Edinburgh University has recently published a consultation paper on responsible investment and is seeking responses.
In the third and last of a series guest blogs on the subject, Tim Hayward of the School of Social and Political Science in Edinburgh, discusses the relationship between university investments and the creation of wealth.
Investment in Reality
To think about the fundamental principles that should guide a responsible investment policy it is helpful to get back to conceptual basics. So I shall start with a moment of philosophical reflection.
Reality is all of what we apprehend, in our human lives, under the forms of space and time. Our lives themselves have objective aspects (what we observably do) and subjective ones (how we interpret our experiences). Investment is, in the broadest sense, a putting of oneself into some venture or commitment: we invest our energies and our time in activities whose objective fruits yield what we apprehend, subjectively, as benefits. Where an abundance of those benefits is achieved, we have a circumstance that can be referred to as wealth. This has both objective and subjective elements: what has been objectively assembled is subjectively appreciated. But what of investment in a narrower sense, that of bestowing money on others that they may in due course return the sum and, hopefully, with more besides? Is this a special case of the general idea or something rather different?
As the ambiguity of my title intimates, we can think of the reality of investment in different ways: either as investing in something real, or as the real practice that is called investment. These are not necessarily the same: when someone is really engaged in the practice it is possible that they are investing in something illusory – either because no objective results are achieved or because those achieved answer to no subjective affirmation of worth.
It is possible to invest, in other words, without thereby generating wealth. Such is obviously the case when a business fails. But it is also possible for a business to succeed in its own terms and still not generate wealth. Take the manufacture of weapons of war, for instance, or tobacco products. The products are inherently destructive; their use engenders real disbenefits; so wealth is not created but destroyed through the production and ‘consumption’ of such things.
And yet, arms manufacturers and tobacco companies make very considerable amounts of money. So how can it be said that they don’t generate wealth?
Evidently, we need to be careful in our use of terms. When the money value of a company goes up, this means that its owners can command increased wealth. But these people do not typically go out and buy machine guns or container loads of cigarettes – things they have no use for – but, instead, they use the money to acquire things that conform to our definition of wealth. So no wealth, on our definition, has anywhere been created by the arms business or the tobacco industry, and yet some people’s wealth has increased. Elementary logic therefore tells us that the wealth available to others must have decreased in this process. The wealth that has come to the owners has not been generated by the firms in question; it has been transferred to them from other parties.
This process by which some people get rich, then, need not involve wealth creation, but it does necessarily involve wealth transfer – which, as discussed in my previous blog, is what indices of economic growth capture. Economic growth – as standardly measured, by reference to transfers – may appear to outstrip the growth of actual wealth.
This process, and its illusory effects, are made possible by money, or, more exactly, by money being taken to represent reality in a more direct way than it does. It may seem puzzling or even perverse to say that money is not the equivalent of wealth, but appreciating this is crucial for understanding the reality of investment. Arguments in favour of economic growth trade on the assumption that the growth in question is a growth in wealth. But if it is growth in monetary transactions that is measured, we need to recognize that these are not only not the same thing as wealth, they are, in an important sense, its opposite.
In a simplistic way, it is obvious that money is not wealth – we know you cannot eat it, live in it, play golf on it or go for a sea cruise in it – but because a sum of money can usually be converted into an item of real wealth we pay little heed to that simplistic thought. Until, that is, something happens to bring about a reality check.
For instance, in the game of Musical Chairs that is played out to the tune of highly leveraged financial instruments, those left holding the promises to pay may be brought to their knees by the reality that the promises do not correspond to real assets.[i]
A reality check alerts us to a simple but important fact about the difference between wealth and money. If you increase the amount of wealth available in a society, then you do just that, namely, increase the amount of wealth available in that society. If, by contrast, you increase the amount of money in a society, then you may find that any given sum of it will have the power to purchase less wealth; if you inflate the amount of money enough, you can bring it to the point of virtual worthlessness. This is pretty much the exact opposite of increasing a society’s wealth.[ii]
That simple point was emphasised, some ninety years ago, by the Glaswegian Nobel physicist turned economist Frederick Soddy. In his 1926 book Wealth, Virtual Wealth and Debt: The Solution of the Economic Paradox (a book that presaged the market crash of 1929) he highlighted something that our contemporary observers, too, have increasingly been reminding us:[iii] the essence of money – despite the powerful practical assumptions we make to the contrary – is an expression of debt.
Soddy pointed out the fundamental difference between real wealth – buildings, machinery, oil, pigs – and money in the form of debts issued by banks. ‘Debts are subject to the laws of mathematics rather than physics. Unlike wealth, which is subject to the laws of thermodynamics, debts do not rot with old age and are not consumed in the process of living. On the contrary, they grow at so much per cent per annum, by the well-known mathematical laws of simple and compound interest … .’ (p.70).
What money represents is a claim to goods or services that might be provided to its bearer in the future; national money is like a national IOU (p.79). But it won’t be the Queen or her chief cashier who pays the bearer of her banknotes something called £20, and nor will it be the bank that has issued the paper promise. Indeed, that sum of £20 itself does not exist: nowhere in the world is there any thing that answers to the description ‘sum of £20’. Money works by being passed around, and, indeed, like electricity, only exists insofar as it passes around: as long as each and every handler of a banknote believes it to be ‘worth £20’, then that belief suffices to make it an everyday reality that whatever goods and services one thinks of as ‘worth £20’, then this piece of paper is good for them.
Since sums of money do not exist, it should come as no surprise that banks do not hold sums of money. However, this proposition is true not merely in the philosophically intriguing sense, but also in the practical sense that banks do not hold on reserve the money deposited with them. In fact, through fractional reserve lending, and further leverages, banks create far more money as debt than can be regarded as representing pre-existing assets.
Yet while money may not represent actually existing assets, it does represent claims on those people who have been credited with it as debt. The money injected into a society by its banks comes on terms that may appear individually and severally reasonable, but jointly and collectively represent a burden that may then be disaggregated in unfair or harmful ways. Because of the way money is put into circulation – created as credit by commercial banks rather than injected by governments – the current economic system needs to grow or inflate constantly. The growth imperative is entirely indifferent to whether the growth is beneficial in terms of the health and welfare of human society or our environmental quality and the natural world. When the creation of money has the form of credit there will always be people, moving forward in time, who are obliged to produce together more than was produced previously in order to service the debt. Since every piece of money is itself a piece of debt, then every piece that is destined to be repaid carries with it an additional debt that, as a matter of conceptual logic, will never be repaid; therefore the system has to keep on expanding. And because, along the way, individual repayments become due, stuff does need to get produced on pain of foreclosure against what one has already had. That leads to a treadmill for working people and also, we are starting to realise, eventual devastation for the natural world that constitutes the site and materials of the ceaselessly expanding activity. The system of financial debt can thus ultimately yield consequences aptly described as ecological debt.
Financial debt thus refers to claims on future activities that will generate real costs against human time and ecological space. A wealthy person has command over an abundance of those resources that extend in ecological space (i.e. space in which nature supports useful functionings for us, as opposed to the vast topographical space of a desert), as well as extensive freedom with regard to the use of their personal time. A poor person has marginal or inadequate access to the ecological space necessary for a decent life, and has to absorb all her time in eking out such living as she can from that little. The reality underlying the ethereal dance of global digitized finance is one in which both people and planet are increasingly imperiled.
There is a powerful case, then, for thinking that quite radical changes to our financial arrangements would be in order if the macroeconomic system is to be cured of its endemic tendencies to social and ecological irresponsibility. What such changes should be, and how they could be effected, are dauntingly difficult questions, but I think we – as a global community – would ignore them at our peril.
Meanwhile, what can be said with regard to the university as an institution investing financial claims on future economic productivity is that it should do so with regard to what constitutes real wealth. A business creates real wealth (in this avowedly normative sense of the term) when its products – in virtue of their use value, and not merely through having a value in exchange – add to human weal, and do so without adding to environmental damage. That ought to be the criterion for deciding what is a good investment, in reality.
The criterion may not be simple to apply, even in principle – especially as some activities (and basic research of a university would be among them) do not issue directly in benefits but support indirect benefits down the line. We also need to be aware that a fundamental value of the liberal worldview is to allow people to decide for themselves what is beneficial, and so the invoking of judgments about which products are worthwhile raises questions of paternalism or illiberality. And, of course, such judgements of real value may not be reflected in market prices – at least in the shorter term, and especially when government incentives may work against it – and this adds to the challenges for the responsible investor.
But lest it be thought that these difficulties arise only as a result of taking a moral stand with one’s investment decisions, I would emphasise that the focus on the reality of investment has its prudential side too. Awareness of how wealth – human and ecological – can be undermined as well as created is ultimately crucial for understanding the worth of an investment. Fund managers, who are required to deliver risk-mitigated financial returns, have also increasingly to address new kinds of risk that are not yet addressed in the legal framing of fiduciary responsibility. As Kelly Clark (Guardian 8 July 2013) points out, issues such as ‘global warming, the carbon bubble, stranded assets, environmental externalities and defined planetary boundaries’ represent grave material risk to markets as well as planet.
It could thus be suggested that our financial investments should be guided by the same kinds of principle that guide our choices of socially responsible research objective – choices that reflect an enlightened understanding of the longer term, global, and ecological dimensions of human interests. Some concerns for nonhuman cohabitants of our biosphere, too, would not be out of place.
The responsible investor’s task is hardly made easier by such a burden of inquiry, and so it is only right and sensible that the thinking about it be shared across the wider membership of the institution that is a university – as Edinburgh is currently doing with its consultation. It is important to include students, too, since they will be particularly alert to changes affecting assumptions about reality and investment inherited from previous generations.
To think anew about the reality of the wealth of this world and what it means to invest in it, is a task that can be conceived as nothing less than that of a new – social, ecological, and global – Enlightenment.
6 March 2014
[i] The dynamic of financial crisis, and its likeness to the children’s game, is concisely analysed by Richard J. Cabellero and Arvind Krishnamurthy, ‘Musical Chairs: a comment on the credit crisis’, Financial Stability Review 11 (2008): 9-11.
[ii] Why it has come about that movements of money are treated as a good proxy for a growth in real wealth is an interesting question for another time.
[iii] See e.g. David Graeber, Debt: The First 5000 Years, Melville House 2011.