ESG marks the beginning of capitalism 2.0

Glasgow is not just the city hosting the United Nations’ COP26 climate summit, it is also the city where the Scottish moral philosopher Adam Smith (1723-1790) wrote his most important works. As an economist, I find that connection striking, because Smith is widely regarded as the father of modern economics. He is also regarded as one of the founders of classical liberalism, the breeding ground for the capitalism-based society.

The self-interest of capitalist society

In his best-known book The Wealth of Nations (1776), Smith writes that ‘the most just society is the result of citizens wisely pursuing their own interests’. Seventeen years earlier, he had already indicated in The Theory of Moral Sentiments that this self-interest must be seen ‘in the context of the responsibilities of that citizen’. According to Smith, the self-interest of capitalist society is ‘based not on selfishness, but on concern for others, from an understanding of one’s own position’.

Man as a consumer or as a worker

In the two centuries since Smith’s death, his view has become a bit clouded. Particularly during the industrial revolution, capitalism took on the form we are familiar with, which is purely focused on the economic domain: man as a consumer or as a worker. 

Henry Ford is often cited as an example by economists of an entrepreneur who put this principle in practice. The American automaker came up with the assembly line to produce its T-model. As a result of this efficiency leap, the price of a T-model fell by almost two-thirds. In 1914, Ford started paying its employees the - at that time - high wages of five dollars a day, so that the cars produced became affordable for the employees themselves.

Maximizing GDP

This ‘industrial capitalism’ has served us really well for a long time as it created a lot of value in terms of higher incomes and better living standards. In addition, this capitalism was attractive because we could pursue only one single objective: for companies it was profit or shareholder value, for countries the gross domestic product (GDP). Over the past decades, the major industrialized countries have been mainly concerned with maximizing their GDP. A country’s government could be satisfied if it could point at an impressive GDP growth number, just like a company’s board could be pretty proud if it could show high profits.

The Limits of Capitalism

We are reaching the limits of Adam Smith’s capitalism. GDPs are barely growing to begin with, but more importantly we are increasingly dealing with undesirable side effects of mono-variable maximisation. The limits to what the environment can bear have come very close. Excluded groups grow in numbers and express their displeasure. Just to name two examples. While pursuing the monetary goal, we pass the associated costs (the external effects) on to others: future generations, society, the environment.

Responding to megatrends

It has been clear for some time to economists that this cannot go well for long. During the climate summit in Glasgow, most politicians also indicated that it is ‘1 to 12’; when it comes to climate change. But capitalism 2.0 is more than global warming and the environment. Other megatrends such as the possibilities of technology, demographic developments and economic and political power shifts also raise the question of how governments, organisations and citizens should respond.

To help us making sense of the cloud of side effects, we at PwC have developed the ADAPT framework. ADAPT (Asymmetry, Disruption, Age, Polarisation, Trust) stands for urgent, global issues to which we must find an answer together in the coming years. COVID-19 has made these trends more visible and more acute.

Contribution to people, society and the environment

It is now clear that we have to take into account more criteria than just the gross domestic product or profit figures to determine whether our prosperity and well-being are growing. Organisations derive their right to exist in the long term from what they contribute to people, society and the environment. 

That is why the United Nations established the Sustainable Development Goals (SDGs) for countries in 2015. Those seventeen goals together are promoted as a multivariable basket of components of ‘decent development’. The term ‘broad concept of prosperity’ has come into use in the Netherlands. 

For companies, the focus has been shifting from shareholder value to stakeholder value first, since the beginning of this century. Then society and the environment were added as stakeholders. And with that, the ESG themes (environmental, social and governance) were born.

Regulations surrounding ESG

ESG indicators don’t emerge out of nothing, they have to be developed. Authorities have taken on the task of finding out what indicators would be needed as a proxy for ‘decent performance’ of companies and institutions. Rightly so, because it is up to governments to orchestrate the transition to capitalism 2.0. 

The process of establishing the proper ESG goals may look a bit messy today, but I think in a few years we will realize that we are just taking the first baby steps. It is no surprise that we now see how extremely difficult it is to neatly define which measures express exactly what we believe to be ‘good climate’, ‘neat income distribution’, ‘healthy living conditions’ or ‘decent management’. Not to mention how you measure that objectively, for different kinds of companies in different industries and different geographies and cultures.

ESG will be a cornerstone of capitalism 2.0

We may come to look back melancholically at those simple days in the 20 th century when capitalism boomed pursuing a one-dimensional objective. But in the coming years we will undoubtedly grow towards appreciating and embracing a brand-new mature set of instruments. On which there will be a considerable consensus, eventually. 

There is no way back, is what the planet and the people are telling us. Organisations will have to face the inevitability, and prepare. Capitalism 2.0 carries the potential of another century with decent prosperity development for mankind and the planet.