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Polar bear climate change

Sustainability

Fighting climate change may be right, but it also needs to be fair 

Published 25 October 2022 in Sustainability • 5 min read

Measures to safeguard the planet are expensive and tend to hit those on the lowest incomes hardest. So, when it comes to ESG, it is vital to take social factors into account as well as the environment.

Finance and business have many tools at their disposal to combat climate change. The power of markets can be harnessed, but businesses and consumers also need to take a leading role in finding solutions to the crisis rather than waiting for governments and policymakers to implement the necessary measures.

A “just transition” would be one in which no one is disadvantaged by climate change action. To achieve this, more attention should be paid to the S and G elements of the ESG equation: environmental, social and governance. This is the only way to ensure that environmental actions do not negatively impact low-income people and countries. In its fight against climate change and global warming, humanity will fail if it does not also fight inequality and ensure a just transition.

The conflict between E and S in ESG

Many decision makers use the term ESG without giving much thought to the interdependence of the three elements. In doing so, we often overlook the significant conflicts that can exist, especially between initiatives to protect the environment, which is the E, and measures to support socially vulnerable populations, which is part of the S.

A prime example of this conflict would be the violent protests of the “gilets jaunes” movement in Paris three years ago. A long-simmering discontent with Emmanuel Macron’s government eventually led to significant unrest when tax increases on diesel and gasoline contributed to a higher financial burden on motorists. President Macron justified the tax increases as a “green” measure intended to protect the climate.

Indeed, economics teaches us that taxes on climate-damaging emissions, such as on CO2 from car exhausts, are the best solution for reducing such emissions. These and similar levies provide financial incentives for both producers and consumers to switch to more climate-friendly alternatives, whether for heating, driving, or electricity consumption. In addition, the revenue from these levies can be used to subsidize research into climate-friendly technologies or the sale of more energy-efficient household appliances.

'Gilets jaunes' protests in France were sparked by a supposedly 'green' tax increase on fuel prices

So, in hindsight, the French government’s tax increases still seem like smart policy in terms of the E in ESG, don’t they? So why did these protests lead to some tax increases being rolled back? Because the proposed rises hit commuters the hardest. This group, as well as those who are socially disadvantaged, have to spend a comparatively high proportion of their income on gasoline or diesel. For them, the short-term financial losses were much more important than a green policy that was intended to reduce climate damage in the distant future. In short, smart E-policy had inadequately addressed the impact on the S. Raising the minimum income proved insufficient, so the Macron government’s U-turn, thanks to the yellow vests, was ultimately a victory of the S over the E.

Green policy of CO2 certificate trading was antisocial

Regulations to combat climate change cost citizens money. In Germany, for example, the national CO2 trading system introduced in January 2021 led to higher prices for heating oil, gas, and fuels. The move was politically motivated; the higher prices were supposed to lead to a reduction in consumption, and thus also in CO2 emissions. However, the higher energy costs hit lower-income groups hardest, as they already have to spend a larger proportion of their disposable income on energy, housing, and food. Put simply, the green policy of CO2 certificate trading, good for the E, was basically antisocial – i.e., bad for the S. The German government was, or is, aware of this problem and has now, in view of the exploding energy costs in the wake of the Ukraine war, set the EEG levy, which the German state has been charging since 2000 to finance green electricity, to zero as of 1 July, 2022. This provides a little relief for lower-income households in particular, so it’s good for the S – but not good for the E.

Due to the high inflation rate and a possible blackout, the Federal Criminal Police Office and politicians are already warning of social unrest. The German government will probably further subsidize energy costs so that households can heat more and at lower cost, and perhaps also extend the running times of coal-fired power plants. From the point of view of the S, these would each be good decisions, but they would again be at the expense of the environment, the E.

Green climate policy requires redistribution from top to bottom

And so, the conflict between S and E goes on and on. The unpleasant truth is that there is no easy solution to the conflict. Combating climate change costs money, lots of money. But measures that particularly affect the already economically weak sections of the population are often, especially in times of crisis, politically unpopular and hardly enforceable in democracies such as France and Germany. Climate policy must not serve climate protection alone. Such a policy must also be socially just. This necessity poses a major challenge not only for governments and regulators, but also for companies and households.

Both the wealthier households and the most profitable companies must bear a significantly higher share of the costs of climate-friendly regulations. In other words, a green policy always requires redistribution “from top to bottom”. Now, this may sound like class warfare, but there are no politically majoritarian alternatives. Without social justice, the transition to a green future will always be slowed or even stopped by political resistance. And in doing so, we lose valuable time that we don’t have in the face of rapidly advancing climate change. For rich countries like Germany, this means that a green climate policy must also take account of inequality at home.

Authors

Karl Schmedders - IMD Professor of Finance

Karl Schmedders

Professor of Finance at IMD

Karl Schmedders is Professor of Finance at IMD. In his research, he applies numerical solution techniques to complex economic and financial models, shedding light on relevant market issues and industry problems. He is also Director of IMD’s new online certification course for structured investment products in partnership with Swiss company Leonteq, teaches in the Advanced Management Concepts (AMC) and Executive MBA programs, and is an advisor on International Consulting Projects in the MBA program.

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