Reprinted with permission from ICAEW
Global financial meltdown is bad enough but what about catastrophic climate change?
Floods in China and Pakistan, forest fires in Russia, drought in Australia – the ‘climate crunch’ could be more devastating than the credit crunch. Accountants were at the heart of the operation to rescue the global economy from financial meltdown and they have a similar central role to play in rescuing the environment from devastating change.
The desperate need to create a sustainable global economy throws up a range of issues which can only be tackled by a concerted effort among finance professionals who are in a position to change and modify the activities of multi-national companies and governments in ways which protect our planet for future generations.
ICAEW recognises the urgent need for strategies to create sustainable economies and the vital role its members have in averting catastrophe. As Prince Charles, a member of the institute, has identified, there were three issues at the heart of the financial crisis: The rapid increase in debt without the ability to repay; over-confidence in the ability of market and regulatory systems to manage risk; and individuals and organisations incentivised to generate short-term profits without regard for their long-term sustainability. He went on to note that these issues also lie at the heart of a much more fundamental and alarming crisis, ‘the climate crunch’.
If we do not seek to avoid the climate crunch, the ensuing economic crunch will be dramatic. Long-term economic well-being relies on far more than the financial services sector and appropriate interest rates. It depends on a wider set of environmental and social considerations. If we can get this right, we can avoid the economic crisis yet to come.
The ICAEW Sustainable Business programme, launched last December, examines the mechanisms through which individuals, society and governments encourage business to promote sustainable development. The unifying theme is exploring how organisations and markets are motivated to deliver sustainable outcomes and what the role of information flows is in that.
A safe system for all
This has led to the creation of the Finance Innovation Lab. Its goal is to help create a financial system that is safe not just for bankers but also for society and the environment. The people who set up the Finance Innovation Lab believe that financial crisis has shown us that the current market arrangements, rather than markets per se, are flawed and have failed us. There is a strong public sense that the business world and the financial community in particular have abandoned values and ethical behaviour.
The Lab brings together two unexpected bedfellows, ICAEW along with WWF-UK (the World Wildlife Fund). This unlikely combination alone makes people take notice, says Richard Spencer, ICAEW head of sustainability. Together the two bring expertise in the often incompatible worlds of finance and the environment. ‘While many people working in finance care deeply about society and the environment they have not traditionally allowed these concerns to intrude on their professional lives,’ says Spencer. ‘In fact it is possible to ensure that finance serves society and the environment. That is what the Finance Lab aims to do.’
The range of themes the finance lab works on is dizzyingly broad. At the very highest level, the Lab provides a platform for discussion about whether economic growth is compatible with sustainability and if current measures of national progress, such as gross domestic product, lead society towards unsustainable development while neglecting more accurate measures of human well-being. The Lab is also posing similar questions about the operation of businesses and the fund managers. They have been working on ways to ensure that company accounts reflect any harm to society or the environment. Equally crucial, they have been examining methods of reconciling the pressure on fund managers for short term returns with the long term impact they have on society.
Accounting for resources
Take for example, the issue of externalities – damage inflicted by business or investors on society for which they do not bear the cost. The Finance Lab has a working group considering just this question. Under current arrangements, companies do not need to take many of these costs into account and so have little incentive to change their behaviour. In the end this can lead to disaster, not just for society but even for the businesses, says David Nussbaum, at the World Wildlife Fund. ‘The risks of resource depletion need to be built into financial accounts in some way,’ he says. ‘For example, the Grand Banks fisheries in Canada were so over-exploited that they collapsed. Obviously this ended the cash flow for the commercial fisheries so it would have been very helpful to include this in the accounts.’ This group is being led by Pavan Sukhdev, former chief of Deutsche Bank’s global markets business in India and now head of United Nations Environment Program’s Green Economy Initiative.
With water shortages looming in many parts of the world, Mr Nussbaum believes there should be a way of accounting for the amount of water used to produce everyday items, such as cotton shirts. ‘There are plenty of market failures to be explored,’ he says. ‘And accountants have a crucial role in ensuring that this information is available and easy to understand and act upon.’
Another programme is looking at how finance could work in a steady-state economy. Our current economic system is based on continuous economic growth and therefore assumes infinite natural resources. This group is exploring how we could work backwards from ecological limits to consider how the financial system should work. Meanwhile the Lab is considering a pilot programme in Nairobi or Sao Paulo to organise communities in poor countries that have limited access to financial services.
Aside from developing imaginative solutions to these problems, the Finance Lab aims to create coherence. ‘At the moment there is a cacophony of voices on these issues,’ say Spencer. ‘As a result it is hard for good ideas to be heard – especially by the people in power. Our aim is to bring a more joined up approach, getting heterodox thinkers together, identifying where there are gaps and providing a more unified message.’
As yet, much of this work is still at the early stages. But the lab has brought together an impressive array of institutions that have been wrestling with these vexed questions, including the University of Oxford, the United Nations and individuals from financial institutions such as HSBC.
‘Finance can be an incredible force for good,’ says Spencer. ‘There is a lot of power here that can be harnessed to protect the environment and reduce poverty. We just need to learn how to use this power.’
More about — Gross Deceptive Product
Why traditional measures of progress can be misleading:
For generations gross domestic product – the grandfather of economic statistics – has been an undisputed gauge of national progress. American leaders wishing to assert the superiority of their brand of capitalism over European socialism needed only to point to their faster GDP growth. But ICAEW has recently taken a more sceptical line. An association study, Qualitative Growth, launched at the EU Commission, underlines many of the drawbacks of GDP.
An obvious first problem, says Hazel Henderson, one of the report’s authors, is that economists tend to look at GDP rather than GDP per capita. As a result, a nation can appear to get wealthier when, in fact, all that’s happening is the population is growing. Henderson believes there are far deeper problems with the measure, however.
Essentially GDP is a measure of cash flow. It does not take into account any damage inflicted on the nation’s environment – which may eventually affect the ability to create wealth. Indeed, in GDP figures, wasteful and unnecessary spending is good. A country where people often throw out and replace goods has a high rate of growth but not necessarily a superior standard of living.
This is no mere academic matter. Since the financial community focuses so intensely on GDP, national policies are geared towards maximising traditional growth. Chinese local officials, for example, are even paid partly on the basis of GDP growth – whatever the environmental problems this expansion causes. What is needed, says Henderson, is a broader measure. Such a gauge would internalise the costs of waste and environmental degradation. Any scorecard of nation progress could be made even better by including health and education along with other measures of human well-being, Henderson argues. Since you get what you measure, you had better measure what you want.
For information about the Finance Innovation Lab, visit www.thefinancelab.org
For information on ICAEW involvement in corporate responsibility, visit www.icaew.com/corporateresponsibility