Retirement Plans Can Help Save the World – But Not on Their Own
A mobilization of public and private capital on a scale not seen in the United States since the 1930s and 1940s is necessary to meet the challenge of the climate crisis.
There is a transcendent social good to be achieved – avoiding the worst catastrophes of global warming. Moreover, overall energy costs as a share of GDP may actually go down with a more efficient, decarbonized economy. But as in the Roosevelt era, private capital will not play the decisive role it must in the time available unless part of the risk of the necessary long-term investment is shared by the federal government and, essentially, borne by the entire society.
In particular, the US retirement system has the necessary scale to play a leading role in transitioning the economy to a decarbonized future and, further, has the need for stable, secure, long-term returns. But a federal risk-sharing role will be required to enable the retirement system to play this role and to help avert climate disaster.
This article seeks to explain why.
The problem to be solved
Scientists speaking through the Paris Climate Conference have advised that we should cap global warming below 2 degrees Celsius above pre-industrial levels, with a strongly preferred stretch goal of 1.5 degrees. This target is aggressive; it goes far beyond what the nations of the world have yet agreed to in practical terms. But we must face up to the dire nature of the situation. Even achieving the stretch goal of 1.5 degrees would not avert damaging and costly effects of global warming. A sobering recent Oxford study estimates that even with a 1.6-degree ceiling on warming, the world would still experience adverse climate effects costing 27% of per capita GDP by 2100 – with the worst impacts concentrated in the Global South where per capita GDPs are not high to begin with. This bland statistic implies substantial levels of suffering, migration, and inevitable death under the best of circumstances. However, the consequences of (i) no climate-related mitigation or (ii) simply implementing current national mitigation pledges are far worse, with the world forecasted to experience climate effects costing 45% and 40% of GDP, respectively, and large areas of the Global South experiencing climate effects costing 90% of GDP. That implies depopulation on a massive scale. So, we must be aggressive. It is the only morally, not to mention practicably, defensible choice.
How do we do this? The scientific consensus is that to hold global warming to approximately 1.5 degrees we must cut global greenhouse gas emissions by roughly half by 2035 and eliminate them entirely, on a net basis, by 2050. While there is a plus or minus five-year range on the 2050 target as expressed in the relevant IPCC report, the United States and the rest of the developed world have the most capacity to make the transition and need to be on the leading edge of implementation. Therefore, we should regard 2050 as a firm deadline for the United States. This paper will focus on the transition necessary in the United States.
Reaching net zero by 2050
So how do we do it? Quite simply, we stop burning fossil fuels (except in limited amounts with carbon sequestration). We electrify everything. And we modify certain industrial processes like cement and steel manufacturing that produce significant greenhouse gases.
Of course, it’s not simple. Since fossil fuels are now deeply embedded in all parts of our economy, accomplishing this will be enormously complicated and far reaching. A popular book and a very readable report are informative in examining how to get to net zero. One particularly useful study, published in December 2020 by a research team at Princeton University, is entitled “Net-Zero America.” The Princeton researchers adopted the 2050 deadline and examined several pathways to reach net zero with certain variables such as how much nuclear energy, how much carbon sequestration, and what reliance on biofuels would be assumed. However, the core strategy is consistent across scenarios and getting started did not require choosing immediately among pathways. The researchers dug deeply into the granular specifics of what is required for each element of the strategy in order to calculate the estimated total cost of the transition. While some technological innovation was assumed – and the cost of research was included in the estimate – the strategy generally relies on existing technology.
Key components of the strategy include replacing all fossil-fuel-powered appliances and machines in homes, businesses, and industries with high-efficiency electrical ones. This includes furnaces, water heaters, driers, stoves, boilers, motors and vehicles. Fortunately, available electrical technology is generally more efficient than legacy gas- or oil-fired systems offering long-term economic as well as energy savings. To meet this new demand for electricity, electrical generation capacity must be doubled – and doubled while fossil-fuel-fired generation plants are decommissioned or linked to expensive carbon sequestration technology. Solar and wind generation must continue their rapid expansion in all suitable locations. Local and grid-level energy storage must be deployed to deal with the intermittency of these energy sources – one area where technological innovation is needed. To accommodate and distribute all this electricity from source to storage to use, the US transmission grid must be more than tripled. There are many elements to the strategy, but these highlights give a sense of the scope.
How much is all this going to cost? The Princeton researchers estimate at least $2.5 trillion above business-as-usual capital spending through 2030 – nine years from now – and $10 trillion through 2050. The Princeton strategy is not the only one available and the path ultimately followed will differ from any single forecast, but the study is one of the most comprehensive efforts to date to encompass and specify all that needs to be done to get to net zero by 2050 and to estimate the approximate cost.
To appreciate the scale of the challenge, imagine a packet of 100 newly minted one-hundred-dollar bills, with a neat paper ribbon around it. That packet is worth $10,000 and is almost exactly one centimeter thick. Assuming it is exactly one centimeter thick, a stack of one hundred such packets is worth $1 million and will stand one meter high – just over a yard. A stack worth $1 billion will stand one kilometer high or over 3000 feet – higher than the tallest building on earth. A stack worth $1 trillion will stand 1000 kilometers or over 600 miles high. A stack worth $2.5 trillion will stand 1500 miles high. Recall that John Glenn orbited the earth in outer space a mere 90 miles up. The upshot: You cannot solve a multi-trillion-dollar problem with a multi-billion-dollar strategy.
Paying for this
How are we going to pay for this massive and essential expenditure? There is some good news here. Most of the capital expenditures described in the Princeton study either generate long-term savings because of the efficiencies of the new systems relative to legacy systems or are tied to revenue generating rate bases. This suggests that most of these expenditures are, at least in principle, financeable. Further, Princeton’s researchers forecast that a “successful net-zero transition could be accomplished with annual spending on energy that is comparable or lower as a percentage of GDP to what the nation spends annually on energy today.” In theory, if we could we finance the entire effort at a sufficiently low interest rate over a sufficiently long term, it is possible we might come out ahead economically. Another researcher has concluded that net savings is certainly the case for the household and transportation replacements required of homeowners. We must transition our economy in any event to prevent disaster, but the fact that this transition could be successfully financed offers a way to imagine the path forward.
So where would this financing come from? The short answer is we need a wartime-like mobilization of our capital resources to meet this emergency on the required timeframe. We have 9 years to invest an additional $2.5 trillion in our energy economy.
In theory, the states and the federal government could just borrow the money, write checks for everything and raise taxes as needed. At this writing, the Biden administration is beginning to discuss a multi-trillion-dollar infrastructure bill at least some of which could be dedicated to climate-related projects. But apart from the politics, the states and federal government will have their hands full with infrastructure investments that are not readily financeable because they do not generate discrete income streams or savings. Think of adding resiliency like seawalls or levees to cities threatened by rising sea levels or river flooding or addressing long-deferred maintenance on roads, bridges, and tunnels where it is impractical to add toll lanes. And there are pressing and expensive public needs beyond infrastructure, like healthcare, housing, and education to name a few, that must be addressed by government. Public spending will be part of how we transition the economy to net zero, but not the whole answer.
So we also need to move private capital off the sidelines. Let us focus on one of the largest repositories of private capital: the US retirement system. Depending on what’s included, US retirement assets total up to $33 trillion. If we limit ourselves to traditional public and private pensions and 401(k)-type plans, the total is approximately $20 trillion.
For decades, commentators have written about what a great match infrastructure investment is for retirement savings because both have very long time horizons. The only problem is that this type of investment has never happened in the US. Infrastructure investments account for less than 2% of US defined benefit pension assets and essentially 0% of 401(k)-type plan assets.
For comparison, the largest Canadian retirement plans are nearly 10% allocated to infrastructure. What if we could achieve something like that allocation in US retirement plans? Ten percent of US pension and 401(k) plan assets is $2 trillion. Bump the allocation up to 12.5% and we have our $2.5 trillion. Voila, as they say in Quebec. Problem solved, at least through 2030.
But it’s not that easy. Direct infrastructure investment requires a high level of expertise. Infrastructure investment is tough. It’s riskier than it looks, and its long-term nature adds to that risk. Any asset with a payout period of 20, 30 or even 40 years is a challenge for investors. Much can change over that long span of time, including conditions necessary for infrastructure-generated income to be maintained.
Moreover, it is difficult – not impossible, but difficult – to fit infrastructure into funds suitable for small retirement plans much less individual plan participants. This is because infrastructure investment tends to be lumpy and illiquid – that is, individual investments can be quite large, making portfolio diversification difficult, and it is hard to get your money out once it is invested.
With these realities in mind, it is hard to see how we could solve the problem by emulating Canada. The US retirement system consists predominantly of individually managed accounts, including over 600,000 separate employer-based 401(k)-type defined contribution plans, most of which are very small. Canada’s retirement system is almost entirely a defined benefit pension system. Canada has small plans like the US, but a few large plans dominate the system and those plans have developed the in-house expertise over decades to invest directly in infrastructure.
Australia is sometimes mentioned as another possible model with 6% of retirement assets invested in infrastructure. Like the US, Australia’s system is based predominantly on a defined contribution model. But, the dissimilarities are also striking. For one thing, employer-based plans make up a very small segment of Australia’s retirement systems. Most plans are managed on a multi-employer basis by large private, public, and non-profit managers providing the scale that facilitates successful infrastructure investment.
While Canada and Australia offer interesting models, their retirement systems are substantially and relevantly different from the US system. Each nation has developed its system over many years and there are political, cultural, and economic reasons not easily overcome for why each nation has the system it has. The fact is we don’t have the time to evolve our retirement system organically to more closely emulate these foreign models.
Fortunately, we don’t need to look abroad. We have American solutions that we have used before and, in some cases, are still using now.
An American Model
Let’s start with the cost of converting homes to all-electricity. Saul Griffiths, an MIT-trained engineer and net zero transition expert, has estimated that the average cost of the necessary household energy conversions would be about $40,000 - a lot of money for most people. The good news is that the savings resulting from higher efficiency systems can pay for that capital investment through financing – assuming a low enough interest rate over a long enough period of time. However, the private sector, on its own, is not going to offer those terms – certainly not on a wide basis. Unless bought down by a manufacturer or retailer, consumer financing rates often approach credit card rates and terms are seldom more than five years.
A similar challenge confronted the Roosevelt Administration as it faced a severe housing shortage during the Great Depression. FDR created the Federal Housing Administration in 1934 and the Federal National Mortgage Association - Fannie Mae – in 1938. Both have the power to backstop the credit risk of home mortgage loans. The result has been mortgage loans in the US that are the envy of the world – 30-year fixed rate loans at low interest rates, currently under 3%. While US retirement plans would have great difficulty in directly or indirectly making long-term real estate loans to individuals at low rates without government support, they routinely purchase trillions of dollars of FHA-insured and Fannie-Mae guaranteed mortgage-backed securities. This includes securities held by funds appropriate for 401(k) investors. Federal backing makes this financing safe for retirement plans.
We can look to Fannie Mae and FHA as homegrown models for a new financial vehicle to extend energy conversion loans to households, mobilizing retirement capital in a way that is safe for retirement savers while enabling households to make the energy conversions necessary as part of the larger decarbonization strategy.
The Roosevelt Administration faced equally daunting challenges with regard to infrastructure development and industrial development. In the mid-1930s, only 10% of rural homes were served by electricity. The Rural Electrification Administration, formed in 1935, extended government loans to private rural electrical cooperatives, funding both large construction projects, like generation plants and power lines, and individual home wiring. Interest rates were tied to federal borrowing rates with up to 25-year terms. The REA is largely credited with electrifying America outside of cities.
The Defense Plant Corporation was formed in 1940 as the prospect of war loomed – although more Americans were then employed in candy manufacture than aerospace. The agency used a variety of techniques including constructing plants which were then leased to private manufacturers and making long-term low interest loans, backing more than 2300 private sector defense manufacturing projects through the end of World War II.
These innovative vehicles were the Roosevelt Administration’s response to the twin emergencies of economic depression and impending war. The New Dealers recognized the scale of the problems faced by the nation and the fact that the private sector, left to its own devices, would not respond at the scale, with the speed, and with the unity of purpose needed to meet the emergency. They used a variety of innovative vehicles and mechanisms to absorb part of risk of capitalizing large-scale construction and economic transformation and to engage the power of private capital and private enterprise to help carry it out. And it worked, whether measured in millions of housing units financed and built, hundreds of defense plants created, or rural electrification accomplished. An additional result was the creation of millions of jobs in construction and manufacturing.
As a nation and as a global community, we face a similarly dire emergency now – if not more dire – and we need a wartime-like mobilization of our financial resources to address it. The New Deal models are not an exact fit to the many dimensions of the enormous task of reaching net zero greenhouse gas emissions, but they highlight techniques for mobilizing private capital and provide inspiration both in their ambition and in their ultimate success.
Two additional points are in order. First, engaging private capital and private enterprise to help achieve a common goal cannot be approached as “outsourcing” the problem by a passive, limited-purpose government to an active, competent private sector – both must be active and competent. As economist Mariana Mazzucato has persuasively argued, to achieve large goals government must act with purpose and establish clear conditions for its support for private sector investment and action. In the context of transitioning the economy to net zero, this includes addressing issues of equity and environmental justice, the quality of jobs created, and managing a just transition for workers displaced in the transition.
Second, the retirement system, in fact, needs secure, long-term investments at reasonable rates of return. The Wall Street casino of high volatility securities and high fees is not a good match for retirement saving. People should not have to fear whether they can retire with dignity every time a speculative asset bubble bursts. Long-term infrastructure investments with appropriate government risk sharing can help anchor and stabilize retirement portfolios and are, in fact, a good match for retirement savings.
What is needed now is an effort similarly ambitious to that engaged in by FDR and the New Dealers to design a set of federal risk-sharing vehicles to address each piece of the necessary transformation of our energy economy. We need smart, experienced people, a lot of midnight oil, and a short amount of time to prepare recommendations for the Biden Administration.
Fortunately, we have a successful history to draw from.
