When It’s in Your Interest Not to Be Self-Interested
September 22, 2013 Editor 0
“I have never known much good done by those who affected to trade for the public good,” Adam Smith wrote in The Wealth of Nations. “It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.”
What truly promoted the public good, Smith argued in the same famous paragraph, was the merchant who acted in his own self-interest, and in the process was
led by an invisible hand to promote an end which was no part of his intention … By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.
Just because Adam Smith wrote it doesn’t make it true. But you have to admit that his distinction sort of feels right. Profit-seeking businesses have surely created more wealth than and brought at least as much positive social change over the past couple of centuries as philanthropists and governments. And do-gooders seeking to alleviate societal ills — poverty in Africa, say — have a frustrating habit of causing at least as many problems as they solve.
So what exactly is one to make of a new movement like “impact investing,” about which the World Economic Forum issued an intriguing report on Thursday? One of the definitions of impact investing, according to the report, is that you have to intend to have a positive environmental or social impact when making the investment.
This amounts to a willful flouting of Adam Smith’s warning, something that not just impact investors have been doing lately. Lots of big corporations are, at least in their marketing and employee recruiting, emphasizing purpose over profits. The entire Millennial generation, we are told, sees business as a big playground for social responsibility and idealism.
One way to look at this attitude, as Adam Smith did in 1776 and Milton Friedman reprised in a famous critique of an earlier generation of corporate idealists back in 1970, is as a dangerous distraction from the true role of business. Another is to see it as mainly window-dressing, a way to make employees feel better about the work they do, customers feel better about the products they’re buying, and investors feel better about the profits they’re making. This can have real economic value if, say, it means you can recruit better employees or get them to work harder. But it still feels a little dodgy.
Several of the impact investing types who showed up at the World Economic Forum’s New York office first thing Thursday morning to discuss the new report offered hints of another, more satisfying explanation. What this is really about, said Audrey Choi, head of global sustainable finance at Morgan Stanley, is “redefining how mainstream investment managers understand risk.” David Chen of Equilibrium Capital Group said the strength of impact investing is its “longevity of value.”
Psychologists and behavioral economists have in recent decades accumulated lots of evidence that humans tend toward myopia in financial decision-making — we are “hyperbolic discounters” who place a lot of value on immediate rewards and rapidly lose interest if the payoff seems far away. In other words, we often self-interestedly act against our long-run self-interest. In financial markets, where most decisions are made by professionals managing other people’s money, this psychological tendency is often reinforced by the economic incentives faced by those professionals. As Andrew Haldane and Richard Davies of the Bank of England documented in 2011, “[c]apital market myopia is real. It may be rising.”
All this talk of purpose and impact, then, can be seen as a way of nudging decision-making in a more long-run-oriented direction. It’s an imperfect way — a heuristic, basically. It clearly brings with it some dangers. But there’s a reasoning behind it that Adam Smith and Milton Friedman appear to have missed.
Subscribe to our stories
- Prize-winning projects promote healthier eating, smarter crop investments June 28, 2018
- Reliable energy for all June 28, 2018
- Making marble from bottles: plastic waste’s second life in Kenya June 28, 2018
- A regional enterprise to commercialize an integrated technology for waste water treatment and biowaste conversion in eastern Africa May 27, 2018
- Dr Peggy Oti-Boateng May 27, 2018