Experts agree that climate change and global warming pose systemic risks to the world economy, with major impacts on the availability of resources, the price and structure of the energy market, the vulnerability of infrastructure and the valuation of companies. But from a macroeconomic level, little has been done.
One of the first lessons students are taught when studying economics is the basic problem of limited resources and unlimited wants. Given that resources are scarce, there are trade-offs to consider when determining what to produce and what to consume. Solving this problem should allow the efficient allocation of resources, but what if we’re not measuring outcomes or indeed resources correctly? What if wants are not unlimited or can’t be fully measured in dollar terms?
Generally we were taught that some resources are free – such as air - and others are subject to a cost – such as labour. While there has been some focus on the “externalities” of economic actions, such as air or water pollution, these concerns have largely been absent from the headline discussions and the scale of them inadequate based on what science tells us we are doing to the planet.
Climate change is a cost on all of us and will likely have significant macroeconomic consequences. But are resources such as air, water, green space being valued correctly when we determine what should and shouldn’t be produced in an economy? The science around climate change would argue no. Experts agree that climate change and global warming pose systemic risks to the world economy, with major impacts on the availability of resources, the price and structure of the energy market, the vulnerability of infrastructure and the valuation of companies. But from a macroeconomic level while some great work has been undertaken over the past ten years by some organisations, overall little to date has been done.
Over the past 10 years there has been increased attention and focus on the importance of considering environment, social and governance (ESG) factors when investing. Responsible investing is now well recognised and sought after by many investors when seeking to allocate capital. The results from integrating ESG factors into the investment process clearly show a benefit to investment performance, as shown in CFSGAM’s latest Responsible Investing report. This in turn should lead to a more efficient and sustainable allocation of capital, underpinning long-term returns for investors and society while creating a more sustainable economy.
But should it be left purely up to investors to allocate resources to create a more sustainable economy? Should the economic framework evolve to help? There has been some evolution on this by analysis such as the World Economic Forum’s global risk report. Overtime, environmental and social issues have become increasingly prevalent in the report rather than economic factors. Between 2007 and 2010 there were no environmental and only one social risk in each year, while in 2016, eight of the top ten were environmental and social risks and included extreme weather events, natural disasters, water crises, large-scale involuntary migration and unemployment. One important point the paper makes is that recent political outcomes, including Brexit and the rise of populism, bring into focus policy questions such as how to make economic growth more inclusive and how to reconcile growing identity nationalism with diverse societies .
Currently the success or otherwise of an economy is largely represented by growth in Gross Domestic Product (GDP), as well as secondary indicators such as the unemployment rate and even the inflation rate, which is the main goal of monetary policy. But in the same way that investors are broadening the set of indicators to reflect that the allocation of capital and use of ownership rights have both real world and real investment impacts, perhaps placing economic growth and prosperity in a broader context, could help to better allocate scare resources across the economy.
In some sense central bankers have started to evolve their framework beyond an inflation target. We can see this in Australia. The Reserve Bank of Australia, under Governor Dr. Phil Lowe, has raised the importance of financial stability in setting monetary policy, noting it has been conscious that “a balance needs to be struck between the benefits of monetary stimulus and the medium-term risks associated with rising levels of debt relative to our incomes”. The RBA has also more recently specifically called out a focus on “public interest” and “the human cost of financial instability” when setting policy.
While this is a start and could help improve the resilience to future financial crisis, alternative measures of GDP should also be discussed. One example, is the “Doughnut of social and planetary boundaries” that notes that humanity’s 21st century challenge is to meet the needs of all within the means of the planet, ensuring no one falls short on life’s essentials, while ensuring we do not overshoot our pressure on the Earth’s life supporting systems on which we all fundamentally depend. Importantly, it brings together social and environment concerns, which should be supplemented with economic goals. Maybe just like incorporating ESG principles into investing, this could see benefits to economic outcomes going forward.
The Doughnut of social and planetary boundaries (2017)
This material has been prepared and issued by First Sentier Investors (Australia) Limited (ABN 89 114 194 311, AFSL 289017) (Author). The Author forms part of First Sentier Investors, a global asset management business. First Sentier Investors is ultimately owned by Mitsubishi UFJ Financial Group, Inc (MUFG), a global financial group. A copy of the Financial Services Guide for the Author is available from First Sentier Investors on its website.
This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs. Before making an investment decision you should consider, with a financial advisor, whether this information is appropriate in light of your investment needs, objectives and financial situation. Any opinions expressed in this material are the opinions of the Author only and are subject to change without notice. Such opinions are not a recommendation to hold, purchase or sell a particular financial product and may not include all of the information needed to make an investment decision in relation to such a financial product.
CFSIL is a subsidiary of the Commonwealth Bank of Australia (Bank). First Sentier Investors was acquired by MUFG on 2 August 2019 and is now financially and legally independent from the Bank. The Author, MUFG, the Bank and their respective affiliates do not guarantee the performance of the Fund(s) or the repayment of capital by the Fund(s). Investments in the Fund(s) are not deposits or other liabilities of MUFG, the Bank nor their respective affiliates and investment-type products are subject to investment risk including loss of income and capital invested.
To the extent permitted by law, no liability is accepted by MUFG, the Author, the Bank nor their affiliates for any loss or damage as a result of any reliance on this material. This material contains, or is based upon, information that the Author believes to be accurate and reliable, however neither the Author, MUFG, the Bank nor their respective affiliates offer any warranty that it contains no factual errors. No part of this material may be reproduced or transmitted in any form or by any means without the prior written consent of the Author.
In Australia, ‘Colonial’, ‘CFS’ and ‘Colonial First State’ are trade marks of Colonial Holding Company Limited and ‘Colonial First State Investments’ is a trade mark of the Bank and all of these trade marks are used by First Sentier Investors under licence.