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Allocation, distribution, and scale

Although ecological tax reform uses price as the policy instrument (price plus tax), the major goal is to limit quantity of throughput to a sustainable scale. A secondary goal is to raise public revenue. In practice, one should begin with an acceptable quantity of throughput in mind, and set the tax so as to likely result in that quantity. That tax would then represent a rough internalization of the previously externalized cost of excessive scale. If the tax bears on resource use in general then there will not be much room to avoid the tax by substitution, and resource demand will be inelastic, so revenue raised will be large. If the tax is aimed at inducing substitution away from the taxed activity (e.g., emissions of toxic wastes) then there will be a trade-off between revenue raised and success in inducing substitution. As with the present tax system, some fine-tuning would be required from time to time.

The relation among the three goals is clearest in the design of tradable permits schemes. These utilize a socially and ecologically set limit to the total annual depletion or pollution in a given area or sector of the economy. The right, say, to pollute was previously a free good because it was unlimited. With limits it becomes an economic asset. Who owns the new asset? It could be anyone, but it is best to vest ownership in the government and require firms to purchase the rights at auction from the government. The scarcity rents arising from scale limits are thus captured by the society as a whole and become public revenue. Once purchased, these permits can be freely traded among firms. Sustainable scale is served by the limited aggregate number of permits. Equitable distribution is served by initial public ownership of the new asset. Efficient allocation is served by allowing exchange of the new asset among firms.

Once an overall throughput scale limit is fixed as a social goal, one can thus fix that right quantity directly and let the market indirectly determine the corresponding right price. It is also possible to set the price (tax) directly and allow the market to find the corresponding right quantity. In both cases the target is the right quantity, and the "right" price is the price that leads the market to that quantity. Both procedures assume that there is a strong social preference for a sustainable aggregate scale, and that a market directed only by individualistic preferences and maximizing behavior cannot incorporate that social value.

The great virtue of the tradable permits scheme is that it forces us to distinguish three separate policy goals and to recognize that they require three separate policy instruments. The goals are:

(1) Allocation - the division of the resource flow among alternative product uses;

(2) Distribution - the division of the resource flow, embodied in products, among different people;

(3) Scale- the total volume of the resource flow, the matter-energy throughput taken from the environment as low-entropy resources and returned to the environment as high-entropy wastes. Scale is relative to environmental carrying capacity.

Economic theory tells us that relative prices formed by supply and demand in competitive markets lead to an efficient allocation. Economic theory also tells us that there is a different efficient allocation for every initial distribution of ownership, so that justice or fairness of distribution is a separate goal from efficiency and requires use of separate policy instruments - transfer payments such as welfare, social insurance, inheritance taxes, etc. As for scale, it is largely ignored by standard economic theory, which has implicitly assumed that environmental sources and sinks were infinite. Consequently there is in traditional economic theory no policy instrument for keeping scale within carrying capacity - nothing analogous to the Plimsoll line or load limit mark on a ship.

The scale limit, the economic Plimsoll line, is evolving in practice ahead of theory. The beauty of the tradable permits scheme is that, first, the society must face the scale question and draw a Plimsoll line at the amount of aggregate pollution (or depletion) that is ecologically sustainable. Second, rights to pollute (or deplete) up to that limited amount become a valuable asset and their ownership must be initially distributed in some politically acceptable manner. Only after these two political steps can market trading attain the efficient allocation. The market is "free" only after its ecological and distributional boundaries have been politically established.

The distribution and scale questions are just as "economic" as the allocation question, in that they all involve the comparison of costs and benefits. But the dimensions in which costs and benefits are defined are different in each of the three cases. Allocative prices cannot measure the costs and benefits of scale expansion, nor can they measure the costs and benefits of a more equal distribution of wealth. The three different optima require three different policy instruments. In each case an optimum is formally defined by the equality of falling marginal benefits and rising marginal costs. But the definitions and measures of costs and benefits in each of the three cases are different because the problems to whose solution they are instrumental are different. The relative price of shoes and bicycles suffices to allocate resources efficiently between shoes and bicycles, but is clearly not sufficient for deciding the proper range of inequality in wealth, nor for deciding how many people consuming how much per capita of natural resources gives the optimal scale relative to the ecosystem.

Distribution and scale involve relationships with the poor, the future, and other species, that are more social than individual in nature. Homo economicus, whether the self-contained atom of methodological individualism or the pure social automaton of collectivist ideology, is in either case a severe abstraction. Our concrete experience is that of "persons in community." We are individual persons, but our individual identity is defined by our social relations. Our relations to each other are not just external, they are also internal - i.e., the nature of the related entities (ourselves in this case) changes when relations among them change. We are related not only by the external nexus of individual willingnesses to pay for different things, but also by relations of kinship, friendship, citizenship, and trusteeship for the poor, the future, and for other species. The attempt to abstract from all these relationships a Homo economicus, whose identity is constituted only by individualistic willingness to pay, is a gross oversimplification of our concrete experience as persons in community an example of what A. N. Whitehead called the "fallacy of misplaced concreteness. "

The prices that measure the opportunity costs of reallocation are unrelated to measures of the opportunity costs of redistribution, or of a change in scale. Any trade-off among the three goals (e.g., an improvement in distribution in exchange for a worsening in scale or allocation, or more efficient allocation resulting from the harsher incentives of a less equal distribution of income), involves an ethical judgment about the quality of our social relations, rather than a supposedly simple willingness-to-pay calculation. The contrary view, that this choice among the three separate policy goals, and consequently the social relations that help to define us as persons, should be made on the basis of individual willingness to pay, just as the allocative trade-off between chewing gum and shoelaces is made, seems to be dominant in economics today. It is part of the retrograde contemporary reduction of all ethical choice to the level of personal tastes weighted by income.

The omission of the scale of the macroeconomy from economic theory has several explanations. The most obvious is that when the theory was first devised, the scale of the economic subsystem was small relative to the environment; the world was "empty," so it seemed reasonable to treat the environment as a free good. Those days are clearly past, and we now live in a relatively "full" world. The second explanation is more complicated. Basically it is the doctrine that all we consume is value added, and all value added is the product of the human agents of labor and capital. This notion is examined in the following section.

Consumption and value added

When we speak of consumption, what is it that we think of as being consumed? Alfred Marshall reminded us of the laws of conservation of matter/energy and the consequent impossibility of consuming the material building blocks of commodities:

Man cannot create material things - his efforts and sacrifices result in changing the form or arrangement of matter to adapt it better for the satisfaction of his wants - as his production of material products is really nothing more than a rearrangement of matter which gives it new utilities, so his consumption of them is nothing more than a disarrangement of matter which destroys its utilities. (Marshall, 1961, pp. 63-64.)

What we destroy or consume in consumption according to this view is the improbable arrangements of those building blocks, arrangements that give utility for humans, arrangements that were made by humans for human purposes. This utility added to matter/ energy by human action is not production in the sense of creation of matter/energy, which is just as impossible as its destruction by consumption. Useful structure is added to matter/energy (natural resource flows) by the agency of labor and capital stocks. The value of this useful structure imparted by labor and capital is what economists call "value added." This value added is all that is "consumed," i.e., used up in consumption. New value needs to be added again by the agency of labor and capital before it can be consumed again. That to which value is being added is the flow of natural resources, conceived ultimately as the indestructible building blocks of nature. The value consumed by humans is, in this view, no greater than the value added by humans, which in turn is equal to the sum of all value added. In this standard economist's vision we consume only that value which we added in the first place. And then we add it again, and consume it again, etc. This vision is formalized in the famous diagram of the isolated circular flow of value between firms (production) and households (consumption) found in the initial pages of every economics textbook.

With all this focus on value added one would think that there would be some discussion of that to which value is being added. But modern economists say no more about it than Marshall. It is just "matter," and its properties are not very interesting to economists. In fact they are becoming ever less interesting to economists as science uncovers their basic uniformity. As Barnett and Morse (1963) put it:

Advances in fundamental science have made it possible to take advantage of the uniformity of matter/energy - a uniformity that makes it feasible, without preassignable limit, to escape the quantitative constraints imposed by the character of the earth's crust.

In such a view, that to which value is being added are merely homogeneous, indestructible building blocks - atoms in the original sense - of which there is no conceivable scarcity. That to which value is added is therefore inert, undifferentiated, interchangeable, and superabundant - very dull stuff indeed, compared to the value-adding agents of labor with all its human capacities and capital that embodies the marvels of human knowledge. It is not surprising that value added is the centerpiece of economic accounting, and that the presumably passive stuff to which value is added has received minimal attention. (Daly and Cobb, 1994, Chap. 10)

Three examples will show how little attention is given to that to which value is added, which for brevity I will refer to as "resources." Some Philistines ("noneconomists" as they are now called) have questioned whether there are enough resources in the world for everyone to use them at the rate Americans do. This ignorant fear is put to rest by Professor Lester Thurow (1980, p. 118), who points out that the question assumes that the "rest of the world is going to achieve the consumption standards of the average American without at the same time achieving the productivity standards of the average American. This of course is algebraically impossible. The world can consume only what it can produce."

In this comforting view, you can only disarrange matter (consume) if you have previously arranged it (produced). Resources are totally passive recipients of form added by labor and capital. Value added is everything, and it is impossible to subtract value that was never added. So if you are consuming something you must have produced it, either recently or in the past. More and more high-consuming people just means more and more value was added. Where else could the arrangements of matter have come from? It is "algebraically impossible" for consumption to exceed value added - at least in the economist's tight little abstract world of the circular flow of exchange value.

A second example comes from Professor William Nordhaus (1991), who said that global warming would have only a small effect on the U.S. economy because basically only agriculture is sensitive to climate, and agriculture is only three per cent of total value added, of GNP. In this perspective, it is solely the value added to seeds, soil, sunlight, and rainfall by labor and capital that keeps us alive. Older economists might have asked about what happens to marginal utility, price, and the percentage of GNP going to food when food becomes very scarce, say, due to a drought? What about the inelasticity of demand for necessities? Could not the three percent of GNP accounted for by agriculture easily rise to ninety per cent during a famine? But these currently unfashionable considerations give mere stuff a more than passive role in value, and diminish the dogmatic monopoly of value added by human agents of labor and capital.

The importance of mere stuff is frequently downplayed by pointing out that the entire extractive sector accounts for a mere five or six per cent of GNP. But if in reality the ninety-five per cent of value added is not independent of the five per cent in the extractive sector, but rather depends upon it - is based on it - then the impression of relative unimportance is false. The image this conjures in my mind is that of an inverted pyramid balanced on its point. The five or six per cent of the volume of the pyramid near the point on which it is resting represents the GNP from the extractive sector. The rest of the pyramid is value added to extracted resources. That five per cent is the base on which the other ninety-five per cent rests: that to which its value is added. Value cannot be added to nothing. Adding value is more like multiplication than addition - we multiply the value of stuff by labor and capital. But multiplying by zero always gives zero.

Indeed, since the value of the extracted resources themselves (the five or six per cent of GNP) represents mostly value added in extraction and processing, practically the entire pyramid of value added is resting on a tiny point of near zero dimension representing the in situ value of the resources (user cost). This image of a growing and tottering pyramid makes me want to stop thinking exclusively about value added and think some more about that to which value is being added. What, exactly, is holding up this pyramid of value added?

A third example comes from the theory of production and the customary use of a multiplicative form for the production function, the most popular being the Cobb-Douglas. Frequently production is treated as a function of capital and labor alone - resources are omitted entirely. But now economists have taken to including resources. However, the welcome step toward realism thus taken is very small, because, although resources are now admitted to be necessary for production, the amount of resources needed for any given level of output can become arbitrarily small, approaching zero, as long as capital or labor are substituted in sufficient quantities. Georgescu-Roegen referred to this "paper and pencil exercise" as Solow's and Stiglitz's "conjuring trick."*

*N. Georgescu-Roegen deserves to be quoted at length on this point because so few people have understood it. He writes the "Solow-Stiglitz variant" of the Cobb-Douglas function as:



"where Q is output, K is the stock of capital, R is the flow of natural resources used in production, L is the labor supply, and a1 + a2 + a3 = 1 and of course, ai > 0.

From this formula it follows that with a constant labor power, Lo, one could obtain any Q0!!!, if the flow of natural resources satisfies the condition


This shows that R may be as small as we wish, provided K is sufficiently large. Ergo, we can obtain a constant annual product indefinitely even from a very small stock of resources R > 0, if we decompose R into an infinite series, with Ri (r) 0. use Ri in year i, and increase the stock of capital each year as required by (2). But this ergo is not valid in actuality. In actuality, the increase of capital implies an additional depletion of resources. And if K (r) inf, the R will rapidly be exhausted by the production of capital. Solow and Stiglitz could not have come out with their conjuring trick had they borne in mind, first, that any material process consists in the transformation of some materials into others (the flow elements) by some agents (the fund elements), and second, that natural resources are the very sap of the economic process. They are not just like any other production factor. A change in capital or labor can only diminish the amount of waste in the production of a commodity: no agent can create the material on which it works. Nor can capital create the stuff out of which it is made. In some cases it may also be that the same service can be provided by a design that requires less matter or energy. But even in this direction there exists a limit, unless we believe that the ultimate fate of the economic process is an earthly Garden of Eden.

"The question that confronts us today is whether we are going to discover new sources of energy that can be safely used. No elasticities of some Cobb-Douglas function can help us to answer it."

(N. Georgescu-Roegen, "Comments ..." in V. Kerry Smith, ea., Scarcity and Growth Reconsidered, Baltimore: Resources for the Future and Johns Hopkins University Press, 1979, p. 98.)

Policy implications

A fundamental economic principle is to maximize the productivity of the limiting factor in the short run and to invest in its increase in the long run. If factors are good substitutes, then the absence of one does not limit the usefulness of the other - i.e. neither can be limiting. But if they are complements, then the one in short supply is limiting. For example, plant growth requires sunlight, soil, and water. These factors are complements, not substitutes. Extra sunlight does not compensate for a lack of water. Plant growth is effectively limited by whichever of the three factors is most scarce. Unless that limiting factor is increased, it does no good to increase the others. The idea is familiar to ecologists and chemists as Liebig's Law of the Minimum.

From the foregoing it is clear that the relationship between value-adding agents (man-made capital, including labor power) and that to which value is added, natural resources (the natural income flow produced by the stock of natural capital), is one of complementarily. Even if man-made and natural capital were good, but imperfect, substitutes, the process of transforming the latter into the former would still reach an optimum extent. But if man-made and natural capital are complements, that optimum extent will be reached much sooner and more dramatically, since the scarcity of the factor in shortest supply will limit the usefulness of the other, more abundant factor. In the empty-world economy of the past, man-made capital was the limiting factor. In today's full-world economy it is remaining natural capital that is scarce and therefore limiting. The fish catch is limited not by the number of fishing boats, but by the remaining populations of fish in the sea. The timber harvest is limited not by the number of sawmills or lumberjacks, but by the remaining standing forests and our desire to preserve the non-timber services of forests (wildlife habitat, flood control, recreation, etc.).

As we move into an era in which natural capital is limiting, we need to economize on it more. That means its price must go up relative to man-made capital. But since much natural capital is common property, outside the market, and since the market itself is very shortsighted temporally, it is necessary to raise the price of natural capital by public policy. As we have seen earlier, this can be done in a general way by shifting the tax base from value added (labor and capital are no longer limiting) on to that to which value is added (the natural resource flow yielded by natural capital). In short, tax throughput, not income.

Consumption limits will be set by differing national policies - not by a single global policy. Nations could limit their total consumption (scale) by a strategy of low population and high per capita consumption or by a strategy of high population and low per capita consumption. Different nations will make different choices. Some will not even limit aggregate consumption and those that do will make different choices regarding per capita consumption vs. population. These differences cannot be maintained in a world of free trade, free capital mobility, and increasingly free (or uncontrolled) migration. Compensating tariffs will be necessary to keep these national differences from being homogenized. National policies of controlling consumption and population, and of counting external costs, are more important to sound allocation, distribution, and scale than are the tenuous gains from comparative advantage and free trade, which are currently celebrated beyond reason. This argument does not imply autarchy, but it does throw cold water on the faddish advocacy of global economic integration and consequent homogenization of policies as an unquestioned good. "Globalization" ranks with "the demographic transition" and "dematerialization" as a false panacea another germ of truth that has been allowed to grow into a whale of a fantasy in order to protect the dominant myth of our culture: that of an ever-growing economy.

Two views of production have been discussed: (a) only value added to indestructible building blocks is consumed, vs. (b) value added by nature as well as human agents is also consumed. There are important policy differences implied by each.

(a) The value-added view of wealth would lead one to reject the very notion of a "global pie" of wealth to be divided justly or unjustly among nations and people. In this view, there is no pie - there are only a lot of separate tarts which some statistician has stupidly aggregated into an abstract pie. The separate tarts are the product solely of value added by the labor and capital of the nations that produced them. If nation A is asked to share some of its large tart with nation B who baked a small tart, the appeal should be made to nation A's generosity and not to any notion of distributive justice, much less exploitation. On the assumption that all value comes from labor and capital, and that nature contributes only a material substratum which is indestructible and superabundant, and hence valueless, this is a quite reasonable view. Are you poor? Well, just add more value by your own labor and capital. There are no limits from nature. Stop whining about this imaginary pie, and get busy adding value. This view is common among neoclassical economists. And if we accept its presuppositions it is not unreasonable.

(b) The natural capital view can reject the imaginary pie also, and look at the tarts different people have baked. Are they really only the product of labor and capital and random atoms? Certainly not. You need flour and sugar and butter and apples. Before that you needed wheat, sugar cane, milk, and apple trees. And before that you needed a gene pool for wheat, sugar cane, cows, and apples, with some minimal degree of genetic diversity, and grass growing on soil whose fertility is maintained by all sorts of worms and microbes, and sunlight without too much ultraviolet, and rainfall that is not too acidic, and catchment areas to keep that rain from eroding topsoil, and predictable seasonal temperatures regulated by the mix of gasses in an atmosphere without too much CO2, etc., etc. In other words, we need natural capital and the flow of resources and services that it renders a whole lot more than indestructible building blocks! Our dowry of natural capital is more or less given, and is not the product of human labor and ingenuity. It is in many ways systemic and indivisible more like a vast pie than separate tarts. How it is stewarded and distributed is not an idle question based on some gratuitous aggregation. The demands of justice impinge strongly on the stewardship and distribution of the common life-supporting exosomatic organs we refer to as natural capital, but very little on value added, since the latter rather naturally and reasonably belongs to whoever added it.

A North/South bargain will have to be struck in which the South gets very serious about limiting fertility (and the over-consumption of its elites), while the North gets very serious about limiting over-consumption (and the poverty-reinforcing high fertility of its marginalized underclass). But the North will not get serious about limiting consumption as long as our leaders remain convinced by our economists' view that all wealth comes from value added, that we can only consume what we have produced. We have to recognize that we can and do consume a lot more than we produce, and that what we consume over and above conventional value added is value added by nature. But in addition to consuming value added by nature we are now consuming the very capacity of nature to add value in the future, i.e., natural capital.

Also, in the absence of a North/South bargain not much is likely to happen on either population or consumption. Why should the South control its overpopulation if the resources saved thereby are merely gobbled up by Northern over-consumption? Why should the North control its over-consumption if the saved resources will merely allow a larger number of poor people to subsist at the same level of misery in the South?

The policy implications for the North are that we must economize on and invest in natural capital, because it has become the limiting factor (replacing man-made capital in that role) as we have moved from an empty world to a full world. To force ourselves to economize on natural capital we must raise its price above the market level. A concrete method of accomplishing this is ecological tax reform. Viewed in a North/South context, ecological tax reform takes on even greater relevance as the North's best contribution to a global bargain.


Since our consumption uses up value added by nature, as well as by human agents, the scale of the macroeconomy must respect the rate at which nature "adds value" - i.e., the rate at which resources can be regenerated and wastes can be absorbed. Ecological tax reform can make scale more sustainable, allocation more efficient, and distribution more equitable.

We are consuming natural value added, converting raw materials into waste, depleting and polluting, faster than nature can absorb the pollutants and regenerate the resources. Economists who tell us not to worry because it is algebraically impossible for us to consume more value than we added have studied too much algebra and not enough biology and physics. Consumption that is, the transformation of natural capital into man-made capital and then ultimately into waste - cannot escape the basic question of what is the sustainable scale of this transformation. What is the optimal scale of the economic subsystem, the scale beyond which further conversion of natural into man-made capital costs us more (in terms of natural capital services lost) than it benefits us (in terms of man-made capital services gained)? Growing beyond the optimum is by definition anti-economic. Currently growth appears anti-economic, as indicated by the rate of consumption of natural capital and the deterioration of community associated with growth's requirements for mobility. The future path of progress therefore is not growth, but development not an increase in throughput, but increases in efficiency.

Individual nations, not the globe, will control consumption by limiting both population and per capita consumption. Different national strategies for limiting total national consumption cannot coexist in an integrated world economy dominated by free trade, free capital mobility, and free migration. The use of tariffs and a general backing away from global integration toward relative self-sufficiency will be necessary. But a global North/South compact among nations will be needed to limit over-consumption and overpopulation.


Barnett, Harold and Chandler Morse. Scarcity and Growth. Baltimore: Johns Hopkins University Press. 1963.

Costanza, R. "Three General Policies to Achieve Sustainability" in A. M. Jansson, M. Hammer, C. Folke, and R. Costanza (eds). Investing in Natural Capital: The Ecological Economics Approach to Sustainability. Washington DC: Island Press. 1994. pp. 392-407.

Costanza, R. and H. E. Daly. "Natural Capital and Sustainable Development," Conservation Biology. No. 6, pp. 37-46. 1992.

Daly, Herman E. Steady-State Economics. Washington DC: Island Press. 2nd ea., 1991.

Daly, H. and J. Cobb. For the Common Good, Boston: Beacon Press. 2nd ea., 1994.

Georgescu-Roegen, Nicholas. "Comments ..." in V. Kerry Smith, ea., Scarcity and Growth Reconsidered, Baltimore: Resources for the Future and Johns Hopkins University Press. 1979. p. 98.

Hawken, Paul. The Ecology of Commerce: A Declaration of Sustainability. New York: Harper Business. 1993.

Marshall, Alfred. Principles of Economics. New York: Macmillan. 9th ea., 1961 (originally 1920).

Nordhaus, William. Quoted in "Academy Panel Split on Greenhouse Adaptation." Science. September 13, 1991. p. 1206.
-. Science. October 18, 1981. p. 358. "Ecological Economics" (letter).

Oates, Wallace E. "Pollution Charges as a Source of Public Revenues." Working Paper No. 9122, University of Maryland, Department of Economics. 1991.

Page, Talbot. Conservation and Economic Efficiency. Baltimore: Johns Hopkins University Press. 1977.

Passell, P. "Cheapest Protection of Nature May Lie in Taxes, Not Laws." New York Times, Nov. 24, 1992.

Repetto, R., R. C. Dower, R. Jenkins, and J. Geoghegan. Green Fees: How A Tax Shift Can Work for the Government and Economy. Washington, DC: World Resources Institute. 1992.

Thurow, Lester. The Zero-Sum Society. New York: Penguin Books. 1980. von Weizsäcker E. U. and J. Jesinghaus. Ecological Tax Reform: A Policy Proposal for Sustainable Development. London: Zed Books. 1992.

World Bank, "Development and the Environment," World Development Report. Figure 3.2, p. 69. Washington DC and New York: World Bank and Oxford University Press. 1992.

9. New concepts of fiduciary responsibility

The prudent man
The question of scale
Asset management and the behavior of business
Social investing
Economically targeted investing
The Jessie Smith Noyes Foundation
Intel, SWOP, and the process of engagement
Corporate culture and sustainability

Edward Tasch and Stephen Viederman

As long as an ecological tax reform of the kind discussed in the previous chapter is not put into practice, moving toward sustainability will require ingenious and courageous management strategies because of the inherent tension between economics, as currently practiced, and ecology. When this tension is felt in the business world, most executives tend to choose short-term economic advantage over long-term ecological sustainabiliy, and to justify their choice they frequently evoke the principle of fiduciary responsibility. This argument has again and again been used as the last line of defense in discussions between environmentalists and corporate executives.

The concept of fiduciary responsibility has been based on a narrow notion of financial prudence. An institutional investment manager quoted in the following pages put it succinctly: "As a fiduciary, I have a moral obligation to my investors to maximize return and minimize risk. I simply cannot take into account exogenous factors like social or environmental impact."

In this chapter, Stephen Viederman and Edward Tasch, two top executives of the Jessie Smith Noyes Foundation, argue that new notions of prudence and fiduciary responsibility are developing in the investment community which include concern for the impact of commercial activity on the environment and on local communities. Both authors are well placed to observe these changes, as they are also executives of environmental organizations, Viederman being a Director of the Rainforest Foundation and Tasch a Director of CERES, the Coalition for Environmentally Responsible Economies.

After reviewing the recent impressive growth of the social investment movement, which now influences investment decisions involving billions of dollars by making ecological sustainability an explicit investment criterion, the authors provide an illuminating analysis of the values and practices of their foundation. They point out that among financial institutions, most foundations are in a very curious, self-contradictory position because of an "iron curtain" between their endowment management and grant-making programs. The Jessie Smith Noyes Foundation, by contrast, has come to view its assets as well as its income as tools for social change.

The authors describe in some detail what this means in practice in terms of the management of their assets and the education of their grantees. What emerges from this description is an expanded sense of prudence and fiduciary responsibility, grounded in ecological literacy and concern for future generations.

Rate of return, liquidity, diversification, emerging markets, hedging, derivatives, asset allocation: the business of today's institutional asset manager seems as remote from global warming and ozone holes as mahjongg is from gene mapping.

The notion that financial institutions might play a role in steering business toward sustainability is, to be sure, quixotic. To most financiers, it is downright wrongheaded. Consider, for example, the remarks of two contemporary financiers, whose views are more the norm than the exception. The first, a noted Wall Street investment banker who is also widely known for his environmental interests, gave a 1990 commencement address about lessons learned from the Exxon Valdez spill, after which he took questions from the audience:

Q. You have spoken eloquently about corporate responsibility and the need for better federal regulation, but you have said nothing about the role of Wall Street. Don't investment banks and financial institutions have a role to play in shaping corporate policy, in transmitting investors' concerns regarding the environmental impact of corporate activity?

A. Absolutely not. One of the cornerstones of free markets is efficient capital markets. It would be inappropriate, inefficient, or worse to attempt to layer concerns about environmental impact onto financial intermediaries, who are singularly focussed on the task of providing corporate access to capital on the best possible terms and upon whom the efficient functioning of capital markets depends.

The second institutional investment manager, responsible for many hundreds of millions of dollars of institutional venture capital portfolios, made the following remarks during a conversation:

As a fiduciary, I have a moral obligation to my investors to maximize return and minimize risk. I simply cannot take into account exogenous factors like social or environmental impact, or I will reduce the opportunity set and thereby reduce the rate of return.

Such constructs of the roles and obligations of financial intermediaries and fiduciaries have arisen with a certain inevitability over the past two hundred years, ever since Adam Smith originally formulated the concept of an "invisible hand" through which each man striving only to better himself would, through a thriving free market economy, improve standards of living for all. After tracing how these views have developed and their context in contemporary financial markets, we will describe how one small financial institution, the Jessie Smith Noyes Foundation, is trying to construct for itself a new definition of fiduciary responsibility.

The prudent man

In 1830, a Massachusetts court offered a definition of prudence that has, through decades of subsequent re-examination and re-definition, survived in the canon of fiduciary responsibility as "the prudent man rule":

All that can be required of a trustee to invest is, that he shall conduct himself faithfully and exercise sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering probable income, as well as the probable safety of the capital to be invested.

This describes a narrow form of "sustainability," which persists among fiduciaries today: sustainability as maintenance and growth of financial capital, sustainability as growth of assets sufficient to keep pace with inflation and preserve or even augment purchasing power. The concept of prudence, built around risk aversion, predictability of income and preservation of capital, came to define a whole culture of managing "other people's money." In the mid-nineteenth century, such a definition of sustainability was understandably devoid of a whole range of concerns which had yet to be articulated. But in the late twentieth century, our knowledge regarding environmental degradation and the social problems which persist in the wake of economic growth and rising standards of living should impel us to ask the following questions:

• Can there be fiduciary responsibility without incorporating questions about the social and environmental impacts of economic growth?

• How do concepts of fiduciary responsibility affect corporate culture?

• What is the relationship between fiduciary responsibility and institutional or corporate responsibility?

• Can institutional investment management be an effective agent for change?

Sustainability, as maintenance or restoration of ecological integrity, provision of economic security, and protection of popular participation in the life of a community, takes on a new meaning.

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