Environmental, Social and Governance (ESG) investing has become extremely popular over the past few years. Investors increasingly put capital into ESG funds, “impact” funds or funds driven by the United Nations Sustainable Development Goals. Their investment focus is primarily Environmental, with marginal attention given to Social and Governmental issues. While this support for the environment is encouraging, it is delusional to believe that we can win the war on carbon without more fundamental Social and Governance changes.
Thus far, ESG funds have merely divested capital from the fossil fuel industry. They have put hardly any capital into new cleantech companies that could help with the energy transition. Energy efficiency technologies, hydrogen power, carbon capture and nuclear fusion remain severely underfunded. Instead, ESG investors reallocate capital to almost risk-free opportunities like Apple, Amazon, Microsoft, Alphabet and Facebook, which deliver above-market returns.
As Blackrock and others report, ESG funds are outperforming the market. Clearly, that is because ESG criteria favor companies for their lack of a carbon footprint; not their ability to decarbonize industries; not their social impact on communities that will suffer from the energy transition; not for respecting democratic institutions and rule of law. Isn’t this greenwashing?
ESG investors who want credibility in the war on carbon should change the order of priorities: put sound Governance and Social considerations first to enable real Environmental impact. They should move from ESG to GSE investing.
ESG is for Salon Socialists.
In the ESG space, there is a cadre of Salon Socialists who believe in “doing well by doing good.” They talk the green talk at cocktail parties while sipping their sauvignon blanc and humble-bragging about their Teslas. From Wall Street to Silicon Valley, Salon Socialists believe in fighting climate change through private entrepreneurship without changing existing social and political systems. The government, they say, is too inept to solve the problem. Rather, they believe, the Übermenschen of the Bay Area will devise a “win-win” solution.
This pro-enterprise, anti-government brainwashing gained momentum in the 1980s, when Ronald Reagan and Margaret Thatcher eroded faith in the institutions they were elected to lead. Reagan famously said, “The most terrifying words in the English language are: I’m from the government and I’m here to help.”
Today, during the COVID-19 pandemic, those would be the most reassuring words in the English language. In March, the US federal government didn’t show up to help. Rather, it deflected responsibility for the pandemic to private profit seekers and local governments. As a result, the US is losing its battle against the virus. Meanwhile, in places like New Zealand, Taiwan and Finland, where central governments took decisive action, the virus is much more under control.
COVID-19 is a practice round for climate change, an even deadlier transnational crisis. No matter how private enterprises score on ESG frameworks, they are ill-equipped to solve complex, systemic problems that offer no short-term profits. Climate change, like COVID-19, benefits from private innovation but still needs the support and direction of an effective public sector. Without a new approach to Social and Governance criteria, the war against climate change will resemble the US’s failing war against COVID-19.
The Energy Transition Hinges on Widespread Societal Support
ESG funds that soothe elite guilt while ignoring working class struggles will fail to make a difference. The “S” in ESG cannot be just about shareholders. It must include fair treatment of employees and the public institutions that provide education, infrastructure and public safety for the communities where they operate. To push primarily the E in ESG without more accounting for social impacts will undermine support for solving our massive environmental problems. The financially insecure working class will place its lot with populist strong men who promise yesteryear’s jobs in exchange for autocratic powers.
Social protests ranging from France’s Yellow Vest Movement to Black Lives Matter have put our western democracies to test. Too few people have benefited from the economic boom of recent decades. Today, inequality is as high as it was just before the French Revolution or the rise of Nazi Germany.
In 2011, Harvard business professor Michael Porter together with Mark Kramer argued that the capitalist system was under siege in an essay called “Creating Shared Value.” They noted that business was being “criticized as a major cause of social, environmental and economic problems,” and “companies were widely thought to be prospering at the expense of their communities.”
Governments right and left have subsidized Wall Street, thinking that what is good for banks and publicly listed companies must be good for everyone. Yet Main Street has seen no progress. Since the outbreak of COVID-19, the stock market has made the wealthiest wealthier while depleting the middle class and hitting the most vulnerable the hardest.
If the wealthy continue to indulge in greenwashing while demanding that working class communities sacrifice their livelihoods to fighting climate change, the result will be class warfare. The S issues in ESG investing need substantially more attention before societies can gain mass support for carbon neutrality.
Private Enterprises are Not Surrogate Governments
That brings me to the G in ESG. Officially, “Governance” covers the internal system of practices, controls and procedures companies adopt in order to govern themselves, make effective decisions and comply with the law. In my opinion, internal governance cannot be isolated from external governance, which includes meeting the needs of all stakeholders and the communities in which companies operate, plus responsibilities for regulation, taxes and “externalities” like pollution.
In a true democracy, the government is supposed to define the borders of the playing field, set the rules of the game and hold corporations accountable to them. In practice, companies have become so powerful that they write their own rules and punish regulators and elected officials who resist. For instance, companies regularly threaten to move their headquarters to other jurisdictions unless local authorities give them bigger tax breaks or higher subsidies. The current threats by Unilever and Shell to leave The Netherlands for the UK over a dispute on dividend taxes are cases in point.
ESG investors who would now swap Shell stock for Amazon are choosing between two companies that both fail on governance. Is Amazon really different from the oil companies that won billions in subsidies and protected their turf through lobbying and political pressure campaigns?
Amazon originally gained a pricing edge over local shops by evading state sales taxes in the US. Then, thanks to clever accountants and lawyers, Amazon managed to pay well below the corporate income tax rate, even as its revenue and profits soared. And when Amazon was ready to open a second headquarters, it ran a groveling competition between state governments to see which would offer the biggest tax cuts.
Although a company like Amazon may score high on current ESG factors, Amazon is hostile to governance and indifferent to its social externalities. It depletes governments of tax revenue while fighting a fierce battle against unions and putting local, tax-paying store owners out of business. Amazon paid about 1% in taxes last year—a pittance compared to the tax revenue that the U.S. and local governments would have collected had Amazon been subject to true governance.
Just as no oil company deserves to rob the future of a habitable planet, Amazon surely doesn’t deserve the power to decimate local shops and communities to the point where ordering a liter of milk from Amazon becomes the only alternative to driving 10 km to the nearest store. And think of the environmental impact of that!
Unregulated, governance-free market competition has led to market consolidation where monopolies squeeze competitors and lobby extensively to benefit more and more from their ever-increasing political influence. As law professor Mehrsa Baradaran recently wrote in The New York Times, “Instead of a thriving market of small-firm competition, free market ideology led to a few big winners dominating the rest.”
Isn’t it time to start breaking things up Standard Oil style, as happened 90 years ago during the Great Depression? In current ESG paradigms, the attention to G is a joke. Improved governance is crucial to win the war on climate change.
From ESG to GSE
I believe that ESG investors genuinely care about the environment. They feel a sense of social responsibility and civic duty that shapes their decisions. However, just divesting from oil and gas companies is not tantamount to creating a clean, sustainable future. To make a difference and become more credible, ESG investors must not only invest much more in the clean technologies necessary for a cleaner future, but push hard for social and governance changes. We need to move from ESG to GSE.
We need democratic institutions that are independent from the corporations they are supposed to regulate and can provide social programs and safety nets during the energy transition. Climate action will only work if it gets the necessary votes and addresses systemic inequality. For that, we need to develop new governance systems that balance the best of private enterprise with strong, effective and respected government institutions.
ESG investment criteria, as used today, have major shortcomings. It’s time for fundamental changes that restore democratic governance. Silicon Valley’s Übermenschen have overplayed the “invisible hand of the market,” and it’s time to put them back in their place.