Capitalism and sustainability are deeply and increasingly interrelated. After all, our economic activity is based on the use of natural and human resources. Not until we account for the external costs of investment decisions, will we have a sustainable economy and society.
While capitalism is accurate in its ability to account for capital goods, it is imprecise in its ability to account for natural and human resources because it assumes that they are limitless. This, in part, explains why our current economic development is hard-wired to externalize costs.
Externalities are costs created by industry but paid for by society. For example, pollution is an externality that is sometimes taxed by the government to make the entity responsible for the full costs of production. Over the past century, companies have been rewarded financially for maximizing externalities to minimize costs.
Today, the global context for business is changing and we think financial markets have a significant opportunity to chart the way forward. The interests of shareholders over time will be best served by companies that maximize their financial performance by strategically managing their economic, social, environmental and ethical performance. This is increasingly true as we confront the limits of our ecological system.
The polluter pays principle is just one example of how companies can be held accountable for the full costs of doing business. Now, more than ever, capitalism is directly affecting a company’s ability to manage risks and sustain competitive advantage. There are many examples of the growing acceptance of this view.
In the corporate sector, companies like General Electric are designing products to enable their clients to compete in a carbon-constrained world. Whole Foods and others are addressing the demand for quality food by sourcing local and organic produce. What is of more importance to businesses is making money for shareholders, not altruism.
Over the past five years, we have seen markets begin to incorporate the external cost of carbon dioxide emissions. This is happening through pricing mechanisms (price per ton of carbon dioxide) and government-supported trading platforms such as the Clean Mechanism Board and, the Nairobi Securities Exchange (NSE).
The investment community has also started to respond. For example, the Enhanced Analytics Initiative, an international collaboration between asset owners and managers, encourages investment research that considers the impact of extra-financial issues on long-term company performance. The Equator Principles, designed to help financial institutions manage environmental and social risk in project risk financing, have now been adopted by 40 banks which arrange over 75 percent of the world’s project loan. Also, the rise in shareholder activism and the growing debate on fiduciary responsibility, governance legislation, and reporting requirements indicate the mainstream incorporation of sustainability concerns.
When we are seeing evidence of leading public companies adopting sustainable business practices in developed markets, there is still a long way to go to make sustainability fully integrated and therefore truly mainstream. A short-term focus still pervades both corporate and investment communities, which hinders long-term value creation.
As some have said, “We are operating the Earth-like it is a business in liquidation.” More mechanisms to incorporate environmental and social externalities will be needed to enable capital markets to achieve their intended purpose – to consistently allocate capital to its highest and best use for the good of the people and planet.