In 2000, the trustees of the California Public Employees’ Retirement System, or CalPERS, overhauled their investment policy, adding a dramatic new element called “socially responsible investing.”
Under the new system, investments in the less developed world would no longer be guided simply by the promise of profit by companies and products but would also have to meet certain specific “ethical” criteria to ensure that California was not exploiting workers in “emerging market” countries. The new system was hailed as “a major force for human rights and democracy around the world.”
But today, the CalPERS experiment looks a lot less promising. Its investments have underperformed a broader index of emerging-market investments by three percentage points. It also has become clear that the CalPERS policy is counterproductive, all but ruling out investment in the poorest countries, those that most need it.
Because the rules are convoluted and obscure, the trustees have been tying themselves in knots to justify their investment policies in poor countries.
At issue is the approximately $1.8 billion -- a little more than 1% of CalPERS’ total assets -- that is invested in emerging markets. For the new program, CalPERS developed criteria to declare whole countries -- rather than individual firms -- “permissible” or “nonpermissible” for inclusion in its portfolio.
Investment advisors came up with a numerical scoring system that rates countries on their political stability, transparency and productive labor practices and their financial markets on liquidity and volatility, regulation and legal protections, capital market openness and settlement and transaction costs.
This all seems objective. Yet in practice, the policy favors the relatively rich and small developing nations. Very poor nations score too low and are denied CalPERS’ investment because their civil service and labor practices are inferior to those of richer nations. In other words, the poor are penalized for their poverty.
In fact, the trustees could replace their high-tech scoring system with one simple rule -- “invest only in emerging countries with per capita income above $7,000 (corrected for purchasing power) and fewer than 100 million inhabitants” -- and come up with nearly identical lists of permissible and nonpermissible nations. Under the current system, the majority of permissible countries -- Argentina, Chile, Czech Republic, Hungary, Israel, Mexico, Poland, Korea, Taiwan, Turkey and South Africa -- are small and relatively well-off. Most of the nonpermissible countries are large, poor or both: China, Egypt, India, Indonesia, Morocco, Pakistan, Russia, Sri Lanka, Thailand and Venezuela.
The only exceptions to the rule are Jordan and Peru, which are “permissible” despite having low income, Malaysia, which is “nonpermissible” although it’s small and well-off, and Brazil, “permissible” despite being big and relatively well-off.
The average income (weighted by population) in all permissible countries is $9,150; the average in all nonpermissible countries is $3,550. More than 80% of the population of emerging-market countries is off-limits to CalPERS’ investment.
The unfairness of CalPERS’ ethical criteria is underlined when one looks closely at the ratings. Are Peru and Jordan really better governed than India? They look like the token charity cases invited to the ball.
The problems with ethical investing do not mean that the whole idea should be thrown out. After all, there are truly despicable countries and firms.
One modification to ethical investment practices might be to turn the process around. Every country would be assumed permissible unless it egregiously violated human rights.
Economic development fueled by productive investment is what improves wages and working conditions. If ethical investing systematically denies low-wage nations access to foreign capital, it will only slow down the progress it seeks.
Bernard Wasow is a senior fellow at the Century Foundation in Washington.