Chicago Booth Review Podcast Are You Responsible for Your ‘Passive’ Investments?

Hal Weitzman: Thanks to the growth of index funds in recent decades, more and more of us own passive investments. In theory at least, we are saved from the angst of close daily management of our portfolios. But to what extent are we responsible for what goes into those index funds? If others invest on your behalf, are you tacitly approving their decisions, including the allocation of every single dollar of your retirement fund? Is there really such a thing as a truly “passive” investment?

Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I’m Hal Weitzman, and in this episode we’re sharing insights from John Paul Rollert, an adjunct associate professor at Chicago Booth and our in-house ethicist. In this essay from 2022, Rollert reflected on the ethics of passive investing, and asked whether they confer power without responsibility.

The essay ran under the headline, “The Ethics of a ‘Passive’ Investment,” and it’s read for us by the author.

John Paul Rollert: Ethics is not without accusation—a world where no one is blameworthy is either a utopia or a nightmare—so its practice can put people on the defensive.

Take Connor Chung, a senior at Harvard College and one of the leaders of a nearly decade-long effort to get the university to divest fossil fuel interests from its $53 billion endowment. “As I got situated on campus my first year,” Chung told Slate in January, a few months after the university finally capitulated, “it was both amazing to be part of the Harvard community and really quite painful to learn that the school was actively working against my and my peers’ future through its multitude of investments in the fossil fuel industry.”

“Actively working against” is a phrase that surely grates, at least among those who opposed the public confrontations, vocal protests, and blockades of university spaces favored by Chung’s organization, Divest Harvard. Such individuals might be the first to question whether it is really fair to say that the university is actively working against its students when the investments that comprise Harvard’s endowment subsidize educational opportunities and underwrite scholarly endeavors. Research and instruction are the chief responsibilities of a university. How can it be actively hurting students when they are all benefiting from a passive investment?

The work of hands

Passive investment—this is a tricky term, isn’t it? It implies that a successful speculation is somewhat like manna from heaven, a benefit that magically appears from nowhere, dropping into our laps without any real work on our parts, or the responsibilities that come with it.

This severing of surplus from ethics or even endeavor may be the necessity of an age marked by hopelessly complex, capital-intensive enterprises, but it would have seemed strange and slightly perverse to those who first championed a strong notion of property rights as an indispensable asset of free people.

Take the most famous of these figures, John Locke, a 17th-century British philosopher whose Second Treatise of Government offered one of the most famous accounts of the origin of private property. Starting with the Biblical assumption that God gave the earth to human beings “in common,” Locke wanted to show how, notwithstanding this starting point, “Men might come to have a property in several parts” without the “express consent” of others.

To do so, Locke famously appealed to our instincts about what qualifies as just acquisition by taking us back to the state of nature, a thought experiment philosophers of the 17th and 18th centuries turned to when they wanted to draw lessons about human nature by looking to a time before the emergence of society.

Of course, such lessons were the fruits of creative hypotheticals rather than matters of anthropology or evolutionary biology, so their success depended mainly on how convincing they sounded to readers. Locke’s proved fairly persuasive, at least with respect to private property. He began with the seemingly straightforward observation that we are our own property—“every Man has a Property in his own Person”—and drew the corollary that the “Labour of his Body, and the Work of his Hands” are, therefore, “properly his.”

What does this mean in practice? Consider a violation of Locke’s axiom by means of another hypothetical. Let’s say that the two of us, after a long voyage at sea, arrive on a distant shore. When we disembark, we venture into the wilderness and soon discover a grove of apple trees. We are both quite hungry, so you step forward and pick a single piece of fruit from one of the branches. While you take a moment to admire it, I snatch it out of your hands. “MINE!” I cry and greedily devour the apple.

Now you may laugh at such swinishness, but not because you endorse it. As Locke made plain, the act is an obvious transgression, for it violates an instinctive sense of what fairly constitutes private property.

“Whatsoever” someone “removes out of the State that Nature hath provided,” he wrote, that person has thereby “mixed his Labour with, and joyned to it something that is his own, and thereby makes it his Property.” Simply by virtue of plucking the apple from the tree, Locke said, you imbue it with a sense of possession such that my taking it from you triggers a feeling of injustice. When I can just as well appropriate another apple from another tree, grabbing the first one seems wrong. To use a word that captures the idea that possession alone does not constitute private property, it feels like theft.

The nexus between surplus, ethics, and endeavor

Whatever you make of a philosophical argument that assumes a world in which land is not only synonymous with wealth but ripe for the taking, Locke’s theory of property illustrates the nexus between surplus, ethics, and endeavor. By virtue of some undertaking, I gain the benefit of the endeavor. The surplus is fairly mine, and no one can simply seize it without committing an injustice.

Seen in this light, the accumulation of private property becomes an extended exercise in just desserts. I get property and the benefits it confers not because I take it by force (the Genghis Khan approach to wealth accumulation), nor because of divine right (the feudal account), but because I have earned it.

Still, these benefits do not come cheaply. “There are no gains without pains,” Father Abraham warns in “The Way to Wealth,” perhaps the most famous entry in Poor Richard’s Almanack, the gallimaufry of poems, essays, proverbial wisdom, weather forecasts, mathematical exercises, and stargazing schedules that Benjamin Franklin published annually from 1732 to 1758.

Franklin is a paragon of sorts for the Lockean notion of property accumulation, a vision encapsulated by another chestnut from Father Abraham: “Help hands, for I have no lands.” A runaway printer’s apprentice, Franklin famously made his way to Philadelphia and eventually found his fortune by dint of hard work, careful study, and, by his own account as well as those of his admirers, the cultivation of what is sometimes called the bourgeois virtues.

As one such admirer, Franklin’s occasional pen pal Adam Smith, wrote of the commercial promise of such virtues: “In all the middling and inferior professions, real and solid professional abilities, joined to prudent, just, firm, and temperate conduct, can very seldom fail of success.” For Smith as for Franklin, it wasn’t enough to work hard. If one wanted to accumulate property and underwrite a long-term plan for success, hard work and careful study, the prerequisites of any “professional abilities,” had to be complemented by a suite of virtues that supported personal responsibility and public spiritedness. “The success of such people, too, almost always depends upon the favour and good opinion of their neighbours and equals,” Smith continued, “and without a tolerably regular conduct these can very seldom be obtained.”

Property, on this account, was something owned, operated, and maintained within the scrupulous expectations of a well-defined community. Having a horse to plow your land was all well and good, but you were the one who had to follow the plow in planting season and run all over the neighborhood if the horse escaped the barn.

This conception of private property, the significance of which went well beyond revenue streams and financial security, both assumed and encouraged a broader vision of a well-ordered society. The philosopher David Hume, another of Franklin’s correspondents, wrote in one of his most famous essays that broadly distributing private property and the rights and responsibilities that attend it creates social conditions that are conducive to what today we would call a liberal democratic order. “Where luxury nourishes commerce and industry,” Hume declared, “the peasants, by a proper cultivation of the land, become rich and independent; while the tradesmen and merchants acquire a share of the property, and draw authority and consideration to that middling rank of men, who are the best and firmest basis of public liberty.”

Like his friends Smith and Franklin, Hume believed the very practice of accumulating and maintaining private property was not only a sustained exercise in prudence and careful management, but also the foundation for a stable, responsible society and an education in citizenship.

Absentee ownership

Notably, Hume, Smith, and Franklin exchanged their trans-Atlantic letters more than 50 years before the full flowering of the Industrial Revolution. Even then, the nexus of surplus, ethics, and endeavor so central to the Lockean vision of private property was already imperiled by the rise of wage labor. Smith’s celebrated account of how a pin is made in the opening pages of The Wealth of Nations—“One man draws out the wire, another straights it, a third cuts it”—shows that he well understood that the division of labor (what he termed “the greatest improvement in the productive powers of labour”) would fracture this nexus. True, the workers who helped make a pin would certainly collect a wage, but they could work their entire lives in the factory without ever even owning the stools they sat on.

Still, if wage labor did not sit neatly in the worldview implied by Locke’s theory of property, it hardly rendered that theory null and void. “The prudent, penniless beginner in the world, labors for wages awhile, saves a surplus with which to buy tools or land, for himself,” Abraham Lincoln declared in 1859, “then labors on his own account another while, and at length hires another new beginner to help him.” A rising star of the newly incorporated Republican Party, which was then only five years old, Lincoln captured a kind of hopeful ambivalence about how wage labor might shape society. Yes, insofar as one worked principally with another’s property, the experience did not lend itself to the kind of moral education figures such as Hume envisioned, but so long as it eventually enabled one to become a property owner, wage labor was something like a way station between abject servitude and a substantial sense of self-reliance.

But absentee ownership, a phenomenon that went hand in glove with the rise of wage labor, was a different matter. That term, popularized in the second half of the 19th century, represented a different and far more lethal threat to Locke’s vision. With the advent of highly complex, capital-intensive industries, modern economies came increasingly to rely not on the motive force of individual proprietors but on an army of nameless, faceless stockholders. Most often at great distances from the enterprises they supported, these investors allocated capital without ever exercising in any meaningful or direct way the power it conferred or, for that matter, shouldering the responsibilities that attended it.

This extraordinary change in the structure of capitalism amounted to nothing less than the “dissolution of the old atom of ownership,” Adolf Berle and Gardiner Means declared in The Modern Corporation and Private Property, their seminal study of the corporate form. “Stockholders toil not, neither do they spin” to earn their rewards, they wrote. “They are beneficiaries by position only.”

Berle and Means’s book was first published in 1932, making the duo part of a group of economists, historians, and other close observers of capitalism who had watched large corporations become the “dominant institution” of modern economic life. The men and women of their generation knew firsthand what had been gained by the modern company but also what had been lost. “The capitalist process, by substituting a mere parcel of shares for the walls of and the machines in a factory, takes the life out of the idea of property,” the economist Joseph Schumpeter wrote not long after Berle and Means. “This evaporation of what we may term the material substance of property—its visible and touchable reality—affects not only the attitude of holders but also that of the workmen and of the public in general.”

No pains, all gains

Schumpeter assumed that the severing of surplus from ethics and endeavor, though a necessary requirement for complex enterprises underwritten by shareholders, would inevitably change the way we thought about property in general as well as the wealth it comprises and creates. “Dematerialized, defunctionalized and absentee ownership does not impress and call forth moral allegiance as the vital form of property did,” he wrote. “Eventually there will be nobody left who really cares to stand for it.”

Berle and Means went even further. “The owners of passive property, by surrendering control and responsibility over the active property, have surrendered the right that the corporation should be operated in their sole interest,” they contended. “They have released the community from the obligation to protect them to the full extent implied in the doctrine of strict property rights.”

Schumpeter didn’t rejoice in this possibility, but as predictions went, the withering of these rights seemed inevitable. Great imbalances in wealth are a difficult thing to defend. The Lockean vision explained them by a plausible theory of just desserts. Those who had more got it by hard work and responsible behavior. Passive investments, by contrast, assumed that others would do the real work of wealth creation and assume the responsibilities related to it. The sweat of the stockholder’s brow would only come from risk calculation, not a shoulder to the plow.

Of course, Schumpeter, Berle, and Means were all wrong in what they assumed would be the moral and legal response to passive investment severing surplus from ethics and endeavor. Rather than being released from protections accorded the type of property implied by the Lockean vision, nearly a century later passive investments continue to enjoy power without responsibility. That is one reason why, when someone like a Connor Chung says Harvard has been actively working against its own students through its multitude of fossil fuel investments, it rankles those who conveniently assume a contemporary view about the moral permissiveness of a passive investment.

Harvard “exists to serve an academic mission,” Drew Faust, the former president of Harvard wrote in a 2013 letter, a year after Divest Harvard was founded. She continued:

The funds in the endowment have been given to us by generous benefactors over many years to advance academic aims, not to serve other purposes, however worthy. As such, we maintain a strong presumption against divesting investment assets for reasons unrelated to the endowment’s financial strength and its ability to advance our academic goals.

Another way of putting this is that Harvard has the right to prosper passively from the active efforts of entities in which it invests and bears no real responsibility for how they use the power granted them by these investments. Furthermore, even to acknowledge the possibility that such investments might have any moral import beyond Harvard’s stated academic mission would be to add terms of stewardship that go well beyond what the university desires as well as what is conventionally expected of a passive investment.

Fair enough, but if such a view—which might be described as “no pains, all gains”—is hardly anachronistic, it does not (in Schumpeter’s words) “call forth moral allegiance.” If accusations such as Connor Chung’s strike us as somehow missing the mark, at the end of the day it may say less about his understanding of the responsibilities of great wealth than it does about ours.

Hal Weitzman: That’s it for this episode of the Chicago Booth Review Podcast. It was produced by Josh Stunkel, and I’m Hal Weitzman. If you enjoyed this episode, please subscribe and please do leave us a 5-star review. And for more insights from Chicago Booth faculty, visit us online at chicagobooth.edu/review. Thanks for listening—until next time.