Debate: “Do due diligence laws improve the rights of workers in production countries?”

Markus Krajewski & Gabriel Felbermayr
Jun, 2024
#Social and working conditions
#Corporate responsibility and lead firms

Debate between Markus Krajewski and Gabriel Felbermayr

Markus Krajewski is University Professor at the University of Erlangen-Nürnberg and holds the Chair in Public Law and Public International Law. Prof. Krajewski is one of the programme directors of the MA in Human Rights and chairperson of the Interdisciplinary Research Centre for Human Rights Erlangen-Nürnberg (CHREN). He also chairs the Board of Trustees of the German Institute for Human Rights and is Secretary-General of the German Branch of the International Law Association.

Gabriel Felbermayr
is the Director of the Austrian Institute of Economic Research (WIFO) in Vienna. He is also a Professor at the Vienna University of Economics and Business. Some of his previously held positions include associate consultant at McKinsey & Co. in Vienna, an academic counselor at the University of Tübingen, chair of international economics at the University of Hohenheim (Stuttgart), full professor of international economics at the University of Munich, and president of the Kiel Institute for the World Economy. Gabriel Felbermayr has also been a Member of the Scientific Advisory Board of the German Federal Ministry for Economic Affairs and Energy, Chairman of the Statistics Council of Statistics Austria, and Co-Editor of the “European Economic Review".

In 2011, the United Nations passed the Guiding Principles on Businesses and Human Rights, thereby establishing the first global framework for preventing and addressing risks to human rights in global supply chains and laying down standards for corporate social responsibility in business activities. Yet, despite its widespread endorsement by both states and companies, issues of human rights violations and environmental destruction along global supply chains persist. This has spurred a wave of initiatives for mandatory due diligence laws, both on the national as well as the supranational level. In 2017, France became the first European country to adopt a national due diligence law; the Netherlands and Germany followed in 2019 and 2021 respectively. Meanwhile, in March 2022, the European Commission published its first draft of an EU-wide law on corporate sustainability due diligence. Yet, there is disagreement on the effectiveness of mandatory rules as well as potential unintended consequences. Markus Krajewski lays down arguments for a comprehensive legislative framework, drawing on the example of the recently passed German supply chain due diligence law and its potential to improve human rights along global supply chains. Gabriel Felbermayr, on the other hand, criticizes that a mandatory law disproportionally affects companies and may inadvertently lead to unintended consequences. He instead argues for a negative list of companies known to violate human rights that could be barred from EU supply chains.

Markus Krajewski: Due diligence laws can be expected to improve the conditions of workers and suppliers in production countries

After a long political campaign and internal struggles within the Federal Government, Germany adopted a Law on Supply Chain Due Diligence (Lieferkettensorgfaltspflichtengesetz) on 10 June, 2021. It will enter into force for companies with more than 3000 employees on 1 January, 2023 and a year later for companies with more than 1000 employees. Like the French Loi de Vigilance of 2017 and the Dutch Child Labour Due Diligence Law of 2019, this new German law aims at obliging corporations to engage in human rights due diligence in their supply chains and business transactions. These due diligence laws are based on the voluntary United Nations Guiding Principles (UNGP) on Business and Human Rights adopted by the UN Human Rights Council in 2011. The German law was envisaged in the National Action Plan (NAP) on Business and Human Rights in case that voluntary approaches would not be sufficient. In 2020, an independent study revealed that less than 20% of all German companies followed the soft law guidance of the UNGP and the NAP. Inconsequence, the German government proposed a national law for mandatory due diligence in global supply chains.

The new German Law requires companies to establish a human rights risk management system, conduct regular risk analyses, adopt preventive and remedial measures in the company’s own business and with regard to direct suppliers, as well as install a complaint mechanism. If a company gains substantiated knowledge of human rights breaches further down the supply chain, it is required to also take the above mentioned measures regarding indirect suppliers. The scope of the due diligence obligation is determined by the principle of appropriateness: Companies are only required to engage in activities that are appropriate in relation to the nature and extent of the business activity, the leverage of the company, the severity, reversibility and probability of the violation, and the nature of the company’s causal contribution to the violation. The law also requires companies to prepare an annual report on the fulfilment of their due diligence obligations in the previous financial year.

Does the German Law, do due diligence laws in general, have a positive impact on human rights in the supply chain? After all, this is their objective. The proposal of the German due diligence law states: “This law aims at strengthening the rights of persons affected by corporate activities in supply chains […]”. Thus, any due diligence law will have to be measured against improvements of the rights of workers and affected stakeholders in the supply chain.

Of course, it is too early to expect any empirically sound evidence – the law will only enter into force in 2023 and it will take a while until its effects can be assessed. Even with laws that have already been in force for a few years, such as the French Loi de Vigilance, it is too early to prove a clear causal relationship between the law and an improvement of workers’ rights and affected stakeholders, because the real effects will only be felt in a few years.

Is it likely that due diligence laws will improve the rights of workers in supply chains? This again will depend on the effective implementation of such laws. Due diligence laws will have a positive impact if they induce companies to move from short-term contracts to longer commitments which lead to safer work places and more sustainable production methods. Of course, the behaviour of German, French or other EU companies are not the only, sometimes not even the most important determinant of human rights in the supply chains. Weak governance structures in the production countries, lacking capacity to implement labour and social standards, activities of domestic companies and of foreign competitors from countries that do not have mandatory due diligence laws may off-set any changes in the supply chains of companies obliged to engage in human rights due diligence. However, if a German company ensures that its local supplier pays a living wage as required by Section 2 paragraph 2 No. 8 of the German Supply Chain Due Diligence Law, it is clear that this will have a positive effect on the rights of the workers of the local supplier.

How likely is it that due diligence laws will contribute to a deterioration of the rights of workers and affected stakeholders? Many observers and business lobbyists argue that such laws will lead to the withdrawal of companies from suppliers in countries with weak human rights standards, which would have negative effects on the human rights situation. So far, neither the French Law nor similar laws seem to have had a significant effect on the supply chains. More importantly, many large companies including leading brands of the German automotive industry or the textile sector have been pursuing due diligence strategies in their supply chains on a voluntary basis. This has not led to any significant changes in the choice of countries where they operate or where they source from. It is thus unlikely that a mandatory requirement to engage in due diligence for all companies will have the opposite effect.

Furthermore, due diligence laws increase access to remedies and justice for affected rights- holders. While victims of human rights abuses are often unable to hold lead firms of a supply chain or parent companies of a transnational corporation accountable in their domestic courts, due diligence laws may provide grounds for victims to receive compensation and justice in home state courts. In this context, it is unfortunate that the German Supply Chain Due Diligence law explicitly excluded any claims for liability based on a violation of the law. However, this does not mean that victims of corporate human rights abuses cannot utilise due diligence laws and base their claims on the tort of negligence in domestic courts. The details will depend on the applicable law. In any case, claiming that a lead company of a supply chain contributed to human rights violations by not engaging in due diligence may be a powerful claim even if it is not made in a court of law.
Gabriel Felbermayr reply to Markus Krajewski: A negative list approach instead of a mandatory supply chain due diligence law

In too many countries, the human rights situation and the treatment of the environment are cause for concern. Too many governments do not apply or enforce their international commitments, from the Universal Declaration of Human Rights to the International Labor Organization’s core standards. Germany has introduced a mandatory supply chain due diligence law (MDDL) that will oblige companies above a certain size-threshold to monitor whether their foreign suppliers abide by a list of norms and to take remedial action if needed. Firms that fail to engage in sufficient monitoring are subject to fines. The law mostly focuses on human rights violation in direct suppliers and rules out liability claims. Planned EU-legislation would be structurally similar but could be more far-reaching.

If the regulation works, abusive suppliers would be eliminated from EU supply chains. However, the legislation ignores economic costs that go much beyond the mere monitoring expenses incurred by EU buyers. An alternative approach that consists in negative listing “bad” suppliers by a central EU agency would be at least as effective in weeding out unlawful suppliers but would have smaller negative side-effects on the development process.

The economic problem is as follows: EU buyers cannot perfectly observe behaviour of suppliers in far-away countries. By investing in monitoring activities, they can reduce but not eliminate this uncertainty. Therefore, it is possible that, despite their best efforts, one of their developing country suppliers violates a human right or an environmental standard. The German MDDL foresees substantial fines, reaching 2% of turnover, if the overseeing authority finds that the importer has not provided “best effort” – a rather ill-defined legal concept. So, with the MDDL, buying from foreign suppliers exposes buyers to new risks that they cannot fully eliminate. Rational firms will want to minimize that risk by concentrating their monitoring activities on fewer but larger suppliers and by withdrawing from countries where monitoring is particularly difficult or where the baseline probability of bad behaviour (e.g., because of weak local institutions) is large. Importantly, what matters for firm behaviour is not so much the size of monitoring costs but the costs of potentially being declared, rightly or not, non-complying. Consequently, suppliers that are not at all infringing any rights may be eliminated from EU supply chains. The MDDL risks hurting law-abiding suppliers, too, as they cannot costlessly signal that they are law-abiding.

This is a pity. Numerous empirical studies show that participation in global value chains (GVCs) lifts local communities in developing countries out of abject poverty. Lower poverty, in turn, leads to improvements in social, environmental, and political conditions. Of course, correlation does not imply causation, so hard empirical evidence is difficult to obtain. Furthermore, there are always exceptions to statistical relationships. But the evidence very clearly points towards large societal benefits from GVC participation, particularly in the manufacturing sector.

Two empirical facts are very well established. First, firms that legally participate in GVCs almost always belong to the formal sector, where law enforcement is strongest, taxes are collected, and standards are most likely to be upheld. If they were informal firms, they could not engage in international trade, at least not directly – the link that the German MDDL mostly focuses on. Studies show that the most frequent and most egregious violations of human rights are found in the informal sector, in small-scale farming, in family households, where government regulations, imperfect as they may be, are often not applied. Second, only a subset of formal firms participates in global value chains. But those who do are positively selected. They are larger and more productive; they pay higher wages, offer better working conditions, and respect the environment more. So, if firms’ participation in GVCs declines, fewer workers enjoy the so-called exporter premia and more of them are pushed into informality. Where EU firms move out, buyers from other regions, for example China, may move in – exerting less pressure on suppliers and weakening the geostrategic position of the EU.

Buyers reacting by adjusting their supply chains is not just a theoretical possibility. Kolev and Neligan (2022) provide an empirical evaluation of the French MDDL, which has been in force since 2017. They find that French imports from “risky” countries have indeed fallen and that the new legislation acts like a non-tariff barrier to trade. In the cost evaluation attached to the German law, no impact analysis for poor countries’ participation in GVCs is conducted.

To avoid such undesired restructuring of GVCs from happening, a more centralized approach that does not impose costs and risks on EU firms would be the better alternative. Instead of requiring every EU buyer to scrutinize each and every supplier, a central EU agency should instead assume the monitoring task and maintain a negative list of firms that are barred from EU supply chains. This would avoid costly duplicate monitoring and minimize legal uncertainty. In addition, importers respecting the list would be sure not to be fined. They would not have incentives to adjust their supply chains – except, of course, by kicking out listed firms. Thus, only firms exhibiting bad behavior would be unplugged from EU value chains. There are various examples of negative lists, the most famous one being the US’ “entity list”. Currently, it lists thousands of firms on around 500 pages of text. Clearly, for a supply chain negative list to be effective, a transparent mechanism leading to the listing of a firm and a possible delisting would be needed. In principle, the same stakeholders that are given voice in the German MDDL could bring cases to the attention of an EU decision-making agency.

Policy practitioners may prefer an MDDL over a negative list, because the former outsources the decision to terminate foreign supplier relationship to private firms. That decision would be a purely private decision. If, instead, a public government agency makes such a choice, foreign governments may impose sanctions on EU firms to retaliate against what may be perceived as an unwarranted protectionist measure. This concern is justified. However, proceedings under an MDDL may as well attract political attention if systemically relevant or publicly owned suppliers are involved. Moreover, some politicization may in fact be useful: in contrast to individual firms, a central EU agency can take the wider repercussions of their decisions, such as on the EU’s geostrategic position, into account. And the threat of being put on a negative list that bars exports to the entire EU, with strong signaling effects beyond Europe may be a very potent incentive for suppliers in developing countries to abide by the rules. In short, there are good reasons to believe that a negative list approach would be more powerful and at the same time less detrimental to development than the MDDLs that are currently so popular in parliaments.
Reply to Gabriel Felbermayr:

Gabriel Felbermayr and I agree on two fundamental grounds: Environmental degradation and human rights violations in global value chains need to be reduced as much as possible and participation in global value chains is economically beneficial for many developing countries in their fight against poverty. However, we disagree on the right instrument. A negative list approach as suggested by Professor Felbermayr is bound to fail for three reasons: First, as Gabriel Felbermayr points out himself, the most severe human rights violations and environmental damages are not linked to well-known and established firms, but to small companies, workshops and sometimes even family businesses. Including them in an EU list is simply impossible unless thousands of Brussels bureaucrats spend years in assessing and researching local companies all over the globe. Second, a negative list approach would punish those (European) companies that have already embarked voluntarily on the path suggested by the UNGPs – implementing human rights due diligence by assessing the risks in supply chains and trying to prevent human rights violations through working with local partners, trade unions and suppliers. Why would companies like Volkswagen or adidas continue to invest in training and supporting their local suppliers if there is a risk that the local supplier will end up on the list? And thirdly, a negative list would be a clear non-tariff barrier and thus a violation of Article XI GATT. The negative list suggested by Gabriel Felbermayr is also not comparable to the famous US “entity list”, which includes individuals and companies involved in disseminating weapons of mass destruction and other activities sanctioned contrary to U.S. policy interests. This is a much more narrowly defined field than companies violating human rights or damaging the environment.
Reply to Markus Krajewski:

Towards a Compromise: Markus Krajewski points out problems with a negative list approach. I would agree that such a design is not a panacea. I also share his dislike of bureaucratic monsters. But his criticism goes too far. Supervising myriads of small-scale foreign suppliers more tightly always requires a huge bureaucratic effort regardless of which entities carry out the task. My argument simply is that it is more efficient to concentrate such effort centrally rather than duplicate it in tens of thousands European importing firms. I also do not think that reducing the aggregate cost burden punishes those firms who have already made efforts. Regardless of costs incurred in the past, all companies are happy if red tape is reduced. As to conformity with WTO-law, I leave the judgement to the law professor, just adding the humble note that there appear to be divergent views amongst legal scholars.

But maybe there is ground for compromise. Why not complement the mandatory due diligence law with a combination of two lists? A positive list of countries whose suppliers are exempt from the application of the law and need not be monitored. And a negative list containing companies that need not be monitored either as their participation in European value chains is outlawed. Then, the application of the law could be limited to foreign suppliers from non-listed countries that do not figure on the negative list. Lawmakers should also encourage a private sector certification initiative to minimize duplication of costs and redundancies. Such a design could lower risks and costs for European importers, minimize the likelihood of unintended relocation effects and still achieve the objectives on which Markus Krajewski and I have no disagreement.
Kolev, G. & Neligan, A. (2021), Trade Effects of Supply Chain Regulations: Empirical Evidence from the Loi de Vigilance, Working paper, presented at the Research Conference on Sustainability of Global Value Chains, 7.12.2021


Markus Krajewski

University of Erlangen-Nürnberg

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