Graduating from externalities, ending the grift
No point in burying the lede: “externalities” are systematized grift.
Faced with the 21st century maelstrom of existential consequences of that grift, we have a simple choice: do we reshape the system, or do we just play along?
When you say it that way…
A typical definition of externality/ies, such as this one from the OECD, seems quite reasonable and balanced:
Externalities refers to situations when the effect of production or consumption of goods and services imposes costs or benefits on others which are not reflected in the prices charged for the goods and services being provided.
The OECD page goes on to offer context for the definition which further reinforces the impression of neutrality:
Pollution is an obvious example of a negative externality, also termed an external diseconomy. Chemicals dumped by an industrial plant into a lake may kill fish and plant life and affect the livelihood of fishermen and farmers nearby.
In contrast, a positive externality or external economy may arise from the construction of a road which opens a new area for housing, commercial development, tourism, etc. The invention of the transistor generated numerous positive externalities in the manufacture of modern telecommunication, stereo and computer equipment. Externalities arise when property rights cannot be clearly assigned.
Presented in such a matter-of-fact, breezy tone, the concept of externalities appears inevitable, fault-free, and sometimes virtuous. These are situations that may arise.
Notice the passive voice: no one is responsible: these things just happen.
Move along, nothing to see here.
It’s all in the wrist
This is a textbook example of misdirection, and so prodigiously effective that it has been accepted as a basic operating assumption of healthy markets, both by those performing the flimflam and those being beguiled. Unlike a Las Vegas magic show, however, the propagation of externalities isn’t mere illusion. For the majority of people, externalities amount to having their pockets picked, or far worse.
Neither a victimless nor perpetratorless crime
The point is that externalities aren’t an accident. They happen because they are a construct of the system, constantly reinforced and affirmed.
In the best case scenario, externalities arise from laziness or ignorance. Sure, it is difficult to accurately or precisely price the total actual value — positive and negative — of a policy, product, service, or business model. But it’s hardly impossible to do better than “Math class is tough,”as the ESG, sustainability, SDG, and other movements — and particularly leading practitioners like Adasina Social Capital, Boston Common Asset Management, Nia Impact Capital, Trillium Asset Management, Zevin Asset Management, and others — are demonstrating.
Regarding ignorance, none of us know everything, and everyone starts off with simple assumptions before graduating to increasingly sophisticated models as we learn. Externalities are akin to beginning engineering students’ problem sets contemplating linear systems, point masses, and frictionless surfaces. These are gross oversimplifications of reality that no one would consider sufficient representations of either static or dynamic systems in the real world. In the engineering students’ case, they serve as an introduction, a first step toward acquiring usable problem-solving skills.
Perhaps you are a sophisticated investor and this is the first time you are considering the legitimacy of externalities, in which case welcome! Whether you are new to investing or have decades of experience, embracing externalities as an investor is analogous to adhering to those freshman simplifications. It leads to bad analysis and worse outcomes. As Trevor Noah says, “If you don’t know, now you know.” So what do you do with that new awareness?
As you start to look around, you’ll notice externalities everywhere — not as the occasional exception, as implied in the definition above. They are the rule — they are the markets’ modus operandi. The ubiquity of externalities often seems to be interpreted as a self-referential justification or proof of their validity and even necessity: this is the way it’s done! Even the best-intentioned economists, regulators, analysts, financial firms, and boards and executive teams perpetuate the practice of implicitly or explicitly disregarding the repercussions of capital, information, and material flows, as though the practice derives from a law of nature. But there’s nothing about the way markets function that is either preordained or immutable. As the inimitable Joy Anderson has so brilliantly quipped, “We made this shit up. We can make up better shit.”
In the worst and most cynically extractive applications, of course, the intentional exclusion of unwanted costs and negative impacts from pricing of products or stocks is explicitly designed to channel risk and return in opposite directions, such that one party harvests most or all of the wealth and benefits, and the other is burdened with most or all of the costs and hazards. That is the fundamental narrative of entire industries, and in many instances enjoys the enthusiastic political and financial support of governments and international agencies alike.
Examples, please
Driving labor costs to zero is a market-favored practice for maximizing profits, currently in high vogue. That it just happens to create wage slavery, destabilize economies, shift costs to government and nonprofits, and exacerbate race, gender, and class disparities can’t possibly be laid at the door of the corporation — or its investors — that used legal and customary means to generate widely celebrated outsized profit, market share, CEO compensation, and shareholder returns.
How about investing in conventional venture funds with their winner-take-all, burn more capital faster, glory or die doctrine? If you aren’t personally, your retirement / pension plan, alma mater, and favorite foundation very likely are. The present-day venture model is highly regarded by the majority of capital allocators and consultants, and to be sure there have been some spectacular financial outcomes. Again, that the selfsame venture model also serves as a causal driver for wealth, income, health, and housing inequality; has been riddled with gender discrimination and sexual misconduct; and some of its most celebrated successes have proven to hold deeply problematic challenges to individual freedoms, social justice, and even democracy itself at the core of their business models can’t possibly be the concern of the venture community or its LPs. That’s someone else’s problem. Those consequences are external to us.
Whether by unwitting complicity or willful plunder, it amounts to the same thing: systematic grift.
We are all internal.
Just like the master magician for whom “misdirection came so naturally [that he] would sometimes misdirect himself!”, and the audience who “would swear they’ve been staring at the magician’s hands the entire time—and that they’ve NEVER looked away,” we collectively participate in this grift in one way or another. When we manage to convince ourselves that the financial, environmental, health, or other harms that come to others have nothing to do with us, that is simply denial.
There are no externalities: we are all participants in a closed system. Its faults are our faults. Its harms are our creations.
That realization is acutely uncomfortable for those of us who like to see ourselves on the right side of the capital sectors, and abruptly takes the shine off people and companies who have been most deft at the razzle dazzle.
With the ears of our ears awake and the eyes of our eyes open, do we allow that system to continue to propagate and magnify injustice, inequity, individual and collective harm? Or now that we know better, do we do better?
Truing up, improving as we go
System change is a process. We can’t change the system in a snap. But that doesn’t absolve us of responsibility. It simply means we have to take action to make change and keep changing as we learn, bringing better questions and better practices to bear as we progress.
For our part, Reinventure Capital is practicing a different approach to venture capital, nearly orthogonal to the prevailing model. We are intentional about the positive impacts we endeavor to create and catalyze, and we are actively striving to become more adept at foreseeing and forestalling negative impacts. It’s a learning process for us, our LPs, and our portfolio teams. How might we collaborate to learn better and do better? How can we conspire together to upgrade the system?
If you are working to dispense with externalities, please contact us to explore how we might join forces. And please share how you are ending the grift, so others can join you as well!
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Image credit: Hieronymus Bosch and/or his workshop (see Wikipedia description)
*While there’s no such thing as a guarantee in investing and no one can reliably predict the future, Ed’s prior track record delivering 32% IRR to investors provides direct evidence that it is indeed possible to consistently invest for both financial returns and system change. If you are an accredited investor and would like to learn more about investments that can advance social, racial, and gender equity by supporting high-value companies led by people of color and/or women, please contact us to start that conversation.
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