OSEC Congressional Testimony
Testimony of Robert B. Reich Secretary of Labor Before the Joint Economic Committee United States Congress [06/22/94]
Madam Chair and Members of the Committee:
It's a pleasure to appear before the Joint Economic Committee. I commend the committee's leadership for addressing the issue of Economically Targeted Investments (ETIs). This morning, I want to share with you the Clinton Administration's views on ETIs -- in particular, how our nation's pension funds can invest their dollars not only to achieve competitive rates of return, but also to generate long-term, broad-based economic benefits.
Let me be clear at the outset precisely what I mean by an economically targeted investment. An ETI is an investment that meets two stringent tests. First, the investment produces a competitive risk-adjusted rate of return. Second, above and beyond attractive returns, the investment produces collateral benefits to workers and communities in the form of infrastructure, housing, job creation, or enterprise development.
As the members know, there has been some confusion in recent years about the extent to which ETIs are consistent with a pension fund's fiduciary responsibilities. One reason for this murkiness is that ETIs are frequently confused with what is known as "social investing." In current parlance, this term usually refers to investment practices that subordinate financial return to some other social objective. The Department of Labor does not condone the use of pension funds in this manner. We prohibit it. ETIs are not social investing. They are instead a way that pension funds, whose position in the American economy is uniquely powerful, can satisfy their primary responsibility by deploying their assets to lift the entire economy.
Today, in an effort to clear away any confusion that may surround this matter, the Labor Department is issuing an Interpretive Bulletin that clarifies the law and codifies our long-standing position. Our Interpretive Bulletin reaffirms what has always been true: ERISA, the federal law that governs pensions, does not prohibit economically targeted investments. Pension plan fiduciaries who invest funds in an ETI are acting well within their legal responsibilities so long as the ETI generates a competitive risk-adjusted rate of return, and so long as the ETI is an otherwise appropriate investment. If a pension fund meets its first obligation, achieving a competitive risk-adjusted rate of return, ERISA presents no barrier against efforts to produce collateral benefits for the wider economy. We will encourage funds to reach for such collateral benefits, because -- far from conflicting with their fiduciary duties -- doing so complements their responsibilities to plan participants.
With me this morning is Olena Berg, Assistant Secretary of Labor for Pension and Welfare Benefits, who will explain the Interpretive Bulletin in greater detail. She has been the engine behind these efforts, and has used her office and her own extraordinary talents to bring ETIs to wider attention. Our mutual hope -- and I know the hope of many members of this committee -- is that by dispelling some of the uncertainty about the law in this area, we can foster the wider use of ETIs.
This bulletin comes at a moment when the American economy is in the thick of historic change. International trade -- and especially, new technologies -- have shattered the fundamental premises of the economy our country once knew. Capital and information can now wash easily across national borders, which means a nation's key economic resources are those that remain fixed within its borders -- primarily, people and infrastructure. Although the economy has added more than three million private sector jobs since President Clinton came to office, we still have some eight million Americans unemployed, about four million part-time workers who can't find full-time work, and millions more Americans who are outside the job market altogether. Long-term unemployment remains a persistent problem, and the income gap between well-educated and less well-educated workers widens more each year.
To address these problems, the Administration has launched a plan for economic renewal whose central goal is to build an American ethic of continuous lifelong learning -- together with the institutions to give that ethic practical effect. In the last two months, the President has signed legislation to establish world-class educational and skills standards, and to ease the transition from school to work for the 75 percent of America's young people who do not graduate from college. We've also expanded the earned income tax credit to make work pay, and lift the living standards of the working poor. And in the coming months, the Administration will be hard at work reforming the health care system and turning the unemployment system into a reemployment system. (By the way, thank you again, Senator Boxer, for cosponsoring the Reemployment Act.)
An essential complement to this skill-building agenda is stepped-up investment in the enterprises where workers can deploy their skills. It is here where pension funds are in a unique position. Pension funds today comprise 25 percent of the market value of all the stocks on the New York Stock Exchange -- and 32 percent of daily trading volume. One out of every five dollars of financial assets in the United States now belongs to a pension fund. In all, America's pension funds hold assets that total $4.6 trillion. Since that figure is so unfathomably large, let me put it in perspective. If $4.6 trillion worth of one-dollar bills were laid end-to-end, they would stretch a distance equal to 907 roundtrip journeys from Washington, DC to the moon.
With holdings so enormous, it's difficult for pension funds to beat the market, because they are the market. The law of supply and demand runs smack into Heisenberg's uncertainty principle: the pension fund community has grown so immense that it cannot make a move without affecting the very market it seeks to outsmart. This dominance presents both danger and opportunity. Pension funds are so large that if many of them attempt simultaneously to dodge quickly in and out of positions, they risk disrupting the market and undermining their own objectives. But their size also offers pension funds both the incentive and the ability to improve the long-term prospects of the entire economy.
Pension funds are becoming perhaps the most vigilant and influential custodians of long-term corporate strategy. No longer content to remain passive investors, they are using their expertise and influence to monitor and improve the long-term performance of individual companies. As any CEO will tell you, nothing concentrates the mind so much as an inquiry from a major institutional investor about his or her company's practices.
Now, let me be clear about our Interpretive Bulletin and the policy of this Administration. The foremost responsibility of investment managers and trustees is to provide retirement income for plan participants and their dependents. And the only way to fulfill this responsibility is by uncovering the best possible investments for the exclusive benefit of plan beneficiaries. One reason pension funds have grown so large is the rigorous fiduciary standards that Congress established for private sector pension plans two decades ago as part of ERISA. This Administration sees no need for, and would oppose, modification of these proven standards.
But at the same time, the simple rate of return on funds set aside for retirement does not -- in and of itself -- guarantee a secure retirement income. Retirement income depends in part on the wages plan participants earn while they're in the workforce. For example, workers who participate in defined benefit plans will receive retirement income based on their years of service and their salaries. Those who participate in defined contribution plans will receive retirement income based on what they set aside from their earnings. In both cases, rising incomes and robust job growth are essential in ensuring retirement security for plan participants.
Pension funds -- their dollars reaching 900 times to and from the moon -- are positioned like no other force in the American economy to raise incomes and spark new jobs. Just as owners of a substantial stake in a single company must take a patient, far-sighted view of their investments, pension funds, recognizing their status as the "owners" of much of the economy, can benefit most from similar long-term thinking.
Economically targeted investments are one important way to invest for the long term. Later in the hearing you'll learn about efforts CALPERS has undertaken in California. And across the country, several other examples abound.
The Equitable Company has used its financial expertise to design real estate investments for pension funds in Boston and St. Louis that produce strong returns for investors through renovating and constructing affordable housing. In Massachusetts, more than 100 public sector funds have demonstrated that venture capital investments in start-up companies can be a boon both to the state's economy and their own portfolio. Such investments have created some 5,000 jobs in the Massachusetts and an average rate of return of 16 percent. And the Trust Company of the West, using some $200 million from the Boilermakers and Blacksmith National Pension Funds, has made investments in energy infrastructure projects with a projected lifetime return of over 14 percent.
Economically targeted investments can fortify the foundation of job growth. Investments in the economy's physical foundation -- its infrastructure of roads, bridges, highways, airports, and communications networks -- can produce high rates of return and enhance the long-term prospect of other portfolio investments. You've long been an advocate of such investments, Senator Boxer, and I encourage you to continue your efforts. Profitable investments in enterprises located in underdeveloped communities can create jobs -- and equally important -- new consumers for the goods produced by companies whose stock pension funds hold. Investments in affordable housing can both create new construction jobs and help employers attract and retain employees. Again, the benefits of this investment in growth-based prosperity will ripple to the companies in a fund's holdings.
The same is true for companies that are committed to developing the most important component of our national foundation: our people -- their skills, their talents, their capacity to work together. In an economy where a superior workforce is the cornerstone of competitive advantage, a company that invests in its human capital should, over the long run, increase its productivity and profits -- and, accordingly, the value of its stock.
I have established within the Labor Department the Office of the American Workplace, one of whose duties is to collect data and sponsor studies on just that question -- the relationship between how a company treats its workers and arranges its workplace and that company's long-term performance. Some of these early findings are encouraging, and we would be happy to provide them to you. In general, these studies have found a solid connection between high performance work organizations and long-term investment return. Companies that flatten hierarchies, that empower front-line workers to make key decisions, and that commit to educating and training employees produce good results for their workers and shareholders alike. We have produced a discussion guide to help funds work with companies to evaluate and improve their workplace practices.
I'm also delighted to report that just last week, CALPERS, the nation's largest public pension fund, announced that it would incorporate workplace performance practices into its corporate governance program. CALPERS monitors companies whose stock it holds, and will use workplace practices as one screen in identifying poor performers and taking steps to improve their performance. CALPERS has realized that a deeper, longer-term look at investment alternatives doesn't dilute traditional notions of prudence; it fortifies them.
There is momentum -- momentum that will be accelerated by this hearing. In a few moments, Assistant Secretary Berg will discuss more specifically the Interpretive Bulletin and the other steps the Department of Labor is taking. And later this morning, you'll hear HUD Secretary Cisneros describe a demonstration project his department has launched that will use federal money to leverage pension fund investment in developing affordable housing.
Properly constructed, ETIs are appropriate investments under the fiduciary standards of ERISA. As you all know, there has been some confusion in the pension community on that point. But today's Interpretive Bulletin should erase any doubt. Pension fund investments that produce a competitive risk-adjusted rate of return for plan participants and that produce collateral benefits to workers and communities are unquestionably permissible under ERISA law. I encourage plans to consider such investments when they make their investment decisions. America's pension funds -- $4.6 trillion and still growing -- are the stewards of our economic future.
Thank you for this opportunity to speak with you on this important subject. I look forward to working closely with the members of this Committee in our efforts to improve the lives of American workers and their families.