In 1936, John Maynard Keynes described the behaviour of stock markets as similar to that seen in beauty pageants of that time. Citizens would vote for the most beautiful contestant, and those who voted for the most popular choice stood the chance of winning a prize. The rational thing to do was not to vote for who you thought was prettiest, but for what you thought would be the average opinion of the prettiest. In fact, to vote for what you thought the average opinion of the average opinion of the prettiest would be, and so on.
This analogy is true of (almost) all the assets we invest in. So it's not surprising that many people feel we have lost control over the forces that shape our world. The increasingly complex financial system is largely disconnected from the real world impacts and value – or beauty – of the companies and other assets it funds. They are treated as black boxes.
The consequences of this disconnect are reaching boiling point. The 2008 financial crisis and its aftermath left many without jobs, homes, or pensions. Company valuations based on assumptions of limitless resources and which ignore the risks of climate change have pushed our economic activity to the brink of our planetary boundaries. There is a clear line of responsibility between the financial markets and the state of the world that has largely been evaded in the past few decades. Acting on this responsibility is the challenge of our generation.
But what will get us to act? It is certainty not for a lack of technical solutions. These have been well established and are being implemented by a handful of sustainability pioneers (internalising externalities, accounting for full costs, incentivising long-term decision making, and so on). What is missing is the recognition within individuals that implementing these tools makes sense.
A simple exercise could help to illustrate the point. It has become an accepted truth that short-term incentives faced by some in the investment chain are responsible for the continuation of the status quo. Yet the risks of an unstable and unsustainable financial system have one thing in common: they are systemic. That is, they cannot be traded out of, and they cannot be avoided by any one asset class, sector, or country.
Consider, then, how our view would change if we took off our day-job hat to reflect for a second. We all actually face multiple sets of incentives. All asset managers or executives are also asset owners via, for example, their pension funds. Most of them will be mothers, fathers, husbands, and wives. The same is true for policymakers. In short, we are all first and foremost humans who desire a safe, prosperous and sustainable world for ourselves and for our children. This is arguably the most powerful incentive of all.
From here, we can work towards understanding how each of our different hats helps or hinders our response to this most important incentive. It may become clear that pursuing income growth (national or individual) while ignoring the costs of its pursuit no longer serves us. It would make sense to measure all the costs and benefits of our investments and make more efficient, informed decisions on this basis – or, put differently, to pursue an increased standard of living without the side effects that decrease our standard of living.
Whether or not we are able to mould our financial system to achieve sustainable outcomes in the next few years will affect young people most. In an era of sprawling populations, increasing inequality, resource scarcity, and the threat of a changed climate, the stakes are higher than ever before.
It is not only up to those at the top of finance and policy to create this change. When first-year Harvard students walked out of their introductory economics course in 2011, they were on the right track. They were discontent with being taught theories and models that perpetuate "problematic and inefficient systems". In an open letter to Professor Gregory Mankiw (who authored the most widely used introductory economic textbook – one which I studied in first year too), they argued that "if Harvard fails to equip its students with a broad and critical understanding of economics, their actions are likely to harm the global financial system. The last five years of economic turmoil have been proof enough of this."
More recently, students all around the world, starting in the US, have pressured their universities to withdraw their endowment funds from fossil fuel assets.
This is a youth that recognises the link between what we fund and the world we will grow old in, and it is this type of critical engagement that needs to spread like wildfire.
Those working in finance can question the models and assumptions handed down to them and challenge them if they are no longer applicable. Those outside of finance and economics can educate themselves on how global capital shapes their lives. In doing this, it will become clear that most are not really outside of finance. Whoever has a pension or investment fund is part of the financial system – an asset owner who has a say in how this money is managed – and by extension, has a responsibility for our collective future.
Lise Pretorius is an environmental economist who has worked on various projects and publications in the field of sustainable investment - most recently as the lead author of ShareAction's Green Light Report. She is currently a WWF International Youth Volunteer in Bhutan.
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