How do we get to net zero?

There has been much talk of the finance firms responsible for managing $130 trillion making the net-zero pledge at COP26 and vowing to put climate at the heart of finance. While this was a tremendous development, the nub of the issue remains that just because significant money is committed as being available for investment, that does not alone drive a step change in the commerciality of clean energy and other process technologies we need for net zero. The big question is how to bridge the gap between the money that is available and projects that can meet the minimum return on investment requirements of that finance. There remains a vital role for governments to create mechanisms, ideally competitive mechanisms, to bridge this gap.

We have (finally) listened to the scientists but are we listening to the economists?

Professor Milton Friedman’s famous article in the New York Times (13 September 1970) titled: The Social Responsibility Of Business Is to Increase Its Profits, has drawn much criticism over recent years and is held up as an exemplar of how free marketeers have led us down the garden path. And I myself, as an advocate of sustainable development for over 30 years, long harboured concerns with free market capitalism. I have, however, spent much of 2021 researching the views of Milton Friedman, and having properly given him the time of day, I confess to being quite enamoured with his reasoning and arguments.

Though that is not to say that I am now a born again ‘classical liberal,’ as I believe a balance needs to be struck, particularly in our relationship with the natural world and responsibility for the disadvantaged. But people do a great disservice to the cause of sustainable development by vilifying Milton Friedman and not understanding the power and tremendous value of free markets. 

On the critical issue of pollution and what to do about it, he agreed that there is a role for government. This excerpt from a questions and answers session with Friedman in 1977 makes his position very clear: “Personally, I’m just in favour of free trade. I want even rules. I don’t want to give any subsidy to pollution, on the contrary, I would like to tax those activities that create pollution. But we’re going about it in a very foolish and unwise fashion. We’re going about it by trying to regulate the equipment that people use. And that’s a very bad way to do it. Far better to impose an effluent tax and then leave it to the ingenuity of people to minimise the cost.”

Time for a proper price on carbon?

Friedman was not alone in this view on pollution. And on the challenge of climate change, there has been a widespread consensus of economists, for decades, for governments to put a tax (or create a market price) on carbon (i.e. greenhouse gases). Sir Nicholas Stern made this very clear in The Economics of Climate Change - The Stern Review in 2007, in which pricing of carbon, implemented through tax, trading or regulation, was the principal policy element. 

A World Bank 2020 Report on the state and trends of carbon pricing identified there to be some 61 carbon pricing initiatives in place or scheduled for implementation, but despite the growing number of schemes and increasing prices in many jurisdictions, only one per cent of global emissions were [as at the time of the World Bank study in 2019] subject to what is considered to be a price signal adequate to drive change consistent with the Paris Agreement. 

Post-COP26 and now 15 years after the Stern Report, it is surely time for more governments to act on the advice of the long-standing consensus of economists and introduce (or re-introduce) a proper price on carbon. Positive developments since the World Bank (2020) report include the European carbon market finishing 2021 some three times higher than at the beginning of the year, at approximately 90€. And it is now in China where we find the world’s largest emissions trading scheme, the Shanghai Environment and Energy Exchange. The Chinese understand the power of markets. 

Reflecting on the role of business and government

Over the last five years there has been a widespread and growing chorus from the international finance community and, more recently, the wider investment community on the importance of environmental, social and governance factors. This is driving businesses to increasingly self-regulate in the interest of maximising long-term value creation and protection. 

Business momentum has been so dramatic in recent years that people (including some political leaders) are now placing much faith in business and technology to get it right, largely in the absence of political action. With the tremendous leap forward in renewable energy and the current surge in ESG-related investment, it is understandable, but this blind faith is poor judgement and largely reasoning by false or limited analogy. Real action, of the scale and pace now needed to tackle climate change, partly as a result of us having kicked the problem down the road for the last 30 years, still requires political leadership and government intervention and investment to fix what remains a market failure. 

It would be a cruel irony, if the efforts to fill the gap of political inaction were now the primary cause of continued inaction. 

I used to feel very strongly that what was needed was improved business leadership and greater consumer awareness. But in my experience, having seen charismatic CEOs come and go with little if any long-term positive impact, the terrible legacies of past practices and the failure of business to learn from them, inconsequential corporate social responsibility initiatives that could be argued to have been an exercise in fraudulent misdirection, and the limited bandwidth of the consumer to make informed decisions; I am inclined to advocate for a return to the clarity of Friedman and Stern on the need for an effective policy response by governments. 

The limits of stakeholder capitalism

There are many who have argued in recent years that capitalism needs to change to what has lately been termed stakeholder capitalism; the need to benefit all stakeholders. This is hardly revolutionary. It is just good practice for a business to be focused on customer needs and considerate of its own long-term interests, which is not at all inconsistent with Friedman’s assertions. However, there is a limit to the extent that a business may internalise third party interests and remain competitive, as can be seen most clearly in relation to matters of pollution. And so, a necessary role of government persists. Furthermore, a business simply acts in its interests, and the balance of short and long-term interests is a difficult one, especially when in survival mode (which is the reality for most businesses), and so government intervention is required to help align their short and long-term interests and avoid major negative externalities.

Confronted again by the horror of major conflict and the natural instinct to retreat behind hard borders, we must not lose sight of the value of economic interdependence in reducing the risk of outbreak and the nature of future international conflicts. Achieving net zero will also not be possible without continued open markets and multilateralism. A final word from Milton and Rose Friedman (1980): “The operation of the free market is so essential, not only to promote productive efficiency, but even more, to foster harmony and peace among the peoples of the world.”

This is no longer about whether you are an optimist or a pessimist, it is about us all having the resolve to get this done and ensuring action on climate change stays at the top of the political agenda until it is. And for a start, let’s stop using capitalism as an excuse.

Our event 'Accelerating the business journey to net-zero'  is coming up on April 27 in Sydney. To register for this event and for more information see here.