Well-meaning responsible investment mutual funds won’t save the planet

A fad on Wall Street is the creation of investment funds that promise to invest in companies that have desirable environmental, social and governance attributes. These sorts of funds are very popular. Principles for Responsible Investment, a United Nations-backed non-government organization, recently announced, for example, that signatories to its standards have $121 trillion of assets under management. This represents most of the world’s managed money.

The appeal is obvious. People want to earn a decent return and they want to feel good about themselves as they are doing it. Want to earn 8 percent while fighting global warming, invest in a climate fund. Concerned about labor conditions, invest in a fund that promises to invest in companies paying a living wages. Any cause you can think of, there is a responsible investment fund for that.

The hope is that by funding responsibly run companies, those companies will be able to gain more market share, displacing unethically run companies. The problem is this doesn’t work in a capitalist system.

The reasons are straight forward. In a capitalist system, businesses seek out profit opportunities. Where those opportunities exist, they will be exploited regardless of moral appropriateness. People often justify their actions with the comment that if they hadn’t done it, someone else would have. While this is hardly an excuse for polluting the atmosphere or hiring child labor, in fact, in a capitalist economy, it is nevertheless a correct assertion. There is always someone willing to exploit profit opportunities even when they are unethical.

Refusing to hold an asset does little good as the asset is still owned by someone and that someone continues to operate the unethical business underlying the asset. Indeed, because the asset is undervalued, the ultimate acquirer may earn outsize profits to compensate for any guilt they might feel. To wit, cigarette stocks have for many years paid an above market return, the extra lucre assuaging moral qualms of the shareholders.

Suppose a philanthropist billionaire decided to buy the undesirable businesses, then close them permanently. This won’t work either. Competitors will expand to serve the orphaned clientele of the closed business. The profit motive will incentivize these businesses to adopt the same questionable practices as the now defunct former competitor.

If our goal is to stop undesirable behavior by private profit seeking businesses, the answer is not responsible investment funds nor is it welling-meaning billionaires. Rather, what needs to happen is to make bad behavior unprofitable. That takes government regulation.

If we want to stop global warming, for example, the answer is to make the emission of greenhouse gases unprofitable. Once that is done, businesses will soon find ways to avoid emitting. Cap-and-trade is my preferred approach, but a carbon tax would work also. The implementation of either cap-and-trade or a carbon tax requires government regulation and enforcement. The market can’t do it without government intervention.

Feel-good responsible investment funds won’t work as long as there is profit in irresponsible and unethical business practices. While most businesses people are moral people who want to do what is right, where there is profit, that is to where investments will flow and there is profit in pollution, child labor and exploitation.

If you really want to save the planet, work to establish government regulation that take the profit out of irresponsible investment.

Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. He has taught at NMSU since 1987. The opinions expressed here may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.