When greeting old friends after a period of absence, Ralph Waldo Emerson used to ask: “What has become clear to you since we last met?”
What is clear to us and many others is that market capitalism has arrived at a critical juncture. Even beyond the bailouts and recent volatility, the challenges of the climate crisis, water scarcity, income disparity, extreme poverty and disease must command our urgent attention.
The financial crisis has reinforced our view that sustainable development will be the primary driver of economic and industrial change over the next 25 years. As a result, old patterns and assumptions are now being re-examined in an effort to find new ways to use the strengths of capitalism to address this reality. Indeed, at the Harvard Business School Centennial Global Business Summit held earlier this month, the future of market capitalism was one of the principal themes discussed.
We founded Generation Investment Management in 2004 to develop a new philosophy of investment management and business more broadly. Our approach is based on the long-term, and on the explicit recognition that sustainability issues are central to business and should be incorporated in the analysis of business and management quality.
Nearly five years on, our conviction on the importance of sustainability in delivering long-term performance has increased. Indeed, the past year, and certainly the past two months, has reinforced our view on sustainability. While certainly not a complete list, the causes of the current financial crisis include: short-termism (including but not limited to increased leverage), poor governance and regulation, misaligned compensation and incentive systems, lack of transparency, and in some firms, poor leadership and a dysfunctional business culture.
Forty years ago, Robert F. Kennedy reminded Americans that the Dow Jones Industrial Average and Gross National Product measure neither our national spirit nor our national achievement. Both metrics fail to consider the integrity of our environment, the health of our families and the quality of our education. As he put it, “the Gross National Product measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to country. It measures everything, in short, except that which makes life worthwhile.”
The Keynesian system of “national accounts,” which still serves as the backbone for determining today’s gross domestic product, is incomplete in its assessment of value. Principally established in the 1930s, this system is precise in its ability to account for capital goods, but dangerously imprecise in its ability to account for natural and human resources.
Business — and by extension the capital markets — need to change. We are too focused on the short term: quarterly earnings, instant opinion polls, rampant consumerism and living beyond our means. As we have often said, the market is long on short and short on long. Short-termism results in poor investment and asset allocation decisions, with disastrous effects on our economy. As Abraham Lincoln said at the time of America’s greatest danger, “We must disenthrall ourselves, and then we will save our country.”
At this moment, we are faced with the convergence of three interrelated crises: economic recession, energy insecurity and the overarching climate crisis. Solving any one of these challenges requires addressing all three.
For example, by challenging America to generate 100% carbon-free electricity within 10 years — with the building of a 21st century Unified National Smart Grid, and the electrification of our automobile fleet — we can encourage investment in our economy, secure domestic energy supplies, and create millions of jobs across the country.
We also need to internalize externalities — starting with a price on carbon. The longer we delay the internalization of this obviously material cost, the greater risk the economy faces from investing in high carbon content, “sub-prime” assets. Such investments ignore the reality of the climate crisis and its consequences for business. And as Jonathan Lash, president of the World Resources Institute recently said: “Nature does not do bailouts.”
Sustainability and long-term value creation are closely linked. Business and markets cannot operate in isolation from society or the environment.
Today, the sustainability challenges the planet faces are extraordinary and completely unprecedented. Business and the capital markets are best positioned to address these issues. And there are clearly higher expectations for businesses, and more serious consequences for running afoul of the boundaries of corporate responsibility. We need to return to first principles. We need a more long-term and responsible form of capitalism. We must develop sustainable capitalism.