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Bangladesh, Cheap Production, and Worker Safety: The Cost of Externalities

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Consumers and corporate shareholders will have to compromise if working conditions are to improve.

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The online petitions are multiplying as consumers worldwide react with shock and horror to last month's deaths of more than 1,100 garment workers in Bangladesh toiling in conditions that might have made a Victorian-era chronicler cringe. Several of the world's largest retailers – at least, those of them that happen to be based in Europe – have lined up to sign a legally binding agreement to underwrite the cost of bringing other such factories up to an acceptable workplace standard, and to oversee those repairs and monitor working conditions on an ongoing basis.

For now, let's work on the assumption that companies like H&M (OTCMKTS:HNNMY), Primark, and the Dutch chain C&A are motivated by the same kind of distress that you and I feel when we see the images from Dhaka's collapsed Rana Plaza building or read reports of working conditions there. Give them credit – rightly or wrongly – for being motivated by a desire to ensure that such a catastrophe never happens again and not by fear that consumers will realize that their suppliers worked in buildings like Rana Plaza – or others not too dissimilar throughout Southeast Asia and other garment industry hubs – paying employees a minimum wage of $37 per month.

Even so, the face-off between activists and socially responsible investors on the one hand and companies like Wal-Mart Stores (NYSE:WMT) and Gap (NYSE:GPS) (both of which chose not to go along with the legally binding pact among retailers) sheds new light on a problem that has bedeviled thousands of other publicly traded companies over the decades: how to deal with what are known as "externalities."

An externality, in the jargon of economists, is what happens when a company makes a business decision that has positive or negative consequences for the broader world. A company that pollutes, for instance, is creating a negative externality for those that live near the plant that is destroying the air quality or that draws water from the sources that have been contaminated by its mining operations, for instance. A company that voluntarily takes on extra safety costs that exceed the standards its competitors adhere to or that underwrites the cost of education and training for its workforce when its rivals don't, is an example of the flip side of the coin.

Companies can't avoid wrestling with externalities. All of them walk a more or less narrow line, trying to understand when the cost of preventing a negative "externality" is worth whatever consequences follow in its wake. Regulation is one issue that can affect the decisions they make: The rise of environmentalism and the creation of the Environmental Protection Agency in 1970 made the consequences of polluting potentially more serious; companies trying to balance the costs to themselves of polluting or paying to dispose of their waste in a less harmful way suddenly found the playing field tilted in favor of the latter. In other cases, social trends and consumer choices play a similar role; this time, there's a carrot rather than a stick at play.

A publicly traded company like Wal-Mart or Gap Stores has a fiduciary duty to its shareholders to maximize its returns. The events in Bangladesh have highlighted a giant conundrum for them – one that even before the collapse of the Rana Plaza they undoubtedly wrestled with. Clearly, apparel retailers have been eager to move their facilities from one country to another: as wages and thus production costs climbed in China, to keep the prices of their t-shirts and jeans stable and competitive in North America and Europe, they shifted operations to Cambodia and Bangladesh. To the extent that they know that being too insistent – or more insistent than their peers -- on questions of safety, child labor, or living wages will mean higher costs and lower profit margins, it always has been easier to try to avoid knowing about some of these issues.

Will anything really change now that the true cost of all our inexpensive t-shirts – externalities included – has been made so dramatically apparent? Real change will require more than petitions and pacts. It will demand virtual unanimity on the part of consumers – each of us being willing to pay more for the clothes we buy, reflecting the higher costs associated with those higher manufacturing standards. The reason that apparel manufacturing was shifted offshore, and then to increasingly low-wage countries like Bangladesh, is that we demonstrated that we weren't following through when it counted most: when we went shopping. We can't just tell companies like the Gap that we won't buy garments with such a high non-financial price tag associated with them; we have to demonstrate our willingness to do so, over and over again. Those companies need to be convinced that if they don't take a hit on profit margins or costs, they will take an even bigger one on sales.

Wal-Mart has decided not to sign on to the European plan, and instead intends to hire an outside auditing firm to inspect the Bangladeshi factories that produce garments for sale in its stores. We'll be able to inspect the results – posted on its website – by June 1, and the company has said it will insist that factory owners undertake work to remedy any safety issues at their own expense, or face the prospect of being cut from the list of Wal-Mart suppliers. (Wal-Mart acknowledges that these renovations may show up in higher costs.) Here we have the whole conundrum in one example. Do we – and does Wal-Mart – believe that an outside firm can do a thorough and accurate job inspecting nearly 300 separate facilities in the next two weeks? Given that whistleblowers report violations that inspectors routinely miss even in North America, I'm skeptical.
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