Andrew Pitt: A parable of responsible capitalism

26 Sep 2019 Expert insight

Andrew Pitt from Rathbones looks at what lessons investors can learn from the management of Prussian forests in the 18th century.

What do Prussian forests in the 18th century have to do with capitalism today? My colleague Edward Smith provides a parable below that is surprisingly relevant, especially if you’re a charity managing an endowment. It calls us to consider how we as investors can judge success more holistically, and illustrates why we should all care about responsible capitalism.

It’s the middle of the 18th century and you’re standing in a forest in what we now call Germany. There are elm and beech and alder and spruce and a cornucopia of mosses, lichens, shrubs, flowers and ferns. A mixed choir of birds fills the canopy with tumbling descants, while rabbits, frogs, slowworms and innumerable invertebrates dance below. Two children gather mushrooms from the thick forest floor while their mother collects kindling for the bread oven. To the Prussian state that owned it, the forest was a blissful, flourishing and profitable source of wood.

It’s now the end of the 19th century, and you are standing in the same forest. Only you wouldn’t know it. The elm and beech and alder are gone, as is the cornucopia of flora and most of the fauna. It’s eerily silent. There are no mushrooms for the children to gather, the forest floor is patchy, and the soil is thin and grey. The villagers no longer live symbiotically with the forest. Only row after regimented row of Norway spruce stand before you. And many of them look rather sickly. So, what went wrong?

Forest management. Or mismanagement. The Prussian state and its managers looked past a vastly complex set of processes that constituted the forest and, using a short-sighted fiscal lens, reduced the whole ecosystem to a single number: the annual revenue yield of timber. Everything that seemed unrelated to maximising yield was ignored (the birds or the fungi) and everything that was thought to impede production efficiency was eliminated. 

But the vast array of elements that the state had resolutely dismissed as a source of wood came back to haunt it; not seeing the forest for the trees resulted in Waldsterben, or forest death. It turned out that most of those fungi, insects, mammals, ‘weeds’ and even humans mattered. Soil building and nutrient uptake depended upon them. Acting as though they didn’t, while focusing single-mindedly on increasing spruce yields was a mistake. Uniformity and a lack of diversity also made them highly susceptible to disease. 

The grave consequence wasn’t seen until it was too late. The first rotation of conifers in stripped-down monocultural forests yielded spectacular results. But this tremendous growth was built on the nutrients engendered by the previous regime. By the second or third generation, production losses reached 20—30 per cent. And that’s not to mention the big drop in villagers’ standard of living as pasture, foraged food and other valuable resources were lost.  (This summary of the travails of Prussian forestry management is indebted to James C. Scott’s Seeing like a State, a brilliant contribution to political science that contains many other examples of managerial processes of simplification and reductionism gone awry.)

Like most parables, it’s rather blunt — we don’t think the current regime has resulted in economic Waldsterben. But economic growth, and productivity growth in particular, has fallen to worryingly low levels. And that has huge implications for investment returns, and therefore for charities seeking to maintain or grow their endowments.

Everything is connected    

It isn’t hard to draw parallels between this Prussian forest and today’s economic environment. Our incremental return on investment has plunged and in advanced economies, real wages have stagnated, and inequality has risen. And that lowers economic growth further because the average worker has a higher propensity to spend additional income than the average wealthy capital owner. Altogether, this means lower interest rates and lower prospective returns on both equities and bonds. That puts those in charge of managing a charity’s investments in a difficult spot, forced to lower return targets or expose themselves to a greater risk of loss if they seek to maintain higher returns. 

Let’s not make the same mistake as the 18th-century state and pretend that everything isn’t connected. The whole ecosystem matters. We believe that executives, shareholders and investment managers have acted like the Prussian state. At some point in the 20th century, the company and its purpose in society was resolved, like the forest, into a very narrow set of short-term profit metrics. And thereby the complex relations a firm has with society, the economy and the environment have been subordinated in the name of maximising profits. Like early-modern forest management, we believe that this reductionist strategy is short sighted. Alongside the many negative consequences for the broad socioeconomic ecosystem, it has jeopardised the opportunity for profit long into the future. 

Acting in your own interest

We believe that executives and investors must consider a new approach, one that acknowledges that long-term profits depend on a diverse, thriving ecosystem. This approach is not just a ‘nice to have’ or something for the altruistically motivated ‘ethical’ investment specialist. Societal problems and the prospective collapse of investment returns are one and the same. There is a now-substantial body of evidence to suggest that businesses with the most sustainable practices are better performing than their peers.  (Robert Eccles, Ioannis Ioannou and George Serafeim, ‘The Impact of Corporate Sustainability on Organizational Processes and Performance’, Management Science 60, no. 11 (2014): 2835-857; and Arabesque research.)

We are privileged to work with many charities, helping to manage their endowments, which often have infinite time horizons. Therefore, we must ensure that we don’t diminish the investment returns of tomorrow, which are intimately linked to the investment decisions of today. 

Andew Pitt is head of charities at Rathbone Investment Management, which has dedicated hub for information about responsible capitalism.

This content has been supplied by a commercial partner. Rathbone Investment Management is the overall partner for the Charity Awards. 

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