Why Mainstream Economists Should Take a Step Back from the Divestment Conversation

Ben Wolcott ‘14 is an honors Economics major and a course major in Sociology and Anthropology.  He is not a member of Swarthmore Mountain Justice.

At the recent teach-in about divestment, Professors Kuperberg and Jefferson correctly described the implications of this tactic in a neoclassical world. I am worried that our community is inappropriately privileging their economic arguments. If you want an example, look no further than the Phoenix’s recent news story on the teach-in.

Mainstream economics is a tool that has strengths and weaknesses. At its core, neoclassical theory examines the incentives around actors’ instrumental self-interest in order to describe and predict action given constraints. Unfortunately, neoclassical economics hurts our understanding of both the benefits and the costs of divestment. I will start with the benefits.

While mainstream economics can help us understand situations that encourage people to act in their rational self-interest, it is worse than useless in describing how actors’ value-commitments impact their decisions. Nobel prize-winning economist Amartya Sen famously describes this problem in his 1977 article “Rational Fools.”  Sen argues that people often follow their commitments even if it makes them worse off.  While this is a hard argument for rational choice theorists to agree to, Sen gives examples of decisions that actors choose even though those options lower their utility.

It is not a coincidence that social movements fit into this category. If people only follow their rational self-interest, many social movements would likely fail due to what economists call the collective action problem. While those on the frontlines of extraction have more immediate incentives to fight, it seems descriptively false to say that all activists have enough of an instrumental reason to dedicate themselves to a movement for climate justice.

While someone who believes in rational choice theory would argue that all activists are committed because their dedication brings them enough utility to outweigh the costs, this falls descriptively flat. Even though rational choice theory is tautological and therefore cannot be proven false, it seems unreasonable to say that many activists pour their hearts and souls into campaigns because it makes them feel good. While those feelings exist, many activists continue to fight even when it does not feel good. They do this because of their value-commitment.

To be clear, mainstream economics can only understand commitments as “preferences,” which every neoclassical model takes as given and consistent. Therefore, a neoclassical economist cannot talk about the growth of social movements because that change in preferences cannot be conceptualized within their models. In contrast, political analysis is helpful in understanding why people have value-commitments and how these commitments are shaped.

This distinction is essential for understanding why political considerations are more important than economic ones when discussing the potential benefits of divestment. While I agree that the tactic will not hurt firms’ profits in the short run, I do not think that any informed person on campus would disagree with this point.

Groups like Mountain Justice see divestment as a crucial strategy to build a social movement that can use students’ positions within institutions of influence to demand meaningful environmental change. Because the economic theory that Professors Kuperberg and Jefferson use cannot meaningfully conceptualize of social movements, it makes sense that they did not factor Swarthmore’s power to create societal change into their presentations. This limitation of neoclassical economics matters because all of the short-term benefits that advocates of divestment claim the tactic could bring are political, not economic.

Still, even if economics cannot conceptualize of the benefits of divestment, it could still help us understand the costs. Professor Jefferson carefully explained how limiting the diversification in our stocks by divesting would raise the risk in our portfolio or lower its return, all other things equal.

Professor Jefferson’s analysis implied that any negative change to the endowment — no matter how small — would set off painful decisions about what cuts to make. This argument is based on the classic assumption “all other things equal.” While this is technically accurate, it gives off the wrong impression. All other things will not be equal.

Opponents of divestment make it seem as though the tactic would force the college to make meaningful cuts because it’s operating budget would be lower than it would be otherwise. This argument fails because the endowment’s relationship to the operating budget is more complex than that.

For example, let’s say that in an average year, the endowment makes a return of 8% plus or minus 5%. If the costs of divestment are small, then it is unlikely that you would ever be able to notice the impact of divestment on the operating budget because the returns shift every year. Recent studies do show that the cost would be small. A 2013 study from the Aperio Group estimates that the cost of divesting from the entire extractive industry would impose a miniscule penalty: .0034%.

To put this in context, the endowment’s rate of return was a shocking 24% two years ago. In that good year, the college only spent about one third of the returns and plowed the rest back into the endowment. Even if the college had divested two years ago, the small cost would have impacted the growth of the endowment and not our operating budget.

While the returns from two years ago are not representative, it is clear that the rate of return on the endowment is constantly shifting. Divestment would not bring up new conversations about difficult budget cuts because any small impact it would have could occur in any year due to variation in the college’s rate of return. Because all other things are never equal, our administrators are already adept at running Swarthmore as the returns on the endowment constantly shift.

It is misleading to imply that our community would have to make tough choices about financial aid, environmental studies, and staff compensation if it divests. It is a scare tactic, and our community should demand that professors and members of the Board of Managers stop using it immediately.

Even if neoclassical theory cannot tell us much about the costs or benefits of divestment, maybe it can point the way for alternative actions. For example, Professor Kuperberg argued that Mountain Justice’s time would be better spent building a movement for a carbon tax at the socially optimal level. One problem with a carbon tax is that no one knows what that level should be.

While most people might argue that we should make it very high due to this uncertainty, the fossil fuel industry has significant power to shape legislation in Congress. Historically, carbon taxes have often been too small because of the power that fossil fuel companies wield. Without countervailing power from somewhere else, it seems unlikely that a meaningful carbon tax will be passed.

Luckily, there’s a nationwide movement trying to build that power right now. It’s called divestment, and it’s growing fast.

Furthermore, after so many economists failed to predict the recent housing bubble, I am surprised that more people are not questioning the stock prices of fossil fuel companies. If you believe that as global warming gets worse, our country will eventually take meaningful environmental action, then you should also believe that fossil fuel stocks are overvalued. Currently, the stock prices of firms that make profits from extraction assume that all found reserves will be burned.

This assumption flies in the face of conservative climate science estimates, which argue that only a third of current reserves can be burned before 2050 if the world is going to avoid climate catastrophe. After HSBC makes this point in a recent study, they argue that for the sector, “the potential value at risk could rise to 40-60% of market cap.”  Part of the reason for rational financial markets to fail comes from the inability of financial theory to deal with uncertainty.  While risk can be modeled and is incorporated into stock prices, uncertainty cannot.

While a rational actor might try to ride out the bubble until the last moment possible, Swarthmore College should not. I see no real choice between moral leadership and maximizing returns to the endowment.

Ultimately, everyone engaging in this conversation should examine why economists have so much say on a question that is mostly political. In America today, neoclassical economics is a dominant discipline. While its tools can be useful, it often fails to appreciate the complexities of human action.

Economics is often called the “dismal science” partially because it views people as instrumentally rational and cannot meaningfully conceptualize action based on value-commitments. We need every tool at our disposal to address climate change, and it would be dismal if we abandoned divestment due to economic arguments.

—Ben Wolcott


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10 comments

  1. 0
    alum '12 says:

    As a recent Swarthmore alum, I try to keep a close eye on the College news via friends and social media. I was on campus when divestment became a big issue for the student body, and since leaving, I’ve heard from other recent college alums that fossil fuel divestment is a big issue at other universities. As someone who, regrettably, never took an economics class while at Swarthmore, I am not well-versed in the economic impacts that divestment would have on the endowment or the power of the fossil fuel industry. I look to Swarthmore Mountain Justice and the recent Faculty Teach-In on divestment to provide the facts and figures about divestment. From these sources, I find that divestment would cause endowment instability, decreasing returns, and budget-crunching from the college as a whole. I would not support divestment on these numbers alone – the negative impact that divestment would have on Swarthmore as an institute would prevent the larger goal of the college, in order to serve a subset of the student body that feel fossil fuel divestment is in the best interest for humanity. Don’t get me wrong: I am confident that fossil fuels will destroy the environment if we don’t do something about it. We must ask ourselves, however, if the negative impact on Swarthmore would be compensated by the positive effect of divestment. Again, our economics professors assure us that divestment would provide opportunities to other less ethical groups to invest in the stability and high returns of fossil fuel and would have little impact on the industry. We would be using an ethical high-ground and self-serving righteousness to point out a real and important problem (climate change), but we wouldn’t be making the effort that the issue deserves. Instead, we must approach the problem from a different direction. The reason fossil fuels are used is because they are economically viable. If we want to stop using fossil fuels, we need to find an alternative energy source that will cost less. This is a simple economic fact that I hope an actual economist can back up. And more than that, the fossil fuel companies are in bed with US politicians, preventing progress towards developing these new technologies. This is the area in which we must be focused. Instead of focusing on trying to hurt the fossil fuel industry directly through our spending and investment practices, we should focus on supporting alternative fuel lobbying, legislation and research. If we can make it more economically feasible to invest in alternative energy sources, then we can end investment in fossil fuels. This goal is harder than divestment, but its implications extend further, and will have a more lasting impact.

    1. 0
      ME says:

      Hi alum ’12,

      I’d like to point you towards the end of Ben’s op-ed, where he notes that:

      “While most people might argue that we should make it very high due to this uncertainty, the fossil fuel industry has significant power to shape legislation in Congress. Historically, carbon taxes have often been too small because of the power that fossil fuel companies wield. Without countervailing power from somewhere else, it seems unlikely that a meaningful carbon tax will be passed.

      Luckily, there’s a nationwide movement trying to build that power right now. It’s called divestment, and it’s growing fast.”

      No one who’s fighting for divestment thinks that it’s the only tactic that we should use in the long run. Of course we will need to put direct pressure on governmental leaders in order to make headway in legislation and research, and in order to make renewable fuels more affordable.

      But it’s not as if we haven’t been trying to create this change directly. We’ve been aware of climate change for awhile, and the reason we haven’t seen any action is that fossil fuel companies have enough power to keep the government in a stranglehold.

      Lobbying doesn’t go far enough to loosen the extraction companies’ grip on Washington. What can do that is a social movement. Those of us working on divestment are trying to create a political situation where it will be possible to demand change from politicians.

      Thanks Ben for this great analysis of the issue! Looking forward to hearing from you more in the future!

  2. 0
    Z says:

    Dear Math-Man,

    I warmly welcome you to the open events at the Power Up! Divest Fossil Fuels Student Convergence happening next weekend at Swarthmore. Over 200 students from across the country will meet to learn from those already impacted by the destruction of the fossil fuel industry and work on strategies for building a powerful social movement for climate justice.

    I think hearing stories and testimony from those who are already impacted by our fossil fuel economy and resisting in their own communities might give you some perspective on your own environmental privilege and the political relevance of divestment.

    Some awesome guests will be coming, such as Crystal Lameman, a Beaver Lake Cree First Nation activist, Aura Bogado, writer for the Nation, and Yudith Nieto, a community organizer focusing on environmental racism in Texas, and many more.

    Check out the schedule: http://www.studentsdivest.org

    Thank you Ben for such a thoughtful analysis!

  3. 0
    Milton "Math-man" Friedman says:

    I think it’s interesting that you dismiss the carbon tax as politically unfeasible while still holding the belief that an admittedly ineffective divestment effort will somehow produce a miraculous behavioral shift away from fossil fuel use. MJ may need a tangible and attainable goal to rally around, but it shouldn’t be one that puts the school’s returns at risk for no actual gain. I’m sure there are countless ways to produce the kind of wonderful “social movement” that you feel so strongly about without inflicting unnecessary costs.

    Also must object to your argument that “while someone who believes in rational choice theory would argue that all activists are committed because their dedication brings them enough utility to outweigh the costs, this falls descriptively flat.” It’s not out of the question that the activists here derive sufficient enjoyment from patting themselves on the back (you guys seem pretty good at that) and deluding themselves into thinking that they’re making some kind of difference. Not that I object – whatever assuages your climate guilt and helps you sleep at night. But the way I see it, the world’s gonna burn no matter what we do. Might as well make some money off of it.

    1. 0
      Ben Wolcott '14 says:

      “It’s not out of the question that the activists here derive sufficient enjoyment from patting themselves on the back (you guys seem pretty good at that) and deluding themselves into thinking that they’re making some kind of difference.”

      While this is a common response to the logic in Sen’s argument, please consider the counterfactuals that a “rational” activist would consider. For example, anyone who dedicates 10 hours a week to climate justice could dedicate just 5 hours and chill for the rest. Even though the activists I know all dedicate varying amounts of time, I think that you would be hard pressed to find a difference in the amount of utility that they gain from their work.

      Furthermore, consider the “no activism” option. I canot recall ever meeting someone who doesn’t think of themselves as a “good” person. My impression is that everyone finds moments in their daily life that they use to make themselves think highly of their moral character. Therefore, people who guide their life by their value-commitments gain little to no additional utility but incur additional costs. From this inability to meaningfully conceptualize commitment, it seems like rational choice theory can only hurt our understanding of social movements.

      I also want to respond to your first point about alternatives to divestment. Please tell me just one of the “countless ways to produce the kind of wonderful ‘social movement’ that [we] feel so strongly about.” The current divestment movement seems like one of the first times in a long while that environmental folks have been able to gain traction, and it isn’t from lack of trying. Looking at the growth of the movement over the past year from an empirical perspective has convinced me that divestment is a great option moving forward.

      1. 0
        Ben Wolcott '14 says:

        I’m sorry about the essentialized description of activism that I used to make my earlier point. While problematic, I think it’s hard to avoid descriptions like that in conversations about rational choice theory.

    2. 0
      divestment supporter says:

      “But the way I see it, the world’s gonna burn no matter what we do. Might as well make some money off of it.”

      I just want to highlight this part of what you said, Math Man. Not to change your mind, but so others reading will notice your total lack of respect for human life. You do not care whether anybody else lives or dies, as long as you make a buck.

      There aren’t many sociopaths like you in the world, but the few of you are extremely powerful. The fossil fuel industry also displays this attitude. Divestment seeks to take away your political power and return it to the vast majority of humanity that wants a healthy and stable environment for all.

      1. 0
        Milton "Math-man" Friedman says:

        Glad to see we’re throwing the term “sociopath” around here…

        But to give my position a defense: We make our decisions on margins. When I assert that “the world’s gonna burn no matter what we do”, I’m stating that there is no difference between individual action and inaction with regard to the state of the planet. On the margin, then, the benefit of divestment is zero. “Human life” doesn’t enter our first-order condition since it does not vary with respect to any of our decisions. The school’s return on its endowment, however, does. So to divest and suffer a marginal cost without securing any marginal benefit would be a waste of time.

        So no, you can’t make any inferences about my respect for human life in this case.

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