Policy Studies Energy and Environment

Greening the Invisible Hand: The Policy Implications of Corporate Environmentalism

Authors

Devin Hartman
Policy Director, Energy and Environmental Policy; Resident Senior Fellow
Kenneth Richards
Professor of Environmental Policy, O’Neill School of Public and Environmental Affairs
Emily Giovanni
Principal Consultant, Gnarly Tree Sustainability Institute

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Key Points

Markets are internalizing environmental effects in a manner not previously anticipated. This warrants rethinking the role of government to enable private markets, rather than controlling economic activity, in order to improve environmental outcomes. 

There is a need for government to reexamine fiduciary standards, clarify property rights and reduce information gaps in the age of ESG. 

Fixing government failures that impede individual choice and voluntary investment are more important than ever to improve the economy and environment. 

Policy reforms that unleash the greening of the invisible hand— especially those that correct deficiencies in information, transaction costs, property right definitions and principal-agent alignment—will prove integral to unlocking CE’s potential.

Executive Summary

Over the past decade, there has been a sea change in voluntary corporate environmental behavior. Much of this is associated with “environmental, social and governance” (ESG) activity, a term coined in 2005. But corporate environmentalism (CE) has a history predating the adoption of ESG. Historically, CE has been limited, but it has become mainstream business practice in the past decade. Generally, CE refers to firm-level efforts to reduce pollution and resource use and to protect natural habitats beyond the requirements of the law.

Recent trends in CE behaviors have led to extensive confusion and debate among scholars, practitioners and policymakers. Federal policy development has proven exceptionally contentious, punctuated by the Biden administration’s first veto, which was related to the treatment of environmental factors in pension fund management. States have quickly diverged into pro- and anti-ESG policy agendas that work at cross purposes, with some imposing billions in costs to a single state economy. This has undermined a healthy business climate and underscores why public policy must better reflect CE motivations and mechanisms.

The meteoric rise in corporate environmental investing and environmental management practices between 2016 and 2020 was headlined by clean energy procurement. The investment community was attracted to the financial performance advantage of certain environmental investing practices, as evidenced by the more than 1,000 studies undertaken between 2015 and 2020. Notably, this tipping point occurred when federal environmental regulation was relaxing. This context reinforces that the renaissance of CE is foremost explained as a strategic business response to shifts in market forces and civil society. Since 2021, the relative importance of federal regulation has become far more pronounced. CEO surveys in 2021 and 2022 found a mixture of motivations underlying ESG actions, including regulation, investor requests, consumer trends, ratings and expected business benefits.

To understand the implications of these trends, particularly for policy, it is helpful to contextualize them in terms of economists’ long-held theories on CE motivations, which underlie many existing environmental policies. Historically, CE was primarily motivated by firms’ desires to influence public policy to their benefit, and markets only consistently demonstrated the ability to account for environmental consequences at the local level. This happened through the participation of parties motivated to reduce the environmental harm that they incurred directly. Novel approaches to CE, however, reveal that market actors who do not directly bear the environmental harm nevertheless act on strong intrinsic environmental preferences. In particular, younger generations of investors, consumers, employees and non-governmental organizations are willing to incur higher costs to alter corporate environmental behavior. Such forces have had marked effects on corporate environmental pledges, with roughly two-thirds of global gross domestic product now under a 2050 net-zero emissions commitment.

The environmental and public policy ramifications of such changes are potentially transformative. Conventional policy assumes markets lack the motivation to internalize the environmental costs of their activities, but novel CE reveals an increasing market motivation to self-correct environmental problems. To date, these market forces have not fully translated such motivations into superior environmental outcomes. Markets exhibit poor confidence in the ability to measure and verify the environmental impact of corporate claims, products and programs. There are also challenges in aligning fund-management practices with environmentally motivated clients. Further, CE is constrained by inefficient public policies, especially those preventing investment in cleaner practices and imposing barriers to market access. Altogether, this suggests far greater potential for environmental benefits through the “invisible hand” of unconstrained market activity than previously believed.

Novel CE reveals that a shift in government’s role toward “greening the invisible hand” could improve social welfare. This involves three core functions:

  1. Resolve market failures that are more pronounced with CE. These include aligning fiduciaries with clients pertaining to environmental investing, clarifying property rights regarding environmental attributes, and lowering environmental information deficiencies and transactions costs.
  2. Adjust existing policy to accommodate market trends that internalize environmental costs. This includes reexamining conventional interventions while expanding or improving voluntary environmental programs.
  3. Correct existing government failures that impede voluntary environmental improvement. These include addressing policies that inhibit investor and consumer choice and the deployment of new capital, such as clean energy project approvals.

Greening the invisible hand emphasizes a role for public policy to empower individual choice to address environmental problems where possible. In practice, this means environmental institutions like the U.S. Environmental Protection Agency (EPA) may be more useful in promoting reporting and transparency and less useful in applying conventional approaches that directly control economic activity. This approach also places greater emphasis on non-environmental institutions to enable and facilitate greener market forces. For example, financial institutions may play a more pronounced role in overseeing the provision of material environmental information that is critical to investors’ decisions, productively deterring greenwashing, decreasing corporate liabilities for environmental innovation and aligning fund manager-client incentives. Industry-specific institutions, such as the Energy Information Administration (EIA) and Federal Energy Regulatory Commission, can assist with bringing more environmental transparency to complex supply chains while reducing barriers to the flow of capital.

Novel CE suggests a broader but lighter role for government. In other words, the government may need to address more conditions, but the depth of its role in the economy would decline. Markets need a reliable scoreboard, clear rules of the game and fair referees to leverage increased CE motivations to improve performance organically. If armed with the appropriate tools, the invisible hand has never held greater environmental potential.

Read the policy study, “Greening the Invisible Hand: The Policy Implications of Corporate Environmentalism.”