The COVID-19 pandemic recovery phase is a chance to reshape global economies into new sustainable models
The actions taken by governments in the face of the COVID-19 pandemic are a demonstration of the futility of much of economic theory in the face of real-world crises. Ideas such as the supremacy of the shareholder in management decision-making seem ridiculously naïve today as companies across the globe beg governments for assistance to survive.
Only last August, the Economist, which presents itself as in the tradition of 19th century classical liberalism, was decrying the revised statement of corporate purpose issued by the US Business Roundtable: “However well-meaning, this new form of collective capitalism will end up doing more harm than good. It risks entrenching a class of unaccountable ceos who lack legitimacy. And it is a threat to long-term prosperity, which is the basic condition for capitalism to succeed.”
But even the most ardent advocates of unbridled capitalism in the US are clamouring to get companies to act on the behest of governments. Others are having to be rescued by governments to survive at all. Given that the state is having to step in to rescue them, politicians will be under pressure to ensure that companies respond more seriously to potentially unprofitable themes such as climate change.
What should the future post-COVID-19 framework of capitalism look like? The Economist argues that the sort of “collective capitalism” espoused by the US Business Roundtable suffers from two pitfalls – a lack of accountability and a lack of dynamism. In the case of accountability, the Economist makes the fair point that it is not clear how CEOs should know what ‘society’ wants from their companies. The domination of the economy by large firms means that a small number of unrepresentative business leaders “will end up with immense power to set goals for society that range far beyond the immediate interests of their company”. But the power of social media companies such as Facebook is a clear illustration that this is already occurring, even in the absence of collective capitalism.
The second problem that the Economist sees is dynamism, as they argue that collective capitalism leans away from change. “In a dynamic system firms have to forsake at least some stakeholders: a number need to shrink in order to reallocate capital and workers from obsolete industries to new ones. If, say, climate change is to be tackled, oil firms will face huge job cuts.”
The extreme view of shareholder maximisation has meant that companies are free to cause a negative impact to other stakeholders in the pursuit of maximising shareholder value as long as they stay within the law as it stands. That is the crux of the matter – that corporations are able to operate without the impact of their activities fully priced into their profit-and-loss statements because they are not legally forced to do so. It justifies private gains at the expense of public losses. The crucial debate with which ESG advocates must engage relates to whether or not the interests of shareholders should trump those of all other stakeholders in a company. That debate has not yet been resolved – but the coronavirus has shown, in a dramatic fashion, which way that argument will end.
The debate between shareholder value maximisation and stakeholder satisfaction can be resolved without the two pitfalls raised by the Economist if all external impacts of a corporation were able to be fully priced and accounted for. That does mean accounting for externalities. In the US, an initiative called the Sustainability Accounting Standards Board (SASB) Foundation was set up in 2011 with the objective of establishing industry-specific disclosure standards across environmental, social, and governance topics. Although it is still essentially an independent entity with no legal powers, it is modelled on the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB). A key element of its activities is dialogue with the US Securities and Exchange Commission regarding accounting disclosures.
“The crux of the matter is that corporations are able to operate without the impact of their activities fully priced into their profit-and-loss statements because they are not legally forced to do so”
Accounting for all externalities may still be only a first, although an essential step. Knowing that burning a rainforest to create cattle-grazing land may produce far more public losses than the private gains to the cattle rancher and the taxes accrued to the government in running that ranch is one thing. It may prevent ESG-focused investors from investing, which may only benefit other investors with less scruples.
There is a way of resolving the problems associated with the free-market approach and promoting sustainable investment with a shareholder-maximisation philosophy. That is charging corporations for all external negative impacts created by their activities.
Perhaps the clearest example of this is the tobacco industry, which is responsible for more than eight million deaths a year, according to the World Health Organization. COVID-19 will increase this number significantly – the main health conditions that dramatically worsen its effects are heart disease, lung disease, diabetes and compromised immune systems. The chief cause of lung disease and heart disease today is tobacco. Any future post-mortem of this pandemic must ask the question why were investors willing to finance tobacco companies? The answer is simply that the external costs associated with such investments were not borne by shareholders. But, in truth, most companies are able to benefit from private gains at the expense of public losses when it comes to their impacts on the environment.
The reason that initiatives such as SASB’s may struggle much more to gain acceptance by corporates than by the investment community is not because they are such revolutionary concepts. It is, rather, that many of today’s corporations would be seen as producing large overall losses rather than net profits if all externalities were to be accounted for correctly.
Public goods are not traded and are therefore not priced and, as a result, man-made capital – financial and manufactured capital – has been given higher valuations than all other capitals, whether natural, human or social capital.
COVID-19 is breaking economies. Putting them back together should not mean recreating the old models, which some argue may even have contributed to the rise of the coronavirus. Not everyone is willing to be a vegetarian but if all externalities are priced into the costs of food production, then the pricing of food items will encourage shifts towards more sustainable agriculture. That, in itself, may reduce the risks of future pandemic zoonoses.
When it comes to sustainable investment, as the world eventually recovers from the COVID-19 pandemic, we should not be striving to get back to where we were before. Instead, we should be aiming to get to where we wish to be.