Mastering the Labyrinth of Sustainability: Toward a New Foundation for the Market Economy

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• Building a sustainable market economy requires overcoming a classic market failure: incomplete information. Specifically, because ESG data and other information on corporate sustainability performance are public goods, they are systematically underprovided.

• The widely accepted Coase Theorem has added to the confusion in economic theory by positing that, in the pollution context, no matter whether the underlying rights are lodged with the polluter or pollutee—a factory sending emissions up its smokestack or the neighbors (breathers) next door—the parties should be able to negotiate an optimal outcome. Having assumed away the problem of transaction costs, Coase posits that an efficient level of pollution will be achieved either by the neighbors agreeing to pay the factory to reduce its emissions or the factory compensating the neighbors for their respiratory distress. While this imaginary negotiation might produce an economically efficient outcome, it says nothing about the fairness of the result.

• In this regard, environmental sustainability has emerged as one of the areas of greatest focus as current business practices and our economic system more generally produce enormous amounts of pollution and waste

• a sustainable capitalism based on a reinvigorated commitment to the polluter pays principle, operationalized through a framework of rules (environmental laws) that prohibit uninternalized externalities, thereby forbidding any spillover of environmental harm from private parties onto others or into the shared spaces of the commons at any scale (local, regional, national, or global) without full compensation being paid.

• As a first step toward fully internalizing environmental externalities – which will require harm charges to be imposed on all pollution damage and natural resource use – I argue for expanded corporate disclosure of emissions and other environmental impacts through better structured reporting by companies on their Environmental/Social/Governance (ESG) performance.

• Such ESG disclosure (backed by auditing and enforcement rules) would: (1) address information failures in the marketplace; (2) highlight unsustainable business models and expose companies that derive profits from activities that impose costs on society; and (3) promote marketplace transparency – laying the foundation for calculating the requisite harm charges by bringing hidden externalities into the light.

• Thus, even before regulatory regimes across the world are reframed to fully internalize environmental impacts, more rigorous ESG performance reporting could give sustainability-minded investors and consumers critical data and information to guide their investment choices and purchasing decisions, thereby creating a powerful incentive for corporate sustainability and deterring business practices that generate private gains at public expense.

• It depends on marketplace rules that respond to market failures, internalize externalities, and address the “tragedy of the horizon” (as former Bank of England Governor Mark Carney calls the too-often-ignored business activities that result in slowly accumulating and often-hidden social costs, such as the build-up of GHG emissions in the atmosphere). All of which requires bringing an end to unsustainable business practices.

• The need for such fundamental change and a revised foundation for capitalism has become ever more widely recognized by government officials, scholars, and business people — but the path forward remains uncharted.

• Conceptually, sustainability requires a restructured market economy that prohibits externalities—forbidding production or consumption that results in environmental harms being inflicted on others.

• No longer should pollution be accepted as the necessary byproduct of industrial production and justified on a benefit–cost basis. Nor should the private use of public resources—water, timber, minerals, or other natural resources—be condoned at less than full-price payment to society for the privilege.

• we propose a new starting point for environmental regulation: legal rules that forbid all damaging emissions as well as any natural resource consumption for which a full price has not been paid. We suggest that the legal requirement to stop all environmental harms be rebuttable in recognition of the fact that some production processes (for instance, making steel or cement) cannot achieve zero emissions without significant economic dislocation and societal burden.

• In such cases, the legal obligation should be to minimize environmental damage and pay full monetary compensation for any residual impacts including effects on both people and ecosystems. We propose that these harm charges – to be calculated by regulatory authorities – be paid directly to those affected to the fullest extent possible.

• Likewise, the consumption of natural resources must bear an appropriate price with special attention to the level of societal compensation required for the exploitation of non-renewable resources.

• Adoption of such a no uninternalized externalities principle backed by a new framework of regulatory rules would lay the foundation for a sustainable economy in a way that existing laws do not. Indeed, the basic structure of environmental protection in most nations in the world (at least as implemented) assumes that some degree of pollution is inevitable. And almost all environmental regulatory frameworks set pollution abatement standards based on benefit–cost analysis.

• This legal structure permits billions of tons of uncontrolled air and water pollution, waste, and greenhouse gases to be released into the environment every year.

• Reconfiguring environmental law around a no uninternalized externalities principle makes sense from a range of perspectives — including: (1) economic theory, (2) conformity to the polluter pays principle embedded in a number of international environmental agreements and domestic legal frameworks, (3) environmental rights and natural law, (4) emerging case law around the world, (5) equity and environmental justice, (6) the need for policies that spur innovation, and (7) changing societal norms related to the role of corporations in society.

• Economists have long argued—at least since the work of Pigou a hundred years ago — that efficient markets require that externalities, such as pollution, be internalized. But in regulatory practice, the logic of Pigouvian pollution charges with their focus on limiting the spillover of harms has been overshadowed by the Kaldor–Hicks principle, which translates into a legal framework that optimizes net social benefits.

• This sort of benefit–cost efficiency permits externalities — including enormous amounts of pollution — to go unchecked so long as the value of the economic activity causing the damage is judged to be greater than the burden on those suffering the impacts of the externality.

• But this regulatory approach cannot be sustained in the face of mounting evidence that many externalities have not been fully tracked nor appropriately controlled—and that accumulating environmental harms now threaten planetary boundaries. And while it might once have seemed difficult to trace hard-to-see and widely dispersed emissions, 21st century technologies make such tracking quite straightforward. [14] [14] Daniel C. Esty & Quentin Karpilow, “Harnessing Investor… Likewise, advances in epidemiology, ecosystem ecology, and valuation methodologies make it ever easier to put a price on environmental damage. [15]