herald, October 22, 2001.

Table 3:  Top Ten Companies -- Financial Bottom Line

	Financial Bottom Line	Multiple Bottom Line
Flight Centre	1	66
Westfield	2	71
Woolworths	3	15
NAB	4	12
Leighton	5	11
Telecom NZ	6	52
Suncorp-Metway	7	37
RioTinto	8	28
Qantas	9	49
Wesfarmers	10	20
Average		36

Source:  Good Reputation Index 2001, Sydney Morning Herald, October 22, 2001.

These tables show that, according to the Index and therefore the social responsibility industry:

• Financial performance and social responsibility do not go together.  Only one of the top ten most socially responsible firms is ranked among the top 20 firms in terms of financial performance.  Moreover, all of the most socially responsible firms performed worst on their financial bottom line.  Conversely, just three of the top ten financial performers were ranked in the top 20 in terms of social responsibility and, on average;  they ranked a lowly 36 on so-called social responsibility grounds.
• Government protection and direction is good and market competition is bad.  Five of the top 10 most socially responsible firms are government-controlled.  Two, Australia Post (ranked 1st) and Queensland Rail (ranked 5th), are government-owned monopolies.  Telstra is partially government-owned and heavily regulated.  Holden and Ford are sustained only by the huge subsidies flowing to them from the taxpayer via Canberra.  None of the top ten financial firms are government-owned or subsidised and all face vigorously competitive markets.
• Funding social activists is a key to social responsibility.  All the highly ranked socially responsible firms donate heavily to corporate social responsibility groups (including many of the organisations who acted as judges for the Index).  Westpac (ranked 2nd), Alcoa (ranked 6th) and ING (ranked 10th) are not simply generous financial contributors, but are also strong promoters of the triple bottom line.  Westpac has taken the lead in promoting ethical investment in Australia and helped push the corporate social responsibility amendments to the Act.  ING has taken a similar approach around the world.  Their high ranking is a reward for their contribution to the cause.

WHY IS THE ACT NEEDED IN AUSTRALIA?

There would be some point in all this activity if there were evidence that Australian business is particularly unethical, either absolutely or relatively.  There is no such evidence.

In many developing countries, corruption is routine and permeates all levels of society, including the government.  This is not the case in Australia.  Although no fair comparison can be made with this category, most major Western corporations do operate in such countries.  They daily face the moral dilemmas posed by doing business with actively corrupt officials, suppliers, labour organisations and non government organisations.

It is simple from the comfort of Australia, where the rule of law is the norm, to condemn companies which deal with oppressive and corrupt regimes that are the norm in many other parts of the world.  For businesses, there is a conflict between the incentive to invest and the need to act legally.  This is shadowed at the national level by the tension between economic development and state control.  Sometimes there is little alternative other than to refuse to invest, and in some cases this is what Australian firms have done.

A parallel difficulty for firms is encountered where, in the rush for development, the laws of the developing country actually permit practices that Australian society has now abandoned.  In these cases, the anti-globalisers seek to impose current Western standards on developing countries, denying them the stage of development from which the West has benefited in the industrialised world.  A recent example is BHP's withdrawal from the Ok Tedi mine, where an Australian court and Australian activists prevented arrangements agreed to by the government of PNG and BHP/OTML.  PNG law provided the wherewithal to develop the region and provide compensation to landholders adversely affected by the mine.  BHP has now disposed of its holding in the venture ⁽¹⁴⁾ despite the plea of the PNG government and most locals to remain.  There are, no doubt, complex issues of right and wrong here, but ethical imperatives differ across countries and may be shaped by their most pressing priorities.

According to Transparency International (see Table 4 below), an anti-corruption organisation, Australian companies were the least likely to pay bribes in major exporting countries, ahead of Switzerland, Sweden, Austria and Canada.  Moreover, our companies' performance had improved absolutely and relatively in the last three years between surveys.  This contrasts with British, American, Japanese and French companies, which were significantly more likely to pay bribes.  Non-Australian companies in countries such as Russia, China, South Korea and Italy were more than twice as likely to bribe as Australian companies.

Table 4:  Transparency International Bribe Payers Index 2002

In the business sectors with which you are most familiar, please indicate how likely
companies from the following countries are to pay or offer bribes to win or retain
business in this country [respondent's country of residence]? ⁽¹⁵⁾

(A score of 10 represents a perfect score.)

Rank	Country	2002	1999
1	Australia	8.5	8.1
2	Sweden Switzerland	8.4 8.4	8.3 7.7
4	Austria	8.2	7.8
5	Canada	8.1	8.1
6	Netherlands Belgium	7.8 7.8	7.4 6.8
8	United Kingdom	6.9	7.2
9	Singapore Germany	6.3 6.3	5.7 6.2
11	Spain	5.8	5.3
12	France	5.5	5.2
13	USA Japan	5.3 5.3	6.2 5.1
15	Malaysia Hong Kong	4.3 4.3	3.9 n.a.
17	Italy	4.1	3.7
18	South Korea	3.9	3.4
19	Taiwan	3.8	3.5
20	China (People's Rep.)	3.5	3.1
21	Russia	3.2	n.a.

THE INTERNATIONAL DIMENSION

Not unexpectedly, international institutions have enthusiastically taken up the opportunity to involve themselves in the reshaping of capitalism through imposing new obligations on business.

At the instigation of the Secretary-General of the UN, a "Global Compact" has come into being which contains a set of principles to be observed by businesses which cover human rights, labour standards and environmental protection.  A Global Compact Office has been set up.

The European Commission has drafted a "Framework for Corporate Responsibility" which incorporates codes of conduct, stakeholder monitoring and community advisory committees.

The International Standards Organisation, which has done much good work on technical standards, has moved into management standards with ISO 14000 -- environmental management.

Pressure has also been exerted by other public and private entities, such as the Ford Foundation, The Prince of Wales Business Leaders Forum and a host of universities, who base part of their raison d'être on advising or hectoring the business sector on how it should conduct its affairs.

A common thread is what has been termed the "new tripartism" -- the involvement of government, the community and business in managing the world economy.  What it actually means is the acceptance by business of intervention by government (including international agencies such as the UN and EU) and non-government organisations (NGOs) in their operations, but with no reciprocal obligation.

The intention, and no doubt the result, will be to place greater burdens of consultation on business and further social obligations.

THE DIFFICULTY OF SUPERVISING MORALS

As an attempt to raise the standards of corporate behaviour, the disclosure requirement in the Financial Services Reform Act must be measured against a clear definition and interpretation of the words employed.

LABOUR STANDARDS

Although the criterion has been inserted at the behest of the labour movement, there is considerable disagreement over the best way to improve labour standards.  Labour standards are not simply those prescribed in the various manifestoes issued by the ACTU.  For example, the ACTU has tended to support a relatively interventionist labour market policy, particularly as wage rates and Australian labour markets are relatively heavily supervised.

It is likely that all Australian businesses would answer affirmatively that they took into account all labour standards prescribed by the domestically applied law to the extent of that prescription.  This would not mean the application of uniform standards across Australia because standards do differ from State to State, from region to region and from industry to industry.

It will be very difficult for financial institutions to affirm that they were able to take into account the standards applied in those companies or projects in which they invested.  Not only would it be difficult to assess the degree to which those companies or projects observed the law of the countries in which they operated, but it would be even more problematical to assess the degree to which the behaviour conformed to the equivalent Australian standards.  More importantly, it would be impossible to judge whether the application of Australian standards overseas would be to the ultimate benefit of the workers of the countries concerned.

There is a further degree of difficulty in defining those labour standards which go beyond the black letter law.  Is it simply more of the same?  Does it include the work ethic?

The inclusion of this criterion is all the more curious when we recall that, just last year, Parliament, including the Senate, threw out the Democrat-inspired Corporate Code of Conduct Bill 2001 (which included labour standards), on the grounds of its impracticability.  It shows the way in which unsound ideas, persistently held, can prevail unless the Government exerts the utmost vigilance.

The inclusion of labour standards in the Act has particularly serious implications for the millions of people who plan to live off their superannuation in retirement.

The union movement has long threatened to use its leverage over the superannuation industry for industrial purposes.  Indeed, it is ACTU policy to do so.  However, its efforts to date have been greatly restricted by the requirements, under the law, for trade union trustees to industrial super funds to act in the long-term financial interest of superannuants.  The requirement that such funds now report on an undefined set of labour standards not only provides union activists with a new campiagning tool, but gives them the legal justification to pursue their industrial goals at the expense of returns to superannuants.  Given that members of industrial funds have no choice and little influence over their participation in such funds, this constitutes a significant threat to the rights and futures of millions of Australians.

ENVIRONMENTAL CONSIDERATIONS

The main challenges an institution will face in reporting environmental considerations will be those of nature and degree.  Although there are differences between commentators as to what constitutes an environmental consideration, the debates of recent years have given a very wide definition.

For example, the Australian Bureau of Statistics presented the environment as:  "... the standard compartments the average person usually identifies when thinking about the environment -- air, water, land and living things." ⁽¹⁶⁾  This suggests that environmental considerations would have a fairly comprehensive application to most business activities.

Bjørn Lomborg, the sceptical environmentalist, canvasses human welfare, resource use, pollution, biodiversity, global warming and many other areas in his recent book, ⁽¹⁷⁾ suggesting an equally wide definition of the environment

Areas of doubt will arise generally about what matters to include and in what detail an institution ought to disclose environmental considerations.  Every investment will have some environmental impact, however small.  Some will be more obvious than others.

One approach available to institutions is for their disclosure document to embody a general policy statement on their environment policy and a list of activities in which it will not directly invest.  This would imply that it might invest in any activity not listed.  The disadvantage is that there would certainly be pressure to enlarge the list and to include indirect investments through banks etc.

The institution may begin by offering a fairly general definition of what they judge to be environmental considerations.  But in reporting the extent of their "taking into account", they will be expected to describe what activities they judge to be beyond the pale.

Rather like the other three criteria, the test may turn out to be largely a negative one.  While institutions may state that they are satisfied with the environmental performance of their investments, some investors will want to know whether the institution invested in, say, uranium, mining, forestry or some other sensitive industry.

At what level of detail do the explanations stop?  Environmental concerns are notoriously diverse.  They range from very general matters such as greenhouse gases and salinity, through industry-specific matters such as nuclear energy and logging, down to local issues such as development planning and effluent discharge.

Individuals may be far more passionate about local than global impacts ("think globally, act locally").  At any level from international to local they may require a great deal of detail to feel satisfied they have, in the words of the Act, "such ... information as a person would reasonably require for the purpose of making a decision, as a retail client, whether to acquire a financial product".

What a person would "reasonably" require is not entirely up to the individual in each case.  There must be a general test of reasonableness.  But, with the environment, governments have conceded so much ground to interest groups, large and small, that, in effect, what is reasonable can now be determined by a very large number of entities -- official planning and environmental agencies, NGOs, local action groups and individuals.

What this means for the disclosure obligation is either a very long statement, or the risk of exposure to penalties or litigation for failure to be candid on matters that one group or another judges to be reasonably required.  In any case, the degree of uncertainty and risk in conducting business is enlarged.

Insert 4:  "Workers will use super muscle for green ends" by Paul Robinson The ACTU has warned business that unions would use their clout to force superannuation funds to invest workers' money in more environmentally friendly and socially responsible industries. ACTU president Sharan Burrow told the Sydney Institute last night that employee members sat on half the boards of funds that controlled almost 50 per cent of total superannuation assets -- about $200 billion. Ms Burrow said board members would face increasing pressure to invest in line with the interests and values of fund members as well as providing sound returns. "What all this adds up to is that unions, along with everyone else involved in the superannuation industry, have a responsibility toward ensuring that workers' retirement savings are managed in their long-term economic and social interests," she said. Ms Burrow said business was keenly aware that institutional investors, such as big superannuation funds, controlled most public company share registers. Funds were predicted to make up more than 30 per cent of the capitalisation of the Australian sharemarket within two years. Ms Burrow told the institute that unions were concerned about the independence of boards, transparency of decision making and executive remuneration. Unions were also keenly interested in how companies treated their customers, suppliers, employees and the community. "Are they good corporate citizens?" she asked. Quoting a study by accountants KPMG, Ms Burrow said 80 per cent of working people aged between 25 and 39 wanted to invest their superannuation in socially responsible ways. "There is growing evidence to show that socially responsible investments, such as those based on the Dow Jones Sustainability Index, do not sacrifice good returns," she said. The warning to business follows a powerful message delivered to unionists at the ACTU's June Biennial Congress in Wollongong by Richard Trumka, secretary of the leading United States labour council, the AFL-CIO.  Mr Trumka stressed the financial power of workers and said US investment in socially responsible funds exceeded $US2 trillion. Ms Burrow said profits were essential to business, but excessive profits "at the expense of community services and dignified salaries and conditions for staff must be judged through the lens of a fair share for all involved -- employees, communities and shareholders". She said the ACTU had begun its corporate campaign earlier this year against Rio Tinto at the company's annual meetings in Brisbane and London.  Unions sought resolutions to obtain a majority of independent directors on Rio Tinto's board and company commitments to abide by international labor standards. While Rio Tinto opposed the moves, more than one in five shares were voted in favor of better corporate governance and 17 per cent of shares urged the company to abide by ILO core labor standards. "Support for greater shareholder activism cannot be dismissed as a radical frolic," Ms Burrow said. "The ACTU unashamedly stands for democratic practices and transparency in our political system, in our workplaces, in communities -- and in the boardroom. "We believe that the workers who are the beneficial owners of billions of dollars worth of shares should have those shares voted in ways which will maximise their long-term earning potential and their broader interests as members of the community The Age, 30 August 2000

SOCIAL CONSIDERATIONS

It is likely that the word "social" is meant to connote considerations relating to voluntary, non-profit promotion of social betterment through charitable donations, sponsorship of local community organisations, support for staff community work and similar activities.

Some institutions -- indeed any reasonable individual -- might regard it as a sufficient social contribution to observe all the laws and regulations imposed on them by society and payment of all taxes and fees to support the public welfare bill ($80 billion at last count).  It is likely, however, that a disclosure statement along these lines, although legally acceptable, is not what is intended by the drafters of the Act and would be regarded by them as inadequate.

Equally, the expression of some generalised statement of "social concern" on the part of the management and/or staff of companies attracting investment from the relevant institutions would be unlikely to be accepted as sufficiently taking into account social considerations.

So what is the point of including "social considerations"?  It must remain something of a mystery until some "reasonable" persons define their social criteria, bearing in mind that reasonable people in our society have dramatically different opinions on how to improve society.  Indeed, our political system is built on that disagreement.  With better definition, we will have some concrete expression of the reporting task and the hurdle for those companies seeking to attract funds via the institutions concerned.

What would be retrograde would be pressure for institutions to conform to some state-sponsored social contract.  Such an attempt to shackle the ever-diminishing, creative, freewheeling element of our society would not be to our social or economic betterment.

ETHICAL CONSIDERATIONS

Ethical matters, such as a CEO failing to report important details of the company's operations to the board, are well canvassed in current legislation.  Ethical investment, on the other hand, is a misnomer.  It most often refers to activities which some regard as immoral, but are often nevertheless legal.

An environmentalist might not think it unethical to put dangerous metal spikes in trees where a trade unionist would think it highly unethical (quite aside from its legal status).  The same environmentalist might regard the felling of certain trees as unethical where a forester might see it as essential to the health of the forest (and legal).

Similarly, a social welfare organisation may regard the distribution of free syringes on the city streets as highly ethical (and legal), where the local community, on the basis of the predictable discarding of used needles in streets and children's play areas, might regard the practice as unethical and very dangerous.

Some practices of the Moslem community with regard to the treatment of women have been condemned by feminists as demeaning, discriminatory and, presumably, unethical.  Amana Mutual Funds -- a leading Islamic ethical fund -- refuses to invest in banks and other companies that earn interest, while most other "ethical" funds are overweight in banks.

Arab leaders argue -- indeed they lobby investment funds -- strongly against investing in Israel, while many US foundations are overweight in Israeli stocks and investments.

There are many who might regard donations to a political party which favoured a strict refugee policy as unethical.

These are not extreme examples of inconsistency and they could be multiplied a thousandfold.  They serve to illustrate that ethics, even in stable societies, are very selective, personalised and subject to change over time.  But the clashes of ethical systems can be explosive.  This is one reason why governments have tended to regard ethics as a private matter for which wide tolerance should be observed, and have restricted their supervision of society to a more limited body of laws which have some general assent and some chance of being enforced.

When we begin to think how to describe ethical considerations in the selection, retention or disposal of investments, the choice seems to be between meaningless generalised statements of goodwill towards all men or equally meaningless highly detailed listings of conduct or occupations judged to be unethical or ethical.  Attempting on either basis to measure the degree to which the institution has taken those considerations into account verges on the impossible and/or the ludicrous.

It should be noted that virtually all economic and social activities would raise ethical questions for one group or another in our society.  The essence of our society is tolerance for a diversity of behaviour, so long as it does not cause harm to others.  It comprises that large segment of our national life and individual behaviour that is not supervised by government or any special interest group.

Consider the investments that might be regarded by individuals as raising ethical considerations.  Insert 5 contains a list that reflects a variety of viewpoints.  What we can see is that, although a case for each could be argued with passion and principle, there are very few which even 75 per cent of the population would support and, in many cases, less than 50 per cent would do so.

Is a firm which believes that one or more of these activities are not only legal but ethical, obliged to disclose that it invests in them -- in other words, is it obliged to question the ethics of an activity about which it has no doubts?

Or is it obliged to disclose that it invests in an activity that some (perhaps a minority) of the population thinks unethical and thus effectively be forced to accept others' ethical norms?  If so, there will be no end to disclosure.

If a company consults its own conscience and believes that it conducts morally sound activities in an ethical manner, then it will have virtually nothing to disclose even if it invests in, say, arms production.

The practical difficulties for financial institutions are manifest.

What ethical considerations will be included?  It is not feasible to include all possible considerations.  The list would be never-ending.  Prioritising cannot easily be done objectively.  The task, if not impossible, exposes the institution to invidious choice and grievous moral hazard.

And who is to make the choice on what should be included?  Is it the directors, the managers, the staff, the shareholders, an outside ethical committee or authority?  Apart from the difficulty of making this choice, who is then to synthesise the views and who will have the final say?

The Act and regulations require the institution to report the extent to which the chosen ethical considerations are taken into account.  It is open to an institution to state anything between "not very much" and "to a very great extent".  Those tending towards the first formulation will suffer public obloquy and the latter will be asked for proof.  In any case, the institution will be obliged to defend its disclosure through a description of the processes by which it will achieve the standard of performance which it has identified for the selection of ethics which it has also identified.

In the recent tradition of openness and respect for the numberless "stakeholders" who will want a seat at the table, the institutions will be under pressure to defend their disclosure report publicly and in detail.  The "stakeholders" will demand not only to be informed in detail, but possibly to be participants in a more formal monitoring and auditing process with the right of producing their own reports.  This opens up the institution to criticism of its definition of ethics, its ethical standards and its performance against those standards.

It all involves much more than a simple disclosure and it was always intended by its proponents that it should.

Insert 5:  Ethically (Morally) Challenged Activities Someone, somewhere, will regard even the most apparently innocuous of activities as immoral on some religious, cultural, social or personal ground.  The following are legal activities which have supporters and opponents on grounds of principle: Arms production -- pacifists, environmentalists versus governments. Tobacco production and sale -- health activists versus smokers. Forestry and farming -- conservationists, animal rightists versus foresters and farmers. Mining -- environmentalists versus miners. Abortion -- some religions groups versus the majority of the community. Genetic modification -- environmentalists versus scientists, governments and firms. Nuclear energy -- environmentalists versus governments. Pornography -- religious groups versus civil rights groups.

ON THE WRONG TRACK

The broad intent of the four disclosure requirements is no doubt to encourage higher ethical and moral standards in the finance industry.

The theoretical and practical difficulties posed by the disclosure requirements have been outlined above.  The requirements contrast with the rest of the Act and the generality of legislation.  They force institutions to state their interpretation of social, ethical responsibility and rate their performance without giving them any standard of adequacy or any arbiter who can provide one.  It is saying, "Prove you are a good citizen" without defining "good" or "citizen", or even what might constitute proof.

Definition, performance and reporting are all impossible tasks.

It also reverses the onus of proof, in that the institution is not assumed to be ethical unless it proves otherwise to the satisfaction of hostile parties.  It has to demonstrate that it is ethical or it is assumed not to be.

The reasons why governments generally avoid involvement in general rules of behaviour is not just that they are impracticable in the ways described above.  It is not even that the history of governments prescribing such rules has led to extremely oppressive social regimes and deadly enforcement.  It is that the imposition of any particular system is itself an unethical act on the part of any government with a belief in individual freedom and human rights.  It is a move away from the vital principle of Western societies' toleration of diverse views and diverse forms of living where these do not harm others.

The more intrusive and comprehensive the role of government, the less the freedom of the individual to follow his/her own chosen path.

CONCLUSIONS AND RECOMMENDATIONS

The principal conclusion from a close examination of the FSRA disclosure provisions is that it is ill conceived.  More precisely:

• The provision is designed to facilitate detailed intervention in the operations of Australian companies through supervising the morality of their behaviour.
• It was implemented without proper consideration of its full implications.
• There is no role for government in supervising the morals of private individuals and entities beyond the point where a restricted category of activities is proscribed by law, because of harm to others.
• The Act is likely to impose large costs on millions of Australians for little or no gain and without their consent.
• The Act will expose trustees and other fiduciaries to the risk of acting against the financial interests of unit-holders and therefore breaking the prudent investor rule.
• There is no evidence that Australian companies have low ethical standards -- it is rather the reverse.
• It is invidious that the Government effectively delegates the roles of judge and jury in the process to "stakeholders" who frequently have no stake in the corporation and who are often hostile to it.
• The process involves potentially heavy costs to society through additional compliance and information costs, which are concealed from public view.
• It potentially imposes further costs through the effects on corporate operations and derogates the rights of millions of shareholders, superannuants and investors.

The main role for the corporate sector is to create the wealth which makes our society one of the richest and freest on the globe.  The wealth-creation process is already heavily regulated, and for most businesses the conduct of operations is not value free.  Individuals and branded ethical funds are free to invest using whatever criteria they wish.

It is always difficult for government to retreat from a piece of legislation which they have endorsed, albeit under pressure from their opponents.  Furthermore, this tide of opinion has been subject to only a limited critique.  There is, however, a strong case for repeal of this disclosure provision.

If the Government is powerless to repeal the provision, we would recommend a series of actions to redress its bias:

• Amend the Act so that the disclosure provisions are applied only to proclaimed ethical funds.
• Ensure that any regulation by Treasury or ASIC require funds to disclose the basis on which they screen or rate the various categories or companies.
• Oblige the professional screeners to do the same.
• Encourage greater transparency from the "stakeholders", particularly NGOs, in particular by the use of a Protocol. ⁽¹⁸⁾
• Prescribe compliance with existing labour regulations as satisfying the labour standards criterion

In any case, the Government should:

• Stop funding the activists.  Indeed, governments are one of the main funders of the SRI lobby both in form of grants to SRI promotional activities and grants to the many organisation which are dedicated to promoting it.
• Allow for full consultation with the business sector in changes to the law or subordinate legislation -- including compulsory guidelines.
• Compensate business for any additional costs arising from the Act and shareholders and investors for the loss of any property rights and returns.
• Consider requiring ethical fund managers to issue warnings to potential investors that the pursuit of ethical, social, environmental or labour objectives may lead to lower returns and higher costs.

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ENDNOTES

1.  These provisions include:

• A catch-all provision for regulations to require further detailed information in general or particular situations (Section1013 (4)(c));
• A provision for compulsory ASIC guidelines to reinforce clause 1013D(1)2, of which more below (Section1013DA);  and
• A general obligation to disclose "any other information that might reasonably be expected to have a material influence on the decision of a reasonable person ... whether to acquire the product." (Section 1013E).  There is an attempt (in Section1013F) to define what is reasonable, which does not, however, seem to reduce the subjectivity and openended nature of the general obligation.

2.  "Socially Responsible Investment -- The Response of Investment Fund Managers", Deloitte and Touche, 2000;  "Do UK Pension Funds Invest Responsibly?", David Coles and Duncan Green, Justpensions, July 2002.

3.  ABS, Finance Australia, 5611.0, 2000-2001.

4.  ABS, Australian Economic Indicators, 1350.0, December 2001.

5.  For example, S. Hamilton, H. Jo and M. Statman, "Doing Well while Doing Good?  The Investment Performance of Socially Responsible Mutual Funds", Financial Analysts Journal, November/December 1993;  L. D'Antonio, T. Johnsen and R.B. Hutton, "Expanding Socially Screened Portfolios:  An Attribution Analysis of Bond Performance", Journal of Investing, Winter 1997;  M.G. Reyes and T. Grieb, "The External Performance of Socially-Responsible Mutual Funds", American Business Review, January 1998;  L. Abramson and D. Chung, "Socially Responsible Investing:  Viable for Value Investors", Journal of Investing, Fall 2000, cited in Paul Ali and Martin Gold , "An Appraisal of Socially Responsible Investments and the Implications for Trustees and Other Investment Fiduciaries", Centre for Corporate Law and Securities Regulations, The University of Melbourne, 2002.

6.  Rob Wherry, "The Clean and the Greens", Forbes, 12 June 2000;  "Sinners set to feel the heat", The Guardian, 28 May 2000;  "Counting the cost of social responsibility" Mary O'Hara, The Guardian, 7 July 2002.

7.  Rob Wherry, "The Clean and the Greens", Forbes, 12 June 2000.

8.  The average long-term return of the stock market and therefore of the super funds is 7 per cent per annum.  The expense ratio of SRI Funds in the US is, on average, about 1 per cent per annum higher than for non-SRI funds.

9.  Paul Ali and Martin Gold, "An Appraisal of Socially Responsible Investments and the Implications for Trustees and Other Investment Fiduciaries", Centre for Corporate Law and Securities Regulations, The University of Melbourne, 2002.

10.  Ibid., pages 30-31.

11.  Freeman, R.E., Strategic management:  A stakeholder approach, Boston:  Putnam, 1984, page 46.

12.  Sternberg, E., "The stakeholder concept:  A mistaken concept", Foundation for Business Responsibility, Issues Paper No. 4 1999, page 21.

13.  Greenpeace "Moving Forward:  Benchmarking for Corporate Environmental Change" http://www.greenpeace.org.au/corporate/reports/Benchmarking_Report.pdf

14.  Ok Tedi Mining, 2001 Annual Review, page 4.

15.  The question related to the propensity of companies from leading exporting countries to pay bribes to senior public officials in the surveyed emerging market countries.  A perfect score, indicating zero perceived propensity to pay bribes, is 10.0, and thus the ranking starts with companies from countries that are seen to have a low propensity for foreign bribe paying.  In the 2002 survey, all the data indicated that domestically owned companies in the 15 countries surveyed have a very high propensity to pay bribes -- higher than that of foreign firms.

16.  ABS, Australians and the Environment.  4601.0, 1996.

17.  Bjørn Lomborg, The Skeptical Environmentalist -- Measuring the Real State of the World,.  2001.

18.  This concept is discussed in Wood, R.J., "Protocols With NGOs:  The Need To Know."  Backgrounder, November 2001.  Vol 13/1.