Financial accounting is rather ill suited as well as ill equipped to deal properly with a system that has both finite natural resources as well as boundaries/limits. This is old news. In fact it is very old wine, in quite dated skins.
Why?: The dual book keeping system is not quite as ‘balanced’ dual as we usually assume it to be. Just think of the following: the (only) practice is to record new assets of physical characteristics – say, bauxite from mining operations -, but without recording a matching entry for new liabilities of the physical type – say, loss of groundwater reservoirs consequence of the mining operations.
Invariably, even judging from this very coarse and high-level example, the financial instruments we have at our disposal are built on foundations of a very relevant bias, and sadly only continue to reinforce that very bias.
A physicist would in fact simply and correctly describe the bias as follows: a behaviour and thinking in total ignorance of the Second Law of Thermodynamics. And indeed, our current economic systems are largely built around a wilful oversight in this regard, a fact recognised already in the early 1970 (in Georgescu-Roegen’s ‘The Entropy Law and the Economic Process’) proven yet again to hold true in the 1990 (in McMahon and Mrozek’s ‘Economics, entropy and sustainability’).
Second Law of Thermodynamics: What does it say?
The Second Law of Thermodynamics states that
the total entropy of an isolated system can never decrease over time, and is constant if and only if all processes are reversible. Isolated systems spontaneously evolve towards thermodynamic equilibrium, the state with maximum entropy.
Wikipedia
What does that rather scientific explanation mean for our contemporary challenges at hand?
With every passing day we are becoming more aware of the ecological challenges at hand. With every passing day our well-intended urgency increases to develop a greener, more inclusive economic system. Yet … what we are failing to grasp is the fact that all types of transformations we are currently coming up with – also those to make our planetary system a greener, more inclusive space – induce entropy. And inadvertently only destabilising the system further.
Are we hence merely ‘verschlimmbesser’ing the situation? In other words: are we merely making it worse in our honest attempt to improve the mess we put ourselves, our global society, humanity, in?
Are we indeed even looking at the right issue to solve in order to become ‘greener’?
Reality check:
Our economic system at this point is entirely and totally primed on ‘growth’ (even if called on occasions ‘green growth’, ‘sustainable growth’, or even ‘inclusive growth, more on the topic, see this article here.)
And despite ‘greener’ technologies and materials coming into use, one thing has been constant throughout. And a possible absence thereof sends shivers down the spine of National Banks, politicians and most – albeit not all – economists. The constant is: Growth.
Growth of the amount of materials (but also services) that we make and dispose of in this finite system called ‘planet Earth’. Require proof?
The global GPD trajectory and the trajectory of the Global Material Footprint have been growing both linearly and in lockstep at least between 1970 and 2018. (Source).
In other words: yes, we are making strides to become ‘greener’ in a number of ways. However, when push comes to shove – measured in material usage – we keep using more and more ‘stuff’, no matter what.
This means unfortunately though that when we say ‘greener’, the Earth only hears and experiences ‘more’.
With ‘more’ we only make the problem worse. Despite the best of all intentions.
Turns out, that the solutions we come up with at this current time, in fact, are (part of) the problem!
The Financial Industry, ESG, and ‘real’ Sustainability: A Quicksand problem.
In corporate jargon, the situation we are in as a planet and human society, would be called ‘the Debt Valley’: How long can we live in and off our debt until we can somehow manage to
- get to the other side, successfully, to realise our prosperous future?
- not be eaten up by our debt, and the accumulating interests due, but build up genuine profit?
And this is where the quicksand landscape starts. A landscape where nearly all movement gets you only deeper into trouble. Quick movement in particular. But no movement will mean the definite end.
For one, financial markets – those supposed to have one of the biggest levers for changing the systems – are woefully disconnected from physical realities of ‘stuff’. How else can extraction of materials yield benefits, but the destruction of the environment that created the material not generate costs? (See also this article.) Markets seem to remain ‘unaware’ (in financial terms) of such destroyed, damaged and lost resources. Hence, how could they ever take them fairly into consideration?
On the other hand, as humans we are prone to fast reactions and getting ‘results’, rather than taking a moment to reflect, look at all implications, and then take an educated decision. More so when it comes to the global, holistic scale.
And lastly, we are lazy beings. We do change if we have do. But just that little bit that makes the pain just barely go away, just enough for the symptoms to disappear. Rarely do we go to the full length and remedy the cause of the pain.
For the Financial Industry the sobering insight is: ESG is NOT Sustainability.
ESG is just the same traditional hunt for somewhat greener profits, putting the money into companies, industries, and products that seem to fix the problem. The investments though only address the symptoms rather than the root cause.
A cynic would say: ESG is merely and only greenwashing if compared to ‘true’ sustainability.
Because it ESG does not address the issue of outpaced material growth, and the global economy’s material footprint onto the planet. In ESG. Planet Earth still keeps hearing ‘more. .
Granted: ESG is the finance industry’s reasonably well intended try to come to terms with the needs and possibilities of ‘planet Earth’s closed system’.Albeit without being willing to discard its seasoned and historic key assumption: that the system and our metrics for success just will keep growing. As long as we favour the best and greenest (aka: technological improvement), this will solve the problem.
That is not so. It never has been like that. It won’t ever be like that.
The Finance Industry needs rid itself of the Growth Elephant in the room.
The cash should go towards policy and behaviour change. The latter at the very least includes a shift in definition what prosperity means. Distinctly away from ‘growth’.
Two key ingredients for how that will invariably look like? Less stuff, more equality.
Or if you prefer: Less quantity, more quality.
Further Reading on the topic of ESG, Sustainability and Entropy:
- Daly, Herman E., (1995), On Nicholas Georgescu-Roegen’s contributions to economics: an obituary essay, Ecological Economics, 13, issue 3, p. 149-154.
- Also available in Herman E. Daly’s ‘Beyond Growth’ (Chapter 13)
- McMahon, George F & Mrozek Janusz R. (1997), Economics,entropy and sustainability, Hydrological Sciences Journal, 42:4, 501-512,
- Austin, Duncan (2020), RI long read: Should ESG view sustainability as a quicksand problem?, Responsible Investor, 20 October 2020.
- Wiedmann, T., Lenzen, M., Keyßer, L.T. et al. Scientists’ warning on affluence. Nat Commun 11, 3107 (2020).
