Practical analysis for investment professionals
15 August 2016

The Cost of Cheap: Slavery in the Supply Chain

The Cost of Cheap: Slavery in the Supply Chain

Read any further and chocolate might not taste so good.

Same with shrimp. And I guess I should also mention there’s a decent chance your new t-shirt or skirt won’t look as nice either.

Because especially if you’re buying the cheap stuff, the odds are excellent that a slave is somewhere in the economies of scale that brought it to you. And I mean the strong form of slave: A human who is bought and sold.

Depressingly, this holds for almost any kind of “cheap stuff” you might care to discuss.

And that brings me to the part of the story that’s uniquely applicable to investors: where we have risk, opportunity, and indeed a chance to de-slave the world.

That’s probably worth it, right?

But I’m writing about this here, so something should be obvious. The case against slavery is about more than just morality. It’s also about money and a material risk to a broad cross section of widely owned businesses that is underappreciated, potentially disastrous, and (in time) easily mitigated.

So that’s why I’m not trying to knock you off the fence on the question of whether people buying and selling other people is your fight.

The point is that, unless you’re careful, it might be your business.

Before I get to how pervasive it is, let’s take a second to keep in mind the investment environment of the day: Growth is not that easy to find. Risks are. Whatever stocks may be at the moment, they are not cheap in most of the developed world. And at this point, it’s kind of an article of faith that someday, somehow, interest rates will return.

When stocks are fully valued, reducing risk is a value-creating act.

Interest rates are low. Equity markets are open. Money is reasonably priced and available for most large companies. So now let’s talk about slavery.

It’s pervasive.

Almost 21 million people live in slavery today, according to the International Labor Organization (ILO).

That’s the lowest estimate I was able to find. If all 21 million were gathered in one place, they would compose one of the largest cities in the world.

The US Department of Labor (DOL) maintains a (likely incomplete) list of goods produced with forced labor or child labor broken down by country.

Fifty-five goods are made or acquired using forced labor in 37 different nations, the DOL reports. Coal, cotton, coltan, and cocoa are some of the raw materials harvested through that labor. So it’s conceivable slavery made it into your clothing or perhaps even the circuits that you are using to read this.

And that’s just the letter “C.”

The problem — the reason people capture, trade, and own slaves — is that their stolen potential has monetary value. A t-shirt that was produced by people working against their will looks the same as one that wasn’t. So does a diamond, a Christmas ornament, or a children’s toy.

This is a good time to think about what you’re wearing and wonder: Has a slave touched your socks? You won’t get an answer.

It’s a tough question.

I haven’t seen the complexity of such a question described better than in the essay “I, Pencil“: Leonard Read’s fictional account of the genealogy of a pencil. One line in particular is relevant. And, remember, a pencil is speaking: “Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents.”

You get it. Things we perceive as simple are actually quite complicated. The pencil mentions its lead was mined in Ceylon (now Sri Lanka), and a paper sack was manufactured and discarded to carry it from place to place. Then it was shipped all around the world before mixing with clay from Mississippi and ammonium hydroxide.

It goes on. Imagine how much more complex a smartphone is. So there’s a good reason that if you ask a given company whether a slave touched your particular pair of socks, the ornaments on your Christmas tree, or even just your chocolate bar, you’ll most likely receive an incomplete answer.

That shouldn’t be, and it doesn’t need to stay that way forever.

Slavery exists today on the other side of a semiporous wall from most consumers. The cheap products that slaves manufacture are efficiently aggregated into global supply chains and transmitted around the world. The invisible mechanism that takes cotton from Uzbekistan to garment factories in Bangladesh and then overseas and eventually onto your back is called the market.

And the market should have, can have, and must have a baseline ethics that values the dignity of human beings independent of what they can be forced to produce.

Now.

It takes a long time to change the world, but only a moment to make up your mind. It’s not so hard to imagine that if you’ve read this far you are inclined to do something.

But what?

First, think. Do me a favor and leave a comment below. How do you think the investment community can best express a wish not to be complicit in slave labor? How can we speak so that the management teams you work with will listen?

Your guess is as good as mine. But I’d suggest a simple question will be quite effective: “Can you assert that your supply chain is free of forced labor?”

Ask it in conference calls, one on one, and in annual meetings. And whatever the answer is, if it boils down to “no,” follow up with “When will you be able to prove that assertion?”

The product of stolen labor should not be able to find a market. And if the largest companies do their due diligence to ensure they are not unwittingly enabling this reprehensible trade, it will become harder and harder to make money through slavery.

You can help bring that about with an email. Do you care to?

You Should.

Slavery has been outlawed everywhere on earth since 1981. And companies, in general, should know what’s going on in their supply chains for a variety of reasons. But thanks to a few legal developments, it’s clear that it’s past time to get on the right side of history.

The Modern Slavery Act requires any company that does business in the United Kingdom that has a total turnover of £36 million or more to report on the steps it has taken to ensure that human trafficking is not taking place in “any of its supply chains” as part of its annual reports.

A more prescriptive law has been in effect in California since 2012. The California Transparency in Supply Chains Act is applicable to companies that sell in the state and have worldwide turnover of more than $100 million. It mandates stricter compliance, and has an associated resource guide that might be shared with your portfolio companies.

I am not a lawyer, but I am an investor. And since it seems possible to avoid a swath of legal and moral issues through straightforward due diligence, I’d take a dim view of any management team that doesn’t think now is the time to act.

Thanks to Paul McCaffrey; Tom Collimore, CFA; Paul Smith, CFA; Hanne Dalmut; David Allison, CFA, CIPM; Nathaniel Erb; Brandon Root; and Jacob Watkins for reading drafts of this.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/&#169 Katja Wickert

About the Author(s)
Sloane Ortel

Sloane Ortel serves CFA Institute's members globally as a curator and commentator. Based in New York City, she is a regular contributor to the Enterprising Investor, a co-author (with Jason Voss, CFA) of CFA Institute's Investment Idea Generation Guide, and a frequent interviewer of leading industry figures.

13 thoughts on “The Cost of Cheap: Slavery in the Supply Chain”

  1. Dmitriy says:

    A fascinating read, Will, though I’m equally puzzled on what the solution may be here. Passing human trafficking-specific disclosure laws seems like a step in the right direction, but those laws seem like more of a suggestion than something that’s actually enforceable. On the other end of the spectrum you could ban the import of goods from any country with proven ties to modern slavery, but that’s practically every country. Maybe the solution lies somewhere in the middle–a grading system that awards companies that take efforts to reduce the use of slaves in their supply chain, with the caveat that it’ll be very difficult to definitely prove how successful those efforts are. A participation trophy is still better than no trophy, right?

    1. Will Ortel says:

      Thanks for the comment Dmitriy!

      I agree it’s a heck of a puzzle. The ideal solution would be one that happened at the level of consumer choice, where we got better at communicating what was “clean” and what was “dirty,” effectively leading to a pure free market solution. Unfortunately there’s evidence that only matters to consumers who already care.

      And as you say, a legal ban on imports from countries with issues is impractical from a lot of perspectives. Not only would it be a tough sell, but the humanitarian crisis it produced would likely be worse than the one it was designed to fix.

      Fortunately a complete solution isn’t necessary to make progress, and individual companies can do a lot of good just by being conscious of where they source their raw materials. I think that’s the most effective vector for the investment community to engage with for a lot of reasons, not least because companies are likely to listen to their investors.

      But really the conversation doesn’t evolve until it shifts from “oh gosh, these bad things are happening!” to “not doing these bad things produces a ton of good effects!” I’m hearing promising chatter about studies that are being done in low-wage factories in less developed countries which point to direct financial return from behaviors that are good in general: better wages for workers and better working conditions.

      Turns out people are more productive in those circumstances. A hopeful finding.

      Thanks again for reading!

      Will

  2. Will,
    Thank you for raising this issue.

    I believe that an effective approach requires both a carrot and a stick.
    As you noted, the fear of bad PR may spur companies to clean up their act. That’s the stick.

    What about rewarding companies with clean supply chains? A “Fair Trade” label is a step in that direction. That’s the carrot.

    Rob

    1. Will Ortel says:

      Rob —

      Many thanks for thinking about it!

      One of the points i’ve left to the side is that there is some evidence of a “natural carrot” here — in other words, a return profile that comes from good corporate citizenship. The intuition around this is straightforward: a business is durable in a different way if it consistently meets and exceeds self-imposed standards for the intensity and type of the footprint it invariably leaves.

      There is reasonably comprehensive evidence that good behavior on a cross-section of ESG factors is associated with desirable things. This study should place good corporate citizenship firmly on the agenda of any CEO or CFO. It’s hard to find things that are durably associated with good financial performance, you know?

      I agree that fair trade labeling is super useful on the consumer side, but investors should also be thinking hard about this especially for firms with rich multiples. Take Inditex (ZARA parent company) for example, just because they’re large and we’ve written about them before. With the company trading near 34x earnings, it’s difficult to imagine any equity investors are counting on a payback period much shorter than 20 years. The durability of the franchise matters immensely to the firm’s return profile, and sourcing is literally step one in the repeatable process that gets investors paid.

      I’d be asking about supply chain issues for “natural carrot” reasons as above, but also to avoid a potential discontinuity. Payback is on at least a 20yr horizon, so not baking it into the evaluation is in some ways a bet on static consumer preference.

      Cheers, and all the best —

      Will

      1. Will,

        Does ESG Boost Returns?

        I would like to believe that positive Environmental Social and Governance (ESG) factors lead to a “sustainability premium.” Likewise, I also want to believe that economic freedom leads to higher growth. (Click here for the 2016 ranking of countries from the Heritage Foundation: http://www.heritage.org/index/

        Unfortunately, research cited by Larry Swedroe suggests that investors will not earn a premium by investing in companies that rank high for sustainability, or other forms of ESG. http://thebamalliance.com/blog/sustainable-investing-and-mutual-fund-performance/

        Why?

        I suspect two things:
        1) Market efficiency–investors bid up valuations for firms with high sustainability rankings. This diminishes future returns.
        2) Self-selection: I believe that successful companies are much more likely to embrace sustainability. If your firm has a high ROE and moderate growth, you want to preserve the franchise.

        This is just speculation on my part; I don’t have data to back it up.

        However, your point remains valid: ESG may improve corporate financial performance, as noted in the study you cited (Friede, et al.). So corporate performance may benefit from ESG, even though investors may not realize higher returns.

        Regarding your final point, how do we get companies to think in terms of 20-year horizons? Off the top of my head I suggest:
        1) Long-term compensation for CEOs
        2) Financial reporting that consistently connects effort the company’s quarterly performance to its long-term vision.
        3) Excitement! People will stick to a long-term plan if you get them excited about an idea.

        Thanks for the discusssion.
        Rob

        1. Will Ortel says:

          Rob —

          Thank you for this comment! When we spoke this morning I forgot to thank you for giving me the title for a follow on piece with your question about whether ESG boosts returns. The post (link below) goes in more depth, but in general I think it boils down to how you use the information and what you’re trying to get out of it.

          I love your thoughts on how to get management teams to think more long-term. Compensation & reporting frameworks that reinforce a long term outlook are certainly some of the more interesting levers to pull on there, and excitement is never to be overlooked as a force for change.

          One of the more interesting groups doing work on long termism is the Long Now foundation, which does a lot of interesting work to shift attitudes towards the distant future. I find their style of writing years with a leading zero (02016) to be a really effective way of reminding us just how much future is yet to come.

          Cheers, and all the best —

          Will

          https://blogs.cfainstitute.org/investor/2016/09/01/does-esg-boost-returns/

  3. Hugues Létourneau says:

    Hi Will,
    Thanks for raising these points in this particular forum. As you know, there is an important number of actors in the responsible investment space that are trying to effect change in this area, whether it be asset owners and managers engaging with companies over forced labour risk or sustainability rating agencies providing analysis on such issues.

    To accelerate the acceptance by companies that this constitutes an important issue for investors, there would be a benefit to having forced labour raised on a continuous and ongoing basis during analyst conference calls. If this was done, the problem would make its way to the agenda of board meetings and those of executive managers.

    In parallel, investors need to provide incentives for companies to do the right thing. For instance, long-term investors like pension funds generally accept that a company invest time and resources into a supply chain mapping exercise – they will remain shareholders over years. However, there is still a large part of the financial community that has a short term outlook and that see investments into supply chain transparency/due diligence as wasteful spending.

    As you outlined, it’s a complex issue for which there is not one easy solution but there are a number of investor and multi stakeholder initiatives touching on forced labour. More buy in from “mainstream finance” practitioners would definitely increase the momentum.

    1. Will Ortel says:

      Hugues —

      Thank you for your work on this — I couldn’t agree more that supply chain issues deserve to be raised on analyst calls, and I wish awareness-raising wasn’t necessary. I do think that the returns to good behavior are indirect, but material. As I wrote to Rob below, a business is durable in a different way if it’s cracked the code on sourcing ethically and sustainably. I am a big believer in the “natural carrot” that comes from good behavior.

      I think you made a very provocative statement by raising the short-termism point — I hear that a lot. One of the interesting things i’ve been having trouble on there, though, is the ideal response from the issuer. It’s certainly not the case that shareholders are uniformly short term oriented. If anything, there are plenty of instances where the inverse is the case: there’s this car company with a reasonably well-documented appetite for cash that seemingly has no trouble financing radical long term plans. With multiples where they are at least in the US, the marginal buyer of shares has a long time horizon by mathematical identity.

      So I wonder if there is anything better than an oblique response to the challenge of short termism. A clear strategic identity isn’t a linear solution to “our shareholders don’t give us the time horizon we need,” but it’s a heck of a start. Any reasonable long term strategy for a company that sources things will include approaches to doing that well and ethically, especially given the payback period considerations above.

      In any case, there is tremendous momentum towards the mainstream integration of these sorts of non-financial criteria in investment decision making. I look forward to talking about the natural carrot coming from good behavior in the future and getting a response along the lines of “no duh.”

      Cheers, and all the best —

      Will

  4. Amy Hewett says:

    Thanks for the article, Will. I’m weighing in from the consumer side here; I am a nurse and know approximately nothing about investing and supply chains. I found this article from a LinkedIn group about human trafficking that I belong to…. A big problem, it seems to me, is that most people are not even aware that modern day slavery exists. Hopefully, more consumers would demand that their products are not harming others, if the consumers were educated about this topic. For example, many people choose to be vegetarians because they are aware of the harm to the environment and the treatment of the animals before death. Many people are not going to SeaWorld and dolphin shows after seeing Blackfish and The Cove. Many people chose to buy or not buy from companies based on their views of gender and sexuality issues. But I think a lot of people really just have no clue where there products come from. That awareness would (hopefully) be a factor in their decision-making process.

    1. Will Ortel says:

      Amy —

      Many thanks for reading and for weighing in. I agree with you that low awareness is the heart of the issue. When I brought this topic up in conversation, people tended to already know (and be concerned already) or not know at all, and be shocked.

      One of the things that is both concerning and unsurprising is that labeling different sorts of products as “sustainable” doesn’t impact behavior for people who aren’t already inclined to care (see link below).

      I don’t think that means it’s pointless (after all, there is an effect for consumers who do already care), but it speaks to the magnitude of the challenge.

      I’m not a partisan person, but there’s this great Joe Biden quote which nails it: “Don’t tell me what you value. Show me your budget, and I’ll tell you what you value.” I am hopeful that in the coming years society will understand the wisdom of that and get better at manifesting its expressed values through its spending and assets.

      Cheers, thanks for reading, and all the best —

      Will

      http://escholarship.org/uc/item/3cs0b66v

  5. Mike says:

    Hi Will,

    It’s always great when stops the roller coaster to check the track for safety. I have an investment background, not legal, as well. I would think there would be three ways to police modern international slave labor, and unfortunately none of them involve the US investor because the US Investor sadly doesn’t care.

    1). IMF penalties/sanctions/fines to countries who either house companies using slave labor and countries where slave labor is performed. This could be a pass through tax to be paid be the companies, which would go to the laborers making them paid. I am an optimist.

    2). Trade tariffs on commodities between nations with proceeds used for the same purpose

    3). A world labor regulatory agency for labor coming from The Hague doing the same.

    It’s an incredibly interesting standpoint to think about this as an investor issue rather than a consumer issue. As you referenced, in a world high-jumping for bps I just don’t see the socially conscious investor prevailing because the socially conacious investment manager will not exist sadly. Great article!

    1. Will Ortel says:

      Mike —

      Many thanks for offering these ideas up. I love the idea of high jumping for basis points too — great expression.

      I agree that there’s some role for empowering regulators to address forced labor directly, whether through the IMF or The Hague. But there’s a role for enlightened self-interest as well. There is already enough regulation facing the largest companies in specific jurisdictions that they should have their acts together or have a plan for getting there.

      You may be interested to check out another article I just published on whether socially conscious investing boosts return (link below). I see how it could be rational to expect that there’s no time for such pursuits in an increasingly competitive world, but in fact there’s alpha there. Perhaps the inverse will be the case.

      Whether alpha or just directional change, a really important thing is that the disclosure mechanism we’ve been using to have conversations about value and strategy for decades has within it the potential to address humanitarian concerns as well. Just think about the spillover effects of improved transparency in the human trafficking context — they could be massive.

      Cheers, all the best, and many thanks for reading.

      Will

      https://blogs.cfainstitute.org/investor/2016/09/01/does-esg-boost-returns/

    2. Mekonnen Mandefro says:

      Thanks Will.

      This issue is not an issue of supply chain. It is an issue of value chain. A customer in the US pays $10 for a T-shirt or a dish of shrimp. If we distribute this amount, the “slave” may get some cents at the end of the supply chain. Slavery is nothing but working for mere life sustenance payment under coercion. We can find this spread everywhere all over the world. It seems this will never resolve sometime soon unless we start doing some extraordinary things.

      Some crazy politician may suggest the solution is to change the American capitalism into the European type! What? Another crazy economist may say that the American capitalism is based on excessive exploitation to make money at any cost, be it human or environmental! What?

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