In his 2006 landmark report on the climate crisis, Lord Nicholas Stern of the London School of Economics, and Chief Economist at the World Bank between 2000 and 2003, characterised global warming as an ‘externality’, a damage to others due to market activity whose cost is not met by those who cause it.
According to him, it was the ‘the largest ever market failure’. Global warming arose because the market system was not working well enough, and if we could find a way to correct the fault, the problem would be solved.
In a podcast this year, he refers to the Schumpeterian story of discovery, innovation, investment and growth - creative destruction: “As you move, as you innovate, as you go beyond the old technologies, which are out of date, there's inevitable dislocation. There are so many more jobs in these new industries, whether it's installing solar on roofs, or decentralized solar in Indian village, or wherever it might be. There are so many opportunities there, but they are not necessarily things into which coal miners instantly go.”
Creative Destruction
Economist Joseph Schumpeter described the dynamic pattern in which established firms are unseated through a process he called creative destruction. Schumpeter believed that disequilibrium was the driving force of capitalism; Coal Age technologies gave way to Oil Age technologies that are now giving way to Information Age technologies.
Way back in 1999, a paper published by MIT Sloan Management Review looked at the emerging challenge of global sustainability as a catalyst for a new round of creative destruction that offers unprecedented opportunities.
It also noted that the dynamics of creative destruction will work against firms that rely only on incremental improvements and fail to change the fundamental manner in which they provide products, processes, and services. The paper provided the example below.
An example of incremental improvement is the Chemical Manufacturers Association’s (CMA) Responsible Care programme, which helped rescue the industry from near oblivion but has not led its members to revolutionize practices.
Following the Bhopal disaster in 1984 (in which 3,000 residents of Bhopal died as a result of a toxic chemical explosion at a Union Carbide plant), leading chemical companies (for example, Dow, DuPont, and Monsanto) pressed for self-regulation in the face of public hostility and calls for stricter regulatory measures that threatened industry survival.
In 1988, the CMA adopted Responsible Care — a statement of environmental principles and codes of management practices that included provisions for pollution prevention, product stewardship, and community involvement. To strengthen the programme, the principles and codes were made obligatory for CMA member companies, which comprised 90 percent of the chemical capacity in the United States; noncompliance was grounds for expulsion from CMA. Since 1988, Responsible Care has transformed the chemical industry’s environmental behavior and helped to change the public’s perception of the industry from shameless polluters to a more responsible actor.
While successful in re-establishing the legitimacy of an industry under tremendous public pressure, Responsible Care has failed to address the fundamental underlying problems associated with the chemical industry; many of its products and processes are highly toxic, resource intensive, and continue to place enormous pressures on air and water resources. As an industry-level collaborative process, the Responsible Care programme has fostered incremental improvement by forcing laggard chemical firms to mimic the leaders in terms of environmental management. This has left the leading firms such as Dow and DuPont in a stronger competitive position by helping to shore up support for their right to operate but, ironically, has reduced the likelihood of fundamental innovation by chemical industry incumbents.
If we reflect on the commonly held definition that sustainable development is the ability of the current generation to meet its needs without compromising the ability of future generations to meet theirs, we can see how most existing products and processes fail to meet this criterion.
Visionary companies have an opportunity to drive the redefinition and redesign of their industries toward sustainability. Innovators and entrepreneurs will view sustainable development as one of the biggest business opportunities in the history of commerce.
In a note released this week, Kristina Hooper, the chief global market strategist at Invesco Ltd, expressed her belief that the pandemic has put the process of creative destruction into overdrive, accelerating trends that were expected to evolve over many years, rather than a few months. She believes that the kind of economic destruction created by the pandemic is so massive that it might very well result in enormous progress and innovation. That the pandemic and ensuing economic recession is a likely catalyst for a greener economy and, more generally, a greater focus on Environmental, Social and Governance (ESG) issues. This could turn out to be a moment of creative destruction, with a deep recession begetting a better and more environmentally friendly economy.
What does that mean for investors?
As Stern suggests in the podcast mentioned at the start:
The young people ask that their assets have a decent risk return profile, but they also ask that they be responsible, because that's their future that these investments are influencing.
We are starting to find, and the evidence is building, that investing responsibly, from the point of view of environment is actually to invest wisely.
Because you are betting on the technologies of the future, not on the technologies of the past.
