It's game on for green, sustainable growth

Paul Gruenwald
Growth has become unsustainable mainly because market prices did not capture the negative environmental externalities of economic activity.
Paul Gruenwald
It's game on for green, sustainable growth

Research into economic growth has a long and distinguished history, but the recent introduction of sustainability into the debate has given the field a necessary and overdue shake-up. In particular, a report on the economics of biodiversity, commissioned by the UK government and led by Partha Dasgupta of the University of Cambridge, represents a tectonic shift in thinking, rather than only a logical extension of previous growth models. While this may be unsettling to some, it provides a great opportunity to use the power of data and analytics to put growth and finance on a more sustainable path.

In a nutshell, the new economics of growth no longer regards the environment as external to the economy. Rather, the economy is embedded in the environment, and can prosper and grow sustainably only as long as we manage nature wisely.

There is thus a new bottom line for thinking about growth. Bigger is no longer better; nowadays, sustainable is better. Previous growth models regarded the accumulation of human and physical capital – through education and training, and investment in plant, equipment, and infrastructure – as good, because they expanded the economy. Combining these factors in more efficient ways through technological innovation was seen as beneficial for the same reason. The problem was that these models never explicitly considered the environment, or natural capital.

Growth has become unsustainable mainly because market prices did not capture the negative environmental externalities of economic activity. Resource allocation that followed these price signals thus led to environmental degradation.

Moreover, conventional GDP measures scored increases in output per capita as raising living standards. While this was true in a narrow sense, a balance sheet for the environment, or some way to adjust GDP figures for ecological damage, was missing. Many economists and policymakers thus largely ignored this negative externality.

The textbook way to create more sustainable growth is to tax things that are bad for the environment, and the simplest instrument is a carbon tax. The amount of the tax should raise the private cost of economic activity to the social cost, which includes the environmental impact. This modified market signal will then help to allocate resources in a more sustainable way.

But the private sector can go beyond being a mere price taker in the green transition and play an active role by internalizing the negative externality. Already, sovereign wealth funds, university endowments, and insurance and pension funds are seeking to invest their assets in more sustainable ways. Environmental, social, and governance (ESG) principles and other green financing tools are increasingly available to guide investment. This market segment has exploded in recent years, but more needs to be done to harmonize definitions and track results more accurately and consistently.

The key to prospering in a sustainable world will be to foster economic growth while managing the natural capital stock. Size still matters, but now in a negative way.

A command-economy model of financial repression to fund rapid investment and growth doesn't look too promising, either, unless it can enable an upgrade to a cleaner capital stock with a lighter environmental footprint.

Technology for its own sake is out as well. In a sustainable world, technology needs to reduce the environmental impact of economic activity, and innovations that increase it are unlikely to be adopted. Countries will still need technological change to drive growth, but the focus must shift to environmental efficiency.

Recasting the challenge of growth means altering priorities and policies.

Paul Gruenwald is Global Chief Economist at S&P Global Ratings. Copyright: Project Syndicate, 2021.

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