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Illustration by Mark Smith

Corporate Knights defines clean capitalism as an economic system in which prices incorporate social, economic and ecological benefits and costs, and participants know the full impacts of their marketplace actions.

It’s the belief of this publication that the power of markets can be harnessed to shape and grow an economy that is grounded in a golden rule: Business and society must succeed together. This is the path to sustaining prosperity where it exists, and achieving it where it doesn’t.

We have not, for the most part, been on this path. To continue on our current route is to erase what progress has been made over the last century and throw the global economy into irreversible turmoil.

The challenges ahead are immense, particularly around resource scarcity. A 140-page report recently released by the National Intelligence Council, which reflects analysis from 16 U.S. intelligence agencies, cited food, water and energy shortages – complicated by our changing climate – as a “megatrend” that will contribute to radical economic and political changes by 2030.

A growing global population – and rising middle class in the developing world – has led to more consumption of food than production over seven of the last eight years, while global water demand is expected to exceed sustainable supplies by 40 per cent within the next 18 years, according to the report.

“We are at a critical juncture in human history,” said Council chairman Christopher Kojm, adding that decision makers must be encouraged to “think and plan for the long term” to avoid negative outcomes and give positive ones a better chance to take root.

“We are not necessarily headed into a world of scarcities, but policymakers and their private-sector partners will need to be proactive to avoid such a future,” the report says. It comes down to living within our means.

There is a similar urgency around our growing climate challenge. World Bank president Jim Yong Kim declared in November that the global economy is on a “devastating” course. “The lack of action on climate change not only risks putting prosperity out of reach of millions of people in the developing world, it threatens to roll back decades of sustainable development,” he warned.

Governments are not approaching these challenges from a position of strength. As of year-end 2012, the world’s nations were struggling under the weight of nearly $50 trillion in public debt, according to The Economist’s “global debt clock.” At the same time, more than $35 trillion in public infrastructure projects will be necessary over the coming two decades, with a tremendous opportunity – and need – to address water, waste, energy and transportation inefficiencies. There will be great temptation to cut corners.

In the United States, talk of a “fiscal cliff” has overshadowed the reality of the global climate cliff. With the widest income gap in more than 40 years, a two-decade-high poverty rate and the health care demands of an aging population, America has put short-term economic fixes ahead of the environmental and social gains that would assure the well-being of current and future generations.

As Scottish economist Adam Smith wrote in The Wealth of Nations, published in 1776, “No society can surely be flourishing and happy of which by far the greater part of the numbers are poor and miserable.”

To date, we’ve relied on indicators such as gross domestic product (GDP) to measure wealth, but these hide a much bigger story. Growth in GDP may imply the well-being of a country’s citizens, but it doesn’t truly capture it.

“We have forced ourselves to believe that we can grow ourselves out of the multiple crises we face today,” according to the Inclusive Wealth Report 2012, jointly produced by the United Nations Environment Programme and International Human Dimensions Programme. But, it adds, “Social and ecological factors are also important determinants of well-being, and in some cases, are direct constituents of well-being.”

In other words, education, health, clean air and water, biodiversity and other factors are an integral part of what it means to be truly prosperous. Indeed, a country’s comprehensive wealth per capita can drop even while GDP per capita rises.

What constitutes this inclusive, comprehensive wealth? In addition to financial capital, there is produced capital, such as roads, railroad tracks, electrical grids and machines; human capital, such as improvements to health, education and skills; social capital, representing the health and robustness of our institutions; and natural capital, which covers “ecosystem services” such as forests, fossil fuel reserves, minerals and land.

On balance, when we enhance our various forms of capital on a net basis, we enhance our overall wealth. This is the essence of clean capitalism.

The inclusive-wealth report analysed 20 countries representing 73 per cent of global GDP. It found that overall wealth is falling, despite rising GDP, in six nations – South Africa, Colombia, Nigeria, Russia, Saudi Arabia and Venezuela. In all other countries, with the exception of France and Germany, the average growth rate of inclusive wealth lags the rate of GDP growth.

Alarmingly, 17 out of 20 countries show an unsustainable decline in natural capital per capita over the past two decades, offset partially by increases in human capital. As University of Cambridge economics professor Partha Dasgupta wrote, “When natural capital is included in economic statistics, the recent economic history of nations looks very different from what we are led to believe.”

The Path Forward

To improve our collective well-being in a way that is sustainable over the long term,Corporate Knights believes it is important to make the most efficient use of all our productive resources. That means doing a better job of counting all forms of capital and removing barriers to their optimal allocation.

Where market failures are holding us back, we should fix them. Where others have tried before us, we should learn from them. To guard against unintended consequences, we should plan for evidence-based interventions. As U.S. presidents, both Republican and Democratic, have said many times throughout history: “If not us, who? If not now, when?”

Market failures include, but are not limited to: unpriced externalities, such as carbon pollution and aspects of water delivery and treatment, resulting in goods and services that are not fully valued; lack of timely information on products and national/corporate balance sheets, which makes it difficult for consumers, taxpayers and investors to make informed decisions that affect their well-being; under-provision of public goods, such as electricity transmission infrastructure and high-speed trains, which would enable a faster transition to renewable energy and clean transportation; and institutional inertia, such as the tendency of corporate and financial executives to do what they’ve always done, rather than embrace new opportunities that may be both profitable and more sustainable.

There are four vectors through which targeted policy intervention can largely correct these market failures to unleash the full potential of our planet-based economy: information, incentives, infrastructure and investment.

Information

The release of greenhouse gases and other pollutants through economic activity has an impact on our stock of natural capital – soil, air, water, flora and fauna. But that impact, or externality, is not fully priced into the goods and services we produce and consume.

British economist Arthur Pigou articulated this dilemma more than 90 years ago, yet our natural and social capital are still largely unaccounted for, making it difficult to develop policies aimed at preserving them. We can’t manage what we don’t measure. We need more information to help us live within our means.

This was recognized in 2012 by dozens of financial institutions that signed the Natural Capital Declaration, an initiative of the United Nations Environment Programme aimed at getting governments and business to value natural capital.

The declaration asks that government require companies to disclose their dependence and impact on natural capital “through transparent qualitative and quantitative reporting,” and require its own public spending and procurement to report and account for natural capital.

Once we account for natural capital, we can also make it easier for businesses and consumers to make informed purchasing decisions through better labelling of everything from grocery items to buildings.

Incentives

With natural capital properly inventoried and integrated into the balance sheets of nations and businesses, it becomes more feasible to develop policies that reward responsible market behaviour, such as energy conservation, and discourage irresponsible and inefficient use of our various natural resources.

Carbon pricing is one obvious and much-talked-about example, but others include: fast-track permits for builders of green buildings; road congestion charges to discourage driving and encourage use of public transit, cycling and other low-carbon options; a tax code that prioritizes investment in energy and water efficiency technologies, through mechanisms such as accelerated depreciation; and temporary, targeted subsidies – such as feed-in tariffs – for promising forms of renewable energy.

“By channelling the forces of the marketplace into environmental programs, economic-incentive mechanisms can make the everyday economic decisions of individuals, businesses, and government work effectively for the environment,” wrote Harvard University business professor Robert Stavins in 1990, outlining an approach whose time has come.

In addition to creating supportive policies, there’s also room to eliminate outdated policies that have accelerated our erosion of natural capital. Subsidies for the fossil fuel industry, for example, have long outlived their original purpose and should be phased out to level the playing field for more sustainable forms of energy.

Infrastructure

The decisions we make today on infrastructure, as long-lived public assets, lock us into a future that could prove protective or erosive to our natural and human capital. Coal-fired power plants have provided cheap electricity to industry, but at what cost to environmental and human health?

On the other hand, infrastructure investments that enable the development of renewable power and support public transportation and healthy lifestyles have tremendous potential to boost our inclusive wealth. This is particularly true if such projects, in addition to meeting our economic and social needs, reduce pollution and help with climate change mitigation and adaptation.

Both public- and private-sector investors, such as pension funds, must weigh every infrastructure project through an environmental, social and governance lens, with a view to the long-term impacts. Government’s role is to cut the red tape for what should be high-priority projects, while also working with the private sector to come up with creative financing solutions that will attract the necessary financial capital.

Investment

The difficulty of raising financial capital is one of the biggest barriers to a clean capitalism economy. More than $200 trillion in private-sector capital flows like water through the path of least resistance. This means industries with established track records, technologies, funding mechanisms, and proven investment returns tend to be favoured by the pension funds and investment houses that control the purse strings. Unfortunately, the path of least resistance tends to reinforce a world based on fossil fuels and the “dirty” infrastructure it relies on.

Even signatories to the United Nations’ Principles for Responsible Investment are having a difficult time weaning themselves from “unsustainable” investments. A recent study from the US SIF, which represents a wide range of investors, found that only 11 per cent of all investments under professional management in the United States qualify as “sustainable.” That works out to $3.74 trillion out of $33.3 trillion.

But much can be done to optimize the flow of financial capital to projects that take a balanced approach to enhancing our natural, human and produced capital. Governments can provide partial loan guarantees to “green” infrastructure projects or create public procurement programs that double as demonstration projects for clean technologies, both aimed at lowering private-sector risks.

The creation of government-backed green or “climate” bonds that are dedicated to building sustainable infrastructure is another promising option that can direct more financial capital to the kinds of projects that will enhance the well-being of citizens for generations to come.

One promising tool is the Property Assessed Clean Energy, or PACE, bond, which helps fund energy-efficiency retrofits and small-scale installation of renewables for homes and businesses. A municipality issues bonds and uses the money to extend low-interest loans to property owners, who can pay back the loan through their property taxes with the energy savings.

All a jurisdiction needs to do is amend legislation to empower municipalities to develop PACE programs, which ease the upfront cost burden on property owners looking to lower their environmental footprint. Several U.S. states and Canadian provinces have already made such changes, paving the way for the rest of the continent to follow.

Through a combination of improved information, carefully designed incentives, long-term infrastructure planning and investment optimization, Corporate Knights firmly believes that market failures can be corrected and the clean capitalism economy realized.

Overcoming these barriers will make us more resilient to the uncertain future that lies ahead, while at the same time securing our prosperity over the long term.

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