Defense In Depth
Why U.S. Security Depends on Alliances—Now More Than Ever
There’s a reason climate change is often described as a “wicked problem.” Fully decarbonizing the economy will require not only completely transforming the global energy infrastructure, at a cost of many trillions of dollars, but also retrofitting all of the world’s buildings, remaking the planet’s agricultural practices, and revolutionizing transportation systems. It is difficult to see how this can be accomplished without some kind of global carbon tax or regulatory regime. But putting such a system in place is proving to be enormously difficult. The 2015 Paris agreement on climate change was a good first step, but many countries show little sign of meeting the commitments they made as part of that agreement, and the United States’ withdrawal from the process has presented a significant barrier to further progress. Given the slowing global economy and the slide toward populism and nationalism in much of the world, the prospects for any kind of comprehensive global accord seem increasingly remote. So far, at least, the public sector is failing to confront the problem.
But the private sector has begun to step in to fill the vacuum. In January, Larry Fink, the CEO of BlackRock, the largest asset manager in the world, declared that “climate risk is investment risk” and announced that going forward BlackRock would ask every firm in its portfolio to disclose its carbon emissions. BlackRock has roughly $7 trillion under management and is one of the largest shareholders in nearly every publicly traded firm in the world. So companies around the world paid attention when Fink went on to say that BlackRock would consider voting against boards whose firms “do not make sufficient progress” in addressing climate-related risks and would cease to invest altogether in some fossil fuel projects.
Fink is not alone. Many of the world’s largest asset owners are coming to the conclusion that climate change is the most important risk to the long-term health of their portfolios. More than a third of global invested capital—about $19 trillion—is controlled by the world’s 100 largest asset owners. Nearly two-thirds of this money is in pension funds; the remaining third is in sovereign wealth funds. These funds are now so large that they are sometimes referred to as “universal owners” or “universal investors” since, in effect, they hold the entire market. For that reason, they cannot diversify away from the risk of climate change—a risk that Mark Carney, who until earlier this year was the governor of the Bank of England, suggested could result in an abrupt financial collapse, potentially wiping out as much as $20 trillion of assets. To avert that kind of calamity, major asset owners are starting to push the companies in their portfolios to address climate change.
For the world’s largest asset owners, climate change is not an externality—it is a profound threat.
This trend is not driven by altruism or a deep commitment to the environment: it’s a function of economic interests. For the world’s largest asset owners, climate change is not an externality—it is a profound threat to their long-term returns. It will, after all, be significantly harder to make money in a world where most of the major ports are underwater, harvests are failing on a routine basis, and hundreds of millions of people are on the move.
As more and more major asset owners come to this realization, it is creating increasingly strong incentives for them to cooperate with one another in support of large-scale decarbonization. Together, they are pressing the firms in their portfolios to set concrete targets for emission reductions and to make progress toward meeting those targets, potentially solving the problem posed by firms’ unwillingness to cut their emissions unless they can be assured that their competitors will follow suit. Someone, however, will need to monitor that progress and sanction firms that lag behind—a role that would be best filled by government regulators. The need for such public-sector involvement will likely increase private-sector support for the policy changes required to drastically reduce carbon emissions. In this way, private-sector pressure may serve as the force that finally breaks the political logjam that has long blocked the public action needed to solve the climate crisis.
One of the most promising examples of what this might look like in practice is Climate Action 100+, a nonprofit affiliation of more than 300 investors who collectively control nearly half of the world’s invested capital. The group was founded in 2017 with the goal of persuading the world’s 100 largest private-sector carbon emitters to “cut the financial risk associated with catastrophe” by putting in place board-level processes to assess their climate-related risks and oversee plans for dealing with them, pledging to clearly disclose those risks, and taking action to reduce greenhouse gas emissions across their value chains rapidly enough to help meet the Paris agreement’s goal of limiting the increase in the global average temperature to well below two degrees Celsius.
In December 2018, a group of investors belonging to Climate Action 100+ published a letter in the Financial Times listing some specific steps they were demanding of companies in which they invest, including “the rapid elimination of coal use by utilities in EU and OECD [Organization for Economic Cooperation and Development] countries by no later than 2030.” Six months later, investors from the consortium pushed the oil giant Shell to announce short-term targets for limiting its greenhouse gas emissions and persuaded BP to support a shareholder resolution that binds the oil company to disclose the carbon intensity of its products, the methodology it uses to consider the climate impact of new investments, and its plans for setting and measuring emission targets. More than half of the 40 oil and gas companies with which the group has engaged have set long-term quantitative targets for reducing their emissions. And the group has helped persuade the shipping giant Maersk and two of the world’s largest mining companies, ArcelorMittal and Thyssenkrupp, to commit to becoming carbon neutral by 2050.
These kinds of commitments are sometimes dismissed as mere greenwashing: public relations stunts designed to buy time. And sometimes they are. But they might also help catalyze an economic transformation that could play a major role in arresting climate change.
Of course, large asset holders are not the only players who shape a company’s incentives: employees and consumers do, as well, and they are increasingly insisting that firms go green—and rewarding them when they do. For example, after the consumer goods giant Unilever announced that it planned to cut its carbon footprint in half and double its revenue at the same time—and then followed through by transforming its operations, brand by brand—the firm joined Facebook, Google, and Microsoft on LinkedIn’s list of the ten most desirable employers in the world. Sales of Unilever’s “sustainable living” brands—which include Ben & Jerry’s, Dove, and Vaseline and which Unilever claims “contribute to achieving the company’s ambition of halving its environmental footprint”—are growing 69 percent faster than the rest of the business and providing 75 percent of the company’s growth.
Shifting public attitudes about climate change and public policies intended to combat it have also created clear business opportunities. Solar and wind energy are both multibillion-dollar businesses. The market for plant-based alternatives to meat is exploding. And global recycling could generate close to $400 billion in the next five years.
But embracing the innovation that is required to exploit new opportunities is often risky and expensive. The venture capital industry lost at least $10 billion between 2005 and 2011 investing in clean energy technology. An electric utility that commits to phasing out coal plants might reap the benefits of declining solar and wind energy costs, but it could also misjudge the market and significantly increase its costs. An automobile company that invests in developing electric vehicles might leap ahead of its competitors, but it could also risk losing out to more cautious rivals.
Universal investors can help mitigate those risks by funneling capital to firms that are willing to make the first move. This can be transformational in itself, since companies that decide to embrace new opportunities can often persuade an entire industry to follow them. Walmart’s massive investments in energy saving and waste reduction, for example, have helped persuade many other companies to take similar steps. Since 2010, the price of battery storage has fallen by at least 73 percent, a change driven largely by the electric vehicle company Tesla’s significant investments in the technology, which spurred the company’s competitors to invest more than $90 billion in the development of electric vehicles.
Major asset holders can also push companies to commit to aggressive targets for decarbonizing their business models and insist that they report on their progress. In this way, universal investors may be able to force every firm in an industry to act, solving the collective action problem inherent in tackling climate change. Firms don’t naturally act collectively—for all kinds of reasons, including antitrust law. But when there exists a clear business case for doing so and cooperation can be credibly enforced, voluntary cooperation can be an effective means of creating or preserving public goods. Nearly half of the world’s inshore fisheries are managed through some form of cooperative agreement. Most of the rules governing international trade are designed and enforced by the International Chamber of Commerce, a voluntary association founded in 1919.
Some of the world’s largest firms are increasingly exploring whether these kinds of voluntary agreements might be an effective way to reduce emissions. For example, after Unilever came under pressure from activists to stop using palm oil, the cultivation of which contributes to deforestation, Paul Polman, who was then the company’s CEO, was able to persuade many of his fellow consumer goods CEOs that continuing to purchase conventionally produced palm oil presented a significant threat to their own brands. Partly as a result, more than 60 percent of the world’s traded palm oil is now covered by sustainability commitments. Similar agreements with respect to soy and beef have greatly slowed rates of deforestation in the Amazon River basin. And companies in industries as diverse as airlines, food, retail, apparel, travel, hospitality, construction, health care, and high technology have begun to coordinate to reduce carbon emissions across supply chains, so that no single firm is placed at a disadvantage by going green.
Such arrangements produce a wealth of knowledge about what effective decarbonization might look like on the ground. As one might expect, however, they are often unstable and difficult to enforce, since no mechanism exists through which to punish firms that drag their feet or refuse to conform. Here, universal investors might be able to make a significant difference by acting as enforcers. If BlackRock, for example, follows through on its threat to vote against the boards of companies that do not adequately disclose their climate emissions, every major firm in every industry will be forced to report—in an auditable, replicable way—the degree to which it is meeting its commitments. And if the world’s major investors then vote against the boards of those companies that are falling behind, investors could catalyze the transformation of entire industries.
Arresting climate change will still require government action, of course, and the changes afoot in finance and the corporate world could ease the path. As firms commit to reducing their carbon emissions, they are increasingly recognizing that the most effective way to ensure that they are not undercut by lagging companies is to press for regulation. Together, they are creating a constituency for effective climate policy.
In 2017, for example, when U.S. President Donald Trump declared that he was going to withdraw the United States from the Paris agreement, the CEOs of more than 50 U.S. companies, including Apple, Gap, Google, HP, and Levi Strauss, published an open letter urging him to rethink the decision. When Trump stuck to his plan, Elon Musk, the CEO of Tesla, and Bob Iger, then the CEO of Disney, resigned from some of the president’s advisory councils in protest. More than 2,000 companies have joined a collaborative effort called “We Are Still In,” a group working to ensure that the United States meets its commitments under the agreement despite the administration’s withdrawal. The group includes not only businesses but also states, cities, religious organizations, and universities. Together, they represent 68 percent of U.S. GDP, 65 percent of the U.S. population, and the source of more than half of all U.S. carbon emissions. Such action independent of the federal government could make a big difference. According to America’s Pledge, a nongovernmental organization that tracks local progress toward emission reductions, the “full achievement of already on-the-books policies from state and local actors—paired with rapidly shifting economics in the power sector—would reduce emissions 19 percent below 2005 levels by 2025 and 25 percent below 2005 levels by 2030.” This would be a significant step toward the approximately 50 percent reduction in emissions that the UN’s Intergovernmental Panel on Climate Change estimates is necessary to avoid the most dangerous potential outcomes of climate change.
These efforts and others like them also have the potential to change the nature of the political conversation around climate change. In an increasingly partisan world, firms occupy a unique position. According to the 2019 Edelman Trust Barometer, an annual survey measuring credibility and trust, business is now the world’s most trusted institution, and 71 percent of employees around the world agree that “it is critically important” for the CEOs of their companies “to respond to challenging times.” A broad-based movement among the world’s biggest companies to tackle climate change could help legitimate the idea that climate change is a real danger, that acting to avert it could be a major driver of innovation and economic growth, and that appropriate public policy could be enormously helpful.
Such a movement could also put increasing pressure on companies that resist decarbonizing. One of the reasons that climate regulation has stalled in the United States is that a small minority of firms have invested billions of dollars in actively lobbying against it. If their peers start to push for regulation and highlight the dangers inherent in continuing with business as usual, those laggards will be compelled to change their behavior. One day soon, flooding the political process with money to defend the burning of fossil fuels could be seen as an unacceptable reputational risk—or even as morally indefensible.
For many years, experts have assumed that the fastest and most efficient route to global decarbonization is coordinated state action. But as the world’s political institutions have come under pressure, such action has become increasingly elusive. Against this background, the growing understanding that climate change presents a profound threat to the long-term returns of the world’s largest asset owners provides some reason for hope. As investors push for change and the realization dawns in more and more boardrooms that the benefits of climate action will outweigh the costs, it is possible that leading-edge firms could trigger a cascade of reinforcing reforms, transforming the economics of individual industries and creating a significant constituency for political action. For decades, when it came to addressing climate change, large asset holders and big companies acted more as obstacles than as catalysts. Those days may soon be over.
Preparing for the Inescapable Effects of Climate Change