Accounting and Distributive Justice

John Flower

• Publisher: Routledge
• Year: 2010
• ISBN:
  9781136941467
• Edition: 1
• Topic: Business
• Subtopic: Financial Accounting
• Index: Business

Accounting and Distributive Justice challenges the basic assumptions on which the current practice of financial reporting is based. It argues that the objective of financial reporting should be to contribute to the achievement of distributive justice and not the optimal allocation of resources as in the traditional capitalist paradigm. It explains in non-technical terms the principle philosophical theories of justice and argues that a firm has a moral responsibility to seek distributive justice in its dealings with its shareholders, employees, suppliers, customers, and other people with whom it has dealings, who are considered to be the firm's stakeholders. The book introduces concepts of distributive justice to accountants and provokes them into reflecting on how the discipline of accounting can best serve the cause of justice. Accounting and Distributive Justice provides both a philosophical foundation and a practical game plan for the future of a more sustainable accounting practice.

1
The Wrong Paradigm

In this book I challenge the current paradigm¹ of accounting—more precisely the paradigm that underlies the financial reporting of firms.² I reject the current paradigm and propose a radical alternative. In this first chapter, I analyse the current paradigm and set out my reasons for rejecting it. The rest of the book is devoted to explaining and justifying my proposed alternative.

1.1. THE CURRENT PARADIGM OF FINANCIAL REPORTING

The nature of the paradigm that underlies the current practice of accounting may be gathered from the new conceptual framework that is being developed jointly by the International Accounting Standards Board (IASB) and the USA’s Financial Accounting Standards Board (FASB), and which sets out the principles that these bodies intend to follow in setting the rules that govern financial reporting throughout much of the world.³ In May 2008, the IASB and the FASB presented their proposals in the form of a common exposure draft (FASB 2008), which defines the objective of the financial reporting in the following terms:

The objective of general purpose external financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions in their capacity as capital providers. (Paragraph OB2)

Later paragraphs develop further this objective:

The Boards’ mandate is to assist in the efficient functioning of economies and the efficient allocation of resources in capital markets by developing high-quality financial reporting standards. (Paragraph OB3)

An entity’s financial performance provides information about the return it has produced on its economic resources. In the long run, an entity must produce a positive return on its economic resources if it is to generate net cash flows and thus provide a return to its investors and creditors. (Paragraph OB19)

Financial reporting information helps capital providers make better decisions, which results in more efficient functioning of the capital markets and lower cost of capital for the economy as a whole. (Paragraph QC31)

These citations make clear that these bodies consider that the model that underlies their conception of accounting is capitalism and that the function of accounting is to meet the information needs of capitalists (‘capital providers’). The IASB and the FASB are wedded to the paradigm of capitalism in the particular form of neo-liberalism, whose principal elements may be summarized as follows:

i. The objective of economic activity is to assure the highest possible material standard of living for mankind.

ii. The achievement of this objective requires the maximization of the output of goods and services.

iii. The maximization of output requires the optimal allocation of resources.

iv. The optimal allocation of resources will generally be achieved through the operation of market forces. Producers and consumers should have unrestricted freedom to buy and sell the goods and services of their choice on the market at prices determined by the interaction of supply and demand. They should be motivated solely by their own self-interest and, guided by Adam Smith’s ‘invisible hand’, they will achieve the best result for mankind. For firms, the pursuit of self-interest implies the maximization of profits.

v. The most important factor of production is capital. Capital should be allocated to productive activities through the operation of the capital market, which brings together providers of capital and seekers of capital.

vi. Capital market participants should allocate capital to those productive activities that yield them the highest return.

vii. Hence capital market participants should be provided with accurate information concerning the returns from the outlay of capital.

According to the IASB and the FASB, the primary function of financial reporting is to supply this information. But are these bodies right in deciding that financial reporting should be based on the paradigm of neo-liberalism?

1.2 THE CASE FOR NEO-LIBERALISM

The neo-liberal paradigm is defended by its advocates on two main grounds:

a) Philosophy: The freedom of men and women to pursue their own good through economic activity should be restricted only when it infringes the rights of others. Hence there is no moral obligation on sellers to sell at any but the highest prices and on buyers to pay more than the lowest price, because the people with whom they deal have no right to a different price.

b) Consequences: The neo-liberal paradigm works! The very substantial improvement over the last two centuries in the standard of living in Western industrialized countries and, more recently in China and India, has been brought about principally by allowing the free interplay of market forces.

I deal with the philosophical question in the next chapter, but first I consider whether, in fact, neo-liberalism works.

1.3. THE CONVENTIONAL CRITICISMS OF NEO-LIBERALISM

The neo-liberal paradigm has been criticized on the ground that principle iv is false. The market often does not achieve the optimal allocation of resources, for a variety of reasons:

i. Certain persons or firms may be so powerful that they can influence market operations to their own advantage (for example, monopolies).

ii. Certain goods and services may not be provided most efficiently through the operation of market forces, notably public goods, such as roads.

iii. Market participants, in pursuing their own immediate self-interest, ignore externalities; they do not take into account many of the adverse effects of their actions on others either in the present (for example through pollution of the environment) or in the longer term (for example the effect on future generations).

Most economists consider that these defects of neo-liberalism are so serious that the free play of market forces will not bring about the hoped-for improvement in the welfare of mankind. The state has to act to correct these market failures. Hence government intervention is necessary to control monopolies, to provide public goods, and to curb pollution. It would seem that private firms and institutions are incapable of acting on their own to moderate these shortcomings of neo-liberalism. For example the IASB has made no move to require private firms to report the costs to society of their activities (for example the harm done to outsiders by pollution created by the firm). According to the IASB, these costs should be reported only when they become the private costs of the firm (for example when the government levies a fine or forces the firm to clean up polluted land). The IASB considers that its task is to set standards for private firms operating within a framework (of laws, regulations, and so on) set by the state which seeks to mitigate the shortcomings of neo-liberalism. Within this framework, the private firm should seek to maximize its profits.

The IASB’s attitude is defensible, and therefore it is necessary to find a further, more fundamental, criticism of neo-liberalism.

1.4 A MORE FUNDAMENTAL CRITICISM

However my criticism of neo-liberalism is more fundamental: neo-liberalism neglects society’s most important problem. I consider that society is confronted with two fundamental economic problems:

1. The production problem: what goods and services to produce; how much to produce; who is to produce them; how to produce them most efficiently at the lowest cost.

2. The distribution problem: who gets what is produced; how output and income are divided (distributed) among society’s members.

I consider that neo-liberal economics concentrates almost exclusively on the production problem and neglects the distribution problem. However the distribution problem is the more important for reasons relating to both production and distribution. I deal first with production.

1.5 THE PRODUCTION PROBLEM

I contend that mankind has largely solved the production problem. My contention is based on two arguments: (a) the analysis of mankind’s needs and (b) the current level of production.

(a) The Analysis of Mankind’s Needs

Eighty years ago, John Maynard Keynes predicted a world of plenty for his grandchildren: ‘I draw the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or at least within sight of solution, within a hundred years’ (Keynes 1930: 365–6). What reasons did Keynes give for believing that mankind would soon solve the production problem? He divided human needs into two classes: absolute and relative. Absolute needs are those a person feels irrespective of the situation of others; relative needs are those whose satisfaction depends on superiority over others. Keynes felt that it was impossible through economic activity to satisfy all relative needs and hence regarded their satisfaction as not an economic problem.

A generation after Keynes, John Kenneth Galbraith (1955) argued persuasively that the USA in the 1950s had already solved the production problem. Not only was output at a very high level but it increasingly consisted of goods and services that served no real need. The more recent work of Colin Hamilton (2005) confirms Galbraith’s contention that the ‘needs’ of modern consumers in the world’s richest countries are artificially created by sophisticated advertising techniques that appeal to man’s baser instincts such as jealousy. Economists often claim that the role of the economic system is to satisfy the demands of consumers and that it is not the economist’s role to question these demands: the consumer is sovereign. Hamilton (2003) emphatically rejects this doctrine. He considers that, in the present society dominated by consumerism, the ‘needs’ of consumers are created by the manipulative marketing techniques of multinational corporations. He argues that autonomous individuals should decide for themselves what is good for them and not allow themselves to be manipulated. Hamilton (2003: 12) likens the modern consumer who feels that he must have the latest (heavily promoted) gimmick to an alcoholic, commenting, ‘[A]n alcoholic would prefer more drinks, but we don’t measure his wellbeing by the number of drinks that he has.’

Since Keynes, there has been much research on the relationship between a person’s income and his level of self-reported happiness.⁴ The following conclusions are well supported by the evidence and are accepted by most serious scholars:⁵

(i) In the major Western industrialized countries, there has been no increase in the general level of happiness over the past fifty years, despite very substantial growth in output, as measured by the gross domestic product (GDP). For example, in Japan, the GDP per head increased sixfold between 1958 and 1991, but there was no increase in self-reported happiness.

(ii) At the level of the individual, the correlation between the level of income and the level of happiness is positive but rather weak. At low income levels, an increase in income brings a significant increase in happiness but the effect is less marked at higher income levels. However, at all levels, following an increase in income, happiness reverts to its former level very quickly, as the individual becomes accustomed to her new income level—she adapts her aspirations to her current situation. Given this phenomenon of adaptation of aspiration levels, it is impossible for an individual to increase permanently her level of happiness by increasing her income. The implication is that human wants are insatiable; to maintain a certain level of happiness, the individual has to continually achieve an ever higher income—like Alice in Through the Looking-Glass, she has to run furiously just to stay where she is.

(iii) The individual, in assessing her level of happiness, makes, not an absolute judgement, but a relative judgement; she compares herself with other individuals, such as her work colleagues or neighbours— known as her reference group. If the income of the people in her reference group increases and her income remains unchanged, she becomes less happy; she is unable to ‘keep up with the Joneses’. Easterlin (1994) demonstrates, using data from surveys in eleven industrialized countries, that the consequence of this human trait is that raising the incomes of all does not increase the happiness of all.

Happiness research provides a striking endorsement of Keynes’s insight that human needs may be divided into two categories: relative needs which are generated by the individual comparing himself with other people, and absolute or basic needs which man needs to satisfy...

Table of contents

• Routledge Studies in Accounting
• Contents
• Tables
• Figures
• Preface
• Acknowledgements
• 1 The Wrong Paradigm
• 2 Distributive Justice
• 3 The Firm’s Responsibility for Distributive Justice
• 4 The Contribution of Financial Reporting to Distributive Justice
• 5 The Reporting Function
• 6 The Distribution Function
• 7 The Information Function
• 8 Concluding Remarks
• Notes
• Bibliography
• Index