Why ESG initiatives need a solid economic foundation

ESG (Environmental, Social and Corporate Governance) is more than just a buzzword; it significantly influences economic and social development. But it doesn't come for free, we must always remember the financial sources behind it. And we need to be practical about it – if there is no commercially feasible return, we shouldn’t prioritize it. Instead, we need to work harder to make ESG work – with innovation and ingenuity.

ESG is increasingly important from an investor perspective and, as a result, a higher priority for companies: around 85% of the Chief Investment Officers surveyed for McKinsey said that ESG is an pivotal factor in their investment decisions. Around 60% of respondents screen their entire portfolio for ESG issues, and around 80% evaluate individual company positions in terms of how ESG impacts projected cash flows.

Notably, a significant majority are willing to pay a premium for companies that demonstrate a clear link between their ESG efforts and their financial performance (see Figure 1 below).

A comprehensive study by the NYU Stern School of Business found a clear positive relationship between ESG and financial performance in 58% of company studies, 13% showed a neutral impact, 21% showed mixed results and only 8% showed a negative relationship (see Figure 2 below).

However, ESG initiatives alone do not ensure economic progress and prosperity. Implementing such measures without a solid economic foundation may compromise the resources needed to enforce ESG criteria effectively.

ESG involves significant investments for companies, particularly in the short and medium term. The financial performance benefits of ESG initiatives tend to become evident over longer time horizons. Such investments require resilience and consistent funding. Securing those necessary funds is essential as only available resources can be allocated to these initiatives. Profitability is crucial for maintaining long-term support from shareholders.

To integrate these requirements, it is essential to establish a triad: a social economy, an ecological economy, and a market economy. Therefore, prosperity must be defined by more than just economic growth; it also includes sustainability and social harmony.

Achieving equilibrium within these elements demands substantial investments. A sustainable social, ecological, and market economy needs significant focus on education and innovation for ongoing success.

Educated individuals are generally more productive and earn higher incomes, contributing to greater individual prosperity. At the macroeconomic level, education enhances overall economic productivity and fosters innovation. Research shows, that higher levels of education lead to increased human capital in OECD economies, which supports and enhances the production and utilization of knowledge-based capital (KBC).

KBC drives the development of new patents, technologies, and innovations that enhance productivity and generate new markets. This directly contributes to economic growth and prosperity. Concurrently, research addresses significant societal challenges such as climate change, health issues, and energy supply. These advancements foster long-term stability and prosperity within society.

Accordingly, investing in KBC is essential for societal progress. Hesitation means missing out on innovation and economic benefits as other key players advance research and capture crucial technologies. There are numerous examples:

In future, critical technologies are driven by digital advancements, such as AI, and the expansion of renewable energy sources. Nations strive for technological and market leadership. While several countries share a leading position in AI (including the US and China), Western companies are currently at the forefront of wind energy development.

Yet, domestic political challenges in regulatory conditions in several countries undermine the stability needed for companies. This instability may reduce investment willingness, adversely affecting economic prosperity and ESG objectives. However, significant investment is needed. Research and development are likely to yield significant returns in the medium and long term.

Market mechanisms should be utilized to ensure the efficient allocation of resources. Incorporating environmental sustainability into economic and social systems is both socially and economically beneficial. The implementation of ESG principles, investment in education and innovation, and preservation of societal prosperity are fundamentally interconnected and should be pursued together.