CAMBRIDGE – When it burst into the mainstream several years ago, the sustainable investment movement met relatively little resistance as it sought to persuade managers and shareholders to shift their focus from short-term profits toward environmental, social, and governance (ESG) goals. Lately, however, a counter-movement seeking to prohibit financial institutions from following ESG guidelines has been gaining steam in the United States.

To be sure, ESG warrants more than a little skepticism. Several studies highlight the risk that companies will use it as a public-relations exercise. Often, green pledges turn out to be insincere greenwashing. But the Republican-led effort to ban private investors from pursuing ESG goals is deeply misguided.

Florida Governor Ron DeSantis, who is reportedly laying the groundwork for a presidential bid in 2024, is the unofficial leader of the conservative war against ESG. “From Wall Street banks to massive asset managers and Big Tech companies,” he said in a speech in July, “we have seen the corporate elite use their economic power to impose policies on the country that they could not achieve at the ballot box.” In the same speech, DeSantis announced a series of legislative proposals and administrative actions meant to “protect Floridians” from the ESG movement, which “threatens the vitality of the American economy and Americans’ economic freedom.”

The anti-ESG crusaders seem particularly anxious about the possibility that investors would be allowed to discriminate against gun manufacturers and fossil-fuel companies. In the first five weeks of this year alone, Republican state lawmakers proposed as many as 49 laws to prevent banks and pension funds for public employees from integrating sustainability criteria into their decision-making. Several states – including Arizona, Florida, Idaho, Indiana, Kentucky, Louisiana, Mississippi, Missouri, and North Dakota – have already passed bills restricting ESG.

At the federal level, congressional conservatives are also promoting anti-ESG legislation. Republican Senator Mike Braun is currently seeking to overturn a decision by President Joe Biden’s Department of Labor, which went into effect January 30, to allow retirement fiduciaries to consider ESG criteria in their risk-return analyses. Braun has already convinced every Republican senator to support his effort.

While state governments have the power to prohibit public pension funds from relying on ESG investment criteria, the Republican campaign has also taken aim at private banks and institutional investors. BlackRock, the world’s largest asset manager, is a favorite target. The conservative attack on ESG has less to do with economic freedom than with the US culture wars and the right-wing obsession with “woke capital.” DeSantis, after all, is the same governor who in 2021 used the state government’s power to prevent privately owned cruise lines from asking customers whether they had been vaccinated against COVID-19. Although the GOP has long claimed the mantle of devotion to free markets, it is increasingly clear that DeSantis and the rest of his party have other priorities. 

The debate over the social responsibility of corporations can be traced back to the 1930s, when New Deal architect Adolf A. Berle and law professor E. Merrick Dodd first debated the issue in the Harvard Law Review. In a 1970 New York Times Magazine essay, Milton Friedman famously argued that the only social responsibility of business is to maximize shareholder returns. Over the next five decades, the “Friedman doctrine” prevailed.

Then along came ESG. Proponents make two sorts of arguments. The first is a moral argument: corporations should look beyond their shareholders’ economic interests and consider their decisions’ impact on the interests of other stakeholders, including workers, suppliers, and local communities. I leave it to ethicists to judge the moral issue. 

The other argument is more transactional: good corporate citizenship is rewarded financially in the long run, through increased consumer enthusiasm and improved employee morale.

Is it true that corporations and investors can “do well by doing good”? It depends. Some evidence suggests that reforms in the area of corporate governance (the “G” in the acronym) can indeed be financially rewarding. For example, studies in several countries have shown that corporations enjoy higher returns and higher share prices if they constrain executive compensation by requiring outside directors to sit on compensation committees and allowing stockholders to have a “say on pay.”

The case is weaker when it comes to the “E” in ESG. There are, of course, enormous potential rewards for investors and corporations that jump on the clean-energy bandwagon. I am skeptical, however, that protecting the environment beyond what the law requires and what the government is willing to incentivize would necessarily improve profitability. 

But the question of economic value should be left to financial markets to determine. Customers can figure out for themselves whether they want to buy the products of environmentally conscientious firms. Workers can choose whether to work harder for socially minded employers. And investors can decide whether adhering to ESG practices could be profitable in the long run.

Ultimately, ESG is not a substitute for intelligently designed government regulation. In this respect, Friedman was right. On the other hand, if private investors or companies decide they want to pursue ESG goals, it is not politicians’ place to interfere. That is why it is called the free market. Perhaps DeSantis and his fellow Republicans should brush up on their Friedman.

Jeffrey Frankel, Professor of Capital Formation and Growth at Harvard University, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research.

Copyright: Project Syndicate, 2023.
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