Increasing criticism of ESG (an often incoherent investment “discipline” under which actual or portfolio companies are scored in part by how they score against various environmental, social, and governance measures) and the pushback against it in certain (red) states are worrying those in the ESG ecosystem who have done so well politically and economically (or both) out of it. Newspapers such as the Financial Times complain about elected politicians meddling in topics such as ESG, even though ESG is nothing if not political. Billionaires such as Mike Bloomberg and Tom Steyer have issued warnings that those who oppose ESG just don’t understand capitalism, as has (more or less) Al Gore, climate change “prophet” and profiteer.
All this was (more or less) to be expected. It was more of a surprise to read an article supporting ESG against its conservative critics by Jacob Soll, a professor of philosophy, history, and accounting at the University of Southern California, who cited, among others, St. Francis of Assisi. Perhaps it’s just me, but if I were looking to offer some reassurance to those uncertain about ESG (which may not, of course, be Soll’s aim), citing an individual who rejoiced in poverty is not an obvious course to take.
But before bringing Il Poverello into his discussion, Soll writes:
Conservative critics [of ESG] say giving value to moral or even scientific imperatives goes against the profit principle at the heart of the free market; for them, it’s foolish at best, and at worst an effort to impose a “woke” agenda.
The core of this policy strikes at what goes on balance sheets and how we value things. Are environmental concerns, social well-being and good government assets or liabilities? Or do they simply not matter amid the pursuit of profit?
The furor over “woke capital” is, or ought to be, a sideshow. Woke capital is a symptom, not the disease. A much deeper free-market critique of ESG and its equally repulsive symbiont stakeholder capitalism (an idea that should never be excluded from any discussion of ESG) rests on two core principles: a belief in property rights, and a belief in democracy. Stakeholder capitalism, no less than ESG, dilutes the former and risks eroding the latter. A couple of years ago, I wrote about stakeholder capitalism and property rights here:
[Stakeholder capitalism] is the idea that a company should be run for the benefit of all its “stakeholders,” a conveniently hazy term that can be defined to include (among others) workers, customers, and “the community,” as well as the shareholders who, you know, own the business. It’s a form of expropriation based on the myth that a corporation that puts its shareholders first must necessarily put everyone else last. In reality, an enterprise that, to a greater or lesser extent, fails to consider the needs of various — to use that word — stakeholders in mind, customers, most obviously (but certainly not only) is unlikely to flourish, and nor, therefore, will its owners.
And when it comes to the risk to democracy, I gave some background here:
The wider vision underlying stakeholder capitalism is one in which different interest groups such as employers, employees, and consumers collaborate in pursuit of mutually (if sometimes mysteriously) agreed objectives under the supervision of the state. It would never be quite post-democratic, not quite, in any likely American form, but what it would be is a variety of corporatism.
Corporatism takes many, many forms. It can range from the relatively (relatively) benign — it runs through European Christian Democracy, and it can be detected in early-20th-century American Progressivism — to the infinitely more heavy-handed. It has been an important element in the theory, if not the practice, of some variants of fascism, most notably in Mussolini’s Italy, but not only there.
A company is the property of its owners, its shareholders. It’s thus a simple matter of logic as well as longstanding case law that the job of a company’s management is to run the business for the financial benefit of its shareholders (unless those shareholders vote otherwise). To the extent that ESG or stakeholder capitalism “permit” management to ignore that obligation, they are nothing more than an attempt to justify a breach of trust and the expropriation of property rights (similar arguments apply, in many cases, with regard to the behavior of investment managers). Some might call that moral, others might say that it is theft.
And then there’s the small matter of democracy. In democracies, decisions on issues such as environmental policy should be made by the legislature. ESG and stakeholder capitalism are devices to use corporate power and money to make and implement policy in such areas, but without going through the bother of asking the voters.
And so to St. Francis.
Soll:
Saint Francis of Assisi and the Scholastic thinkers believed that all profit had to be measured with the concept of the “just price” — exchanges had to be mutually beneficial and no one could take an unfair profit from others.
Even beyond the just price, the medieval, Catholic inventors of capitalism believed that profit had to be balanced by morality. They were influenced by the ideas of the Fathers of the Church, that profits should be given to the poor and that those who died rich had as much of a chance of going to heaven as a camel did of going through the eye of a needle.
To shift focus for a moment, there is an interesting argument to be had on the topic of when capitalism (or proto-capitalism) was invented. Some maintain that it took a few more centuries to emerge than the time suggested by Soll, others that it had been around for millennia.
Nima Sanandaji, writing in CapX in 2018:
Far from being a recent innovation, enterprises, banks, advanced commercial practices and free markets evolved some 4,000 years ago in the countries we today know as Iraq and Syria. A better understanding of the story of capitalism is needed; since it shows us how important markets have been for human progress as well as how universal the link between development and market policy is across different societies.
Over time, archaeologists have uncovered and translated a great deal of tablets left from ancient civilisations. Many of the tablets from Babylonia and Assyria, in contemporary Iraq and Syria, are receipts of economic ventures. They show that private profit-seeking merchants, rather sophisticated investment ventures and market price setting were common in these civilisations. Astronomical diaries written some 2,500 years ago show how market prices changed on a monthly, or even weekly, basis in Babylonia.
This shouldn’t come as a surprise. Given how prosperous the ancient Middle Eastern civilisations were and how important they were for human progress, it should come as no surprise that they were the birthplace of enterprise and market economy. Egypt on the other hand relied more on central planning, and predictably stagnated.
Some things never change:
Free markets, in different forms, also seem to have formed in the three other cradles of human civilisation – India, China and Mesoamerica. Since ancient times China has fluctuated between free market policies and statist control. The periods of free markets are those in which China has prospered.
It’s almost as if there’s a message there.
Sanandaji even suggests (Dominic Pino, avert your eyes) that Adam Smith plagiarized Xenophon (more on that here).
But back (sigh) to St. Francis and the scholastics. Soll is not, mercifully, recommending that we adopt a “just” price regime, but making the broader point (I’m oversimplifying) that there is a long tradition that profit is not its own justification, but should also be “moral.” Soll backs up his arguments with (to take a few examples), the views of 16th century Flemish painters, the “spiritual accounting” of 17th century Jesuits, the “moral accounts” of Benjamin Franklin, Jacques Necker (a not uncontroversial 18th century French finance minister), and Henry David Thoreau, another ascetic mystic with a distaste for business. “Trade,” wrote Thoreau, “curses everything it handles,” a somewhat discouraging point of view from someone with, we are supposed to believe, something useful to add to the way U.S. businesses are run.
But, summoning up this crew adds little of substance to a defense of ESG. There are few who would argue that profit is everything. To stakeholder capitalists and ESG’s promoters, Milton Friedman is the archetype of much that is wrong with contemporary capitalism, and yet in his now legendary article (The Social Responsibility of Business Is to Increase Its Profits) on shareholder primacy there is this passage (emphasis added):
In a free‐enterprise, private‐property system, a corporate executive is an employe of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of … society, both those embodied in law and those embodied in ethical custom.
“Embodied in ethical custom.” So far as its greatest advocate was concerned, shareholder primacy was not divorced from morality. Moreover, he evidently (and correctly) had no difficulty in finding those corporate executives who effectively anticipated ESG and stakeholderism, not just misguided, but morally wrong.
In making his case, Soll also cites the examples of Dutch water boards, which date back centuries:
The Dutch water boards, which governed water management, depended on precise accounting and a culture of auditing to make sure that public finance could manage the natural world. Public awareness of the value of water management was high, and leading thinkers and artists warned that thinking only of profits was hubris akin to madness or folly.
“Leading thinkers” and artists will think what they think, but it’s hard to imagine that many free marketeers today would disagree with the contribution made by the water boards (essentially a form of local government), or the importance of “environmental management” to the Netherlands.
After all, as Soll explains:
It… was a society whose wealth came from significant environmental management, as 40 percent of the Dutch Republic was below sea-level. Its rich farmlands were drawn from the sea through its polder engineering systems of levies, seawalls, dikes, sluices and managed lakes.
The Dutch need to manage their land’s relationship with the undeniable threat from the sea was a rational allocation of publicly funded resources. The same cannot be said of the current set of Western climate policies, which, all too often, seem to be driven by a combination of command-and-control nostalgia, and atavistic apocalyptic fears. The real lesson to be taken from the experience in the Netherlands is the extent to which the Dutch relied on adaptation (which later included extensive reclamation). They were able to pay for this with the fruits of their commercial success, both at home and abroad (some of it flowing, it must be said, from the slave trade).
Modern climate policies of the sort promoted within the ESG ecosystem, by contrast, do too little to help adaptation, and too much to install technologies that are not yet ready for prime-time (traditional Dutch windmills, by contrast, did what they were meant to do). What’s more, if climate policy continues along its current course, it will constrain the economic growth that creates the wealth that, if history is any guide, will enable humanity to make the investments needed to cope with whatever the climate may have in store for us and, quite possible, even avert some future difficulties to come.
Soll rightly notes that the Dutch were the first to set up a stock market. Not only that, as Martin Hutchinson points out in his fascinating book Forging Modernity, the most important Dutch province, Holland, had a de facto central bank from 1609, enabling a public debt market to grow up (according to Hutchinson, Holland’s borrowing rate fell by more than a half over the next forty years), another part of increasingly sophisticated financial markets (let’s not talk about tulips). Hutchinson explains that property rights were well-protected in the Netherlands, better than anywhere else in continental Europe. What’s more:
[T]he country also had a well-established rule of law…[and] its bourgeois culture ensured that at least the middle classes could get legal redress if needed. With a solid government bond market and an early stock market had a good savings climate until 1672.
With functioning exchanges, decent property rights, a well-established rule of law, and that “bourgeois culture,” the 17th century Dutch had put key building blocks of a free-market economy in place, and they saw the rewards. ESG and stakeholder capitalism, by contrast, attack property rights, contribute to the dilution of legal certainty, and will discourage growth, investment and, even, the willingness of some companies to go public. The Dutch precedent may mean something other than Soll seems to suggest.
Soll also draws attention to policies such as heavy regulation on trade with USSR during the Cold War that, he argues, “show the U.S. government has not shied away from shaping commerce because of moral concerns and national interest.” That’s true, but the examples he cites were prompted more by security considerations than moral concerns. Needless to say, the leadership of some firms grumbled about the lost business opportunities that ensued, but Adam Smith would have understood what Washington was doing. As he wrote, “defence… is of much more importance than opulence.” It’s worth adding that the priority Smith put on national security would be tricky to square with ESG-driven restrictions (in some cases) on investments in armaments or in fossil-fuel production.
The first of Soll’s concluding paragraphs runs as follows:
In the end, ESG is just another name for moral considerations in capitalism. The left may think that’s an oxymoron and the right may see a woke conspiracy, but it’s a notion that has existed since the rise of capitalism in medieval Italy and which has been central to America since its founding.
As Soll states, the idea that capitalism should operate within a moral framework has a long history. Few would dispute that, but that doesn’t give ESG a clear pass. ESG is not “just another name for moral considerations in capitalism.” Rather it is a distinct system designed to encourage or enforce certain behavior within and by business. Maybe, in parts, it is analogous to a moral code, maybe. But even if that it is the case, just because it’s a moral code doesn’t mean that it’s the right moral code, or that others should have to comply with it.
Apart from obligations imposed by law or regulation, the only people who should decide on the applicability of ESG to their company are its shareholders. Their company, their rules. When those shareholders are funds made up of the savings of third parties, they should invest solely on pecuniary grounds (and vote their shares only in ways intended to maximize investor return), unless those third parties specifically agree otherwise, having been made aware that it may well mean sacrificing some return.
Yes, sacrifice some return: ESG has, famously, been marketed as a way for investors to do well by doing good. Soll refers to a book published in the 1980s, which “showed that ESG considerations [or, rather, earlier forms of “socially responsible” investing] bring higher returns over longer periods of time.” However, more recent evidence is at best mixed. (That’s being kind: Although, to be fair, there are other data that can be read in different ways.) But even assuming for the sake of argument that ESG can deliver sustainable outperformance, the way that markets work will, logically, mean that that will cease to be the case as the ESG advantage is “priced in.”
Meanwhile, Aswath Damodaran, a professor at New York University’s Stern School of Business, has described ESG as space for “useful idiots” and “feckless knaves.” Harsh, if accurate, words. It’s worth reading this, this, and this to see his reasoning, which dismantles much of the economic and, indeed, “moral” case for ESG: Investors may not do well, and (even by their standards) they may not do much “good” either.
Damodaran highlights the way that ESG has become an attractive feeding ground for rent seekers. Then again, many faiths, philosophies, or moral codes have been a source of rich pickings for the unscrupulous—think of the peddlers of Christian relics who did so well in the Middle Ages. Of itself, that does not necessarily discredit the underlying beliefs, but with ESG it comes very, very close.
I believe that ESG is, at its core, a feel-good scam that is enriching consultants, measurement services and fund managers, while doing close to nothing for the businesses and investors it claims to help, and even less for society.
Back to Soll:
[A]ttempts by conservative politicians to block ESG investments go against the basic principles of democracy and capitalism by which we have the right to spend and invest money according to personal choice, religious and moral freedom, and pursuit of the national interest through legislative consensus, all of which are fundamental to free societies and free markets.
On the contrary, the attempts by elected politicians in red states to insist that political decisions should be taken by those elected to do so, rather than by a murky, ever-shifting coalition of businesspeople, activists, investment managers, Wall Street opportunists, and who knows who else, is profoundly democratic. The problem is not that ESG is being subject to political criticism, but that it has still not had enough of it.
And yes, of course, if investors want to invest in ESG funds, or funds that reject “sin” stocks, or any other funds in which non-pecuniary factors play a role in the investment process, they should be able to do so, but investors who want nothing to with ESG or stakeholderism should also be able to invest according to their principles, too. However, the latter may find their choice increasingly constrained, albeit perhaps only indirectly, if the clout of the large institutional investors who have embraced ESG, reinforced by the subtler power of the proxy advisory “duopoly,” pushes more and more companies down a progressive pathway.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by the National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 123rd episode, David is joined by Tim Busch, founder of Pacific Hospitality Group, a leading hotelier and key advocate in the fight for a free and virtuous society. The two discuss the state of inflation, the reality of Fed policy on the hospitality industry, and what we can learn about the silliness of the Los Angeles Dodgers.
No Free Lunch
Earlier this year, David Bahnsen launched a new six-part digital video series, No Free Lunch, here at National Review. In it, we bring the debate over free markets back to “first things” — emphatically arguing that only by beginning our study of economics with the human person can we obtain a properly ordered vision for a market economy…
The series began with a discussion with Fr. Robert Sirico of the Acton Institute. Later guests include Larry Kudlow, Dennis Prager, Dr. Hunter Baker, Ryan Anderson, Pastor Doug Wilson, and Senator Ted Cruz.
Yes, the six-part series now has seven parts.
Enjoy.
The Capital Matters week that was . . .
Municipal Finance
One subtle reform related to elections in particular should become a model for other states. Iowa has moved all municipal bond elections to November-only dates. While the governor and legislators aren’t likely to grab as many headlines with this sort of good-government adjustment as they did with the 2022 tax-reform and universal ESA legislation, its benefit for Iowans may be no less profound.
It may also be a unique feature among the 50 states, most, if not all, of which allow local bond referenda to be held outside of the familiar November timeframe. Consequently, local governments around the country may schedule elections in the spring or summer, when voter turnout is typically lower, increasing their chances of passing potentially unpopular measures. As they focus their efforts on mobilizing small-but-dedicated groups of voters and other individuals with a vested interest in a proposed project, proponents of bond issues have an even greater turnout advantage if the broader public is not expecting to vote. Headlines and election statistics show that both the media and the general public tend to overlook these elections…
Fiscal Policy
The Biden–GOP debt deal adjusted work requirements in the Supplemental Nutrition Assistance Program but did not cut the program’s spending. But cuts are needed because SNAP outlays have exploded from $63 billion in 2019 to an estimated $145 billion in 2023. Congress will have another chance at reform later this year when the program is reauthorized as part of the farm bill…
Inflation
When my Hoover Institution colleague John Taylor developed the Taylor rule for monetary policy, he was able to look back at many years of inflation-fighting around the world and evaluate the patterns and effectiveness of different practices. The work is frequently cited by other economists, and for good reason. It works. The Taylor rule tells you, based on theory and evidence, where the interest rate needs to be today if the Fed is serious about fighting inflation.
In short, given that current inflation is running about 5 percent, and the Fed has a target of 2 percent, and given that the economy is running hot, the Taylor rules says the federal funds rate today should be about 7 percent, or about two percentage points higher than it currently is. In other words, one shouldn’t expect inflation to budge too much more in response to the policies that we have seen over the past year because interest rates are still far too low…
Barring some exogenous shock to our economy, we are about two months away from having functionally solved the latest round of inflation. This is not some brilliant piece of prophecy — nor is it unmitigated good news. It is merely an observation about something that has already occurred, but that is widely misunderstood. The headline CPI data, the main reported figure, is only catching up with the reality. Tuesday’s 4 percent year-over-year figure masks the true current inflation figure, which is much lower and declining.
David Bahnsen and Lacy Hunt have been shouting this from the rooftops for months now, but the message does not seem to have penetrated the Fed. This misapprehension will inevitably lead to policy mistakes, as overly zealous inflation warriors seek to keep the rate hikes coming…
As a college student who has only worked for nonprofits, I don’t have particularly deep pockets. Simply put, I’m broke. But I’m not hungry, thanks to the shockingly cheap McDonald’s breakfast-burrito meal, which includes two sausage burritos, a hash brown, and a small coffee. In midtown Manhattan, the price for this scrumptious and nutritious — I’m not a nutritionist; I’m a writer — breakfast is only $5.65.
Considering the rising cost of groceries and restaurant food, the cheapness of McDonald’s got me thinking: Has the breakfast burrito meal always been this cheap? Was it significantly cheaper before the pandemic? In general, is “McFlation” less than consumer price index (CPI) and personal consumption expenditure (PCE) inflation?
Taxation
Britain’s “common good” Conservative Party is not known for its understanding of basic economics, as its recent plans to encourage “voluntary” price caps on certain food products have already reminded us.
Another Tory folly was the introduction of a windfall tax on oil and gas companies. The tax was going to be a one-off at 25 percent. It was then increased to a one-off levied at 35 percent and extended for three additional years…
Climate Policy
Central planning is, by definition, a rejection of free markets. And that is as good an explanation as any as to why central planners’ projects so often end in miserable and, on occasion, catastrophic failure. The so-called race to Net Zero is shaping up as a classic example of the genre, a carnival of malinvestment that may well lead, if it’s taken far enough, to economic disaster, political upheaval and, for the West, geopolitical catastrophe.
In the meantime, here’s a bit of news from Britain that gives yet another example of how Net Zero will, if those steering its introduction are given the chance, distort the way in which markets operate. This particular example concerns the pricing of money…
Regulation
Google has been taking antitrust flak for its ad-tech business for quite some time, as discussed by the Wall Street Journal. In 2021, the company had to pay a fine of 220 million euros ($237 million USD) to France following an investigation of inadequate data access to competing ad-tech firms. In January 2023, the Department of Justice (DOJ) sued Google for “monopolizing digital advertising technologies,” in violation of (sections one and two) of the Sherman Antitrust Act. Unable to catch a break from regulators, the tech giant now faces a complaint from the European Commission to break up its ad-tech business. The EU’s antitrust complaint, like those of France and the U.S., alleges that Google abuses its market share sell-side, buy-side, and through the exchange of internet ads between publishers and advertisers to lock publishers into its services while purchasing rival firms and making entrance unprofitable…
China
In normal times, China uses roughly 16 million barrels per day (mbd) of crude oil. Of this, it imports up to 12 mbd. Half of these imports come from the greater Middle East, crossing the Indian Ocean and Southeast Asian straits. In short, overseas oil remains China’s lifeblood, and in wartime, the democracies could disrupt its transit.
Aware of this danger, the Chinese Communist Party has long prioritized a two-pronged response. First, its military strategy calls for a “short, sharp” war, seeking victory before energy shortages cripple China. Second, its energy strategy seeks to secure oil sufficient for months of war…
ESG
Companies can enjoy years of spectacular returns boosted by their growing use of energy renewables and leadership in carbon-emission reductions. Naturally, they look forward to a positive score for “E” from rating agencies. As companies also diligently cultivate workforces that look more like the demographics of America, they understandably expect a positive rating for the “S” element. Senior executives and boards are therefore often shocked when they get slapped with poor ratings on these dimensions. Low “G” ratings follow, too, if businesses manage issues such as board diversity in ways that are deemed less than progressive. After some early confusion, corporate leaders are awakening to the fact that they signed on with a progressive cartel dedicated not to steady carbon reduction and social progress but to blinkered environmentalism and ideological — even, partisan — coercion.
Adam Smith
First of all, as David Bahnsen and I talked about on the Capital Record, there’s some ambiguity on the exact date of Adam Smith’s birth. His birthdate was not recorded, and all we have is the date of his baptism. For the first part of his life, that date was June 5, 1723. That’s why you may have seen some birthday congratulations to Smith on June 5 of this year. In 1752, Great Britain changed from the Julian to the Gregorian calendar. That decision shifted dates by eleven days, so Smith’s baptism day on the Gregorian calendar is June 16. That’s the date we decided to use for our Adam Smith 300 essay series. If you also celebrated on June 5, we at Capital Matters see no problem with celebrating Smith’s birthday twice. We’ve been celebrating all year, with a new essay each month.
This month’s essay comes from Craig Smith, the Adam Smith Senior Lecturer in the Scottish Enlightenment at the University of Glasgow…
Adam Smith has been portrayed as the father of economics, and as a founder of classical liberalism. Such portrayals tend to invoke a solitary genius whose ideas emerge from nowhere to change the world. But that is almost never the case. Thinkers such as Smith come from somewhere, and their ideas are shaped by their reading and participation in debates with their peers.
The Scottish Enlightenment took place in the middle years of the 18th century and was part of a wider European Enlightenment, the “Age of Reason,” when science, progress, and freedom of expression and activity came increasingly into the intellectual vanguard…
Frederic Bastiat
Two recent economics articles provide great examples of “what is seen and what is not seen.” That was the title of an 1850 book by Frederic Bastiat, a French political economist…
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