Green markets won’t save us
We can design blankets against potential climate change, but there is no blanket for a systemic event
How can we make wise decisions about a perpetually unknowable future? This question is as old as humanity, but it has become existential in light of climate change. While there is sufficient evidence that anthropogenic climate change is already here, we cannot know all the ways it will branch out in the decades to come. All we know is that we must either reduce our environmental footprint or risk a new global crisis on the scale of the 17th century “little ice age” when climate change led to widespread disease, rebellions, wars and massive famines, killing two-thirds of the world’s population.
British economist John Maynard Keynes argued that investors are ultimately motivated by “animal spirits”. In the face of uncertainty, people act on their instincts, not on “a weighted average of quantitative advantages multiplied by quantitative probabilities,” and it is these instinctive bets that may (or may not) pay off once the dust settles. . And yet, policymakers would like us to trust animal spirits to help us overcome the uncertainty associated with climate change.
Humanity has long sought to reduce uncertainty by making the natural world more readable, and therefore subject to its control. For centuries, natural scientists have mapped the world, created taxonomies of plants and animals, and (more recently) sequenced the genomes of many species in hopes of finding cures for every disease imaginable.
What maps, taxonomies and sequences are to chemists and biologists, numbers and indicators are to social scientists. Prices, for example, indicate the market value of goods and services and the expected future value of financial assets. If investors have largely ignored certain assets, the reason could be that they have been mispriced or mispriced.
As the realities of climate change become increasingly apparent, major efforts are underway to identify and qualify “green investments”. But as the attractiveness of these assets has grown, the problem of greenwashing has grown – when investments are fraudulently labeled “green” or ESG (environmental, social and governance) based on a vague benchmark. or meaningless.
Here, the latest gadget is to “go green” by buying offsets against your “brown” holdings, rather than divesting them. Likewise, the new European Union regulation on “sustainability disclosures in the financial services sector” looks like another attempt to tackle climate change without paying for it in full. By law, all financial market participants must publicly disclose their climate risk management strategies and methodologies for labeling an asset as sustainable, and financial market authorities must do more to coordinate their supervisory efforts. But nowhere is there a word on liability or penalties.
At the same time, major asset managers have called for more standardization, arguing that rational pricing is too difficult under the current alphabet soup of competing metrics. Clear, objective numbers convey certainty and turn complex tradeoffs into a simple calculation. Because the price mechanism compares apples to oranges, it follows that green assets should compare to brown. The more prices there are, the greater the role that markets can play as the ultimate decision maker. With the fate of humanity at stake, politicians can wash their hands of the problem.
But the problem won’t go away, because standard metrics and indicators don’t just increase readability; they also mask the underlying complexities. They don’t just capture and organize information; they also modify behavior, exerting performative effects in light of the types of information that are included or excluded. Judging by the current enthusiasm around green investing, these are the effects that most financial market participants are looking for.
Moreover, we cannot believe that the changes we make to social systems will produce the desired results. Remember the fate of Long Term Capital Management (LTCM), the hedge fund run by a Nobel Prize winner that fell in 1998 after his animal spirit collided with the real world. LTCM has gambled heavily on its prediction that global sovereign debt prices will converge. But then Russia defaulted, spilling over into emerging markets and pushing sovereign debt prices even further away.
At the heart of this failure was the option pricing model, which had been touted as the solution to the uncertainty associated with volatility. By claiming to make option prices more predictable, it has created a huge market for options and other derivatives. Sociologist Donald MacKenzie’s book on this period was aptly titled “An Engine, Not a Camera”. While the option pricing formula guided behavior, it failed to capture reality because it ignored liquidity – the lifeline of finance.
Nature is even less forgiving than a social system like the market, where a state or a central bank can come to the rescue. Earth will not bail us out when things go wrong. By relying solely on disclosures and the price mechanism to deal with climate change, we are making a huge bet on the basis of metrics and indicators that we know are incomplete, if not downright misleading.
We can design as many hedges against potential climate change scenarios as we want, but there is no cover for a systemic event. In the absence of the political will to face our own behavior, we simply assume that climate change can be tackled with the least disruptive and financially neutral – if not profitable – update to the current operating system.
The Covid-19 pandemic should have warned us against such pride. Instead, governments in advanced economies have decided to double private property rights and markets, prioritizing patent protection of pharmaceutical companies over requests for aid in global vaccine production by sharing their technology. By denying a waiver under World Trade Organization rules, Big Pharma and its political allies are betting that the virus will be contained before it can acquire mutations that will render current vaccines ineffective.
With new strains of the virus already in circulation, this doesn’t seem like a safe bet. And even if that fails, it will have cost several thousand more lives. When will we learn that nature finally holds all the cards?
Katharina Pistor is professor of comparative law at Columbia Law School.
Copyright: Project union