Week 32: We need a system change – and this is how

In this issue: ▸ Nordhaus and the spaceship economy ▸ 5 tipping points for a system change ▸ Alternative ESG data is coming ▸ When rain turns to dust ▸ And much more...

Dear all,

Is the hypocrisy we are facing on a daily basis with regards to sustainability, ESG, climate action etc. just another way of saying that we really don’t want to change?

Or is it an indication that we have played this hypocrisy game for such a long time that now we don’t react to it?

However you see it, it’s very discouraging with the level of bullshit we are facing right now.

The recent IPCC report is an excellent example of this. On the one hand, we had a week and a half of the “world is burning up” and “ we need to act now”. But on the day the report was published, just 4 hours later, one of the largest oil and gas companies in the world, Saudi Aramco, reported that they’ve increased their profits by 300%.

I mean, you have to stomach this. Let it land. It is not strange, not strange at all. We are running an economic model that depends on growth and consumption. No matter how we look at it, we end up in the same alley. We can either change how we consume, change how we grow, or we can change how we produce in order to consume and grow. The equation is blunt, hard and cold.

The climate emergency is a consequence, not the cause of our growing troubles. Very few discussions around the world today are related to economic system innovation – how we can change the underlying machinery.

It’s a machinery that connects entire world. One system to rule them all. We have one totalitarian economic model in the world which we all submit too.

Nordhaus and the spaceship economy

In 1974, the economist William Nordhaus described the transition from a “cowboy economy” to a “spaceship economy.” In the former, he wrote, “we could afford to use our resources profligately,” and “the environment could be used as a sink without becoming fouled.” But, in the spaceship economy, “great attention must be paid to the sources of life and to the dumps where our refuse is piled.” He added, “things which have traditionally been treated as free goods – air, water, quiet, natural beauty – must now be treated with the same care as other scarce goods.”

Toward the end of his landmark paper Resources as a Constraint on Growth, Nordhaus discussed the possible adverse effects of energy consumption, most notably the “greenhouse effect”. From a “rough calculation,” he found that the atmospheric concentration of carbon dioxide would increase by more than forty percent in the next sixty years. “Although this is below the fateful doubling of CO2 concentration,” he wrote – scientists had already predicted that such a doubling could cause the polar ice caps to melt catastrophically – “it may well be too close for comfort.”

He was prescient. We are now dangerously on track to hit his estimate, four hundred and eighty-seven parts per million, by 2030. 

A “spaceship economy” could thrive if governments made sure that companies paid an appropriate price for the environmental damage they caused – what would come to be called the social cost of carbon – but that’s not really happening today.

For this to change we need politicians more than ever before, and we need them to roar!

In this piece from Brookings you can read some interesting facts about the economics of climate change and climate policy.

Canada: “We need fossil fuels to stop using fossil fuels”

The climate emergency will continue to dominate the news and various urgent reports for years to come. Slowly but surely the emergency will also enter the life of the even the most protected one percent of the world population.

The rest – the 99 percent – already has some experience of it, and there’s a growing acceptance of this as something that needs to be managed. Not prevented, because that’s obviously too late. But to adapt to the consequences.

Here’s an example of this: The minister responsible for Canada’s role in fighting climate change is defending his government’s purchase of the Trans Mountain pipeline, even after the IPCC report said the continued use of fossil fuels is pushing the climate toward catastrophe.

The minister, Jonathan Wilkinson, said that the revenue generated by the project will help Canada achieve its long-term climate objectives. He reaffirmed Canada’s commitment to phasing out fossil fuels and achieving net zero carbon emissions by 2050, but said achieving that target will require money generated by fossil fuels.

“Canada needs to ensure that in the context of that transition, it’s extracting full value for its resources and using that money to push forward in terms of reducing emissions,” he explained in an interview. “What we’re doing is saying it’s got to be part of the transition, but part of the transition is being able to raise the revenues that enable you to actually make the investments that are required to go there.”

Read that last sentence again. Imagine if he had said that “yes, we need to incise slavery and revenues from slavery to be able to, later on, whenever that time is right, to abolish or replace it.” Not a nice way, eh?

But these people are just doing their job based on the incentives set by the machinery. 

5 tipping points for a system change

So now, let’s have a look at what needs to change in the machinery.

This is a great piece of research on social tipping points. It offers a good explanation of how the machinery needs to change if we really want to tackle the underlying causes of the climate emergency.

1) The energy production system

This is probably the obvious one, given who was asked and the centrality of energy to climate change. The goal of interventions in this system is pretty simple: to increase the financial returns on clean energy investments. The interventions identified as potential STIs fall into two categories. First is removing all subsidies from fossil fuels. The second is redirecting government support to clean energy, particularly decentralized clean energy.

2) Human settlements

Buildings are the source of 20 percent of global emissions, and with the world furiously urbanizing, that number is likely to rise. A tipping point will have been reached in this system when fossil-fuel-free technologies become “the first choice for new construction and infrastructure projects.” Recommended interventions include changes in building codes, large-scale carbon-free demonstration projects, local cleantech clusters, and large-scale public infrastructure projects.

3) The financial system

The main lever for change in this system is risk perception. The idea is that there is a growing “carbon bubble” of assets that will lose their value under serious climate policy. If large institutions can be convinced of that risk, they could begin withdrawing their investments from fossil fuel-heavy assets, sparking a self-reinforcing cycle, bringing rapid change.

4) Norms and values

Human beings are strongly social creatures, their behaviour shaped by the opinions and examples set by their peers. Social scientists have long observed that a sufficiently large and committed minority within a group can trigger tipping points in the larger group’s social norms, causing rapid phase shifts in popular moral opinion. Recent examples of norms and values spreading from committed minorities include rooftop solar panels and electric vehicles (which have both been shown to be “contagious,” spreading fastest where they are most visible) and the youth climate strikes, which seem to have sparked a green mini-wave in EU politics. As it happens, economist Robert H. Frank has a book coming out soon, Under the Influence, about just this kind of social contagion and how climate policymakers can use it.

5) The education system

Research has shown that education plays a large role in social transformation. The intervention here is pretty simple, just increasing the quantity and quality of climate coverage in primary and secondary education. 

Alternative ESG data is coming

Let’s move on to the latest trend from the land of ESG analysis. It’s called “alternative” ESG data. Or let me put it this way: “unstructured” ESG data.  

This will soon be the new frontier of ESG, one that asset managers trying various angles of ESG will need to deal with. Alternative ESG data is and will be a huge topic.

ESG investors need to evaluate companies’ profile to decide whether to include them in, or exclude them from, their portfolio. Since most ESG ratings are based on self-reported information that’s updated infrequently, they can be slow to capture changing perceptions when new data becomes available, and the investment community increasingly considers them insufficient as a stand-alone solution.

With the growing availability of digital information, alternative datasets have emerged to complement these ratings using a more quantitative and systematic approach which can reduce costs, promote more accurate ratings, and raise the prospects of higher alpha.

ESG-relevant signals, from factory incidents to corruption or child labour, are often found in news reports, transcripts, or filings, so sourcing them involves leveraging technology that turns unstructured, textual data into structured insights that can power quantitative ESG approaches.

Overcoming that necessary technological hurdle requires considerable storage and computing capabilities usually found only in highly specialized cloud-based solutions. Making sense of these data however, from identifying trends to connecting parent companies and subsidiaries, translates into more complexity in investment models.

Higher volumes and better consistency can be obtained by venturing into unstructured data. Using natural language processing (NLP), for instance, investors can assess whether company management is being honest in its public communications.

All of this will be more and more needed given the level of hypocrisy we are facing. Asset managers will need to develop multi-dimensional risk patterns for ESG data from multiple datasets they have access to and venture into non self-reported (by companies) ESG data.

The ones that manage to do this will by all means have an edge. This is particularly relevant in emerging markets where the current use of ESG datasets disadvantages companies. However, we must never forget that analysis eats data for breakfast, so unstructured data will need people in the finance industry that have the ability, experience and knowledge to put unstructured data into context.

Sadly, those people are not easily found in the finance industry.

When rain turns to dust

We end this letter with a note of caution, published by the International Red Cross Association (ICRC).

I have a very personal relationship to ICRC. During the war in Bosnia and Herzegovina, when we had almost nothing to eat for weeks, the only packages of food we could get were coming from ICRC.

Years after, I wrote for an ICRC newspaper as a journalist fresh out of university and worked as a war correspondent for them and for UNICEF in Sweden.

My respect for their work and what they do is deep and very personal.

This report came out recently from them, and it got my attention since they usually don’t spill words. They will rather do the work. The report, entitled When Rain Turns To Dust, is addressing one of my biggest personal fears: armed conflicts coupled with climate and environmental crises. A cocktail of sorrow you don’t want to be even close to.

Here are some numbers that outlines the seriousness and magnitude of this problem:

  • 200 million people every year could need international humanitarian aid from 2050, a doubling compared to 2018 partly due to climate change (IFRC 2019).

  • 60% of the 20 countries considered to be most vulnerable to climate change by the ND-Gain Index are affected by armed conflict.

  • 14 of the 34 countries in food crisis experienced the double burden of conflict and climate shocks in 2017 (FAO 2018).

  • 37 percent of GDP. The hunger problem is significantly worse in countries with agricultural systems that are highly weather-dependent, and where livelihoods are largely agricultural. In 2018, on average, agriculture accounted for 37 percent of GDP in conflict-affected countries, which is between two and four times higher than in developing contexts not affected by conflict or fragility (FAO 2018; IFPRI 2000).

  • 1/3 of the world’s cropland has been abandoned in the past 40 years because of erosion. Each year an additional 20 million hectares of agricultural land either becomes too degraded for crop production or is lost to urban sprawl (UN Water 2020).

So yes, we need a system change, and we need to start talking about it. For real.

Best regards,
Sasja