ESG feeds inflation, hurting economic growth

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ESG feeds inflation, hurting economic growth

When companies shift their focus to social goals, they produce less, raise prices.

By David R. Henderson and Mark Joffe

With inflation running at four-decade highs, it’s time to rethink the idea that the economy would benefit if corporations forsook their bottom lines in favor of environmental, social and governance considerations. The truth is that diverting corporate attention from long-term profitability reduces output and raises prices.

In 2019 the Business Roundtable, an association of large company CEOs, abandoned its longstanding commitment to the idea that “the purpose of a corporation” is to maximize shareholder value. Instead, the group argued, business should follow a “multistakeholder” model. If corporate management prioritizes a shifting set of ESG concerns over long-term profit maximization, the Roundtable believes, companies can create “an economy that serves all Americans.”

It didn’t pan out that way. When companies focus only on maximizing profits, their main goal is to produce more at less cost. Of course, some profitable strategies – such as limiting supply – are at odds with maximizing output. But this is impossible without an organized and strong monopoly. Even companies with great monopoly power lose that power over time as competitors emerge. In a competitive market, corporations serve themselves and consumers more at lower costs.

ESG investing and the management practices that promote it, however, typically increase production costs and limit capacity. If a company diverts resources to a formal diversity, equity, and inclusion program, including all of its participating human-resources hiring and bureaucracy, it will have fewer resources to conduct product research and development. Similarly, if a company whose core competencies are oil and gas production chooses to move into wind and solar energy despite having limited expertise in these modes, its output will suffer. In general, an investment framework that de-emphasizes production in favor of social objectives will divert money away from efficient producers—as will taxes.

Milton Friedman showed that increasing the growth rate of the money supply increases the rate of inflation. But it is also true that inflation may increase if aggregate output growth slows. If we think of the economy as a giant market where we trade dollars to buy dollars, reducing the supply of available goods raises the price level, all else equal. If enough companies focus on ESG priorities, then, they risk high inflation and slow growth or stagnation.

This is not to say that the general principles that ESG emphasizes are undesirable, but that doing good is more important than labeling good. A company can be profitable with a diverse workforce without a formal DEI policy. And such a company would ultimately better serve a diverse group of Americans by providing more products at lower costs.

To return the US economy to a path of sustainable growth and low inflation, the Fed must rein in excess liquidity, as it is doing now. But this alone will not be enough. Businesses, investors and their advisors must turn back ideas like ESG that undermine corporate productivity.

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

David R. Henderson and Mark A. Joffe, “ESG Feeds Inflation, Hurts Economic Growth,” The Wall Street JournalJuly 5, 2022 (July 6 print edition.)

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