Norway’s Government Pension Fund Global, the world’s largest sovereign wealth fund, with $860 billion under management, has missed out on $1.9 billion in additional profits as a result of its decision to divest all of its tobacco holdings in 2010. The story that reported this fact, which ran in the Financial Times , goes on to suggest that fund managers should reconsider their investments in tobacco companies, as the sector is generating impressive returns, well above many key performance benchmarks.
This story implicitly highlights one of the most prominent features of capital markets — and one that is largely responsible for why growth is now anemic worldwide — that capital chases only risk-adjusted returns, with no interest in the impact of the resulting investments on driving sufficient economic growth. The implications for investors are profound if their portfolios play a large role in the poor growth conditions that exist today.
Even the 1987 Nobel laureate in economic sciences, Robert Solow of the Massachusetts Institute of Technology, was baffled when he discovered that capital and labor, the primary variables used in economics, can only account for no more than 14 percent of what is behind growth. The unknown 86 percent was “technological progress”; however, this term has yet to be defined by economists. Those of us unencumbered by the limits of the dismal science now understand that what lies at the core of the growth engine is the efficiency with which primary energy and other natural resources are converted into useful products and services. Companies employing technologies and business models that improve upon these processes are fundamental and disproportionately important to driving exponential economic growth.
When we take into account the disproportionate role of technological progress on economic expansion, then investments into companies pursuing, for example, gourmet cat food and highly efficient solar cells cannot be equal. But if they both generate the same level of revenue, earnings and profits — and with the same level of risk — then the market currently treats them as being completely equal. If, however, technological progress represents 86 percent of what drives growth, then advances in solar energy technology will be much more important in driving exponential growth than will great-selling cat food. If the risk-reward equation for gourmet cat food is better than it is for highly efficient solar cells, then we will see happier cats and less efficient solar power.
If this process eventually leads to insufficient investment in technological progress, then growth will eventually slow down. A further outcome, and a worse one, is the massive amount of money being put toward activities that represent negative growth. If the majority of the global economy is made up of negative-, zero and low-growth activities, then it really doesn’t matter which monetary levers are being pulled by Federal Reserve chair Janet Yellen and European Central Bank president Mario Draghi.
The Norwegian oil fund is spot on by refusing to invest in tobacco companies. Such a strategy is the best one if fund managers are interested in returning growth to scale. The good news is that the opportunities to invest in high-growth companies are not only large enough to offset divestments in low-growth activities but also sufficiently big to allow investors to achieve the higher risk-adjusted returns now necessary to meet their growing liabilities. For institutional investors, there is a simple question to ask: How much of our current portfolio is made up of gourmet cat food?
If you are interested in seeing this transition from low growth to high growth based on technological progress in action, then look no further than the two German electric utilities E.ON and RWE. Both of these companies have seen their share price collapse recently, and as a result, they are selling all of their fossil fuel assets and becoming exclusively renewable energy companies. The world is now awash in low-growth investments. The investment opportunity to lift the efficiency of the global economy is the biggest in history and the only path that will allow investors to simultaneously meet their growing liabilities and become central actors in the transition to greater wealth and prosperity.
Michael Molitor is a senior fellow with the Ray C. Anderson Foundation and is a visiting professor at the Paris School of International Affairs, Sciences Po.
