Is ESG on a collision course with Inflation?

The economic landscape is changing rapidly. Inflation is on a collision course with growth. But another collision could be pending.  A collision between ESG – a business that considers environmental, social and governance elements – and inflation.  Sensible heads are needed and a strong focus on people and the long game.

All on board 

Many firms are embracing ESG rapidly, conducting business more ethically across the environmental, social and governance landscape. Think of it as corporate social responsibility, but with more tangibility, simpler to put numbers around, measure, and manage. 

Economists have their own term – stakeholder capitalism, or looking beyond profits or maximising share prices as a measure of success. Stakeholder capitalism involves focusing on long-term value and creating a more sustainable system across management, employees, suppliers, customers and communities. 

Simply google ESG, and you will find a host of reasons to embrace it. A McKinsey Global Survey released in 2020 reported that 83 percent of executives and investment professionals believe that ESG programs will add greater shareholder value in five years’ time than they do today.

Research points out that customers appear more willing to pay for ESG-friendly products. According to a study by Simon-Kucher & Partners in 2021, which included 17 countries and more than 10,000 respondents, 34 percent of consumers reported that they’re willing to pay more, in the interests of sustainability.

Turbulence ahead

You can’t watch the news for long without hearing about inflation.

Inflation is rampant, driven by a combination of over-stimulatory monetary policy (low interest rates and money printing) and fiscal policy (stimulus and budget deficits), and supply chain shocks courtesy of Covid, China and the Ukraine.

Politicians are blaming supply shocks (and Russia) but put simply there are not enough workers and goods available to meet demand. The inflation problem is both demand and supply-related.

Inflation has now rocketed to the top of households’ concerns according to the IPSOS Issues Monitor with 56 percent ranking it a top three issue. Climate change ranks eighth  and environmental pollution ninth.

Inflation provides a challenge to ESG on numerous levels.

Firstly, will customers still be prepared to pay when the inflationary thief is syphoning money out of their pockets? We do not know.

Second, inflation is changing the political and economic landscape. Media reported that G7 leaders debated fossil fuel investments amid what is looking like an energy crisis, particularly in Europe. Some short-term investment for fossil fuels might be back. Then we have the implications of the ongoing Ukraine situation. There are material odds a global food crisis is around the corner too. 

The political reality is that inflation dilutes spending power, which is bad for voters, and will demand a government response.

Third, ESG adds to inflation in the near to medium term.

Higher prices typically foster a supply side response, especially in fossil fuels. Rather we currently have lower investment in the upstream extraction of commodities, which implies tighter supply and more persistently sticky commodity prices. Fossil fuels and plastic are cheaper right now.

More firms are committing to zero-carbon pledges. While generating a positive outcome, such a policy involves higher costs. 

Globalisation has been a dominant theme for decades, and often to countries with questionable human rights practices under the guise of cheap labour. The trend to focus on supply chains for harmful practices, while ultimately a good thing for society, will cost money in higher wages and greater oversight.

With governance, companies need to dedicate greater resources for reporting to stakeholders and governments. It adds to costs.

Businesses are damned if they do and damned if they don’t. Say you decided to pass on ESG? What happens if your access to capital gets turned off because you are involved in a “bad” sector? What is the risk of falling out of favour with the client base?

Adopting ESG might be inflationary. But not adopting it is inflationary too. Plundering resources leads to scarcity and inflation.

Some essentials

Sometimes, so much is going on you lose sight of the forest for all the trees.

If you want to improve social outcomes and transition the economy to a better future which requires embracing technology more and more, the first deposit comes with education. We are now spending more on New Zealand Superannuation (gross) than the education sector.

The economic, environmental and social ledgers are disconnected. Lots needs to be done. ESG is one framework driving change. However, one reconnection variable is simply putting people back to the epicentre of what we do in the business world. People first because they look after the customer, and if the customer is looked after, the shareholder makes money. Let’s not over-engineer something basic with lots of fancy terminology.

Stamp out short-termism. Stay focused on the long game. The coming inflationary years could be quite telling in terms of whether politicians can walk that walk.

We need better adoption of risk management in decision-making. The path to a cleaner, greener, socially and more sustainable future needs to be managed better. The shortage of CO2 following the Marsden Point shutdown being an example.

Bagrie Economics is a boutique research firm that specialises in independent, authoritative analysis of the New Zealand economy and economic issues generally. We don’t do spin or over-complication, just honest analysis of trends and figures.

The views expressed in this article do not represent financial advice.