The Changing Wealth of Nations: Sustainability and the Invisible Hands
The drivers forging the path to a sustainable business model
Borrowing a classic metaphor from Adam Smith’s The Wealth of Nations, the “invisible hands” refer to unforeseen forces which guide the efficient allocation of resources in a laissez-faire market. This thinking laid out the standard formulation of capitalism — an economic system that has profoundly propelled innovation and prosperity in today’s society.
Yet, capitalism has its many weaknesses. As the Covid-19 pandemic has further exposed, maldistribution of the spoils of economic activity creates winners and losers of capitalism. A widening income gap negates the trickle-down effect of free-market prosperity that Smith once promoted. Inequality arguably drives the rise of populist politics that shaped the society we are in today.
On the other hand, the acceleration of economic activity driven by excessive demands, has exploited our most precious ecological resources. I was surprised and equally frustrated when I discovered that globally, over $5.2 trillion of taxpayers money (or 6.5% of global GDP) are spent on fossil fuels subsidies1 -the primary industry that threatens the very existence of our planet.
For too long, businesses have been motivated by generating the best returns with the lowest possible risks. It’s time we adopt a new paradigm — placing ‘impact’ at the centre of our consciousness. Our problems have changed and changing rapidly. New market forces or ‘invisible hands’ have emerged, claiming demands for more sustainable businesses.
The Invisible Hands
Impact-focused younger generation
Values are changing. Young people understand that they will inherit a very problematic planet and so, they pay closer attention to their investing and consumption habits. Their power is not an understatement. In America alone, millennials and Gen Z hold over $9.1trn in asset and stand to inherit over $30 trillion in the next few decades from their baby-boomer parents2. As the pace of wealth transfer doubles by 2036–40, some business models' strengths will become more apparent and the weaknesses of others more glaring.
Research by Morgan Stanley, an investment firm, finds that 95% of millennials were interested in sustainable investing and are twice as likely to sell a holding if they consider a company’s behaviour to be environmentally or socially unsustainable3.
Technology has further contributed to greater shareholder power for Millenials, and Gen Z. Digitisation of proxy voting has brought more first-time voters into the fold. Today, about 35% of proxy votes are cast via electronic ballots4. Access to social media means that younger consumers are more aware and proactive in ensuring their consumption and purchases tailor to their values.
Next-generation clients are the future. To earn their trust and loyalty, businesses need to integrate sustainability in their business models or risk losing out.
Climate Risks & Regulations
Our planet’s temperature has risen by about 1.1 degrees Celsius on average since the 1880s5. More worryingly, its rate of warming is at an order of magnitude faster than any found in the past 65 million years of paleoclimate records6. Heatwaves and floods grow in frequency and severity whilst drought and rising sea levels intensify, all of which could threaten the production factors our economic activity is based.
If left unattended, this could become a leading risk for many businesses around the world. The exacerbation of climate change threats brings dire consequences. Food production disrupted, physical assets damaged, and biodiversity destroyed. These are not the worries of tomorrow, but the urgencies of now.
These are not the worries of tomorrow, but the urgencies of now.
Governments across the world are mobilising efforts to contain the risks above through green policies and regulation. For example, the UK has announced the 10 Point Plan for the Industrial Revolution7. It aims to mobilise over £12 billion to generate new clean power with offshore wind farms, decarbonise electricity through nuclear power, and invest in new hydrogen technologies - all whilst attempting to create new green jobs nationwide.
Similarly, we see more proposed regulatory changes at the UK and EU level. For example, the Bank of England has introduced a mandatory, uniform climate risk test for major banks and insurers. This comes hand-in-hand with the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD) reporting framework8, which encourages such institutions to undertake and report their own analysis.
Public investment and policy changes will continue as we transition to a low-carbon economy. These movements will significantly impact operations and profitability, signalling the importance for businesses to act now.
Sustainable Return
In a capitalist society, the marketplace is a fertile proving ground for testing ideas. 2020 has been a record-breaking year for sustainable companies as sustainable funds or ETFs available to European investors attracted net inflows of €233 billion9. This was almost double the figure for 2019 or over 7 times higher than the figure in 2018.
Accelerated by the pandemic, interest in ESG issues will continue to drive demand for sustainable funds in Europe. Investors have come to realise that ESG funds not only offer comparable returns but in many cases, perform better than conventional funds.
Capital flows to where money grows. Climate-related funds such as clean energy were among the best-sellers last year. At the same time, more funds were diverted from the highest-carbon emitters. Indeed, sustainability does not have to only focus on the ‘E’ in ESG. There are other sustainability-related themes that can be addressed including gender, smart cities, and the UN's SDGs.
Companies must find the right balance to recentre their business model across different sustainability-related issues or run the risk of ‘greenwashing’ when executed poorly.
Looking Ahead
Here’s the fundamental point: climate change is happening and our society is changing. Yet, whilst these changes bring alarming risks, it also brings huge opportunities when we get our response right. The old business models of many companies will cease and the only way forward is to integrate sustainability into the heart of our thinking and doing.
As the invisible hands have shown, the cost of adapting to sustainability is far outweighed by its economic benefits. We need to build a coalition to respond to the demands of the market, or risk being left behind.
Indeed, the signs are everywhere; and if you pay close attention, it’s hard to miss.
Coady, D.P. 2019, Global fossil fuel subsidies remain large, International Monetary Fund, Washington, DC.
Beyer, C. 2017, "Evolution and Disruption in the Wealth Management Industry", The Journal of wealth management, vol. 19, no. 4, pp. 8-13.
Morganstanley.com. 2021. [online] Available at: <https://www.morganstanley.com/pub/content/dam/msdotcom/infographics/sustainable-investing/Sustainable_Signals_Individual_Investor_White_Paper_Final.pdf>
Broadridge.com. 2021. [online] Available at: <https://www.broadridge.com/_assets/pdf/broadridge-next-generation-proxy-voting-strategies.pdf> [Accessed 10 February 2021].
Lenssen, N.J.L., Schmidt, G.A., Hansen, J.E., Menne, M.J., Persin, A., Ruedy, R. & Zyss, D. 2019, "Improvements in the GISTEMP Uncertainty Model", Journal of geophysical research. Atmospheres, vol. 124, no. 12, pp., 6307-6326.
Noah S. Diffenbaugh & Christopher B. Field 2013, "Changes in Ecologically Critical Terrestrial Climate Conditions", Science (American Association for the Advancement of Science), vol. 341, no. 6145, pp. 486-492.
GOV.UK. 2021. The Ten Point Plan for a Green Industrial Revolution (HTML version). [online] Available at: <https://www.gov.uk/government/publications/the-ten-point-plan-for-a-green-industrial-revolution/title> .
Task Force on Climate-Related Financial Disclosures. 2021. Task Force on Climate-Related Financial Disclosures. [online] Available at: <https://www.fsb-tcfd.org>
Morningstar.com. 2021. Sustainable Funds European Landscape. [online] Available at: <https://www.morningstar.com/en-uk/lp/sustainable-funds-landscape?&utm_medium=native&utm_campaign=emea_investor_sites&utm_content=professional>