Traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. We need a more informed version of capitalism, under which investors recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks.
Last week, while engaging in a little commentary on LinkedIn, I suggested that populism was a growing concern across Europe because ‘our capitalist system has failed so many for so long’. Another member subsequently posed the question: Why has capitalism failed? Europeans/Westerners still enjoy the best standards of living in the world.
While I would agree with the latter part of this response, I feel it warrants further exploration.
Simply put, my answer to this question is that traditional capitalism failed so many for so long because it failed to capture the unintended consequences of how it functioned. Instead, capitalism has focussed almost exclusively on financial return.
Capitalism, at its heart, is about investment – allocating capital in order to increase that capital. It is an absolutely essential part of what makes economies and societies work, but capital cannot exist in a bubble measured only in financial terms. Every investment, whether in extractive industry stocks, green bonds, property or even handbags, has a much wider impact on the economy, society and the environment. Unless that wider context is considered, financial returns become almost meaningless. (What good is a 50% return on a pension pot, for example, if our collective global investment decisions have driven up the cost of living by 60%?)
Because traditional capitalism has largely ignored those unintended consequences (risks, by another name), we have ended up in a world where inequality is growing, our climate is changing rapidly to our detriment, companies are not being held to account and populations are not adequately prepared for greater automation.
(Governments and central banks have a lot to answer for too, but those subjects will be covered in future posts.)
The narrow focus of traditional capitalism may also, ironically, end up being its undoing as financial returns become unsustainable. Risks ignored are risks that build and eventually come back to bite.
Those issues, particularly inequality and global warming, are already manifesting themselves in the financial rewards the traditional capitalist approach was meant to generate. But, rather than driving returns up, they are doing the opposite.
MSCI, for example, calculated mid-last year that the spread of populism through Europe and the US over the next two years could result in heavy financial losses. Under their scenario, one outcome may be a lowering of global growth by 3% annually while inflation surges. The potential damage this would wreak on a diversified, multi-asset class portfolio could be a decline of over 11% as equities lose 15.6% and fixed income securities fall 4.6% (although I suspect Trump’s first week in office, and the financial market response to that, could mean the outcome of MSCI’s scenario may look considerably worse now).
The lack of credible and standardised metrics to capture and measure the unintended consequences of investment is at least part of the reason why so many of those risks have not been recognised or managed. This works at the policy level too.
I can’t help thinking though, that if the traditional capitalist model has been more open-minded, those metrics would have been found long ago. And, even where they do exit (data showing growing inequality has existed for some time now), they have still been ignored. As Andrew McNally points out in his book, Debtonator: Since the 1970s the Western World has seen the most prolonged rise in inequality, both in income and wealth, since the 1800s.
So while we in the West might still be enjoying the best standards of living globally at the holistic level, the picture is far from simple and the risks to those living standards continue to build.
What we need now is a more informed version of capitalism, under which investors – and by this I mean anyone who makes decisions about how capital is allocated – recognise the wider risks they create in societal and environmental terms and take responsibility for managing those risks. This includes lobbying government and central banks to push the policy agenda in the right direction.
We desperately need better, more standardised and credible metrics to measure societal and environmental impact so those risks can be robustly analysed and managed, and can begin to take their rightful place alongside financial returns in judging how successful an investment has been. But we also cannot ignore the warning signs that are already flashing before our eyes.
(Debate is an absolutely essential part of finding solutions to the challenges we face. Please don't hesitate to post your thoughts below if you like or dislike this perspective, but also if you want to share your own thoughts on how we can address those challenges.)
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A quick cuppa with Faith Ward, Chief Responsible Investment and Risk Officer, Environment Agency Pension Fund