VW is further evidence that global business has become a law unto itself

Will Hutton in The Guardian

A well-functioning capitalism has, and will always need, multiple and powerfully embedded checks and balances – not just on its conduct but on how it defines its purpose. Sometimes those checks are strong, uncompromised unions; sometimes tough regulation; sometimes rigorous external shareholders; sometimes independent non-executive directors and sometimes demanding, empowered consumers. Or a combination of all of the above.

CEOs, company boards and their cheerleaders in a culture which so uncritically wants to be pro-business do not welcome any of this: checks and balances get in the way of “wealth generation”. They are dismissed as the work of liberal interferers and apostles of the nanny state.

Germany’s economy has been a good example of how checks and balances work well. But the existential crisis at Volkswagen following its systematic cheating of US regulators over dangerous diesel exhaust emissions shows that any society or company forgets the truth at its peril.

Volkswagen abused the system of which it was part. It became an autocratic fiefdom in which environmental sustainability took second place to production – an approach apparently backed by the majority family shareholder, with no independent scrutiny by other shareholders, regulators, directors or consumers. Even its unions became co-opted to the cause. Worse, the insiders at the top paid themselves, ever more disproportionately, in bonuses linked to metrics that advanced the fiefdom’s interests. But they never had to answer tough questions about whether the fiefdom was on the right track. The capacity to ignore views other than your own, no external sanction and the temptation for boundless self-enrichment can emerge in any capitalism – and when they do the result is toxic. VW, facing astounding fines and costs, may pay with its very existence.

So why did a company with a great brand, passionate belief in engineering excellence and commitment to building great cars knowingly game the American regulatory system, to suppress measured emissions of nitrogen dioxide to a phenomenal degree? Plainly, there were commercial and production benefits. It could thus sell the diesel engines it manufactured for Europe in the much tougher regulatory environment – at least for diesel – of the US and challenge Toyota as the world’s largest car manufacturer. Directors, with their bonuses geared to growth, employment and profits, could become very rich indeed.
Nor did the risks seem so outlandish. It was an open secret that car emission tests are artificial constructs, with special tyres, lubricants and measures to reduce car weight and air drag all allowed with the connivance of the regulators. To create a special piece of software that closed down nitrogen dioxide emissions during a test must have seemed to the executives involved only an extension of this artificiality. In any case, regulations are for busybodies, especially in areas as controversial as climate change and air quality. The software ruse was merely taking the game of cat and mouse between regulator and car maker to another level.

Former CEO Martin Winterkorn, who resigned last week over the scandal, claims he knew nothing of what was going on, blaming a few unnamed executives for making a catastrophic error of judgment. Winterkorn was the consummate German engineer, knowing every dimension of engine performance; if he did not know how the dirty diesel engines of some popular VW brands were successfully passing US emission tests it was only because he chose not to ask. He did not need to. He had the backing of the Porsche family, who own just over 50% per cent of VW’s shares and who agree to vote as a block; the support too of the state of Saxony with a further 20% per cent –and of union members on the supervisory board. Winterkorn could run a company of 600,000, as Süddeutsche Zeitungremarked, as if it were North Korea.

VW is about production and jobs which trumps concerns about environmental sustainability – a culture than unites unions as much as the Porsche family. And Winterkorn was its standardbearer, leading the charge against the tightening of EU emission regulations – urging weaker targets and a longer timetable. Despite a vast R and D budget, VW is far from a leader in the electrical car or hybrid market. Mr Winterkorn’s bonuses were based on his capacity to deliver production, jobs and profits: environmental sustainability or engaging with wider stakeholders did not get a look-in.

Make your god the share price, as so many British and US companies do, and you create one basket of problems – under-investment, excess deal-making and cutting corners. Abuse the stakeholder system, as did VW, and make your god production on any terms, damning the concerns of outsiders as irrelevant, and your end can be equally grisly. Capitalism, in short, may have boundless creative and innovative energy – but it also has boundless ways to go wrong. Intriguingly, recent work by a group of researchers at Harvard and the London Business School compared 90 American companies that took sustainability seriously with 90 who did not. Over 18 years the 90 committed to sustainability delivered annual financial returns 4.8% higher than the other 90.

In order to deliver sustainability they had to organise themselves around a core purpose, and then embed checks and balances to keep themselves honest. They shaped the way they were governed to open up to outside stakeholders with whom they checked their strategy. Their reporting measures embraced many metrics beyond share price and they rewarded directors for meeting them. Sustainability was a route to more open governance and rounded strategy – and it delivered.

VW did not believe in this any more than the British government does, now steadily rolling back “green crap” and efforts to promote sustainability as “anti-enterprise”. Transport secretary Patrick McLoughlin, under fire for doing nothing when he was sent the same damning report as the Americans 11 months ago, will have known that in Tory terms there would be no rewards for being cast as a bleeding-heart green. Enterprise is about getting regulators off car-makers’ backs and disempowering meddling stakeholders, especially trade unions.

Yet nor is it right in Corbynesque style to damn capitalism with a reflex call for stronger unions and public ownership. The government of Saxony and union members of VW’s supervisory board proved ineffective whistleblowers. They were not sufficiently interested in human betterment or the fatal consequences of excess nitrogen dioxide emissions. They just wanted jobs at any cost. Checks and balances alone don’t work: they have to be animated by an honest acceptance of mutual responsibility between firms and society – a moral ethic that must inform unions, regulators, shareholders and systems of corporate governance alike. VW lost the plot. But so, in a more profound way, have both the apologists and critics of western capitalism.