Global Finance Can’t Afford to Ignore Externalities Anymore

(Bloomberg) -- We are all grappling with coronavirus right now—both the immediate reality and what it means for the future. Governments are assuming a much bigger role in the economies of developed countries, propping up households and businesses that would otherwise be ruined by the desperate measures being taken to stop the spread of disease.

This crisis has dramatically illustrated something that climate change has been demonstrating in fits and starts over years. Finance assumes a stable, benign world, in the same way that a person with good health insurance might assume they’re protected from the broken health-care system that many of their compatriots have to endure. But that’s a fallacy.

The pandemic has shown us that our financial system—and private capital in particular—just doesn’t adequately account for the often messy and fragile world we inhabit. We may now be at a point where it’s no longer possible to ignore this. Here are a few things we may be force to reckon with:

The real world has hard constraints

The idea that our economies could be constrained by the physical limitations of our planet has often been derided because of the triumphs of technology, innovation, and demographics. The 19th century economist Thomas Malthus failed to see how falling fertility would confound his predictions of overpopulation and famine. Those who predicted “peak oil” in the 2000s were disproved by the U.S. shale oil boom. The 1972 book “The Limits to Growth” is now mostly remembered as a punchline rendered absurd by the 1980s boom.

The coronavirus outbreak demonstrates that we should pay more attention to risks, no matter how unfamiliar, because real-world constraints have an unnerving knack of creeping up on us. That should make expertise in health and ecology more sought-after, both in finance and in general policy-making. This sphere of relevance includes not just atmospheric changes, but also soil and nutrient depletion, water availability, and chemical and particulate poisoning.

Modern society has been quite good at dealing with high-frequency, low-impact disruptions, but bad at managing low-frequency, high-impact crises. If we’re learning anything from this pandemic, it’s that both matter.

There are no easy hacks for a global crisis

The digital advances of the past decade have expanded our confidence that everything can be app-ified: efficiently and easily distributed, quickly and at a low cost. The equivalent in finance is the conviction that every risk can be securitized and transferred to whomever is most prepared to bear it.

This attitude even extends to the climate scene, where carbon pricing has been popular because it avoids contending with the messy specifics of individual sectors and activities. Solar installers and wind farms have prospered because they’re so scalable; their core machinery is an almost commodified product that can be deployed in similar fashion almost anywhere in the world. Investors such as BlackRock Inc. have even tried to carry this logic across to financing our adaptation to climate change.

The attraction of all these approaches is that they allow private enterprise to step in on climate change at a time when public policy is too slow or actively obstructive. This pandemic is showing that we can set our sights higher than such make-do answers. Politics is the most scalable solution to real-world problems we have. Rather than retreating from it, people working in climate will have to engage with it even more closely in future.

Externalities are back

Investors and policymakers will have to be much more conscious of their reliance on complex and fragile systems. Externalities—costs or benefits that aren’t reflected in market pricing—are by definition ignored in most financial decisions.

We’re now living through a powerful demonstration of the problems with that way of thinking. The benefit of having a functional public health system isn’t priced into the market in normal times; now it’s making a decisive difference in guiding the fates of entire nations. Having great personal private health insurance is of limited benefit when the system around you is collapsing because your compatriots don’t.

That should guide a re-evaluation of many parts of our society. “Gig economy” companies like Uber, in the view of short-seller Jim Chanos, are doomed because their business model of labor and regulatory arbitrage won’t be tolerated after governments have to bail out their non-employee “contractors.” We may already be seeing this belief in the resilience of ESG investment products against broader index products and “sin stocks.”

There’s probably no single externality on the planet larger than carbon emissions. Even as rising carbon dioxide takes its devastating toll on our atmosphere, oceans, and individual lives, many countries still provide direct public subsidies for transport fuel and spend vast sums of money on security for the global petroleum trade.

As the world recovers from coronavirus, it will be looking with fresh eyes at its resilience in the face of global threats—and asking anew whether we’re investing to avert future catastrophes. Those changes must be made soon if we’re not to look back at this episode as a mere prelude to still-greater global disasters.

©2020 Bloomberg L.P.

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