Profiting by saving the environment
Exploring ideas of sustainable investments that generate financial returns — a casual study
I believe the most important step in achieving sustainability is to recognise and understand the problem; especially for the ones in charge.
In 2017, Trump Administration withdrew from the Paris Agreement, a deal to minimise greenhouse gas emissions from power plants, industries and cars. Trump has always doubted whether global warming is “man-made” and suggested that temperature would eventually fall in the future. However, when Trump’s statements were challenged by global warming scientists, he simply argued that those scientists have a very big political agenda. Shortly after the Paris Agreement, Trump’s government scientists released a report on devastating changes to weather patterns as the result of human activity. The report denied human influence being the dominant cause of global warming; it reads: “For the warming over the last century, there is no convincing alternative explanation supported by the extent of the observational evidence.”
Trump’s energy policy focuses on energy independence and energy security based on fossil fuels; in other words, using the “finite” energy resources available to America to the fullest. He demonstrated his love for coal in 2018 by cutting the funding for the Office of Energy Efficiency and Renewable Energy by 72%. Moreover, Trump administration’s main proposals on energy lies on ending mining leases, fast tracking current fossil fuel proposals, support mining related infrastructure, and eliminate regulations such as Obama’s clean power plan.
Global warming can be observed by simply knowing how to read the thermometer. Trump knows how to read the thermometer, but he denies the fact that humans are central to the problem. It’s evident that Trump’s cabinet has strong ties with fossil fuel lobbyist and certain politicians would definitely gain benefits by supporting bills related to fossil fuels. Those who pocket tax-payer’s money and avoid taxes is the main concern to our society and the environment. Furthermore, it also appears that people have a misconception about economic development and environmental sustainability; people somehow think there’s a choice between the two. However, I strongly believe that sustainability and economical development are align with one another and sustainable investments is the only way to make the economy wealthier in the long-run, instead of a few crocks earning a few bucks in the short-run. Thus, if our elected leaders do not engage in sustainability, what could we do as individuals?
Clarifying the problem — Based on Geoffrey Heal’s endangered Economies
“In spite of the inextricable bond between ourselves, our economy, and our environment, we are damaging the natural world, undermining the foundations of our economic success.” -Heal, Geoffrey. Endangered Economies : How the Neglect of Nature Threatens Our Prosperity
In Geoffrey Heal’s book, Endangered Economies, Heal suggests we must understand that we don’t need to make a choice between economic development and environmental sustainability. Our economic activities are primarily based on our environment. Nature resources fund all economic activities including agriculture, urbanisation, mining, forestry and etc. Therefore we should focus on economic activities that can sustain our environment and generate wealth for the society. On the other hand, we could also destroy economic value by harming the environment. When the environment is polluted, people around the world are forced to live a lower standard of life; a life in pain and discomfort. Human capital are what drives the society and we act as a catalyst in transforming natural capital into economic activities. So if our environment hinders our efficiency, we are less likely to generate wealth for the society. In more polluted areas of China, pollution incurred from burning coal reduces the life expectancy by five and a half years (Michael Greenstone), which insinuate a loss to human capital; thus the economy.
We now understand the damaging effects of pollution and how we can minimise loss by going greener. However, a more environmentally friendly economy does not just minimise losses, but also generate benefits. In Heal’s book Endangered Economies, Heal gave a perfect example of how a greener economy could minimise loss and generate profits. In the 1970s, oil prices were very volatile; ranging from $3 per barrel to $36. The increased price of oil in the 70s led to inflation and recession. However, in the 2000s, oil prices were ranging from $10 to $145, yet it did not lead to inflation nor recession. How could a more volatile oil market not lead to severe effects to the economy? The formal economist of International Monetary Fund, Olivier Blanchard argued that after the 70s, industrial economies improved the efficiency of energy use, thus the amount of oil used for a unit of output fell substantially. Thus, the fluctuation in oil prices do not matter as significantly as before. By recognising inputs of production and minimise effects of pollution, industries gained prosperity for both the economy and the environment.
Heal suggested 4 interrelated ideas that form the basis of prosperity.
“Natural capital as an input to our prosperity, External costs and the need to make polluters pay, common property and its overuse, and measuring what really matters.” — Heal
In addition to treating natural capital as inputs to our prosperity, external costs is another input. These costs are costs incurred by participants of markets that are not directly linked to the operation of production. Markets are created and run by humans for the purpose of maximising our economic well-being; yet we have self-inflicted several financial crisis. Heal explored the idea by looking at the failures of markets form an environmental perspective. He came to a conclusion that “participants of markets must pay a full cost for their choices and their incentives are aligned with the social good.” We must use full cost accounting to recognise all the costs of an activity, and the costs will be charged accordingly to the person or the firm that carry out the activity. In other words, external costs must be paid by the polluters.
In addition, common Property is an important aspect of the issue. Heal gave an example of a fisherman contemplating whether he should fish for an additional day. If he fish for another day, he incurs the costs for running his boat an extra day, but he will also gain by catching more fish. The question is whether the gain outweighs the loss, if it does, the fisherman will fish for another day. However, there’s a problem. Fish come from a pool where other fishermen also get their fish from. If the fisherman catch more fish in the same pool, other fishermen will fish less, and eventually everyone catches less fish. The idea behind the story is that if participants of a market weighs short-term profits more important than long term expenses, both the participant and the competitor will lose. As a result, more natural resources are wasted.
The example of the fisherman demonstrates a problem of perspectives. The fisherman measures his success on direct economic gains, but doing so alleviates other aspects of his prosperity. This can also be reflected on our society today as many still measure “Well-being” by using GDP (Gross Domestic Product). GDP measure the sum of all economic activities of a nation, it is suppose to be used as an indication of how well the individuals live in a particular nation. Business can always improve and GDP can always increase, but we are not looking at all the costs of doing business, so are we better off when the GDP is higher? Imagine a scenario where a tsunami just destroyed a city; thousands of jobs would be created to help the construction of the city. Income and employment would rise and GDP would increase, but in reality, the people are not better off. What is necessary is for us to find a true measurement that are related to the well-beings of the citizens that can account the true costs of economic activities.
We are worshipping a false God
The Big Idea
The United Nations have set out 17 sustainable development goals that aim to achieve a better and sustainable future for all. These goals address the challenges that humanity face today; such as climate change, inequality, poverty, and etc. They aim to achieve each goal by 2030.
I read each of the goals in detail and found all goals have interconnected networks that by solving one challenge could potentially aid in finding solutions for other challenges. I can also confidently use one word to sum up the solution to achieve these goals; ” efficiency”.
Efficiency
If future technology allows us to find a way to harvest and use renewable energy more efficiently than the harvest of non-renewable energy, we will be able to reduce our dependency for fossil fuels. Thus, minimise the external costs for our economic activities such as production, consumption and business. The extra social benefits generated could lead to a more efficient market space as more capital can be distributed amongst the participates of the market. However, for developing countries, such projects would be difficult due to the low level of resources. Hence, there should be a clear “economic incentive” for countries to contribute in researching sustainable technologies and infrastructure. However, it can’t be done with ease, especially not with the cooperation of government institutions.
It’s evident that poverty is linked to hunger, low quality of education, low health and well-being. Causes of poverty could be a result of weak institutions, poor management of natural resources, corruption, political violence, etc. All these causes are linked to the inefficient use of inputs on all levels of society. Firstly, corruption tend to be the most prominent factor for poverty and many other social issues that lead to inefficiency. In 2001, a paper called “Corruption and Economic Growth” published by Pak Hung Mo found that a 1% increase in the corruption level reduces the growth rate by 0.72%. Corruption also reduces production return since resources flow from productive activities to corruption activities, efficient use of natural and human capital is then minimised, hence, economic growth. In addition, corruption is also a cause for both political and social inequality. For example, as we learn from our history, gender inequality hinders societal growth as voices of many great minds were not heard due to their gender status. Income inequality forbids individuals to unleash their potential for a greater cause. If income is more equality distributed, more intellectuals could receive education and a place in society that could help change the world.
Society and the market are great inventions that guide our prosperity. However, human character faults such as greed, discrimination, and arrogance led to several inefficiency for markets and the society. Therefore, I believe to achieve efficiency in the market (Achieving UN goals), we must engage in sustainable finance.
Sustainable Finance
Sustainable Finance refers to any form of financial service that use environmental, social, and governance as a guide for investment decisions for individuals and societies at large. There are several ways to engage in Sustainable Finance such as Green Bonds and impact investing.
Green Bonds
Green bonds are debt instruments that are designated for projects that involve the development of sustainability and supports climate or conservation related issues. Green bonds finance these projects that specifically subject to energy efficiency, pollution prevention, sustainable agriculture, clean transportation, sustainable water management and the cultivation of environmentally friendly technologies. To be able to qualify for green bonds, one must go through the verification of a third party such as the Climate Control Board.
There are several methods of verifying green bonds; according to the Green Bond Principles (GBP), to be eligible for green bonds, one must meet one of the following.
1. Renewable energy; 2. Energy efficiency; 3. Pollution prevention and control; 4. Sustainable management of living natural resources; 5. Terrestrial and aquatic biodiversity conservation; 6. Clean transportation; 7. Sustainable water management; 8. Climate change adaptation; and 9. Eco-efficient products, production technologies and processes.
China is now the world’s leader in pollutant emission and the largest emitter of greenhouse gases. Their fast growing economy demonstrates the strengths and weaknesses of the market and act as a perfect example of the collusion between market and the natural world. Comparing to western societies, politicians in the China are less ideological in the way they think of the economy. Subsequently, China is the world leader in production of clean renewable energy and have taken the lead as the fastest growing green economy in the world; out-performing the United States, where some ideological politicians still have a narrow and outdated interpretation of free market economies (Heal, 2016). However, China still lacks regulatory framework for green technologies that the US has and the journal for China is still far.
In 2016, Green bond insurance hit a record high of $93.4 billion worldwide, compare to 2012, green bond issuance was merely $2.6 billion. Green bonds are highly attractive due to the associated tax incentives such as tax exemption and tax credits. The large increase from $2.6 billion to $93.4 billion was mostly due to Chinese borrowers, who accounted for 1/3 of the total amount. China is transitioning into a green economy, policies are made to make polluters pay. According to China’s Belt and Road Initiative’s Vice Premier Liu He: reducing pollution is one of China’s main strategic goals as it pursues this initiative, along with preventing major financial risks and alleviating poverty. As a result, deaths associated with pollution will be minimised and more economic activities will be generated.
The European Commission published a 174 page report called “Study on the potential of green bond finance for resource-efficient investments”. The report analysed the impacts of green bonds in different industries and the limits of the market of green bonds, as well as the potential solutions.
According to the chart, Green bond mainly finances projects related to renewable energy. The demand for green bonds have been higher than ever and it’s still increasing. The study suggests European Union interventions are possible. The interventions could raise awareness for such bonds and its potential growth in the future since risk averse investors are not certain about this new type of instrument. In addition, by disclosing information and promote autonomy, it could decrease the information asymmetry and making green bonds more secure. Developed countries have already high demands for green bonds, but other countries still persist the uncertainty.
However, there’s a downside; a bond is green doesn’t mean it’s good for direct financial returns. Traditionally, just like any other bond, the success of the bond is measured in coupon and capital repayments depends, and it’s dependent on the financial health of the issuer. A firm that issues green bonds to finance it’s renewable energy projects are exposed to the fluctuation of source of energy such as nuclear and coal. If the issuer defaults, the bondholder who have claim on the firm’s assets will then expose to the same risk. We must acknowledge the risks when making investment choices, higher risks involve higher returns. It might not seem like a high return investment for green projects, but as I mentioned before; if we go beyond financial measurements, the external return generated might have a chance to be higher than the risks involved.
Impact investing
Impact investment, per Global Impact Investors Network (GIIN), are “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. It’s one of the fastest growing assets, and JP Morgan reported that their impact investments, an emerging asset class, “offers the potential over the next 10 years for invested capital of $400 billion–$1 trillion and profit of $183– $667 billion”. Traditional businesses measure mostly on one bottom-line: economic returns. But as the triple-bottomline model is introduced, many firms engage in activities that would serve a societal and environmental purpose. There are still many misconceptions regarding how measuring success using impacts on society and the environment hinder financial returns. Academic research have proven that external benefits provided for the people and the environment is also good for business — hence, higher returns.
On a purely finance perspective, however, according to a traditional investor Phil DeMuth, when you give out a $5 note to a beggar on the street, you usually don’t expect a ROI (return on investment). In other words, the business model for Impact investing is great, but it creates an illusion and distortion in the economy. As investors who put money in impact investing funds do not care about returns, so the worse the funds do financially, the better the investors feel about themselves. Thus, I think there should be a clear distinction between philanthropy and impact investing. One must not consider impact investing as a charitable act, but rather a proper investment and treat and dedicate time and resources to treat it with care.
One of the most viral example for impact investing was Micro-Finance. Countries such as Bangladesh demonstrated a decline in poverty rate since Micro-Finance was introduced, but not for countries like Pakistan. Academic Research found 3 main factors that cause the failure of micro-finance:
- Lack of education, training and business experiences.
- High amount of loan, and borrowing costs, results in the inability to pay back principal.
- Some borrowers use the capital for immediate needs such as health, education, marriage, etc.
There are simply way too many uncontrollable factors associated with Micro-Finance. Despite its success in Bangladesh and some other countries, it’s not considered as a very successful investment overall. If the borrowers don’t pay back, there’s no financial return, and it goes against the principles of impact investing. Thus, there are still much more governance and regulations needed for the model to work.
A need to revitalise the financial markets
A market is competitive and social and environmental conscious investors have to compete with investors who do not care about other bottom-lines other than economic returns. The competition between the two investors who have different goals will lead to market inefficiency. Investors and institutions must align their interests and recognise the external costs and external returns. Study shows that a successful environmental and social account leads to a successful business. Subsequently, analysing investment opportunities becomes harder than ever. It goes beyond income statements, balance sheets, earning powers, and liabilities. The future is always hard to predict, and intrinsic value associated with an investment is always hard to determine. We need to acknowledge the present, and what we can do now “collectively” to ensure prosperity.
As Warren Buffet put it,
“The numbers in any accounting report mean nothing, per se, as to economic value. -Warren Buffet
We must understand something about the business before we make an investment. Numbers provide guidance and indication, but what happened in the past will not certainly hold for the future. We must look beyond the numbers and towards other measurements that maybe not directly measurable. If we engage in the revitalisation of our financial markets towards a more sustainable environment, we might just have a higher probability to live a prosperous life in the future.
I’m just a guy behind a laptop that like to research about the topics that I’m interested in. I’m no expert in environmental science nor sustainable finance (yet). I look forward to any of your comments and opinions that could help broaden my knowledge in this area.
