No, I haven’t had a damascene conversion to become an ESG critic. Rather, my argument is that the ESG (environment, social and governance) community needs to add another ‘E’, for economics.

The starting point is low. The responsible investment community’s understanding of economics is indistinguishable from the 90% of the investment community that has no interest in ESG.

The financial transaction tax, vertical pay ratios and corporate tax avoidance are three examples that evidence this low baseline. Even projects like the Sustainability Accounting Standards Board and the International Integrated Reporting Council look set to ignore economic indicators of corporate performance and key intangible drivers (eg, customer satisfaction and employee engagement) which do not fit under the narrow definition of ESG.

And pension funds, who speak loudly about members’ best interests, regularly undermine those interests in profound ways; economic illiteracy is at the core of the problem. UK Local Authority pension funds – among the most responsible of pension funds – nevertheless oppose the sensible proposal to aggregate their assets. Yet this could really boost their impact on the investment system. US corporate pension funds make legal, but unrealistic, assumptions about actuarial rates of return, erasing the need for difficult decisions, and setting off on a chase for ‘alpha’.

So what could investors who want to aim higher do?

Heads of ESG, often corporate governance or environmental specialists, could be sent on a crash course in systemic risk and economic thinking, including behavioural finance. This could be a leveraged investment if the individuals and the management context are suited. But because of corporate incentives and typical workloads, training won’t work in many firms.

In such cases, the executive could appoint an economist to work with the ESG team, perhaps even lead it. Although the current head of ESG might see this as a demotion, it could represent a shot in the arm for ESG professionals, who are more marginalised than they are able to acknowledge. Such appointments could give ESG teams a leader who could engage senior managers using mental models that have traction. It would put heads of ESG at the same level as other senior decision-makers.

Of course, this depends on appointing the right kind of economist: numeracy per se is not the panacea. Indeed, those who have drunk too much of the kool-aid at investment banks, business schools and traditional academic departments or those who support an un-reconstructed CFA orthodoxy would bring the mindsets that caused the global financial crisis, underpin our failure to adapt to our climate risks or to value human capital.

Fortunately, there are centres where economic thinking relevant for the twenty-first century is being elaborated. These include the Institute of New Economic Thinking, the Council on Economic Policies, the Centre for Market Dysfunctionality and the New Economics Foundation.

And more good news: there has been intellectual flirting between forward-thinking economists and the ESG movement. Vivid Economics, for example, played an important role in the Mercer climate change study. Behavioural economists are regularly at PRI academic conferences. John Kay, has done more to popularise the idea of long-term investing than all PRI and ICGN members put together.

And the new UNEP inquiry into how to make the world’s economy more sustainable has showed interest in this link. There is a growing body of academic research linking ESG and economics and contrarian economists like Andrew Lo and Tim Jackson, who get the social purpose of finance, are becoming better known.

The time is now to bring the second E into EESG.

 

Raj Thamotheram is an independent strategic adviser, CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University