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| 'Chicago, Board of Trade II' – Andreas Gursky (1999) |
While estimates of the cost of moving to a
green economy vary, one thing is clear: achieving a green transition is not
going to be cheap. To move to a green economic model, substantial increases in
research and development in areas such as energy efficiency are necessary
alongside considerable investment to replace old technologies with newer,
cleaner substitutes. Such measures have large financial requirements with the
UN Environment Programme estimating that 2% of global GDP (currently US$1.3 trillion per year) will
be needed to finance the transition to a green economy by 2050. When
confronted with such a hefty figure, the question of how to finance a green
transition becomes significant and is one subject that I hope to address over
the course of this blog.
Following the financial crisis, governments
have found themselves facing tight budget constraints and, as aging populations
continue to place upward pressure on social security expenditures, public
financial resources devoted to green investments are unlikely to increase. In
these circumstances, the private sector is critical to financing a green
transition with some studies estimating
that as much as 80% of the capital needed to address climate change issues in
future decades will come from the private sector. However, despite the clear
importance of private sector financing, international organisations acknowledge
that there is a fundamental conflict between the long-term nature of much green
investment and the increasingly shortsighted behaviour of corporations (for example see pg. 623 here and pg. 29 here). If the private sector is going to fund a
green transition, this considerable barrier must be addressed.
While the causes of such corporate myopia
are complex, Lazonick and O’Sullivan (2000) explain how changes in corporate
governance ideologies that emerged in the 1970s and 1980s have had a major
impact. The ‘shareholder value’ hypothesis argued that misaligned incentives
between the owners of corporations (shareholders) and corporate decision-makers
(managers) had led to falling profit rates in the US and that, in order to
redress this, incentives should be aligned by tying managerial pay to stock
price performance.
This practice, which has proliferated over
the subsequent decades, wouldn’t in itself disincentivise green investment if
stock markets were far-sighted and stock prices reflected predicted corporate
profits over periods of, say, 10-25 years. The problem is that they don’t.
Share prices tend to respond significantly to current period profit results
indicating that contemporary stock markets are extremely short-sighted. The
combination of ‘shareholder value’ corporate models and myopic stock markets
has led to what has been termed ‘quarterly capitalism’: a situation in which
managers are incentivised to do whatever it takes to ensure good quarterly or
annual profit performance in order achieve high stock values and by consequence
a nice heavy pay packet. Several studies evidence such corporate short-termism
(for a summary see pg. 3-4 of Haldane 2011) with Graham et al (2005), for example, finding that
78% of a sample of executives wouldn’t invest in a project that lowered
earnings below quarterly expectations even if, beyond this, it yielded
increased profit.
In contrast to the short time horizons of
contemporary corporations, green investments only tend to be profitable in the
long run as large up-front costs are offset by efficiency gains over extended
periods. In a system of ‘quarterly capitalism’, managers balk at the high upfront
costs of such projects owing to the reduction in current profits they would
cause. In these circumstances, substantial green investment by the private
sector is unlikely.
It appears, therefore, that financing a
green transition is at an impasse: private sector investment is essential but
current management practices mean it is unforthcoming. Reluctance of
governments and regulators to exercise their influence over the operation of
financial markets makes fatalism here easy: the increasing short-termism of
stock markets and managers appears as an unfortunate but inevitable
development. But this belief is wrong. Haldane (2011) emphasises, there are a
number of measures through which the myopia of the private sector can be
redressed including, for example, making managerial pay dependent on
performance over an extended period rather than annual stock prices.
Achieving a green transition is a long-term
game that demands substantial financial resources. While the magnitude of these
financial requirements is beyond the capabilities of the public purse, it
should be recognised that action by governments is necessary in order to
address the current system of ‘quarterly capitalism’. Without these measures,
private institutions will continue to shun long-term investments and the green
transition will remain unaffordable.
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