The debate about ESG investing is not what you think it is. Anyone with assets to protect has to ask how to avoid proportional risk attached to unsustainable practices.

The evidence is clear:

• Human activity is causing disruption of Earth’s climate system, dangerous pervasive plastic pollution, and the collapse of biodiversity and ecosystems.
• These violations of planetary boundaries—the upper limit for what Earth can sustain in a number of critical areas—are putting supplies of fresh water, nutritious food, and affordable goods across the economy, at risk.
• The state of general multi-decadal human health most societies now expect may soon be unaffordable or unachievable for nearly all human beings, regardless of income levels.

These overwhelming and pervasive costs are known to economists as “negative externalities”. A business can remain profitable so long as society (and nature) tolerate these costs being hidden or forced onto them. They are, however, becoming increasingly quantifiable, and traceable.

• The Global Turning Point report published by Deloitte in 2022 found that unchecked climate change would cost at least $178 trillion globally by the year 2070.
• The Food System Economics Commission has found that hidden costs from unsustainable food systems have already cost us more than $132 trillion since the Paris Agreement was signed in April 2016.
• The Commodity Futures Trading Commission and Financial Stability Oversight Council—two major US financial regulators—have both found that unchecked climate change will eventually collapse the financial system and undermine its ability to support the wider economy.

The 2023 State of the Climate Report found:

By the end of this century, an estimated 3 to 6 billion individuals — approximately one-third to one-half of the global population — might find themselves confined beyond the livable region, encountering severe heat, limited food availability, and elevated mortality rates because of the effects of climate change (Lenton et al. 2023).

Should the United States really have to choose between supporting today’s dominant industries and having long-term shared prosperity and security? Should any country? The numbers take us beyond ideology, beyond cozy relationships between industry leaders and politicians. They also take us outside of conventional market wisdom.

Conventional wisdom says if a business has market value, if it has capitalization through the stock market, if it has revenues, then it is a business worth investing in. From this standpoint, nothing except the value of goods and services exchanged, and market speculation, should determine whether a business does well or fails to compete.

This is the purported foundational logic for coordinated opposition to investing that considers environmental, social, and governance (ESG) concerns. That opposition, of course, comes from for-profit businesses that cannot compete against this higher moral and operational standard. What they are attempting, to resolve this challenge in their favor, is that all people be barred from considering whether their businesses cause unaccounted-for harm or generate hidden costs.

They are asking that open, free societies, cease to be so, and that all people be subject to an effective court order that they give some of their income to businesses that are harming the environment, harming human health and social cohesion, and engaging in deceptive practices to skirt transparency and governance requirements. (Those are the three general areas of hidden damage ESG standards are meant to help investors avoid.)

Whether they find friendly judges or not, whether a court issues a ruling that holds up to Constitutional scrutiny that somehow finds using common standards for better performance is some sort of unlawful collusion, all economic actors will have to face the proliferating cost of unsustainable practices. The question is where that cost falls, and how it is paid.

Remember: planetary boundaries are not theoretical; they are the mathematical representation of what our planet can sustain. If we need water to live but cannot secure enough of it in the future, then we will have problems far bigger than quibbling over how investors make their choices.

If the effort to block ESG investing succeeds, it will result in the more precise scoring of specific business activities becoming less available, less detailed, or possibly nonviable. That means the hundreds of trillions of dollars in proliferating cost and risk will be spread across all economic actors, and risk will be managed more inefficiently. One option for government agencies, investment managers, or retailers, would be to assign proportional risk to all actors.

This would be done by experts in financial data tracking, sustainability data, macroeconomics, and statistics. In some countries, a central statistics agency or financial regulator might manage the allocation of proportional risk; in others, it will be done by a loose web of market actors and service providers.

Insurers must already evaluate where increased risk attaches to specific activities, and banks must consider what the availability of specific kinds of business insurance means for the viability of a commercial enterprise seeking credit. Citing analysis of rapidly rising insurance costs, the Guardian reports today:

Across all US counties, those in the top fifth for climate-driven disaster risk saw home premiums leap by 22% in just three years to 2023, compared to an overall average of a 13% rise in real terms, research of mortgage payment data has found. The Guardian has analyzed the study’s data to illustrate the places in the US at highest risk from disasters and insurance hikes.

Analysis of anti-ESG legislation and its impacts shows such laws reduce competition and impose higher costs on the affected local economies. According to Columbia University’s Sabin Center Climate Law blog:

Under Oklahoma’s anti-ESG law, companies seeking to contract with Oklahoma must certify in writing they do not and will not boycott energy companies. The law had resulted in a 15.7% increase in borrowing costs for municipalities, and $184 billion in expenses, as it limited competition among financial institutions and tightened the competitive bond market for municipalities. 

In other words, the big question is not whether ESG will succeed or fail; the big question is:

How will you avoid proportional risk falling on you, especially if you are not responsible for the hidden costs at issue?

1. The most efficient approach is for ESG standards and performance tracking to become more sophisticated, more precise, and more mainstream; that would allow those already succeeding against these higher standards to prosper, without having to invest to avoid costs generated by others.
2. A less efficient approach would be for every individual actor in society to take on the responsibility of demonstrating that they are innocent when it comes to generating massive pervasive costs.
3. The least efficient (and most costly) approach would be for all of society (and nature) to live with these all-pervading (and worsening) costs, until there is no way to sustain a mainstream financial system or open market economy.

Some argue that Option 2 is part of Option 1, and that innovation in provenance tracking, logistics, and labeling—along with possible beneficial side effects of the rise of distributed ledger technologies and digital currencies—will allow the whole economy to efficiently provide this investable value added, without pre-emptive divestment from polluting industries. Others note that major technical innovations tend to come from unique thinkers or firms that already have or eventually achieve leading positions in their field, not from the collective effort of all small businesses to do something beyond their core function.

So, the question remains: How will you avoid proportional risk falling on you, especially if you are not responsible for the hidden costs at issue?

All economic actors should use what leverage they have to make better choices, and then to celebrate progress wherever it is achieved. And never forget which vendors and service providers went to court or asked your elected representatives to strip you of your right to decide for yourself where you put your money. They are signaling something about their future intent and the hidden costs they hope you will tolerate.

Share best practices, let others know what is working, and advertise that you are succeeding where powerful industrial-scale actors say they cannot. Doing better is doing better, and doing better in a way people can see makes you a better candidate to earn their retail or investment dollars.