Do we want to end the extractive destruction?

One part of the New Economy movement is calling for divestment. The cry is for institutional investors to divest from Wall Street and the multi-national corporations that are profitably fueling the high probability of an uninhabitable planet for the coming generations. Institutional investors range from the endowments of churches, colleges and universities to the pension funds of municipalities, unions and again colleges and universities. This is important because institutional investors own 70% of the largest 1000 publicly traded corporations! Also, most of these institutions are created for the purpose of serving the greater good, they have a social mission, and yet through the choices of their investment fiduciaries, they are funding the destruction of the commons.

This is not the first time Americans have made the connection between where our collective money is invested and those profiting off of doing harm, or the investees. In 1962 the United Nations General Assembly passed a resolution calling for economic and other sanctions on the government of apartheid South Africa. This resolution was a call for action to stop the atrocious South African government and their absurd and abusive system of minority white rule over the black majority. The resolution was boycotted by many of the western nations, primarily the US and Britain, because they did not want to stomach the lost revenue necessitated by divestment from South African companies and western companies doing business in South Africa.

A very strong anti-apartheid movement began to sweep the US in the 70’s and 80’s, led primarily by students as they called for their institutions of higher learning to divest from any company doing business in South Africa. This movement was fairly successful over time with some holdouts, like Harvard, which eventually gave in to the pressure as well with a “partial divestment” policy. In 1984 53 educational institutions divested, 128 in 1985, and 155 in 1988. This campaign spread to local municipalities and finally, the federal government. In 1986 the congress passed the Comprehensive Anti-Apartheid Act which banned new U.S. investment in South Africa, sales to the police and military, and new bank loans. The act was vetoed by president Ronald Reagan in all his wisdom, but then the republican controlled senate overruled his veto. Then in 1987 in the Budget Reconciliation Act there was an amendment passed which closed a tax reimbursement loophole for corporations paying income tax in South Africa. All of this pressure ultimately led to the dismantling of the apartheid system.

Now, students are once again realizing that where we invest our money matters. One of the 14 New Economy summits which happened across the nation this spring was at Swarthmore College and it focused on the idea that the college’s $1.5 million endowment should not be invested in the companies and industries making it more certain every day that this generation will not have a future. John Fullerton from The Capital Institute, spoke at the summit further on this idea of divestment. He also hit on one of my favorite concepts, that of investment risk. He lays out a scene for us of the trustees at Swarthmore having a conversation about what divestment would look like and why they should or should not do it. One part goes like this, “The Chair of the Investment Committee's protests about the ‘risk’ of altering the investment strategy away from the conventional approach will ring hollow when the group discovers that “risk” in his mental frame relates only to the backward looking volatility of monthly returns in a portfolio of securities, an abstraction entirely divorced from the very real forward looking risk of climate change threatening unimaginable disruption of civilization itself in the lifetimes of the students in the room.”

The idea here is not to simply not invest in the current structure and its profit extracting machines, I mean corporations, but to look forward and figure out how much money could and should instead be invested in building a sustainable future. This is tricky as I have talked about in prior blogs, however, if you really dig into risk, I agree that funding the transition to renewable energy, local food, and sustainable local manufacturing is much less risky (especially for young people) than funding the current dismal selection of multi-national corporations on the easy-to-invest-in docket.

Moving forward we must create the local intermediaries necessary to aid in the movement of capital from the extraction economy to the new localized generative economy, and then the calls for divestment can rain down like fire to fuel the New Economy!

Slow Money and Local Investment

I attended the Slow Money national gathering this week which catalyzed much thought about local investment, or perhaps more properly, the lack of local investment. I attended a break-out session called "where should slow money fit into your portfolio?" hosted by 4 asset managers from four large wealth management funds. The panel was made up of: Steve Schueth, President, First Affirmative Financial Network; David Wolf, Chief Investment Officer, BSW Wealth Partners; Matt Patsky, Chief Executive Officer, Trillium Asset Management, LLC; Joel Solomon, Chairman, Renewal Funds. The panelists all had very interesting things to say about what they do and how they are slowly transforming the wealth management industry towards more of a values-based investment and triple-bottom-line investment industry. However, much of the conversation really just moved the audience towards asking the question related to the title of the session, how does slow money fit into the investment strategy of these firms and their clients? The answer was basically that it currently doesn't. Very interesting.

The problem is one of scale. These wealth management firms can only afford to invest in and complete due diligence on other large securities or funds. They are not doing targeted local investments in building the new economy, local food business startups, or local revolving loan funds. The problem is really two-fold. One, as I mentioned, they cannot afford to complete the due diligence on many small local projects and it would most likely be more expensive to have many small projects (each with different returns and timelines) than several large projects. Two, the current expectations for returns on these investments by the clients are still completely out of sync with what is truly sustainable. Even when the wealth management firms can invest in local revolving loan funds for local projects, the returns they expect are not something the local funds can produce. Part of building a new economy and also part of the Slow Money movement for alternative finance is about bringing our expectations for financial returns into sync with the reality that only fairly extractive businesses can produce 10, 15, 20% returns, which is exactly the kind of structure and behavior we must eradicate if we are to become sustainable as a society.

One of these problems can be tackled by the wealth management firms themselves, and the other cannot. The issue of our mental models and expectations around investments and returns can and is being changed by the wealth managers of these more progressive firms. They work with their clients to help them realize that good investments can have multiple returns, some financial, some social and some environmental. This helps the clients change their understanding of money and the purpose of investment, and thereby their expectations for financial returns and the desired impact of their investments in the world.

The issue of scale is not a problem that will likely be solved by the existing firms in the industry. This leads to an exciting opportunity and challenge however. Small, local investment intermediaries need to be created which can connect small local projects with the capital they need to be successful. These local intermediaries could invest funds from individuals and institutions into new or exisiting local triple-bottom-line businesses because they could build the relationships needed to provide quantitative and qualitative due diligence. Just like we need local banks and credit unions again which will actually invest their assets in the local community, we also need investment intermediaries which can put local money to work building the local economy. I believe that it will also be easier to change the mental models about returns, the purpose of money, ect. on the local scale where social and environmental returns are more tangible to the investor. Destroying your own community to gain a larger financial return on your investments seems harder to do than destroying someone elses community for those outrages returns.

The new economy is all about slow, place-based, social purpose enterprises in all industries becoming the norm so as to preserve and enhance spaceship earth to facilitate life and happiness instead of destroying it in the pursuit of ever growing financial returns. Thus this is both an opportunity and a challenge.

Stakeholder Start-up Strategy

I am always interested in how stakeholder engagement or analysis changes so much depending on your position and therefore your literal perspective. Much of stakeholder analysis and engagement literature is written for the large corporate audience. For instance, a great piece by Neil Jeffery called "Stakeholder Engagement: A Roadmap to Meaningful Engagement," is very helpful, yet pointedly aimed at the large corporate audience. Jeffery says, "It is particularly important in the context of running an organisation responsibly and is integral to the concept of Corporate Responsibility. An organisation cannot be serious about Corporate Responsibility unless it is serious about stakeholder engagement – and vice versa." I agree wholeheartedly with this statement, yet it is not something you would need to say to an enterprise that is embedded in its local context already. This statement would be like a resident of Cleveland that the city has the second lowest median income ( $18,500) among American Cities; the resident would know this fact well as it is part of their daily reality.

I was thinking about how we got to the place where businesses need to be taught how to successfully engage with stakeholders, versus it being the starting place in their business plan development and execution. It largely has to do with the scale of economic entities in our current system, in that many corporations are larger than many national governments and have revenues sizing in multiples of third world country's GDPs.

For an alternative example, lets look at Green City Growers (GCG) in Cleveland Ohio. They are one of 3 new worker-owned cooperatives which are part of the Evergreen Cooperatives, a community wealth building strategy to create jobs, build wealth, and stabilize neighborhoods. For starters, here are Evergreen's community engagement goals:

• Create a shared sense of ownership and responsibility based on the concept of partnership and co-investment between grassroots and institutional stakeholders.
• Build cross-neighborhood connections to promote a unified identity among stakeholders in the neighborhoods.
• Identify, develop, and support local leadership within local residents, groups and community organizations.
• Deconstruct historical barriers between stakeholders, enabling residents to the access the social capital opportunities provided by local anchor institutions, and helping the institutions to be more responsive to the community needs, interests, and priorities.

The Evergreen Cooperative Corporation (ECC) started with a robust stakeholder and community engagement strategy before they were even an operational network of worker-owned cooperative businesses. So, for Evergreen and Green City Growers, stakeholder engagement is the strategy for both launching and sustaining viable enterprises. As you can most likely tell from the goals above, this strategy is also place based or rooted in a particular context. I will now lay out some of my GCG stakeholder analysis, which will also help tell their story. 

ECC is the central organization in this strategy, in its operational phase. To start at the beginning though, The Cleveland Foundation is central. In 2005, the Cleveland Foundation was seeking to develop a "Greater University Circle Initiative" which would revitalize the Greater University Circle (GUC) part of Cleveland. This is a grouping of very poor and diverse neighborhoods surrounding what they termed the "Anchor Institutions" of the City. Those being large institutions, with significant economic impact, that are unlikely to offshore their operations. Among these Anchor Institutions were the Cleveland Clinic, University Hospital and Case Western Reserve University. These three institutions represented $3 billion in annual procurement of goods and services. The majority of this $3 billion was sourced from outside the Cleveland City limits, let alone the GUC.

So, the GUC Initiative was launched to address the issue of poverty and take advantage of the $3 billion anchor institution procurement stream opportunity. They quickly partnered with The Democracy Collaborative (TDC) who had expertise in community wealth building strategies. TDC lead a series of community roundtables and events to learn more about the GUC issues from the residents themselves and to gather community leaders to talk about solutions. The key conversations were of course with the anchor institutions. TDC then partnered with Towards Employment, a non-profit which connects low-income folks in Cleveland with jobs and training, thus acquiring a workforce from the GUC. They also partnered with the Ohio Employee Ownership Center (OEOC) for their expertise in creating business plans for worker-owned cooperatives along with specialized training in democratic ownership for worker owners.

The Evergreen Cooperative Corporation was created as the 501c3 that would oversee and hold together all of the pieces and parts of this strategy. The Cleveland Foundation, along with the anchor institutions, invested a hefty sum with Enterprise Cleveland, a community development financial institution (CDFI), to create the Evergreen Cooperative Development Fund. The fund would act as some low cost start-up capital for enterprises such as GCG. Also, as the cooperative enterprises under the umbrella of ECC become profitable, they will return 10% of their annual profit to the fund. This will allow the network of cooperatives to self-replicate by creating their own pool of capital to loan from.

The City of Cleveland was also important in this strategy. They are committed to improving the quality of life in the City of Cleveland by strengthening our neighborhoods, delivering superior services, embracing the diversity of our citizens, and making Cleveland a desirable, safe city in which to live, work, raise a family, shop, study, play and grow old. The City was able to help leverage New Markets Tax Credits as well as HUD Section 108 loans and grants to capitalize GCG.

GCG is a 3.25 acre hydroponic greenhouse operation in the heart of Cleveland. They will produce 3 million heads of organic lettuce and 300,000 pounds of herbs annually. Their key customers are the anchor institutions, which agreed to purchase the majority of their products. Another key stakeholder of GCG, are the worker-owners themselves. This enterprise has no employees as such, because everyone who works at GCG quickly becomes vested as a full owner.

To wrap this all up, stakeholder analysis and engagement can be used not only to achieve buy-in or legitimacy with certain groups, but as the key strategy for successful business incubation and operation as well.

What does "risk" really mean?

So what does risk really mean in our economy today? We all know that every investment involves some risk. We are led to believe though, that our system is setup with the proper structures in place to minimize risk for investors, lenders, lendees, and ordinary folks with a pension, insurance or a college fund for their children. The 2008 financial crisis should have thrown all of this into doubt, however, there are still some very maligned mental models of risk operating in our society. I will explain my meaning with an example. 

Amy Cortese has a wonderful article in the New York Times about crowdfunding, or a cutting edge investment mechanism whereby many ordinary people would be able to make small investments in new small businesses or ventures. Cortese says, "To its advocates, crowdfunding is a way for capital-starved entrepreneurs to receive financing that neither big investors nor lenders are willing or able to provide." This idea has been around for a couple of years and was popularized by the success of Kick-starter. The difference is that Kick-starter facilitates crowdfunding through donations, not investments seeking a return; meaning it is currently legal while actual crowdfunding of investments is not.

The JOBS act signed by President Obama in the middle of 2012, contained crowdfunding legislation which is still not in play because the Securities and Exchange Commission (SEC) has not completed the requisite rule writing. The SEC had until the end of 2012 to finish its work on the JOBS act, but failed to meet that deadline. "The JOBS Act contains investor protections. For example, legislators capped the amount that unaccredited investors can invest through crowdfunding in a given year to $2,000, or 5 percent of their income, whichever is greater," Cortese points out. Comment from the SEC on the rule writing process has focussed on the complexity of creating regulation which would provide sufficient protections for investors and mitigate risk. 

The Institute for Local Self Reliance made a recent post about some successful attempts at crowdfunding within the current laws. They write of a California-based company, (Solar) Mosaic, which is working to install community solar electricity projects funded by a broad based group of individual investors. On their latest project, "The combined capacity of 235 kW of solar capacity sold out in just 24 hours to over 400 investors with an average stake of just $700.  The investment uses a common securities law exemption (Rule 506 of Regulation D), and investors will earn a 4.5% annual return (net of fees) over 9 years, greening the economy and their pocketbooks." 

This is where we encounter the skewed concept of risk in our current system. SEC Rule 506 of regulation D is the closest thing to crowdfunding currently available. It allows the investment project to privately solicit investment from an unlimited amount of "accredited" investors, but only up to 35 "unaccredited" investors. The SEC defines accredited investors as those with at least one million dollars in semi-liquid assests not including real-estate, or an annual income of over $200 thousand for at least the last two years. The current rules imply that those meeting the definition of accredited investors automatically understand risk and can invest in projects like the Mosaic community solar arrays at will, while those not meeting the definition of accredited investors do not and must be limited in their activities. 

Somehow the SEC regulations are keeping us all safe by reducing risk, however, they are also severely limiting the ability both of non-rich folks investing in projects they care about and important new ventures receiving the capital they need to be successful. These new kinds of investment projects and "crowdfunding in general, have 'the potential to be disruptive,' Harvard Business School Professor Clayton Christensen says, by opening up financing to companies that have traditionally struggled to raise capital and to investors who have been excluded from the market."

To take this discussion further, I turn to a post by Dr. Norm Becker regarding our system of shadow banking. He points to an article called "Shadow banking: Economics and policy priorities," which points out two important aspects of our current system which drive what it called "shadow banking," or the financing activities which are derived from real assets and investments, but which themselves are not real or tangible. The article explains that, "The first key shadow banking function, securitisation, is a process that repackages cash flows from loans to create assets that are perceived by market participants as almost fully safe and liquid." Securitisation was a major factor in the 2008 financial crisis which put our entire economy into a massive recession. This process is completely legal and permitted by the SEC. 

The second shadow banking function is called "collateral intermediation." The authors of the article say that, "One of the main challenges in using collateral is its scarcity. The shadow banking system deals with the scarcity through an intensive re-use of collateral, so that it can support as large as possible a volume of financial transactions." This process is highly complex, involves risking very large amounts of real assets as collateral for multiple investments of varying types allowing companies and investors to leverage what they really have (or increase their capital multiplier) many times over. This process also can allow multiple entities to point to the same collateral asset for multiple other investments, each one of which then holds a claim to that original asset. This practice again is completely legal and permitted within current SEC regulations. 

Crowdfunding is in some ways new financial territory, and in some ways an old story of many people pooling their money to support a new business they value. However, our current economic system defines risk in such a way as to deem crowdfunding (even when locally constrained) as highly risky and complex, while securitisation and collateral intermediation, which are both enormously and unimaginably larger in scope and complexity, not risky enough to be further regulated and constrained. As I have pointed out before in my blog, power plays a highly important role in shaping our system and its structures. It is in the interest of the highly wealthy beneficiaries of our current system to deem shadow banking practices as low risk, while stifiling and delaying community level investment mechanisms due to their inherantly high "risk." 

Taxes and a Healthy Economy

The relation of tax rates to the health of our economy is and has long been contentious. I was interested to see a recent post by Norm Becker which contained the summary remarks of the Congressional Research Service report on tax policy. A key finding was that, “the real GDP growth rate averaged 4.2% and real per capita GDP increased annually by 2.4% in the 1950s. In the 2000s, the average real GDP growth rate was 1.7% and real per capita GDP increased annually by less than 1%.” They compare these rates of GDP growth to the income tax rates from those two periods to make the point that, “analysis of such data suggests the reduction in the top tax rates have had little association with saving, investment, or productivity growth.” This is important because the income tax rates from 1945 through 1970 were significantly higher than they have been in the last 40 years, and yet real GDP growth, and particularly GDP growth per capita, have slowed with the decreasing tax rates on the top income earners in this country. Why is this and why all of the heated debate about income tax rates in recent years?

I have several proposed reasons which, oddly enough, come from a study of neo-classical macroeconomics, or the very school of thought that those in the U.S. who argue for reduced tax rates for the wealthy are supposed to be champions of. First, let me sketch out the basic model: the production of goods and services by firms (output) creates payments to households (income). This income is put towards either consumption or Savings. Savings create the capital stock which firms can use as investment in their production operations (intended investment). Total consumption by households and intended investment by firms equals spending or aggregate demand. If there is full employment and if all savings are efficiently used as investment by firms, then the aggregate demand should equal output, where we started.

One very important thing to understand about all economic models and schools of thought is that they are theoretical. That is to say, not necessarily representative of what really ends up happening in an economy. For instance, taxes and government spending are not represented in this model. So, proponents of lowering taxes in general argue that taxes just reduce the income of households which then decreases the overall level of spending which can result from consumption and investment. This would be unhealthy for the economy because then aggregate demand would not be sufficient to meet the total output of producers, which would then ripple through the whole cycle causing unemployment, recession, and reduced or negative growth. The other argument used for lowering taxes specifically for the top income earners in society is that the savings of those top earners becomes the investment stock of firms and is also directly invested to create jobs and increase spending, thus increasing the health of the economy.

To respond firstly to the issue of government taxes in general, we must realize that if taxes and government spending were properly represented in this theory, all monies diverted to the government from incomes, also end up both as incomes for government employees and as consumption and investment in the economy through government services and programs. Thus, taxes still work through the cycle to increase aggregate demand. In fact, all taxes get spent in the economy unlike some of household income which is diverted to savings (called a leakage in the model).

More importantly, when we look at the incomes of top earners in the U.S. we find several reasons why the argument for diverting less and less of their income to taxes as a policy for a healthy economy, holds no water. Leakages as savings from the incomes of the wealthy can create the investment stock for business expansion, operation or creation. However, this does not happen when a large share of their income is stored in off-shore bank accounts for the purposes of avoiding taxes. The money in those accounts is not accessable as the capital stock for investment in job creation or expansion in our economy and it is not available to be spent by the government if it had been taxed. Also, when the untaxed incomes of top earners is used extractively through investment in venture capital endeavors which require rapid growth of industries through measures of austerity and reckless abandon (low paid employees, turning quick profits through risky activities, tax avoidance) the long-term health of the economy is decreased. As we saw in the lead up to the recent crash and recession, much of the untaxed incomes of the wealthy were invested in derivatives and other clever financial instruments which do not play any part in aggregate demand or the actual production of goods and services. Often now the excess wealth of top income earners is invested in private equity firms spurring mergers and acquisitions which succeed through rapid and extensive off-shoring of more expensive U.S. jobs and outsourcing company functions to the lowest bidder globally.

John Maynard Keynes had a slightly different, but still limited take on the classical macroeconomic model. In his line of thought, households do not just automatically direct all of their incomes to savings and the rest to consumption. They automatically consume at a level called “autonomous consumption” which would account for basic necessities regardless of their income. Then they also have a “marginal propensity to consume” which changes with their income level and confidence in the health of the economy. In line with this theory I would argue that we could more effectively stimulate aggregate demand by raising the incomes of the majority of folks who cannot even meet their required autonomous consumption levels (ie. a living wage) let alone a very significant marginal propensity to consume. Plus the majority of households in our economy which have low to moderate incomes, spend all of their income, contributing directly to aggregate demand thus increasing aggregate demand. So, it would be much more effective to tax a larger share of the incomes from top income earning households in the U.S. in order to stimulate aggregate demand. The decrease in their excess income which would would have been put towards the detrimental activities described above, would instead be spent in the economy by the government.

Even if my argument and logic make sense, you may then wonder why this argument to lower taxes overall and specifically those of the top income earners seems so loud. In an Economist article called “The Rich and the Rest,” they state that, “one analysis suggests that 80% of the total [campaign spending] comes from fewer than 200 donors.” They also point out that 90% of the income gains since the recession have gone to households in the top 1% of income earners. This paints a very clear picture of where power in our society lies. If there are 200 people at the top that control 80% of the financial sway in elections, and are part of the small group which not only caused the recession, but now are the only ones recovering from it, then it would be in their direct but narrow self-interest to reduce taxes on the wealthy.

Banking Oligopoly

The topic this week is Markets. This is a tricky economics topic because the terms "market", "markets", and "market economy" are used so often in the mainstream without any real critical discussion on what these terms really mean. When we learn about markets in economics, we are often only taught the abstract, theoretical meaning from the school of thought called neo-classical economics. In this theoretical world, markets are magical places where there are no barriers to entry for producers, all involved have perfect information, and there is perfect competition. This means that there are many small buyers and sellers, all of which wield no power over the structure of the market. Only in this setting can a market truly facilitate the laws of supply and demand and move towards an equilibrium position which is equally beneficial to both buyers and sellers.

Lets look at the banking industry in the US through the lens of markets. First off, let me state that no market in the real world functions without power, with perfect information, and with no barriers to exit or entry. If you read this post by the Institute for Local Self-Reliance on the banking system, you find immediately that this industry market is not one of perfect competition. First, they note that, "the top banks now control 60 percent of U.S. bank assets, but provide only 27 percent of small business loans." The market for banks in the US operates more like an Oligoply, defined as a market which is dominated by a small group of producers/sellers where entry is difficult. Why is this important? Well, both sides of the political system constantly legitimate everything they do and stand for in terms of how much their policies support small and family businesses. Small businesses after all do create the largest share of jobs in the economy, and they operate more as a model perfect competition market than any other sector. I imagine that early economists were modeling their theories for how markets work based on their experience with thriving local economies filled with many small businesses competing with each other.