A Powerful and Knowledgeable Critique of ESG

Sustainable: Moving Beyond ESG to Impact Investing, by Terrence Keeley (Columbia Business School Publishing, $29.95, 320 pages)

U ntil June 2022, Terrence Keeley worked for BlackRock as managing director, global head, and senior adviser of the Official Institutions Group (OIG). There he oversaw BlackRock’s relationships with “central banks, sovereign wealth funds, finance ministries, and supra-nationals around the world.” In addition, he led the firm’s “education.” There may not be a single person on earth better qualified to assess the results of the experiment of environmental, social, and governance (ESG) investment. In his book, Sustainable, Keeley does just that.

ESG began in 2004 as an attempt to globally coordinate capital regulation and allocation and direct them towards particular environmental and social goals. As of late last year, the total amount of funds managed by firms using “ESG-integrated strategies” exceeded $120 trillion. ESG integration means that “funds seek to enhance their financial performance by analyzing material ESG considerations,” according to Keeley. For years, $8 billion per day had been moved into explicitly ESG-labeled funds.

It’s perplexing, therefore, when just a few pages later Keeley refers to the remaining advocates of shareholder primacy as “defenders of the status quo.” Surely, the true defenders of the status quo are the ones integrating ESG into $120 trillion in assets under management, not the remaining implacable adherents to the Friedman doctrine, armed with blogs, Wall Street Journal op-eds, and perhaps red-state legislation. This is the central problem for ESG and stakeholder-capitalism advocates. They’ve caught the ball and wonder why everyone’s trying to tackle them.

Despite this and other notable blind spots, Keeley considers both sides of the ESG debate, and attempts to split the baby. In brief, Keeley judges that the ends of ESG are sound, but not its means.

“We’ll first need to agree upon ends,” Keeley tells us, prior to “a more fulsome discussion of means.” While he is widely read, he may have passed over Friedrich Hayek’s Law, Legislation and Liberty. The Austrian declared that “the possibility of men living together in peace and to their mutual advantage without having to agree on common concrete aims, and bound only by abstract rules of conduct, was perhaps the greatest discovery mankind ever made” (emphasis added). The sustainability of ordered liberty is never guaranteed. Hayek warned that “the attempt to secure to each what he is thought to deserve, by imposing upon all a system of common concrete ends towards which their efforts are directed by authority . . . would deprive us of the knowledge and aspirations of millions, and thereby of the advantages of a free civilization.”

Hayek, of course, warned of socialism. But that critique could just as easily be applied to ESG.

Back to Keeley. The goal to which he urges our agreement is “inclusive, sustainable growth.” He identifies it with the United Nations’ Sustainable Development Goals. Even assuming the reader agrees with the general premise that the economy should be directed to some specific goals, the U.N.’s agenda is obviously not the one to choose.

Take the U.N.’s fifth goal: “Achieve gender equality and empower all women and girls.” As Richard Reeves of the Brookings Institution has argued, gender equality should include a concern for when men fall behind as well. Indeed, male labor-force participation has fallen for generations. Meanwhile, men face elevated rates of suicide, drug-overdose deaths, and incarceration. Men have much lower rates of college-degree attainment, and in general lower educational performance and worse health. Imagine, though, a single ESG enthusiast’s declaring that their “gender equality” efforts were focused on increasing male well-being. When ESG advocates speak of “gender equality,” equality is not necessarily what they have in mind.

Corporate diversity, equity, and inclusion (DEI) efforts similarly often focus on the U.S. government’s racial- and ethnic-classification regime. Yet, as George Mason University’s David Bernstein has shown, these categories “have no valid scientific or anthropological basis.” For example, “the government may classify a fair-skinned Spanish immigrant as Hispanic,” but an immigrant from Egypt, Iran, or Afghanistan is always “white.” Unsurprisingly, conventional DEI efforts do not seem to work. A better approach could be to focus on the dignity and unique gifts of every individual, rather than lumping them into quotas or categories.

Keeley therefore is unlikely to build consensus around ESG’s ends. His critique of ESG’s means, though, is devastating. The arguments may not be new to NR readers, but they are notable when coming from a book with a foreword written by BlackRock CEO Larry Fink.

On Fink’s comparison of ESG to mortgage securities, Keeley writes, “We learned in the global financial crisis that officially sanctioned bubbles portend deeper troubles. . . . Good intentions create unsustainable market valuations. When those valuations correct, hell can be unleashed.” He notes on the next page, “About one thing there should be no debate: the current ESG investment phenomenon has all the makings of a potentially catastrophic investment bubble.”

ESG was supposed to mitigate systemic risk; in fact, ESG is creating it. ESG’s focus on Western companies means increased revenue for China, Russia, and OPEC nations, for no environmental benefit. When the West invests less in future production, or sells off assets to other nations, the rest of the world is more than happy to keep meeting global demand. Keeley therefore urges ESG investors to switch from divestment strategies to engagement. This is ultimately counterproductive, however. Engagement simply moves the locus of divestment from the portfolio to the firm, where it’s harder to mitigate.

Keeley notes, “[ESG-motivated] shortsightedness in Europe and the United States meant revenues for Russia’s state-owned energy champions and war funds for Putin’s decimation of Ukrainian cities and citizens.” Chevron boosted its ESG credentials by selling 75 percent of its South African assets to China’s Sinopec. Surely that will save the planet. As Steven Soukup joked, it’s too bad “Suicide of the West” is already taken as a book title.

Confronting ESG’s manifest failure, Keeley suggests the “1.6 Percent ‘Solution.’” It involves annually dedicating 1.6 percent of the $220 trillion controlled by the largest investors to impact investing, while the rest is traditionally managed. The percentage is intended to yield the $3.5 trillion per year of private money supposedly needed to achieve net-zero carbon emissions by 2050. Such a private, delineated effort would surely be preferable to trying to reengineer the whole world economy to ESG specifications. So long as the U.S. government is doing so much to entrench the current ESG paradigm, however, innovative approaches such as Keeley’s may stand little chance of success.

In the end, the readers, even those who may disagree with some of Keeley’s conclusions, should be thankful Keeley published a powerful and knowledgeable critique of ESG so soon after leaving BlackRock. And Larry Fink’s foreword suggests that concerns with ESG may not be limited only to former BlackRock executives.