Macro Roundup

“…Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable. It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change….My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself….”

Also note“…In practice, there has been avery weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project…”

James Mackintosh, "Why the Sustainable Investment Craze Is Flawed,"Wall Street Journal, January 23, 2022, https://www.wsj.com/articles/why-the-sustainable-investment-craze-is-flawed-11642865789

Why the Sustainable Investment Craze Is Flawed

The financial industry has spotted an opportunity to make money by helping people feel good about themselves. Despite claims to the contrary, these investments don’t do much to make the world a better place.

ESG funds, as they are known, promise to invest in companies with better environmental, social and governance attributes, to save the planet, improve worker conditions or, in the case of the U.S. Vegan Climate ETF, prevent animals from being eaten.

Money has poured into ESG funds as noisy lobby groups push pension funds, university endowments and some central banks to shift their investments. The United Nations-supported Principles for Responsible Investment says signatories have $121 trillion of assets under management; even assuming lots of double-counting, that is most of the world’s managed money.

Over the next few weeks, Streetwise will explore the explosion of ESG investing and why I think it is mostly—but not completely—a waste of time. I will also offer up some solutions and discuss how to use your money to make a difference, while understanding the inevitable trade-offs.

ESG supporters can point to what look like successes: Their pressure has encouraged many companies to sell off dirty power plants, mines and, in the case of Anglo-Australian miner BHP, its oil business. It has even forced board changes at Exxon Mobil.

Sadly, selling off assets or shares by itself does nothing to save the planet, because someone else bought them. Just as much oil and coal is dug up and burned as before, under different ownership. And there are plenty of people out there to buy the assets, because never before in history has there been so much private capital operating without the public reporting requirements brought by stock markets.

Rich people who want to make the world greener could make a difference, by buying and closing dirty businesses even when they are profitable. So far, though, this hasn’t happened in any significant way. The pitch from Wall Street fund managers is the exact opposite—that by going green investors can change the world and make more money, not less.

“A lot of only really get enthusiastic if they get comfortable that they are not sacrificing return,” says Valentijn van Nieuwenhuijzen, chief investment officer at fund manager NN IP, which is being bought by Goldman Sachs.

Someone has to take a loss somewhere if fossil fuels are going to be left in the ground rather than extracted and sold. ESG investors’ hope is that the losses will fall on other people. The problem is that less environmentally-minded investors buying those shares, oil wells or power plants are absolutely not going to shut them down unless they stop being profitable.

It might make sense for an investor or company to sell out of fossil fuels early if they think the retreat from coal and oil is inevitable—indeed, that was the pitch by the activist who took on Exxon—but that is simply to invest according to a political prediction, not a way to fight climate change.

There are three big pro-ESG arguments, which sound reasonable, but have major flaws.

First, if companies treat the environment, workers, suppliers and customers better, it will be better for business. This could work where companies have missed something to boost profits, such as add solar panels on a sunny roof or create a better employee retention program. Early ESG activists plucked the low-hanging fruit here, but management has become painfully aware of changing customer and employee expectations, so there is less opportunity ahead.

Adding costs to reduce a company’s carbon footprint, or paying staff more, should only help the stock price if it also raises revenue or reduces other costs, by say generating more loyalty from carbon-conscious consumers, lowering staff turnover or improving relations with regulators.

Otherwise profits can only be maintained by passing the higher costs through into higher prices, and—unless the firm has monopoly power—eventually customers who don’t care will go elsewhere. The alternative is to reduce profits, but ESG investors are almost universally against this.

The second ESG point is that by shunning stocks or bonds of dirty companies, and embracing those of clean companies, it will direct capital away from bad things and toward good ones. After all, a lower stock price or higher borrowing cost in the bond market should make it less attractive for dirty companies to expand, and vice versa for clean companies.

In practice, there has been a very weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project.

That is not to say there is no link. Tesla, with extremely expensive shares, has repeatedly taken advantage of its ability to issue new stock to invest in factories and research. The high prices early last year for clean-energy stocks might have encouraged similar corporate investment. The flip side of course is that buying wildly overpriced shares isn’t a good way to make money, as losses of a third or more from this year’s peaks for clean-energy stocks shows. Shifting the cost of capital just might help save the planet, but after the short-term shift in valuations is over, it should lead to underperformance.

The third claim from some ESG investors is that they are just trying to make money, and that involves shunning firms that are taking unpriced risks with the environment, workers or customers. Since they call themselves “sustainable” or use “ESG integration,” funds doing this look very like the rest of the ESG industry. The selection principle of the most popular ESG indexes, for instance, those from MSCI, involves identifying only risks that are financially material.

I would say, sure. If you think the government is going to, say, raise fuel taxes, don’t buy manufacturers of gas-guzzlers. If you think the government will impose more restrictions on coal plants, then coal generation will be an even less attractive investment.

Equally, if you think customers will be willing to pay more for brands that cut their carbon use, by all means bet on their shares. Just don’t fool yourself that you are making much difference to the world with your investment decision. Red-blooded capitalists chase these profits just as much as any green-minded investor. There is no need to try to persuade capitalists to have a conscience; they will do what you want if you make it profitable via customer demands or government intervention (or, if we are lucky, new technology).

There is one way that ESG investing does, sort of, work. Shareholders can push companies to stop lobbying governments in favor of fossil fuels. Conceivably this might help push customers and governments to do the things that would really make a difference.

My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself.

Giovanni Peri and Reem Zaiour estimate that relative to the 2020 trend the United States is down 2 million working aged immigrants, half of whom would have been college educated, "...During the years 2020 and 2021, the number of immigrants arriving in the United States decreased substantially...This decline in immigrant and nonimmigrant visa arrivals resulted in zero growth in working-age foreign-born people in the United States. Prior to 2019, the foreign born population of working age (18 to 65) grew by about 660,000 people per year, as reported in data from the monthly Current Population survey…. This trend came to a stop already in 2019 before the pandemic, due to a combination of stricter immigration enforcement and a drop in the inflow of Mexican immigrants. The halt to international travel in 2020 added a significant drop in the working-age immigrant population. As of the end of 2021, the number of working-age foreign-born people in the United States is still somewhat smaller than it was in early 2019. and,relative to the level it would have achieved if the 2010-2019 trend had continued, there is a shortfall of about 2 million people. A similar calculation done using Current Population Survey (CPS) monthly data on foreign-born individuals with a college degree indicates that of the missing two million foreign workers, about 950,000 would have been college educated, had the pre-2020 trend continued. This is a very substantial loss of skilled workers, equal to 1.8 percent of all college-educated individuals working in the US in 2019.... As the U.S economy recovered from the Covid-19 crisis in 2021 and job-creation increased, employers found it more difficult to fill jobs. Across sectors, these shortages are significantly associated with the loss of foreign workers. The recent economic recovery has seen more numerous job openings and jobs going unfilled for longer periods of time. In spite of upward pressure on wages in several sectors, such as hospitality and food-related services, the number of unfilled job openings relative to employment has remained very high. The absence of foreign-born workers plays an important role in this. Those sectors that had a higher percentage of foreign workers in 2019 had significantly higher rates of unfilled jobs in 2021 (see second chart). Our estimates suggest that an industry that had a 10% higher dependence on foreign workers than another industry in 2019 saw a 3% higher rate of unfilled jobs in 2021….The loss of two million potential immigrants, of which a million are college educated, could impact productivity and employment in the long run..."

Giovanni Peri and Reem Zaiour, "Labor Shortages and the Immigration Shortfall,"Econofact, January 11, 2022, https://econofact.org/labor-shortages-and-the-immigration-shortfall

Labor Shortages and the Immigration Shortfall

The Issue:

The Facts:

During the years 2020 and 2021, the number of immigrants arriving in the United States decreased substantially. In the early months of 2020 and in response to the Covid-19 health crisis, the Trump administration closed the borders with Mexico and Canada and placed restrictions on international arrivals. Visa processing at U.S. embassies and consulates around the world was also severely disrupted, leading to a dramatic decline in the inflow of foreign nationals on all types of temporary visas. According to the Department of State, the slowdown in visa processing generated much fewer visa entries and a large backlog of more than 460,000 people with unprocessed visas as of late 2021. Similarly, the number of permanent residents arriving in the U.S. also fell substantially. Statistical estimates relative to the Fiscal year 2020 (from October 1st 2019 to September 30th 2020) indicate a decrease of immigrant visas by 45% and a decrease of nonimmigrant visas by 54% relative to the previous year.

This decline in immigrant and nonimmigrant visa arrivals resulted in zero growth in working-age foreign-born people in the United States. Prior to 2019, the foreign born population of working age (18 to 65) grew by about 660,000 people per year, as reported in data from the monthly Current Population survey (see the first chart). This trend came to a stop already in 2019 before the pandemic, due to a combination of stricter immigration enforcement and a drop in the inflow of Mexican immigrants. The halt to international travel in 2020 added a significant drop in the working-age immigrant population. As of the end of 2021, the number of working-age foreign-born people in the United States is still somewhat smaller than it was in early 2019. and, relative to the level it would have achieved if the 2010-2019 trend had continued, there is a shortfall of about 2 million people. A similar calculation done using Current Population Survey (CPS) monthly data on foreign-born individuals with a college degree indicates that of the missing two million foreign workers, about 950,000 would have been college educated, had the pre-2020 trend continued. This is a very substantial loss of skilled workers, equal to 1.8 percent of all college-educated individuals working in the US in 2019.

The loss of foreign workers is not the only reason for the high rate of unfilled jobs. Increased retirement and increased bargaining power of workers are likely playing an important role. While more generous unemployment and welfare benefits introduced during the crisis may have discouraged workers from taking low-paying jobs in 2020 and early 2021, they do not seem to be the cause of current shortages, since most of those benefits expired by mid-2021. Recent anecdotal and preliminary evidence finds a push by workers for more job-flexibility, safety and, generally, better conditions causing resignations and contributing to unfilled job openings. Moreover, increased retirement rates have contributed to the decline in available workers. A recent study finds that just excess retirement and reduced re-entry of retirees to the labor force has increased the share of retirees relative to the US labor force by 1.3 percentage points in the last 2 years (compared to an annual rate of increase or about 0.3 percentage points prior to the pandemic). These factors have affected labor availability, especially in low-paying manual-intensive jobs in sectors as food services and hospitality. The second chart shows that the rates of unfilled jobs in those two sectors are well above what is predicted by the statistical association across all industries between the rate of unfilled jobs and industries' dependence on foreign workers, suggesting that other factors are at work in those sectors.

The loss of two million potential immigrants, of which a million are college educated, could impact productivity and employment in the long run. A recent study by one of the authors shows that college educated immigrants are likely to work in the Science, Technology, Engineering and Math (STEM) sectors; these jobs are drivers of innovation and productivity growth. Additionally, research focused on the high-skilled STEM jobs shows that they are responsible for creating a job-multiplier effect at the local level, producing opportunities of up to 2.5 additional jobs for each additional employed high-skilled worker through local demand for goods and services and by companies expanding and hiring other workers. In light of these effects, the loss of one million college-educated immigrants may leave the U.S. economy with lower productivity which translates to lower growth. Applying the estimated job multiplier from the research referenced above to the observed loss of college-educated immigrants implies 2.5 million fewer jobs in those local economies where the immigrants would have worked.

The loss of immigrants could imply a large loss of entrepreneurship. Immigrants have a three times higher probability of starting firms than natives in the U.S., according to estimates from an article published in 2020. Immigrants are more likely to start small firms (with 0-10 employees) but also medium size and large firms (with 1000 employees or more) relative to natives. Using the estimated entrepreneurship rate of immigrants from this study, two million fewer immigrants would imply a decline in firm creation, solely due to lack of entrepreneurs, corresponding to a loss of more than 200,000 jobs.

The loss of foreign college students will affect American educational institutions. Foreign college students are the part of the foreign-born population with the largest decline in the last 2 years. After decades of continued growth in foreign enrollment in American colleges and universities, peaking in 2018-19, their number dropped by 20% in 2020. This has had an adverse effect on higher education, one of the largest U.S. service exports. Furthermore, foreign students, especially graduate students, have been very important contributors to US research and innovation and patenting. Their absence could weaken the innovation and patenting potential of those universities, research institutions, and businesses that depend on cutting-edge research and innovation.

What this Means:

The shortfall of immigrants over the past two years has had immediate adverse consequences for filling jobs and also harms the long-run prospects for the U.S. economy. The drop in the number of foreign students and high-skilled immigrants is particularly concerning for the long-run effects on productivity, innovation and entrepreneurship. The drop in the number of less-skilled immigrants can be contributing to the current shortages in several industries in which they had been highly represented. In light of this, the government should make an effort this year to facilitate the processing of non-immigrant and immigrant visas to avoid further reducing the number of immigrants and the resulting negative economic consequences.