Adam Tooze: What Is ESG Investing and Why the Sudden Backlash?

About $139 billion flowed last year, through September, into ESG investment funds—that is, funds that invest according to various environmental, social, and governance criteria, like lower carbon emissions. It’s become a booming global business in recent years—and a controversial one, at least in the United States. Republican officials have accused ESG investment funds of “woke capitalism”—of unfairly hurting businesses in favor of an extraneous political agenda. Last week, Republicans in Congress voted to block a Labor Department rule that would allow retirement plan managers to incorporate ESG criteria into their investment decisions. Similar laws have been passed in Republican-controlled states across the country, to the consternation of liberals—and investors.

How did the concept of ESG investing get its start? If investors have to choose between profit and climate goals, won’t they ultimately always choose profit? And does the finance industry identify more with Republicans or Democrats? Those are a few of the questions that came up in my recent conversation with FP economics columnist Adam Tooze on the podcast we co-host, Ones and Tooze. What follows is an excerpt, edited for length and clarity.

LISTEN HERE: For the entire conversation, and episodes in the weeks ahead on this subject and others, follow Ones and Tooze wherever you get your podcasts.

About $139 billion flowed last year, through September, into ESG investment funds—that is, funds that invest according to various environmental, social, and governance criteria, like lower carbon emissions. It’s become a booming global business in recent years—and a controversial one, at least in the United States. Republican officials have accused ESG investment funds of “woke capitalism”—of unfairly hurting businesses in favor of an extraneous political agenda. Last week, Republicans in Congress voted to block a Labor Department rule that would allow retirement plan managers to incorporate ESG criteria into their investment decisions. Similar laws have been passed in Republican-controlled states across the country, to the consternation of liberals—and investors.

How did the concept of ESG investing get its start? If investors have to choose between profit and climate goals, won’t they ultimately always choose profit? And does the finance industry identify more with Republicans or Democrats? Those are a few of the questions that came up in my recent conversation with FP economics columnist Adam Tooze on the podcast we co-host, Ones and Tooze. What follows is an excerpt, edited for length and clarity.

For the full conversation, look for Ones and Tooze wherever you get your podcasts.

Cameron Abadi: How did the concept of ESG investing get its start? And why were so many financial actors seemingly so quick to endorse the idea?

Adam Tooze: Yeah, it’s a really big deal. I mean, globally right now we’re talking about an industry of asset management run according to ESG principles perhaps in the order of $18 trillion. And, at least until recently, the expectation was that this was going to grow very dramatically over time.

There’s been a kind of ethical, moral capitalism since the beginning of the system. Famously, somebody like Max Weber would say that capitalism actually grew out of a sort of theological inspiration. And in the 19th century, you could think of firms like Cadbury, the Quaker chocolate manufacturers who were big in anti-slavery activism. But I think the woke badge that’s been attached to ESG by the Republicans is quite telling in the sense that the modern ESG model is really a product of the 1970s, which I think is also historically where you would see wokeism as a form of politics. It’s a child of the ’70s in the sense that it’s post-traditional radicalism, it’s not socialist politics. It’s a kind of new alignment of civil rights-orientated, human rights-orientated, rights-based thinking with elite politics. And I think that’s what really drives the Republicans in the U.S. crazy.

But I think the genuine start in the modern form of campaigning activists is really the Sullivan principles over apartheid and investing in South Africa. These were initiated in 1977. And then you see big American pension funds like TIAA in ’78 issuing a statement on its business in South Africa and fully divesting by 1983. And the divestment movement of the 1980s, I think, is really the precursor of the modern ESG line. By the 1990s, there is really a sort of global corporate responsibility movement in full swing at the same time as there’s also, of course, the anti-globalization politics of the 1990s. And this sort of synthesizes, then, in the U.N. principles for responsible investing from 2006, which actually coins the ESG slogan. And it’s really from that moment onward that we have this badge, ESG, as a kind of common denominator for this kind of politics.

CA: How does that work in the case of, say, climate polluters. Do investors, through their mechanisms of acting as shareholders, really control the fate of carbon emissions? Do publicly traded companies even produce the majority of carbon emissions in the world?

AT: This is a key issue, and it also goes to the matter of history, because if you went back to the world economy as it was in the early 1990s, then for good reason, climate activism would have centered on the Exxons, the BPs, the Shells of this world. And they, of course, remain very significant polluters. But if you actually look at the more recent trends in the global economy since the end of the Cold War and the advent of the latest phase of globalization, the thing we have to wrap our heads around is that of the top 10 polluters worldwide in the fossil fuel business, only two are privately owned, widely traded Western oil majors, Exxon and Shell. The top eight are government-owned, government-linked energy companies, largely in the emerging market world. So at the very top is China’s coal industry, as a whole. Then next is Saudi Aramco. Then you’ve got Gazprom, then Iran’s national oil company, then you’ve got Coal India, then you have Pemex in Mexico, then you have Russia’s coal business and then China’s national petroleum company.

And those between them account for something like 33 percent of global emissions since the 1980s. Because you’re talking about the entire energy sector of two of the most rapidly growing economies in the world, which are gigantic—China and India are vastly huge. So this idea that by way of Western publicly traded capitalism, you can control the whole world economy is anachronistic. It’s no longer the case. There’s no way around politics, ultimately, because state-owned enterprises are key to this story now.

Even within the West, there is another sort of worry, which is that if ESG takes the form of divestment—so brand-aware, major publicly traded companies trying to get clean—it’s one thing if they shut activities down, which actually does result in a net reduction in pollution. But if what they do is actually divest themselves of the assets, sell them off, the question, of course, is who they sell them to. And often what they’ll do is sell them into non-publicly traded companies, basically private-equity firms of various types or privately owned energy companies that will then run these assets. And, of course, that doesn’t do anything for global pollution. And in terms of corporate governance, it may actually reduce the capacity of environmental politics to reach those assets, because those companies will be much less responsive to pressure. And if things go wrong, they also don’t have the deep pockets to pay large-scale compensation in the case of, say, offshore oil spills. If we have a major disaster, it’s clearly much better that it’s a BP that’s on the hook that can pay out billions in compensation, whereas a small, cheap-and-dirty private oil company might just go bankrupt and roll away from the losses.

CA: Is there a more fundamental mismatch here: If investors have to choose between profit and climate goals, won’t they choose profit? Isn’t there just a motivation problem here from the perspective of the investors?

AT: There certainly is. And you see that every time the fossil fuel market revives, all of a sudden the oil majors begin reconsidering their energy transition plans because there’s just so much money to be made in oil and gas. And they feel they have an obligation. And, you know, if you’ve got a player in the system like Exxon, for instance, which is doggedly defending its fossil fuel-based energy model, then it’s very difficult for its competitors under those kind of circumstances to stay on their ESG track.

There are two different ways of bridging this. The first is to claim that being green is actually profitable. In the end, there isn’t a trade-off. One of the early reports of the 2000s on ESG investing literally had the title “Who Cares, Wins,” as a riff on the SAS slogan, the British Special Forces slogan: “Who Dares, Wins.” And that’s part of the argument of the ESG lobby, the ESG campaign, is that actually to posit a stark contrast between profit and sustainability is a false contrast. In any case, that’s one way of answering this.

And the other is to face it head-on and to say, “Well, you know, who are investors? What are investors?” And generally speaking, what we’re talking about is pots of money, say, from pension funds or insurance firms, which are then passed on to fund managers. And so the investor, here, is the combination of the fund manager and the ultimate owners of the pension pot. And it’s perfectly legitimate for the pension fund, you know, the Californian teachers pension fund or whatever, to specify that our members do not want profit to go ahead of environmental sustainability. We do not want to retire on the basis of profits extracted from underpaid workers in Central America. And then you just pass that on as an instruction to the manager, and then there’s really no conflict.

CA: Republicans are obviously making this a political issue in the United States—but is finance as a whole already a polarized industry? Does it identify with one party in the United States more than another?

AT: I think it’s very complex, because finance is a diversified industry sprawling across the country, both small and large, with major centers, of course, in the coast and California and, above all, in New York, but all the way down the East Coast and taking lots of different shapes and sizes, from very small family-run financial advisory outfits to giant banks. I think at the level of corporate leadership, you see a kind of split consciousness in that they like tax cuts and deregulation, which is what the Republicans provide. But on the other hand, if you’re running a big, globally orientated business in the United States, you find yourself willy-nilly in the camp of the Democrats right now, so long as the Republicans are in kind of culture-war, Trumpist-clown-show mode, because you simply can’t align a big business with that kind of politics. And so there is a real tension there.

At the global level and at like Davos or at COP27 or whatever, the leaders of major corporations around the world want to appear as though they are on the right side of history. Meanwhile, if you go down into the rank and file of the giant American financial industry, of course, you’ll find loads of folks working on Wall Street who are solidly Republican-voting and are probably chuckling to themselves over the dilemmas that their corporate leadership find themselves in, while, like, swanning around at Davos and places like that trying to look good.

And I have to say, I have a sort of sneaking sympathy for this, because the ESG shtick is an interesting form of liberal politics that doesn’t really dare to speak its name. Right? What it does is to translate a set of what are, by any stretch of the imagination, political judgments on how you value community, the distribution of income, the priorities of ecological policy. It translates them into values that it then attempts, as it were, to place outside the sphere of political debates and then mandate as a sort of consensus of values. And in a sense, what the Republicans are doing is just calling their bluff and saying, “No, we see you coming.” This is basically the Democratic Party’s agenda cast as a value set, which we are supposed to subscribe to, and we just frankly don’t. So if you want to have this agenda, spell it out, be upfront, and pass legislation that requires it, for instance. But if you can’t win that argument, then don’t try to smuggle it in by way of corporate agenda-setting.