Remaking capitalism for a sustainable future

Planetary boundaries now loom, including most notably the risk of overloading our atmosphere with greenhouse gases (GHGs). This reality imposes a sustainability imperative on all of us, requiring new rules of engagement for business. Simply put, we must learn to live within the safe operating space of the Earth’s biophysical and ecological systems to avoid life-threatening environmental damage. A commitment to sustainable development – the requirements for which the 2015 UN Sustainable Development Goals spelled out in detail – has been ratified by 193 nations as the foundation for a world in which both humans and nature might flourish.

But the idea of living within boundaries has proven easier said than done. Fundamentally, a sustainable future requires an economic system that promotes conservation of natural resources and protection of our critical Earth systems, while ensuring long-term economic opportunity for all. Instead, our current market economy produces an enormous amount of pollution and waste that threatens to cause climate change and other environmental damage. We need to make sustainability a core principle of our 21st century economy – and undergird this commitment with a legal framework that prohibits the spillover of environmental harms onto others.

End externalities

Conceptually, sustainability requires a new foundation for capitalism that takes seriously the Polluter Pays Principle and prohibits – as economists would say – uninternalized externalities. No longer should pollution be accepted as the necessary byproduct of industrial production and justified on a benefit-cost basis. In cases where pollution is truly unavoidable, harms inflicted on others should be paid for in full – as should the exploitation of natural resources.

Many international environmental agreements invoke the Polluter Pays Principle, and governments across the world claim to have built their environmental policies on this concept. In practice, however, commitments to internalize environmental externalities are often ignored in favor of emissions limits set by benefit–cost analyses. But this legal framework gives businesses a license to pollute and leaves more than seven billion people across the planet breathing unhealthy air and nearly a billion people without access to safe drinking water. And all 7.9 billion global citizens face climate change risks as GHGs rise to dangerous levels.

New rules for business

Companies have long understood their mission to be maximizing shareholder value, often taking to an extreme Milton Friedman’s doctrine of shareholder primacy and the suggestion that any business practice not deemed illegal is legitimate as a pathway to greater profits. This theory advances corporate gain at societal expense, as pollution is rarely fully regulated, nor is the extraction of water, minerals, timber, or other natural resources charged for in full. Consequently, the doctrine of shareholder primacy, combined with incomplete government regulation and the propensity to underprice natural resources, has led to widespread unsustainable business practices. Simply put, our current structure of capitalism privileges profits over human needs and environmental integrity. 

Fortunately, many business leaders have come to understand (and accept) that attitudes are changing. A new theory of corporate purpose has emerged, centered on stakeholder responsibility. This revised understanding of the role of corporations provides a basis for changing the ground rules of business – most importantly, moving to an expectation that companies will not spill environmental harms onto others. 

Insofar as corporations are legal constructs of society, companies owe a duty not just to their owners but also to their customers, suppliers, and employees – as well as to the communities in which they operate and society more generally. But even as the notion has taken root that corporations should be held to a standard higher than the Friedman doctrine would suggest, the path from the status quo of pervasive, environmentally harmful business practices to a sustainable future – in which these damaging practices stop, and residual harms are fully paid for – remains undefined. 

We now have an opportunity to blaze that trail, building on the Big Data revolution that has swept across society, and the growing interest in sustainable investing and more robust corporate environmental, social, and governance (ESG) reporting.

Improved corporate sustainability metrics and reporting

To make the “no uninternalized externalities” principle effective, we must be able to identify and measure GHG emissions; air, water, and soil pollution; natural resource use; and other environmental impacts. An important first step in this direction would be to require companies to report comprehensively and consistently on their ESG performance, including their emissions and resource use. While some corporate ESG data exists today, much of what is available is self-reported and aggregated by private data companies without independent verification. This leads to methodological inconsistencies and untrustworthy metrics that in turn create difficulties in doing company-to-company or industry-to-industry comparisons. These reliability issues foster a lack of trust in the data and a lack of confidence that the true sustainability leaders (and laggards) have been identified. Because so many of the existing ESG metrics are self-reported, companies can (and frequently do) cherry-pick their data to create the illusion that they are more sustainable than they really are – a process known as greenwashing.

While these challenges complicate adoption of a “no uninternalized externalities” rule, the solution is clear: we need a transparent and trustworthy framework of ESG metrics that facilitates benchmarking and accurate tracking of emissions and other environmental impacts. The shortcomings of the existing regime of voluntary corporate reporting and private data collection efforts make clear that a comprehensive and rigorous ESG framework can only be established through a government-defined mandatory sustainability reporting structure backed by the threat of legal penalties for misreporting. A few places, notably France and the EU more broadly, have specified new ESG disclosure rules and some countries – including Kenya, the United States, Switzerland, Germany, Finland, and the Netherlands – have expanded requirements under consideration. Yet none of these proposals offers the basis for a full-fledged structure of sustainability reporting on which a commitment to end externalities could be built. Other entities such as the Global Reporting Initiative and the World Economic Forum have proposed new ESG frameworks, but a broader consensus on a common set of metrics and underlying methodologies is needed to underpin the transformation of environmental rules proposed here.

Toward a sustainable market economy

Full, validated ESG data would provide the analytic foundation for a sustainable market economy. Specifically, better metrics on corporate emissions and natural resource use could help the world move to full implementation of the Polluter Pays Principle and a broad-based commitment to end uninternalized externalities. Government-mandated corporate ESG reporting would provide a mechanism for getting the data needed to gauge and price environmental harms. Even before governments have tightened regulatory requirements and made companies pay for their environmental impacts, the presence of reliable ESG data would allow sustainability-minded investors to buy shares in those companies. This would help to move the world toward a clean energy economy and sustainable future and to steer capital away from enterprises whose profitability depends on imposing environmental burdens on society.

The transparency provided by a comprehensive ESG database with high-quality data on emissions and resource consumption would highlight the companies and industries that enjoy special interest status and environmental privileges unavailable to others as a result of campaign contributions and lobbying that torque policy outcomes. Publicly available ESG information would furthermore provide evidence and support to opposition political leaders, the media, NGOs, and competitors to call out the unfairness of allowing environmental miscreants to carry on with their damaging practices. This would also put direct pressure on any environmental ministries or agencies that were slow to hold these polluters accountable.

Conclusion

Today’s structure of capitalism is on a collision course with the sustainability imperative. To ensure that our global society does not crash through planetary boundaries and damage life-sustaining Earth systems, the foundations of our market economy must be reimagined, and then rebuilt. Essential to this rebuilding is the implementation of a “no uninternalized externalities” rule that severely limits pollution. For proper tracking (and subsequent internalization) of externalities, a robust framework of mandatory corporate sustainability disclosure offers great promise.