Investors to the Rescue?

Environmental, social, and governance investing (ESG) as Paul Tice describes it is “liberal progressive politics masquerading as finance.” With his book The Race To Zero, he is sounding the alarm: There is more than one “zero” in play. Environmentalists are thinking zero carbon emissions, but are they leading the world toward zero GDP? Viewed in context, his work is the latest chapter of a very long story. 

The economics of Adam Smith, like the biology of Charles Darwin, has always had enemies because it is a system that creates an elaborate world without a guiding intelligence. For those who, in one way or another, have the Book of Genesis as their model, spontaneous order is an incomprehensible state of affairs. Someone must be in charge, preferably themselves. Darwin had to contend with the Church. Smith and his descendants have had to see off first the socialists and more recently the corporatists. The debate, however, will never end. Since neither Darwin nor Smith ever promised Utopia, enough goes wrong from time to time to keep collectivist hopes alive. 

Global warming, because of its scale and potentially grave consequences, is the grandaddy of all calls for state intervention in the economy, an observation that by itself should stir apprehension. A sizable majority in every country that has been polled accepts the theory of man-made warming and agrees that something has to be done. Support for action, however, dwindles once people appreciate the cost of actually doing something. 

The economics are harsh. Energy powers growth. Any country that materially constricts fossil fuel before a viable alternative is available would have to accept slower economic growth, with all of the consequences that would ensue from the loss of social lubrication that growth provides. In the United States, living conditions would stagnate, Blacks and other rising groups would advance more slowly, the country would lose international standing. Tension, both domestic and international, would rise. 

Faced with the intolerable discomfort of the available choices, governments everywhere have proceeded cautiously and come forth with the policies we see today, a combination of virtue signaling, scapegoating, and long-shot bets, of both public and private funds, in the hope that technology will save the day. Many recent efforts look promising, and one hears optimistic forecasts that some combination of solar and nuclear power will soon offer a transition to non-carbon fuel with little or no loss in GDP. Large-scale subsidy programs, like the Biden Administration’s Inflation Reduction Act, if they can be well designed, might also bring that day closer. Be that as it may, nothing so far has inflected the trend toward rising temperatures, much less accommodated the doubling in energy production that is likely to take place over the next twenty-five years. Scientists who have looked into the problem maintain that time is running out. The world can only hope they are wrong.

It might be a cliché, but it truly is an ill wind that blows no one any good, and one of the undeniable side effects of environmental worry has been a shot of new life for the adversaries of laissez faire capitalism. They have always been there, but this is the moment to press their case, and they have come forward in their motley legions. Their argument, judging from a writer like Garrett Hardin, one of their more articulate voices, is that degradation of the atmosphere is the greatest Tragedy of the Commons mankind has yet confronted. 

The atmosphere is a common resource without an owner. Everyone uses it, no one is explicitly rewarded for conserving it. Conditions can only deteriorate. Even though problems of this type are not without precedent, governments so far have dealt best with localized situations. The state of Maine prevents fishing out of the lobster beds by a system of tradable quotas that the lobstermen observe and enforce upon one another. There are other examples, but in general instances of large-scale success are difficult to find. Efforts to prevent depletion of the oceans, for example, are not going well. Piecemeal reform, so the argument goes, will not save the world. Capitalist economics and the bourgeois materialism it engenders are the problems and must be eliminated.

A similar if less extreme hypothesis holds that global warming is a byproduct of the economic growth much of the world has enjoyed since the advent of industrialization in the late 18^th century. Since most of the world’s great economies are capitalistic to one degree or another, the way to improve the environment is to sharply constrain capitalism and get the world economy, and for that matter all of society, under more rational—that is, centralized—control. Once set rolling, these patterns of thought rather quickly slide toward a generalized contempt for middle-class life and for those who pursue it. It’s only a short step from there to entering the Louvre Museum and throwing soup on the Mona Lisa or proposing that population be controlled by requiring couples wanting to have a child to first obtain a government-issued permit.

One of the less absurd, if so far no more efficacious, ideas to come out of the environmental movement is ESG investing, the subject of Paul Tice’s well-written and engaging book. Tice’s is not a work of political advocacy, but an alternate subtitle for it might be something like, “An Intelligent Person’s Guide to Voting for Donald Trump.” It documents the activities of a vast group of well-paid international civil servants, types whom the Brazilian economist Francisco Santos once christened the Feasting Left. This particular group is housed within the United Nations and its affiliate organization, Principle for Responsible Investing (PRI). Their mission is no less than to circumvent the political obstacles that so far have prevented the world from eliminating fossil fuels. They plan to do it by manipulating stock and bond prices so as to deny fossil fuel producers access to capital, a methodology that is at once simple minded and exaggerated in the power it imputes to financial markets.

Reduced to one sentence, the objective of ESG investing with regard to the environment piece is to raise the cost of fossil fuels by raising the cost of capital for its producers. Oil and gas companies, according to this story (one hesitates to call it a theory), will respond to higher capital costs by raising prices. Producers of solar panels and other approved forms of energy will enjoy the inverse—lower capital costs, more money available for research, and an easier time sustaining their activities. Facing a new set of relative prices, energy consumers will, perhaps after an adjustment period, switch from one source of energy to the other, and the world will be saved.

There is not enough room here to deal with all of the theoretical and practical problems this story encounters before it can hope to come true. Indeed, one possible criticism of Tice is he is too ready to accept PRI’s own PR. The odds of ESG investing attaining its goals, even the more limited ones, are quite low. Recognizing this observation, however, would deprive Tice’s book of the emotive force that is part of its charm.

The first question, then, is can ESG investors channel enough money in the proper direction to alter stock and bond prices? Won’t arbitrageurs come in and undo their good work by shorting shares that become overpriced and buying those that are underpriced? The asset pricing model for which William Sharp won a Nobel Prize doesn’t have any arguments for social benefit. It deals only with earnings growth and risk. So, there is reason to believe ESG investors will find themselves in an arm-wrestling match with those annoying students of Milton Friedman who believe the proper role of business is to earn money, not make public policy. 

The ESG investor is not entirely without hope in this struggle. The recent efforts of the Federal Reserve to lower the level of long-term interest rates by buying big chunks of the national debt are a source of inspiration. PRI’s approach has to be a worldwide effort, however; world equity markets are a good bit larger than the Treasury bond market, and there’s a lot more at stake.

PRI will have to enlist massive sums even to meet its first objective, and on paper they have. Tice describes a 20-year evangelical campaign by PRI, aided by the World Economic Forum, that has enlisted over 5,000 signatories who collectively manage over $120 trillion in assets. That sum exceeds the value of all equity listed on U.S. stock exchanges. Indeed, its very size is a source of skepticism. With that much money behind it, why hasn’t the sustainable investment movement been more successful already? 

Tice admits the results of ESG investing so far are undetectable to the naked eye. One possibility is many of the PRI adherents want to be virtuous, but not if it costs them any real money. Many of them are managing the endowments of schools and churches with programs of their own to support. They can afford lip service, but there is a limit to how far they will go.

For the advocates of ESG investing, their ace in the hole is and always has been government coercion. If all else fails, governments have enough regulatory power to supersede competitive markets and direct investing toward sustainable ends, the full program including who gets access to the ladies room. Herein lies the starting line of Tice’s Race to Zero. It is the outcome, he argues, that has always been the PRI agenda, and much of his book is taken up with documenting the network of social control that he sees spreading over global markets. 

Much of what he describes is impressive, but it isn’t clear whether the overall effect so far goes beyond body English. One does hear more social babble out of the mouths of CEOs than was the case even a few years ago, but how many have put any money at risk? The Securities and Exchange Commission recently mandated all listed firms to release information regarding their carbon footprint, but it’s the type of measure that helps ESG investors feel good about themselves rather than doing any real economic damage. If the regulatory agencies are truly going to get into the market’s way, they will have to be a good bit more vigorous than they have been to this point. Investment restrictions, however strict, might not be enough. The fifteen years prior to 2021 were a disaster for the equity prices of Exxon and the entire American energy industry. During the same period the United States rose to become the world’s largest producer of fossil fuels.

In handicapping these prospects one has to bear in mind the environment is the entire world’s problem. It wouldn’t do much good to reduce carbon emissions in the United States if doing so just shifted the restricted activities to other, less regulated countries. Any regulatory program that was not copied by other countries would find itself injuring domestic companies to no real end, in which case the issue would rather quickly descend into the same politics that have to date withheld the government’s hand. 

Paul DeRosa taught economics at Columbia, ran a hedge fund for some thirty years, served on the research staff of the Federal Reserve Bank of New York, and has written extensively on topics related to economics.

Image: A computer screen displaying a stock chart. (Unsplash: m.)