Why the CSR law is not a success

The Companies Act 2013 requires large (above a specified threshold level) firms to spend 2% of their net profits on corporate social responsibility (CSR) projects. This law came into effect in April 2014. The results on CSR expenditures by firms in the fiscal year 2015-16 were released recently. It is certainly true that Indian firms collectively are more than complying with the CSR law. According to PRIME Database, India Inc. spent Rs. 9,309 crores on CSR projects in 2015-16, which was Rs. 163 crores more than the amount required by law, and Rs. 703 crores more than the previous year.

Of the nine different schedules prescribed by The Companies Act, two schedules: combating various diseases and promotion of education accounted for 44% of the total CSR expenditures, while reducing child mortality received no funding and eradicating extreme hunger and poverty received only 6% of the total CSR expenditures. Given that about 50 percent of children in India are malnourished due to pervasive poverty, it is unlikely that the above allocation of resources reflects the democratic will of the Indian people.

The general reaction in the Indian press has been positive and suggests that the CSR law has been a success. Here are some headlines: ‘Substantial rise in CSR spending compared to previous year’, and ‘India leads in CSR spending growth.’ However, the CSR law is only apparently successful, and in reality is harmful.

The problem is that reported expenditure on CSR projects is not a good metric of societal welfare. These numbers overstate the effect of the law. It is not clear whether firms have really increased their CSR spending after the law compared to what they were spending voluntarily before the law, because CSR spending was not well reported historically. There is some evidence that while firms that were initially spending less than 2% increased their CSR activity, but those that were initially spending more than 2% reduced their CSR expenditures. Another possibility is that firms spent money on CSR activities that also lead to increasing firm profits, such as inculcating goodwill and good public relations. There is evidence indicating CSR spending leads to brand building and employee engagement. In that case, firms would have carried out these activities with or without the CSR law.

Even if we take the CSR expenditures at face value and assume these are valid numbers, there are still major problems with the CSR law. A required expenditure that does not lead to higher profits is essentially a tax. The CSR law can be viewed as a 2% tax, albeit spent by the firms rather than given to the government. This is a back-door way to increase corporate taxes without a transparent political debate. The corporate tax rate in India is 32.45 percent—already one of the highest, compared to a global average of 24.09 percent, according to KPMG, an audit and consulting company. Given the emphasis on economic liberalisation and economic growth, it is unlikely that the Indian polity desires an increase in the corporate tax rate. This certainly will not help to make Indian firms more globally competitive nor attract more foreign investment into India.

Five states -- Maharashtra, Gujarat, Andhra Pradesh, Rajasthan and Tamil Nadu -- account for well over one-quarter of all CSR spending. Towards the bottom of the list are Nagaland, Mizoram, Tripura, Sikkim and Meghalaya, all from the Northeast. This, of course, reflects the inclinations, interests, and priorities of the business sector.

Even to the extent that there has been a real increase in socially beneficial activities, the spending has not gone to democratically determined priorities, but rather to whatever the companies prefer to emphasize. Of the 9 different schedules prescribed by The Companies Act, two schedules: combating various diseases and promotion of education accounted for 44% of the total CSR expenditures, while reducing child mortality received no funding and eradicating extreme hunger and poverty received only 6% of the total CSR expenditures. Given that about 50 percent of children in India are malnourished due to pervasive poverty, it is unlikely that the above allocation of resources reflects the democratic will of the Indian people. It is the government's responsibility to determine high-priority needs of society and target public expenditure in these areas. With the CSR law, the government has abdicated one of its primary functions.

There is also an issue of geographic equity. Five states: Maharashtra, Gujarat, Andhra Pradesh, Rajasthan and Tamil Nadu account for well over one-quarter of all CSR spending. Towards the bottom of the list are Nagaland, Mizoram, Tripura, Sikkim and Meghalaya, all from the northeast. This, of course, reflects the inclinations, interests, and priorities of the business sector. But, it is the responsibility of the government to help achieve a more egalitarian society.

CSR is a controversial idea with many executives, academics and officials on both sides of the issue. Thus it is not surprising that the Indian law does not clearly define CSR for the purposes of expenditures. The law lists only a few genres of CSR activities: “eradicating extreme hunger and poverty,” “promotion of education,” and “social business projects.” This is much too vague to work as a legal definition. It is not surprising that the law does not even discuss, let alone define, an enforcement mechanism or penalties for non-compliance.

Inequality in India, which was already high, has increased even more. India's Gini coefficient, the official measure of income inequality, has gone up from 0.32 to 0.38 in the last two decades. The CSR law does not go far enough in reducing inequality and helping the disadvantaged.

The CSR law is inherently contradictory. CSR is fundamentally an inspirational exercise, and it is very difficult to legislate aspirations. Laws only set minimum standards, but do not create an impetus for positive action. For example, it would be difficult to require that companies build ‘excellent’ schools; the legal requirement can be met merely by spending money on education.

Inequality in India, which was already high, has increased even more. India's Gini coefficient, the official measure of income inequality, has gone up from 0.32 to 0.38 in the last two decades. The CSR law does not go far enough in reducing inequality and helping the disadvantaged. Without a coercive enforcement mechanism, it is unlikely that the law will result in widespread compliance and real effectiveness. In other words, ‘required’ CSR will remain largely voluntary, but give the illusion of progress. This is ‘greenwashing’ on a national scale!

India is the first country to require companies to expend resources on CSR. There is sound logic behind why other countries have not done this, and India should not either.

(The writer is a Professor of Strategy and International Business at the Ross School of Business, The University of Michigan. He authored the book ‘Fighting Poverty Together: Rethinking Strategies for Business, Governments, and Civil Society to Reduce Poverty’ in 2011.)