‘Law & Economics’ Must Better Inform Design of Business and Human Rights Regulation

[Saparya Sood is a doctoral research fellow at the Max Planck Institute for Research on Collective Goods (Bonn, Germany). She is a lawyer qualified in India and received her postgraduate degree in law and economics as a recipient of an Erasmus Mundus scholarship. Views expressed are personal.]

A New Dawn in BHR Discourse

Business and Human Rights (BHR) discourse has become increasingly mainstream in recent times. Pinning responsibility on businesses for human rights harms occasioned by their activities is now far from a radical line of thought (having been the case for a long time in the post-Friedman world). The discourse – which saw increasing momentum after the United Nations Guiding Principles (UNGPs) came into effect in 2011 – has to an extent, come to fruition. Most tangibly, this has manifested in the shape of domestic laws which require businesses to either take certain affirmative actions or which impose a duty to be vigilant in preventing, mitigating or otherwise addressing the adverse human rights impacts caused by their business activities. 

However, the spurt in regulatory activity masks an important facet of such frameworks: mandating human rights due diligence for businesses or holding them responsible for human rights harms in their supply chains is not merely a question of law. Despite this, early analyses of such frameworks suggests that they have largely centred on narrow legal perspectives.

Integrating ‘Law and Economics’ Approaches in BHR Discourse: Awkward Conversations and Inconvenient Truths?

Any policy intervention, to be effective, must have a definite objective, the absence of which makes impact analysis almost impossible. Given the intertwined and global nature of supply chains, and the often-suboptimal state of regulatory enforcement in developing economies, the downstream protection of human rights in supply chains is a complex issue. These issues are further complicated by potential disagreements around what constitutes ‘welfare’ – which itself is a complex question enmeshed in layers of philosophical and economic analysis. It is thus, no surprise, that conversations regarding ‘welfare standards’ that BHR legislation must look to achieve, have been largely missing. 

As an example, consider the complexity of discussing (at an international level), the conditions that would make a working child in a shoe store in a developing state “better off”. Some would argue that a child working in a shoe store is, by itself, immoral. Others may consider that the status quo is better than the child risking starvation – particularly in absence of a guarantee of having a better chance of attending school. This would not just be an awkward conversation between lawmakers at international fora, but an unacceptable one in the world of diplomatic politics. 

An ill-thought-out legislation in developed countries can also have several negative consequences for developing states. For example, if companies find it too costly to comply with labor standards in developing states, or do not find the risk of being on the wrong side of human rights (that may be unavoidable to an extent given the complex and global nature of supply chains) worth it, it is not far-fetched to imagine that they would re-configure the structure and geographical locations of production facilities and consolidate supply chains in the North. This would have the perilous consequence of leaving workers in the developing world unemployed. Further, although controversial, if the extreme scenario of reverse-globalization is a real possibility or becomes reality, then the existence of self-serving objectives of governments passing BHR legislation must also be questioned. Within context of these uncomfortable questions, and perhaps not surprisingly, the BHR policy discourse has so far been dominated by legal scholarship and perspectives. Mainstream policy discourse has often suffered from a lack of in-depth consideration from a ‘law and economics’ perspective. 

It is not the purpose of this article to define optimal outcomes (welfare standards for workers in developing states) of BHR legislations (the entire field of development economics has sought to answer such questions). Rather, the purpose of this piece is to emphasize that these conversations are imperative to have or to have more often. In addition, the perspectives of the developing world cannot and must not be ignored, especially given that such regulatory efforts may impact human rights adversely by having unintended, yet inadvertent consequences – curing one harm, and causing another. In the world of economics, this would be referred to as ‘externalities’ of the law. Within such an environment, empirical legal approaches and analyses can pave the way for a more scientific approach to further policymaking in this area. Experiences of existing frameworks must be carefully evaluated before embarking on a spree of legislation making in the domain.

Adopting a Scientific Approach to What Works

Although, several aspects of the BHR discourse stand to benefit from adopting a ‘law and economics’ lens, certain issues are in critical need of interdisciplinary approaches. One such aspect centers on the fundamental need, design, and degree of regulatory intervention to produce optimal outcomes. 

 Some would argue that it is too late to question the need for regulatory intervention in this domain – free market and transparency frameworks (considered much softer forms of regulation as they merely facilitate the market mechanism) have largely proved insufficient in preventing or remedying human rights harms. Therefore, the most pertinent question to ponder is the optimal degree of intervention and efficient design of regulation. 

In the context of BHR legislation, good regulatory design would, arguably, not be too costly for the state to enforce, create the right incentives for managers and companies to comply with the regulation in spirit (not just with the letter of the law), and make access to remedies for victims a practical possibility. Although the UNGPs discuss the objectives of preventing, mitigating and remedying human rights harms altogether, if the design of the domestic regulation is not carefully considered, it may incentivize one of these objectives at the cost of the other. 

For instance, the French model of regulation, which imposes a “Duty of Vigilance” on companies may incentivize mitigation and remediation, and not prevention, if the harms are not easily discoverable, or if the access to justice mechanism for victims is ineffectual. If companies cannot reasonably foresee which harms they may become liable for (or where the scope of harm that they may be held liable for is very wide), ex-ante preventive measures may not eliminate the risk of liability completely. With a low probability of detection of violation / non-compliance, the risk of ex-post adjudication for harms might be more favorable than taking reasonable care and risking the possibility of being sued despite reasonable efforts. This effect may be worse where the harms that must be prevented are not clearly defined in law. This is because ex-ante costs of prevention are higher where the law is not foreseeable enough. In the law and economics literature, such a regulation defines a sort of ‘standard’ (for example, of “reasonable care”) that is determined on a case-by-case basis, through ex-post adjudication. Such a standard is cost-effective for the state to enforce where the number or frequency of violations expected is low, and hard to predict ex-ante. However, it can also be very costly, if violations are frequently brought to court and adjudicated upon.

Although some of these questions would benefit from empirical insights, in the case of human rights violations, these questions are complex as the harms caused may be wide ranging and are hard to foresee. Even if the frequency or number of violations might be high, since companies are the least cost information gatherers, (and by design, possess maximum information in the supply chain creating information asymmetries) the probability of detection of non-compliance / violations by third parties might be very low. This makes the question of access to justice to victims even more pertinent. However, in the current international legal system, making such access expeditious, accessible and convenient is still a distant possibility. If companies are not sure what ex-ante measures would absolve them of liability, and the probability of detection is low, they will prefer to cut down prevention costs and favor remediation, should they be sued ex-post. 

On the other hand, another recent intervention, the German Supply Chain Due Diligence Law (Lieferkettengesetz) imposes a “due diligence” obligation on certain categories of companies. In law and economics literature, such a regulation is akin to “rules” – providing ex-ante foreseeability for companies to take steps and comply with the law. Here, legal certainty is higher as specific obligations for compliance are more expressly laid down in law, and thus, compliance may be more worth it if companies can reasonably lower or eliminate the risk of liability by complying. It must be emphasized here that laying down a standardized list of rules which accounts for all possibilities and situations that might come up and apply to all kinds of companies, is by no means an easy feat. However, such frameworks may have unintended consequences in the developing world if the cost of compliance is too high for companies and they find it more profitable to stop importing from or manufacturing in certain countries. Further, the administrative costs of monitoring and enforcement of such a law (by government) might be high if the number of companies that are required to comply are large. Despite this, if the number of violations or cases of non-compliance anticipated are large, these costs might still be lower than where the law sets a standard. Regulation that lays down rules might also cause companies and their managers to get into a ‘tick the box’ compliance mentality – doing the bare minimum, instead of trying to comply with the spirit of the law.  By design, rules for ex-ante compliance also focus a lot on prevention, but not enough on remediation or access to justice for victims. This is a very preliminary analysis of the trade-offs that must be considered while deliberating over regulatory design but serves to point out that from a law and economics lens, both models produce widely different incentives for compliance by companies and entail different costs of enforcement and adjudication for the state.

‘Law and economics’ can also provide useful guidance in deciding the optimal degree of regulatory intervention, that is, the kind of companies (large/ small or medium scale enterprises) required to comply or the relationship with suppliers (direct/ indirect) that would fall within the ambit of regulatory scrutiny. Compliance can be quite costly for smaller companies and may have the effect of pushing some companies out of the market or creating barriers to entry. Restricting the scope only to large companies may still have ripple effects on the smaller companies that might do business with these companies and must comply with their contractual codes of conduct. When the scope of the law extends to indirect suppliers, it automatically has the effect of reducing legal certainty for companies and increases the cost of compliance. 

Whether direct or indirect, intended or not, the effects of regulation on the incentives of companies/ their managers, and its impact on the welfare of workers in developing states stand to get affected through the choice of these regulatory options. There are no easy or clear answers to these questions, but they are critical and deserve more discussion in mainstream forums. 

Human Rights Due Diligence and the Way Forward: ‘What Is’ Versus ‘What Should Be’

While the debate on Human Rights Due Diligence has progressed quite a bit, and there seems to be broad consensus on the need for mandating such due diligence, the meaning and definition of ‘due diligence’ as used in the UNGPs has so far been explored primarily from a legal perspective. Leading scholars have offered guidance from jurisprudence in International human rights law and corporate law. While ‘what is’ due diligence in law merits consideration to guide law makers regarding the intended meaning of the term in the UNGPs, a more pertinent question to ask would be ‘what should be’ the meaning of due diligence in the BHR discourse. Arguably, the meaning and interpretation accorded to this term in the BHR context must be guided by independent consideration of what kind of obligations would incentivize companies to comply with the spirit and not just the letter of BHR regulations without creating unintended inadvertent negative consequences in developing states.

In this context, this article seeks to make a limited point – that a ‘law and economics’ approach can provide critical guidance to policymakers in the BHR domain by not making regulation sub-optimally onerous for companies and/or states, or which has significant adverse impacts in the developing world. The above are a few questions that deserve careful thought and deliberation while thinking about BHR policies and outcomes. While it is important to bring many different experts and voices together on the BHR policy table, it is also important that not only siloed perspectives are heard, but that interdisciplinary approaches get more room in such conversations.