The government has crossed a bright-line rule in its proposed changes to Kiwisaver.

Its proposal to require default funds to divest of any fossil fuel stocks is incredibly unlikely to have any direct effect on greenhouse gas emissions.

To the extent it does, it will only be by reducing returns for investors who stuck with the default funds. Even in that case, it is doubtful to be cost-effective. The government could do more by working through the Emissions Trading Scheme.

And it sets bad precedents for political interference in Kiwisaver investment

If that were not bad enough, it also means writing climate policy could be done on-the-hoof in response to political demands rather than after careful assessment to ensure our collective efforts to reduce greenhouse gas emissions do the most possible good.

Climate change is too important to address with half-baked initiatives, and retirement savings are too important to become political footballs.

Let’s take each of these in turn.

The government is laudably working to strengthen the emissions trading scheme (ETS). Under the strengthened scheme with a binding cap, there will be a comprehensive and rising price on carbon which will incentivise innovation.

As American economist Alex Tabarrok puts it, a price is a signal wrapped in an incentive. Anyone able to reduce greenhouse gas emissions at a lower cost than the current price in the trading scheme can profit by reducing their emissions and selling the resulting credits – or avoid purchasing costly credits. That ensures the lowest-hanging fruit are the fruit first picked, rather than reaching first for the apples higher up the tree.

Divestment mandates, by contrast, are unlikely to have any direct effect on global carbon emissions. The only direct way they might is by raising the cost of capital for fossil fuel industries, increasing the hurdle rate for new investment projects. That cannot happen unless the mandates push down returns for the funds making those divestments. But as those funds divest, other investors will be attracted to invest by slightly higher returns.

In other words, the mandates push against price signals whereas a carbon price works with price signals.

It can make perfect sense for a fund manager to say investments in fossil fuels are vulnerable to policy risk or do not fit their fund’s risk profile. That is very different from a mandate banning it from default funds.

An effective ETS can go a long way in reducing greenhouse gas emissions. But even if you think the scheme must be complemented by additional regulatory measures to push even further those measures need evaluation too. Regulatory measures should be tested to see if the cost of emission reductions is higher when using them than the price of carbon in the ETS. If the ETS price is lower than the cost of the regulatory measure, it makes more sense to buy and retire credits in the system than to impose the regulation.

Not structuring it in this way would be a highly pernicious precedent.

Consider Heathrow. This past week, the UK appeals court barred Heathrow’s new runway due to the potential effects on climate change. The airport’s proposal had not done enough to satisfy the court that it had incorporated the government’s commitments under the Paris Agreement. Some councils in New Zealand have wondered if consenting should consider not only potential sea level rises (well worth worrying about) but also the effects on total greenhouse gas emissions. British rulings have a way of influencing courts down here too.

Impeding consenting of new activities because of effects on greenhouse gas emissions might be sensible if the effects are likely to be very large and if a carbon price is not in place. A cost-benefit assessment could test this.

But when carbon is already priced through an ETS, the regulatory measure is worse than useless. Under an ETS with a binding cap, every tonne of emissions avoided by one sector is a tonne available for someone else to purchase. It may be slightly cheaper for a government to buy and retire ETS credits, but it will be at a cost exceeding that benefit. Buying and retiring credits would do more good.

While international air travel is not yet properly accounted in emissions trading, the solution is not banning airport investment; the solution rather is strengthening international conventions about properly accounting for emissions in international travel.

We need to be establishing precedents that carbon mitigation measures are properly costed. Government needs to know the cost per tonne of emissions avoided by different measures so that we can focus on the areas where the most good can be done. Instead, we have a politically driven initiative unlikely to do anything to reduce emissions.

The precedent for Kiwisaver is also destructive. It ignores the entire economic rationale for the investment scheme and invites future depredations.

The behavioural economics underpinning Kiwisaver holds that default options can matter. They are ‘sticky’ – people can be slow to switch to the option they really want. Setting default options to line up with most people’s preferences reduces those switching costs. If most people wind up opting into a retirement scheme eventually, at fairly high cost, why not switch the default?

A wide variety of ethical investment funds are already out there, each catering to different preferences. Mindful Money provides a helpful tool for people choosing a fund which best matches their ethical preferences. But how many people really want to opt into them? Switching the default will only increase switching costs rather than reduce them.

Source: https://mindfulmoney.nz/funds/finder/

And where the precedent is established for forcing default Kiwisavers into funds matching the ethical preferences of the government of the day, it is easier to justify further changes with changes in government. Mandates requiring that funds prioritise domestic investment are far too easy to imagine.

The precedent established here will make it harder for the NZ SuperFund to maintain a sharp focus on maximising returns. And it will further encourage innovative companies to seek private equity rather than an NZX listing.

The government’s proposed changes maintain one opt-out. You can flip to other funds not subject to the mandate, if you want, for now. That may not last. And the government has banned those of us already in Kiwisaver from leaving. We might wonder about the ethics of that as well.

Dr Eric Crampton is Chief Economist with The New Zealand Initiative.