'Earth Day' investment lessons

Our most recent post contains a discussion of the dangers of zero-sum thinking and notes that many international organizations, such as the UN's Population Fund (UNFPA) are clearly coming from a zero-sum worldview when they support assertions such as: the "solution to climate change and food security must tackle population growth."

Sadly, children in schools around the world today will be taught "Earth Day" lessons replete with messages that humans are rapidly depleting the planet's scarce resources. Readers who doubt the level of rhetoric that has been directed at the upcoming generation on this front can peruse the book reviews offered last week by the Wall Street Journal's children's books columnist Meghan Cox Gurdon, who lamented the heavy-handed "eco-propaganda" directed at children in a piece entitled "Scary Green Monsters."

As we have pointed out in a previous post, there are serious economic consequences to proposals for "sweeping global goals" designed to force individuals and economies to "curb energy use and greenhouse gas emissions," such as those called for in a NY Times blog that we cited in our post from 2007.

Most basically, it is by no means settled that human activity is causally related to global climate, as the talk given by Professor Noah Robinson of the Oregon Institute of Science and Medicine linked previously explains.

Further, even if one were to grant a causal relationship, it does not necessarily follow that the best response to such a causal link would be to impose government restriction of free enterprise. On the contrary, it can be demonstrated using empirical data that economic freedom and the corresponding increase in wealth, productivity, and technology that it brings about is the very thing that enables greener and cleaner societies and improvements in the health of the environment.

For example, as economics Professor Mark Perry of the University of Michigan's Flint campus demonstrates in his excellent Carpe Diem blog yesterday, various measures of air quality in the US have improved dramatically over the past twenty to thirty years (a 28% decrease in particulates over the past seventeen years, a 76% decrease in carbon monoxide levels over the past twenty-seven years, and a 91% decrease in lead levels over the past twenty-seven years), despite the fact that the US population has increased by 50.25% since 1970 and the number of miles driven has increased by 159% (see "Earth Day 2009: Air Quality's Better than Ever.")

Professor Perry links to other examples that support the fact that free enterprise and rising prosperity are the best prescriptions for environmental health, such as this article by John Tierney in Monday's New York Times.

Government interference can not only smother the kind of innovation and economic value-creation that help improve air quality and other measures of environmental health, it can also act to artificially direct capital towards projects that are wasteful.

Normally, capital flows towards innovation based on rational decisions made by those who provide the capital based on their potential rates of return. However, when governments artificially tip the playing field, capital can flow into areas that it normally would not, a phenomenon properly termed "malinvestment."

For example, the government gives out subsidies for the use of solar technology in order to make it appear to be more economically viable than it actually is. Unlike the profits earned by an unsubsidized business, which must demonstrate value to customers who then voluntarily trade their money for the products or services of the business, these subsidies come from taxes which are taken from taxpayers using the force of law.

Venture capitalists and other investors will allocate more capital to solar start-up companies than they normally would, and those solar start-ups can make profits they otherwise would not be able to make. Thus, capital flows towards solar which might otherwise be more profitably employed towards a technology or innovation that would be able to stand on its own merits. It should be noted that there are plenty of recent examples of government-induced malinvestment, such as the real estate bubble, in which the government encouraged more home lending than would otherwise have occurred.

The argument that government should encourage home ownership is exactly parallel to the argument that government should support solar energy, and the results of the malinvestment in residential housing should be a warning to those who assume government should be tilting the playing field and encouraging capital to flow where it otherwise would not.

While individual investors cannot do much about the government's decisions to encourage capital to flow towards "green" initiatives (or the use of their tax dollars to subsidize such initiatives), they can make sure that they don't fall into the same trap when they are making the decisions about the allocation of their own investment capital.

While the areas that receive huge inflows of capital due to malinvestment appear to flourish for a while (think of real estate related investments during the period from 2003 to 2006, for instance), artificially-induced bubbles inevitably deflate. As we have written several times before, investors should remember that investing is ultimately about "providing capital to businesses" -- and if those businesses are making profits in large part because of government subsidy, they may not be a very wise place to direct your capital.

Ultimately, we would argue that the best lessons investors can contemplate on "Earth Day" are the importance of free enterprise, and the importance of allocating their own investment capital to the very best enterprises that they can find.

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