ESG Feeds Inflation, Hurts Economic Growth


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With inflation at a four-decade high, it’s time to reconsider the notion that the economy will benefit if companies sacrifice profits for environmental, social and governance considerations. The truth is that diverting corporate attention away from long-term profitability lowers output and raises prices.

In 2019, the Business Roundtable, an association of CEOs from large companies, abandoned its longstanding commitment to the idea that the “purpose of a company” is to maximize shareholder value. Instead, the group argued, companies should follow a “multi-stakeholder” model. If corporate leadership prioritized shifting ESG concerns over long-term profit maximization, companies could “create an economy that serves all Americans,” according to the roundtable.

It didn’t turn out that way. When companies focus solely on maximizing profits, their main goal is to produce more at less cost. Admittedly, some profitability strategies – such as B. Limiting supply – contrary to maximizing output. But this is not possible without an organized and powerful monopoly. Even companies with great monopoly power lose that power over time as competitors emerge. In a competitive market, companies serve themselves and consumers by producing more for less.

However, ESG investments and the management practices they encourage typically increase production costs and limit capacity. When a company redirects resources into a formal diversity, equity and inclusion program, with all the associated hiring and bureaucracy, it has fewer resources available to conduct product research and development. If a company whose core competency is oil and gas exploration chooses wind and solar power despite having limited expertise in those modes, its performance will suffer as well. In general, an investment framework that dilutes production in favor of social goals will divert money from efficient producers – as will taxes.

Milton Friedman showed that increasing the rate of money growth increases the rate of inflation. But it is also true that a slowdown in overall output growth can increase inflation. If we think of the economy as a vast market where we exchange dollars for whatever dollars can buy, reducing the supply of available goods raises the price level, all else being equal. If enough companies focus on ESG priorities, they risk higher inflation and slower growth or stagflation.

This is not to say that the general principles emphasized by ESG are undesirable, but that doing good is more important than being called good. A company can be profitable with a diverse workforce without having a formal DEI policy. And such a company will ultimately serve a diverse group of Americans better by offering them more goods at a lower cost.

To put the US economy back on the path to sustainable growth and low inflation, the Fed must rein in excess liquidity, as it is doing now. But that alone will not be enough. Businesses, investors and their advisors need to push back on ideas like ESG that undermine business productivity.

Mr. Henderson is a research fellow at the Hoover Institution at Stanford University and editor of the Concise Encyclopedia of Economics. Mr. Joffe is a Senior Policy Analyst at the Reason Foundation.

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Appeared in the July 6, 2022 print edition as “ESG Feeds Inflation, Hurts Growth”. ESG Feeds Inflation, Hurts Economic Growth

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