Comment GEORGE I D E N

Congressional Budget Office* The use of nontraditional criteria for investing pension fund assets is a maj or new field and the paper by Professors Barth and Cordes is an important contribution to our economic understanding. A major theme o f their paper is that nontraditional investing of pension fund assets is very likely to have a cost associated with it and that, at least in some circumstances, it may be less effective than many o f its proponents believe. In addition, their paper provides an analytical framework that is both comprehensive and insightful - - a starting place for future economic work in the area. In my view, the paper is especially useful in isolating important relationships and major determinants. It identifies the broad determinants of pension saving and of the allocation of pension funds among types of assets with particular reference to nontraditional investing (NTI). It also analyzes the roles o f pension saving and NTI in a macroeconomic context - - the implications for total saving, investment, productivity, and inflation. I would like to see more attention devoted to the possible benefits from NTI or at least the reasons for the growing interest in NTI. For example, one of the motivating factors may be an interest in diffusing some of the power of highly concentrated wealth in the United States. At least, it strikes some union members as ironical that they have considerable pension wealth and yet have not in their view exercised the rights or responsibilities o f ownership. Others may view NTI as a tool for controlling externalities such as pollution or nuclear risk. Thus, where one comes out on this issue may also depend on one's assessment o f the status quo with regard to the current management of pension funds and the character o f corporate decision-making. I shall highlight some o f the major conclusions o f the paper and, in some cases, elaborate on or take issue with the authors' interpretations.

Pension Fund Growth and Objectives Professors Barth and Cordes (BC) document and describe the phenomenal growth of pension funds, and argue that traditional economic criteria explain shifts in pension fund portfolios. Nonfederal pension fund assets totalled roughly $550 billion in 1979. That might be compared to the estimated net value o f busi-

*The views expressed in these comments are the a u t h o r ' s and do not necessarily reflect the views of his employer. The author wishes to thank Debra Blagburn for typing these c o m m e n t s . JOURNAL OF LABOR RESEARCH Volume H, Number 2 Fall, 1981

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ness fixed capital for that year, which was about $2,000 billion (more than onefourth). Some of the causes of this phenomenal growth are alluded to in Part IV of the paper where the authors state: "The level and composition of total saving depends upon disposable income, wealth, expected future and present real after-tax rates of return, and legal factors . . . . " Tax considerations, particularly the favorable tax treatment accorded to the pension form of saving, probably played an especially important role. •

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Nontraditional Investment Objectives (NTI) In a new field, terminology can be a stumbling block. Specifically, such terms as "social investing" often mean different things to different people. Yet, classification is important because it can facilitate analysis. The authors discuss NTI in terms of either "ethical" or "social" purposes, in contrast to traditional objectives of maximizing asset value subject to risk and legal considerations. Two examples of conflicts with ethical objectives are cited: firms that invest in South Africa and firms that violate civil rights laws and regulations. Social objectives refer to a broader range of concerns: the environment, occupational health and safety, unionization, investment policies of firms especially relating to the Frostbelt versus the Sunbelt and domestic versus foreign. But many of the social issues have strong ethical implications, to the point that the distinction may not be useful. ~ I believe that a different classification of nontraditional objectives might be useful for analysis: economic and social. There are nontraditional but still economic objectives in pension fund management. They pertain to the economic objectives of union members: jobs, working conditions and say in decisionmaking. In addition, unions may have social objectives which pertain to qualities of the community, which conceivably could be served by ownership in pension funds. 2 The benefits of nontraditional objectives in pension fund management are conceptualized by the authors in terms of maximizing individual utility. In their framework of analysis, NTI almost always involves some sacrifice of traditional fund management objectives. It costs something to pursue NTI, although the cost may be worth it if the utility of individual pension fund participants is thereby raised. Alternatively, the increased interest by unions in the possible use of pension funds for NTI could be viewed as a manifestation of the same concerns that gave rise to the union movement: dealing with economic power that is highly concentrated. Wealth is power and wealth is highly concentrated in the United States.

'The recommendations of the AFL-CIO Pension Fund Investment Study cite four policy objectives: (1) to increase employment, (2) to advance social purposes such as worker housing and health centers, (3) to improve the ability of workers to exercise their rights as shareholders, and (4) to exclude from portfolios "companies whose policies are hostile to workers' rights" (AFL-CIO, 1981, p. iii). ~Nontraditional objectives of pension fund management may have a parallel in government regulations, which are sometimes divided into economic regulations and social regulations.

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Union leaders are very conscious of that and it strikes them as ironical that union members have wealth in their pensions but have not made much use o f it.3 In evaluating nontraditional pension fund investing, it is important to analyze the way pension wealth is now managed and the way corporate decisions are now made. One o f the most succinct descriptions o f the former is provided by Julius Allen (1978). In general, pension funds tend to be managed by very large financial institutions. For the most part, the trustees o f pension funds d o n ' t participate in the affairs o f the corporations in which they hold stock and do not exercise their voting rights. On the other hand, the relationship between the financial institutions that manage pension funds and the portfolio companies is described as " s y m b i o t i c " (Allen, p. 573). This situation would not necessarily be cause for concern if one could be complacent about corporate decision-making. But there is a lot o f uncertainty on this score even among economists: Who runs the corporation, for what purpose, for whose benefit and how are decisions made? 4 Couched in these terms, it may not be surprising that unions are considering a more active role in the management of pension funds. The authors point out (Table 5) that there seems to be, as yet, little agreement among pension funds about socially sensitive issues. The data in that table also suggest that unions have been more interested in economic NTI, than social NTI (as I have defined it). In any case, if unions choose to pursue NTI, it may be difficult to establish consensus and priorities. But there arc different degrees of " o f f e n d e r s . " Some firms, for example, openly disregard or obstruct legal procedures pertaining to collective bargaining, while others may be simply nonunion. It would clearly be easier to agree about some things than others. B / C call attention to several barriers to NTI, such as lack o f agreement on specific objectives. Other factors could be mentioned: • Government regulations such as ERISA; • Conservative nature of the pension objective and the risks associated with NTI; • Possible backlash, including legal regulation, if NTI is " m i s u s e d . "

Strategies of NTI B / C describe two strategies of nontraditional investing: greater stockholder participation by pension funds and altering the composition o f portfolios. As B / C point out, whether a pension fund holds stock in a particular company probably matters very little to the direct financial wellbeing o f that company. It may have public relations importance, although that would be difficult to quantify and it could help to focus attention on an issue. In my view, the authors give short shrift to the stockholder participation and voting route, which may be the more

~Seestatementsby Lane Kirkland and John H. Lyons (AFL-CIO, 1981, pp. i and ii). Another viewis that growing union interest in nontraditional investing of pension funds may stem in part from the mounting economicpressures on unions (Bennett, 1981). "See, for example, Simon (1959)and the recent survey by Marris and Mueller (1980).

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effective tool. Stockholders' voting rights provide a potential handle for influencing corporate policies directly, and that strategy might also be used to affect public opinion. The authors argue that the portfolio strategy would probably be ineffective. Other investors would step in if a "bargain" developed. In effect, the market for shares of large corporations is world-wide. However, there may be circumstances in which pension fund actions could make a difference. One such situation is when a corporation issues new stock or new bonds. (B/C point out that pensions accounted for about half of all net financial saving in 1979). Another way in which pensions might have some leverage is through the managers of pension funds. The management of pensions assets is quite concentrated, yet competitive. For example, a single financial institution was handling some $19 billion in pension fund assets in 1976 in addition to its other functions as a major bank (Allen, 1978, p. 598). Conceivably, major banks could be pressured by the threat of losing fees for managing large pension portfolios.

Microeconomic Impacts o f N T !

B/C argue that, if pension managers were maximizing returns subject to risk considerations, then the introduction of NTI criteria must reduce performance in terms of traditional criteria. However, the study cited (Rudd) found that the cost of not investing in firms that do business with South Africa was quite small (B/C point out that some of the costs, such as from additional transactions, were not included in the estimates by Rudd.) Fundamentally, the cost of a portfolio strategy would depend on the scope of investment opportunities that are excluded and the economic characteristics of that sector. At one extreme, the cost might be very high if pension funds were permitted to focus heavily on narrow sectors of the economy that met some criteria of worthiness. However, special purpose funds might be established to diversify risks (AFL-CIO, 1981, p. iii). The prospect of NTI raises some interesting questions about the traditional institutional roles of the corporation, management and labor which, in turn, could have significant microeconomic implications. For example, NTI could result in more worker involvement in productivity or quality improvement efforts, or a greater emphasis on occupational health and safety. Conceivably, also, there could be abuses in the use of NTI which would probably result in additional government regulations to define limits. M a r k e t Failure ~ A Special Case. B/C qualify their argument above in one important respect. " I f a portion of the returns to human capital are specific to particular occupations, industries, or regions, targeting of pension assets may reflect attempts of plan participants to maximize the combined return to human and non-human wealth." Moreover, there may be other rent aspects to the relatively high wages received in some mature industrial areas which, from a private standpoint, might justify NTI. B/C point out that such uses of funds, though privately rational, may be socially costly to the extent that it slows economic growth.

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The particular exception cited by B / C may be one o f a general class of " m a r k e t failures" that could in some circumstances justify NTI. For example, because o f imperfections in capital markets, it may be economically (privately) rational to use pension funds for such purposes as housing, community facilities, or student loans. To cite another example involving international competition to attract industry: Suppose a particular country was so poor that it had no environmental or work safety standards. N T ! might be one rational technique used by unions to discourage this kind o f competition for jobs. It could be argued that a more effective approach would be through international law. But what if such law does not exist or is ineffective?

TheFrostbelt-Sunbelt Controversy. As B / C argue, the Frostbelt versus Sunbelt issue illustrates some o f the potential pitfalls o f NTI. Essentially, they argue that the East and Midwest have been losing industry relative to the rest o f the country for a very long time, in response to very fundamental factors. Hence, it may be fruitless and costly to pensioners if pension managers attempted to go against this tide. In general, I agree with this warning. NTI can be very risky and pension trustees may not be best equipped to make this kind of decision (dispassionate assessment of feasibility, risk and expected cost). However, this particular structural change has taken place at varying rates; and during the 1970s, the relative decline in employment became an absolute decline in many northern communities. Thus, the incentive to " d o something" has been especially intense. Moreover, there are examples (such as Jamestown, New York) where concerted community efforts have been able to overcome the inertia of industrial decline.

Macroeconomic Impacts The B/C analytical treatment o f saving, investment, and economic growth is especially enlightening because it emphasizes the substitution possibilities between pension and nonpension saving and among different uses of saving. Thus, only two of the uses of saving contribute to productivity growth - - business capital formation and human capital formation - - while investment in housing does not. In assessing the macroeconomic implications of NTI, I would place greater emphasis on the potential importance o f NTI as a factor that could slow productivity growth. The principal reason is that as a society we have noneconomic as well as economic goals and our economic policies reflect both kinds o f objectives. S The noneconomic goals include such considerations as a clean environment, a just society, and broad participation in the economy. Further, it is very difficult to develop effective mechanisms to deal with such nonmarket objectives. Their pursuit can affect not only the allocation of investment, as stressed by B/C, but also innovation and economic decision-making in general. Moreover,

5For a recent discussion of the tradeoff between economic growth and nonmarket objectives, see Abramovitz, March 1981.

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nonmarket objectives such as NTI have become increasingly important in the last 15 years, though the pendulum may be swinging back.

Concluding Comments That nontraditional investing of pension fund assets can be hazardous to pension plan participants and possibly fruitless is a valuable warning contained in the Barth/Cordes paper for any group that may be contemplating such a course. Their paper points out some of the economic pitfalls in nontraditional investing. As an emerging area of public policy, much analysis of nontraditional investing of pension funds remains to be done. One approach would be to build on the framework provided in the Barth/Cordes paper. Work could proceed toward further integration of the micro- with the macroeconomics of pension saving with particular reference to nontraditional investing and toward a more complete and specific model. The key relationships need to be analyzed in detail, such as the relationship between the scope and nature of portfolio exclusion and the cost to pension plan participants. In addition, nontraditional investing of pension assets should be analyzed from an institutional perspective. A complete evaluation of the nontraditional approach requires a thorough scrutinizing of traditional pension investing and of traditional corporate decision-making.

REFERENCES Abramovitz, Moses, "Welfare Quandaries and Productivity Concerns," American Economic Review, Vol. 71, No. 1 (March 1981), pp. 1-17. Allen, Julius, "The Exercise of Voting Rights by Large Institutional Investors: A Survey," in U.S. Senate, 95th Congress, Committee on Governmental Affairs, Voting Rights o f Major Corporations (Washington, D.C., Government Printing Office, 1978). American Federation of Labor and Congress of Industrial Organizations (AFL-CIO), Investment o f Union Pension Funds (Washington, D.C.: AFL-CIO, 1981). Bennett, James T., "Union Use of Employee Pension Funds," The Journal o f Labor Research, Vol. 2, No. 2 (Fall 1981). Marris, Robin and Mueller, Dennis C., "The Corporation, Competition, and the Invisible H a n d , " Journal o f Economic Literature, Vol. 18 (March 1980), pp. 32-63. Simon, Herbert A., "Theories of Decision-Making in Economics and Behavioral Science," American Economic Review, Vol. 49 (June 1959), pp. 253-83.