[REPORT] Stakeholders go to war. Stakeholder capitalism and ESG in a new reality

• Russia’s aggression against Ukraine has resulted in the greatest increase in geopolitical risk in decades, which increases the likelihood of stagnation coupled with high inflation in Western countries. The increase in geopolitical risk brings with it a significant increase in uncertainty about global economic policy, driven by both sanctions and the further course of monetary and fiscal policy. Given the magnitude of the increase in uncertainty about global economic policy following the outbreak of war, the negative impact on U.S. investment can be estimated at -4.6 percent.
• The concept of stakeholder capitalism (SC) and investing based on ESG (environmental, social and governance) criteria are gaining prominence in international business and politics, contributing before the outbreak of war to, among other things, making it more difficult for arms, mining and other companies in sectors perceived as “unsustainable” to obtain financing. A strong impetus to promote the SC model and generally criticize the market economy was provided by the COVID-19 pandemic, which raises serious questions as the cause of this crisis was not market processes.
• After February 24, however, ESG came under criticism. One reason was that ESG funds held at least $8.3 billion in Russian assets just before the war. Available research and analysis allow us to form the thesis that this was not an ” work-related accident,” but is a consequence of structural, internal weaknesses with which the ESG-based approach to investing is burdened. The problems with SC – related to inconsistent economic incentives, inability to align preferences, and measuring impact against different stakeholders and ESG factors – are analogous to the unsolvable problem of economic coordination under socialism.
• The possible reconstruction of the economic model toward stakeholder capitalism with ESG in the radical variant will reinforce the negative impact of war on the economy and society. “Equalitarian” variant of SC together with ESG implies reducing the importance for owners’ interests and subordinating the company’s financial result in favor of non-financial results. The implementation of such an agenda will mean a very far-reaching and costly interference with economic freedom, whether of entrepreneurs, investors, or consumers.
• Stakeholder capitalism with ESG will contribute to the deterioration of capital productivity by distorting decisions at the level of firms and financial investors. Capital will be invested in less profitable projects (given the average), as well as there will be increased non-investment spending, but related to the pursuit of various non-financial objectives, often imposed by powerful stakeholders and the most powerful of them all – the government.
• The result of lower quality of investments will be less value added produced by companies, which can be shared among various stakeholders in the form of profits, wages or taxes, or price increases – i.e. lower consumer welfare. In the context of inflation, one of the most commonly cited examples of ESG distorting markets is that on the one hand it stimulates demand for green technologies, while on the other hand it worsens financing conditions for companies that extract the necessary raw materials (most often metals) for these green technologies. This in turn may slow down the transformation of economies towards climate neutrality and significantly increase the costs of this process.
• The outbreak of war in Ukraine along with intensifying geopolitical rivalries have undoubtedly complicated the prospects for implementing a radical version of stakeholder capitalism. With rising inflation, high debt, energy supply concerns, and the specter of a food crisis, policymakers in the West are likely to focus on addressing those key issues that will determine voter support. For many politicians, the risk of destabilizing the economy even more will be too great and they will probably decline to take it.
• Policy makers will align different policies to increase the coherence of the goals pursued, as exemplified by the EU in the areas of energy and climate. Difficult trade-offs and greater pragmatism in the approach to decarbonization will be required. Research indicates that increased geopolitical risk leads to accelerated green energy development, which in the case of the EU would both reduce GHG emissions and reduce dependence on Russian imports. A more pragmatic approach to SC and ESG can also be expected from the private sector, including the financial sector – especially in a situation of high inflation and dynamic changes in interest rates.
• In the fight against climate change, actual technological innovation, new business models, and the cost of CO₂ emissions, whether in the form of emission allowances or carbon taxes, will be far more important than ESG metrics. Not only is stakeholder capitalism not necessary for decarbonization, but it may even inhibit the process by negatively impacting investment decisions and industrial productivity. The prevalence and intensity of promotion of the stakeholder capitalism model is surprising in the absence of a robust theoretical framework and convincing empirical evidence. There are no theoretical or data-driven arguments to justify that implementing SC is necessary or optimal.

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