The Week of March 13, 2023: ESG, crumbling banks, tax, trade and much, much more.
The Week of March 13, 2023: ESG, crumbling banks, tax, trade and much, much more.
R ecent signs of a pushback against ESG have been encouraging, but there is a long, long way to go. There is too much money and too much power resting on the preservation of ESG — and the rent-seekers’ ecosystem that it nurtures — for its backers to pack up their bags and slink away in shame.
Nevertheless, these early signs of resistance have produced something of a panic among ESG’s defenders, from Mike Bloomberg to Al Gore to the Financial Times. And naturally, the New York Times too is doing its bit too. Indeed, the paper has come out with a podcast: What is E.S.G., and Why are Republicans so Mad About It?
The interviewee is David Gelles, a climate correspondent. The Times sets the stage with a brief introduction:
The principle behind E.S.G. is that investors should look beyond just whether a company can make a profit and take into account other factors, such as its environmental impact and action on social issues.
But critics of that investment strategy, mostly Republicans, say that Wall Street has taken a sharp left turn, attacking what they term “woke capitalism.”
Unfortunately, that is not what ESG is. Nor is it “woke capitalism,” although it is true that ESG’s critics sometimes label it as such — as do critics of its critics — for reasons that I have discussed before, such as in this Capital Letter from last August:
It’s also telling, and understandable, that Wendland [writing for the Financial Times’ Moral Money] has characterized the attack on ESG as worries about corporate wokery. Some of ESG’s loudest opponents have indeed concentrated on that, even though that is only one element in, as described above, a far bigger story. Some have done so out of personal conviction, others, (and the two motives are not mutually exclusive) as a matter of tactics. It’s easier to gin up popular support for a campaign to oppose corporate wokery than to base it on a defense of shareholder rights or a rejection of corporatism, causes with possibly rather less immediate populist appeal. Something similar holds true for those in the opposing camp. It is far easier for defenders of ESG and stakeholder capitalism to frame the debate as another chapter in the culture wars than to address the serious threat to both property rights and to democracy that their efforts represent.
The Times’ description of ESG as “the principle . . . that investors should look beyond just whether a company can make a profit and take into account other factors, such as its environmental impact and action on social issues” leaves out a major part of the story.
ESG — which involves measuring an actual or potential portfolio company against various environmental, social and governance benchmarks — was sold as a way of doing well by doing good. The podcast acknowledges as much, but certainly underplays this idea. The reality is that ESG was not marketed as an investment technique that looked beyond profit, but as one that would either increase profit, or reduce the risk attendant on securing it.
Unfortunately, whether it does that is debatable at best or simply not true. I have discussed this on various occasions, including here, here and here. Writing recently in the Wall Street Journal, Andy Puzder (who does use the term “woke capital”) took a slightly different tack, looking at the performance of companies that were politically neutral against ESG-registered funds. The results were not good news for the ESG camp, but as Puzder concludes, this should hardly come as a surprise:
The data indicate that, as common sense would suggest, companies that focus on profits outperform companies that don’t. As a corollary, it seems obvious that asset managers won’t maximize shareholder returns if that isn’t their focus. It’s hard enough to generate profits and returns when that is your focus, let alone when you’re trying to change the world.
When the business of business is no longer business, it may be unclear who wins, but it’s clear that shareholders lose.
Turning to the transcript of the Times’ podcast, I read Gelles saying this:
ESG proponents would tell you that not only are a lot of these things that ESG is paying attention to good for the world, but they’re actually good for business in the long term. This strategy’s proponents will tell you that it’s good long-term investing for companies to wean themselves off fossil fuels because the science is clear. Society needs to stop burning fossil fuels. So the companies that are further along in that journey, they say, are going to be better investments.
For all the (very) superficial appeal of this argument, it makes little sense. The timetable on which “society” — which really means Western society (many other societies seem distinctly less interested) — will stop “burning fossil fuels” is, to say the least, uncertain. Plastics? Fertilizers? Natural gas? All gone you say. By when? There is also the small matter of the fossil fuels used in the manufacture of the technologies that are, allegedly, going to save the planet. And then, of course, there is the question of supply and demand. If less of something is produced due to political or regulatory pressure, but the demand for it shrinks at a slower pace, then the price of that product may well rise rather than fall. And that, in turn, may well boost the profits of those who produce it and thus, quite possibly, increase their shareholders’ return.
Also, as is often the case with defenders of ESG, there is the emphasis placed on “long-term” investing. Perhaps it is too cynical to suggest that this is a way of avoiding difficult questions about short-term returns. Perhaps. But to be blunt, there is no intrinsic financial merit in investing for the long term. All that matters is the price paid for an investment when it is bought and the price received for it when it is sold. A good investment is one that reaches a valuation that satisfies or exceeds an investor’s price target. That target will reflect the return the investor is looking for — a return that will be affected by the length the investment is held — as well, of course, as the investor’s view of what the share should be worth, two variables that may change from day to day.
Besides, how substantial (at least in some cases) is the dichotomy between long-term and short-term investing? It’s easy to argue that investors who bought, say, Amazon in 2002 because they did not believe that the company’s share price at the rime adequately reflected what it could be making in 2020 were long-term investors. But if those same investors sold those shares in 2005 because they thought that the share price now fully reflected Amazon’s earnings in 2020, were they short-term investors or long-term?
The answer isn’t as clear as one might think. And that’s one of the main reasons why the deployment of capital is (or should be) fluid — not necessarily long- or short-term. Indeed, patient investing by someone who believes that an investment will ultimately work well as an investment (as opposed to delivering some non-pecuniary societal good) is one thing, fetishizing long-term investment quite another.
Later in the discussion Gelles and his interviewer, the Times’ Michael Barbaro discuss the inroads that ESG has made. Gelles cites a few: Apple (no discussion of the company’s reliance on China, sadly), Nike, Walmart, and Target. There was no shout-out to Silicon Valley Bank. “All of these companies”, he explains, “have big operations where they’re pursuing their ESG goals and telling the world about it.”
Gelles continues:
And it’s not only the companies that are doing it themselves. From this emerges a whole cottage industry of ratings agencies, companies like Bloomberg and Dow Jones and Thomson Reuters, S&P Global, Moody’s, who’d start issuing ESG scores. And then with those scores, fund managers, that is big institutional investors that buy these big chunks of companies and put them in portfolios that retirement funds that invest in, they start creating ESG funds.
“Wow,” exclaims Barbaro.
“Wow” is right. This is the ecosystem flourishing under ESG that I referred to above. It is an ecosystem of value destruction, populated by rent-seekers. To understand this sort of financial markets phenomenon, it helps to follow the money. After all, one of the reasons that ESG has attracted the support of major asset managers is that it’s a label that often brings higher fees in its wake. The system also makes money for consultants of one sort of another. They charge for defining what ESG is; they charge for helping companies to raise their ESG scores; they charge for counting those scores to “rate” how well those companies are doing. And there are many more wagons on the ESG gravy train.
New York University finance professor Aswath Damodaran, someone I have frequently quoted before, explains how this ecosystem works here:
Why is ESG being sold so aggressively? Because accountants, measurement services, fund managers & consultants are on the ESG gravy train, with stockholders & taxpayers paying. Corporate CEOs are buying into ESG, because it makes them accountable to no one.
And here:
I believe that ESG is, at its core, a feel-good scam that is enriching consultants, measurement services and fund managers, while doing close to nothing for the businesses and investors it claims to help, and even less for society.
Say it ain’t so.
Gelles:
[T]he biggest investment firms in the world, BlackRock, Vanguard, these titans of finance, are now increasingly putting their money into an ESG strategy that is taking up more and more of the assets under their management, as much as $18 trillion in the last couple of years.
“Wow,” replies an impressed Barbaro.
But, via Reuters (January 12, 2023):
Vanguard Group’s decision last month to quit a key climate change coalition underscores how the retail investors who dominate its client base focus less on environmental, social and corporate governance (ESG) priorities than institutional investors.
Oh well. The little people, they just don’t understand. Or maybe the real difference is that it is their money at risk. After all, the institutional investors who embrace ESG are playing, for the most part, with other people’s money.
Gelles accepts that ESG has its critics, including those who don’t approve of ESG’s priorities and dispute that “it’s actually a good long-term investment to pursue these policies.” Over the last couple of years, he frets, “we’ve seen those critics get organized and go on the offensive.”
Gelles then explains that “one of the most crucial moments in the backlash against ESG” was “about three years ago,” when “independent oil producers, small drillers in Texas” found it difficult to get financing from “their usual banks.” They blamed this, he maintains, on the E in ESG, and started complaining. Matters escalated from there.
While it’s true that some in the oil sector have objected to the way that the E in ESG has been used against them, a more accurate interpretation of why the opposition to ESG sprung up at around that time is that, although ESG had been around for a while, it only started becoming really visible in 2017. I was working in financial markets in those days, and if I recall correctly, only first came across ESG in 2019. My reaction: It was nonsense, or worse. And I wasn’t alone. It took a while before “outsiders” became aware of ESG (which had been growing, but somewhat under the radar). And it took a while longer for them to fully understand its implications, and to start pushing back.
One critical moment in this process was the embrace by American big business of “stakeholder capitalism,” ESG’s equally repulsive symbiont. That was crystallized by the Business Roundtable’s redefinition in 2019 of the purpose of a corporation. No longer was a corporation to be primarily dedicated to generating shareholder return, now it was supposed to serve the interests of a variably defined collection of “stakeholders,” of which shareholders were only one class. As with ESG, the economic interests of capital owners were being downgraded.
To be fair to Gelles, he recognizes that there is more to the pushback against ESG than the unhappiness of fossil-fuel interests. He cites the more general concern that ESG is being used to advance a liberal agenda in ways unrelated to the bottom line. This led to more discussion as to whether ESG is a money-maker, which ended with Gelles concluding, a little weakly, that “the upshot is there are studies that conclude that ESG investing is indeed a good bet in the long term”.
Ah yes, the long-term.
So far as the “political” agenda within ESG is concerned, Gelles acknowledges the objection from some on the right to the way that specific social objectives are being advanced through the exercise of corporate power. He also accepts that part of that objection is rooted in the belief that such issues are better decided democratically than in the C-suite. But he and Barbaro point out that the GOP did not object to corporate power before. To them, the change of attitude reflects the way that corporations’ agendas have diverged from that of their traditional Republican allies.
It would be naïve to totally dismiss this, but it would also be naïve to think this is the whole story. Indeed, something deeper has been going on. When corporations participated in the political process (through lobbying and the like) to advance, directly or indirectly, their economic interest, that political agenda was likely to overlap with a pro-business Republican Party. But, constrained by the linkage to corporate economic interests, that agenda was also going to be narrow, and properly viewed as equivalent to that of a constituent. When that agenda is no longer connected to the proper purpose of a corporation — working in the economic interests of its shareholders — that gives a company’s managers the power to use corporate money (which is to say, other people’s money) to pursue objectives that should not be within their remit. Under those circumstances, they are not acting as constituents, but as activists, beholden to who knows who. And that’s something to which politicians on both sides of the aisle should object.
That the ESG debate has become politicized (indeed, as Gelles and Barbaro note, it may lead to Biden’s first use of his presidential veto) is thus to be welcomed. ESG is profoundly political — if it were just about economic return this would not be the case — and it is only fitting that it is now subject to increasing political scrutiny by elected representatives. That’s how democracies are supposed to work.
Gelles concludes:
If you ask the CEO of a big company, as I often do, if all this noise is making an impact on their ESG goals, they will very quickly tell you that they are committed to going net zero carbon emissions in the next couple of decades. They will tell you that they believe a diverse workforce is a healthy and productive workforce. And they are all for good governance. In the same breath, they will tell you, off the record usually, that if they never have to say the word ESG again, they would be totally fine with that.
This whole debate has become a political liability that they don’t necessarily like dealing with every day, even as they continue to fundamentally believe in a lot of these priorities as the right thing to do in the long term. So whether or not we call it ESG two years from now, these policy priorities are not going anywhere anytime soon.
Let’s put that another way.
C-suite to investors (as opposed to the investment managers to whom they have entrusted their money): You don’t count.
C-suite to voters: Do what you’re told.
National Review Institute: Ideas Summit
We will be holding an ideas summit in Washington DC on March 30-31.
Topic: The Sources of American Strength
Participants include:
Ryan T. Anderson, David L. Bahnsen, Louis Brown, Senator Tom Cotton, Allen C. Guelzo, Pano Kanelos, Megyn Kelly, Terry & Matt Kibbe, Bjørn Lomborg, Jessica Melugin, Douglas Murray, Ajit Pai, Mike Pence, Vivek Ramaswamy, Ian Rowe, Carrie Severino, Elise Westhoff, Rich Lowry & National Review writers.
More details here.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 110th episode, David is joined by Alan Reynolds. Alan is a senior fellow at the Cato Institute and a long-time Reagan-era supply-side economist and thought leader. Listen in for a conversation on why inflation is lower than people think — and has been — and why the Fed is making the same mistake in 2023 that it made in 2021, only from the other side of the coin. Just as “too easy” creates all sorts of problems, “too tight” does the same — and then, guess what, leads to a new era of . . . “too easy.”
No Free Lunch
David has also launched a new six-part digital video series, No Free Lunch, here on National Review Online. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy . . .
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
Capital Writing
As part of a project for Capital Matters called Capital Writing, Dominic Pino will be interviewing authors of economics books for the National Review Institute’s YouTube channel. This time, he talked to Sir Paul Tucker, a former deputy governor of the Bank of England, about his book, Global Discord: Values and Power in a Fractured World Order. Here you will find an edited transcript of a few key parts of their conversation as well as the full video of their interview.
The Capital Matters week that was . . .
Urban Planning
In the suburbs outside Washington, D.C., politicians’ and bureaucrats’ glowing predictions have once again run face-first into economic reality. The announcement that Amazon is pausing construction of its “HQ2” project in Arlington, Va., demonstrates yet again that the best way for an American city or state to “win” in economic development is by not playing the game . . .
Healthcare
Eli Lilly announced recently that they will cap the cost of insulin at $35 a month, putting the pharmaceutical giant in line with the popular insulin-cap provision in the Inflation Reduction Act. While some are praising President Biden and other politicians for the price cut, the real winner in the reduction of insulin prices is the market . . .
Banking
Michael Ryall and Siri Terjesen:
With fitting irony, Silicon Valley Bank (SVB) was founded about 40 years ago over a poker game. As it grew from those humble origins, SVB became a fixture in the Silicon Valley finance ecosystem, with loans extended to 44 percent of all venture-capital-backed tech and health-care companies.
Then, last Friday, SVB was shut down by the FDIC following an 87 percent crash in its stock . . .
Bank failures are always complicated stories, even when they are, at bottom, very simple. It is worth unpacking a few of the angles of the failure of Silicon Valley Bank, both in public-policy terms and in more basic business terms . . .
The failure of Silicon Valley Bank and the reaction to that failure raise the question of what a successful banking regulatory regime looks like.
On the one hand, policy-makers want a competitive banking sector. They want lots of small banks competing for customers rather than a few big banks dominating. You hear this in the laments over the decline in community banks and efforts to rejuvenate them.
On the other hand, policy-makers want every bank to succeed . . .
John Cochrane, who was today’s guest on Charlie’s podcast (listen here), wrote a blog post about a paper that four economists wrote over the weekend. They look at the question many people are now asking: How unusual was Silicon Valley Bank?
Every bank is dealing with the same Federal Reserve raising the same federal funds rate, but so far most have been fine. SVB was unusually dependent on long-term securities for its assets and unusually monolithic in its depositors, which were almost entirely tech companies. Other banks with more diversified assets and depositors shouldn’t have as hard a time.
That’s roughly what the paper found, although there do seem to be considerable risks going forward . . .
The failure of Silicon Valley Bank should not have been a surprise to financial executives and bank regulators. They should have seen it coming, and the fact that they didn’t raises significant concerns about the post-2008 regulatory apparatus that was supposed to prevent this kind of thing.
SVB’s failure was not due to fraud . . .
After all its years of trouble, Credit Suisse is in the middle of a three-year restructuring program, but in the last couple of days, it has received two major blows, made worse by the crisis of confidence in banks sweeping in from across the Atlantic. The most important came from the bank’s lead shareholder . . .
Another way to put it is that those managing the bank, and to some extent the depositors, bought into the notion that the super-low interest rates of the past decade would never go up so there was no reason to worry about large account deposits well above the insured level. But interest rates went up.
These SVB managers and shareholders aren’t alone in having held the belief that interest rates would forever stay low. I had been told many times that we never have to worry about the debt accumulated by Uncle Sam because interest rates were low and would never rise . . .
Tax
State lawmakers have been driving down income-tax rates across the map for two consecutive fiscal years, and they show no sign of relenting in 2023. The extraordinary wave of state income-tax cuts that began in 2021 is set to continue as states such as West Virginia, North Dakota, and Kentucky are moving quickly to cut rates this year . . .
Electric Vehicles
Electric vehicles are probably in the future of most drivers in the West (at least the future of those drivers who will be able to afford them) — whether or not they are based on the automotive technology car buyers prefer. Reason being that the choice to opt for ‘traditional’ cars will be more and more constrained. And the reason for that is that Western consumers freely deciding what car they want to buy is not the sort of choice climate policymakers want them to have . . .
Adam Smith 300
Adam Smith and Jane Austen share many things, from ethics to common sense, but perhaps the most significant is a kind of celebrity across political and disciplinary boundaries. If Austen is “everybody’s Jane,” Smith is becoming everybody’s Adam, celebrated by people as diverse as Ludwig von Mises and Robert Reich.
As an English professor, I claim Adam Smith for my own discipline, not least because he began his career as a teacher of Rhetoric and Belles Lettres (a term roughly meaning “polite literature”) . . .
ESG
The debate over ESG investing has so far focused on publicly listed corporate equities, but participants in other capital markets have also expressed interest in “socially responsible” asset management. The U.S. municipal-bond market, for one, has seen a lot of ESG activity. Unfortunately, much of this activity ranges from dubious to dangerous . . .
Trade
Hailed as President Biden’s signal legislative achievement, the Inflation Reduction Act (IRA), passed in August 2022, encapsulates the Biden approach to industry. The IRA spends big on the ambitious, if debatable, goal of speeding up America’s adoption of lower-carbon technologies. Rather than applying its tax incentives in a neutral way that would facilitate efficient purchases of products such as electric vehicles, however, the law and the guidance to it provided by Biden’s Treasury Department explicitly channel business to American manufacturers. The new law effectively limits the incentive now known as the clean-vehicle credit to cars and trucks assembled in North America with North American battery components.
For the EV market this immediately yielded perverse outcomes . . .
Climate
As the Telegraph‘s report makes clear, the BBB owed its success to more than its opposition to the nitrogen rules, and (from what little I know about it) the party is not anti-green; it is merely paler green than its opponents. Voting for it was one way of signaling general discontent with the Rutte government. Nevertheless, that it was the vehicle chosen by so many Dutch voters to show their unhappiness means something.
The senate is the Netherlands’ upper legislative chamber. It has the power to block laws passed in the Dutch parliament’s lower house. In other words, it matters.
It will be interesting to see what happens next. In the meantime, politicians in France, Italy, and (above all) Germany who are concerned about what electric vehicles could mean for their auto sector and for those who work in and for it must be feeling a little nervous.
If not, they should.
Fiscal Policy
We propose a debt brake for the U.S. that would initially be more stringent than the Swiss debt brake, because of the high and unsustainable levels of debt in the U.S., including a possible big addition to that burden if President Biden’s proposals are enacted. We propose that a spending limit (read: cap) be calculated each year, and that the cap be reduced by 1 percent. This procedure would remain in place until debt is reduced to less than 100 percent of national income (it is around 120 percent now). When less than 100 percent of debt to GDP has been reached, the U.S. debt brake would switch to a standalone cap, like that of the Swiss . . .
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