Writing in the Wall Street Journal, David R. Henderson and Marc Joffe highlight the way in which ESG (a form of socially responsible investing in which actual or prospective portfolio companies are measured against various environmental, social, and governance benchmarks) may contribute to inflation.
To take a step back (and to oversimplify), there are two halves to the inflationary equation. Too much money. Not enough goods. As Henderson and Joffe argue, pressure from investors who have adopted an ESG approach (a type of investor, I would add, that stretches far beyond those offering a specifically designated ESG product) can lead companies to operate in a way that, economically, is suboptimal. Put another way, that is likely to mean that they produce less than they otherwise would, or (and this too would put upward pressure on prices) their production is not as efficient as it could be.
Henderson and Joffe:
When companies focus solely on maximizing profits, their principal aim is to produce more at lower cost. Admittedly, some profitability strategies—such as constraining supply—are at odds with maximizing output. But that’s impossible without an organized and powerful monopoly. Even companies with great monopoly power lose that power over time as competitors arise. In a competitive market, corporations serve themselves and consumers by making more for less.
ESG investing and the management practices it promotes, however, usually increase production costs and constrain capacity. If a company diverts resources into a formal diversity, equity and inclusion program, with all its attending human-resource hires and bureaucracy, it will have less resources available to conduct product research and development. Similarly, if a company whose core competence is oil and gas production chooses to move into wind and solar 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—in the same way taxes will…
To get the U.S. economy back on a path to sustainable growth and low inflation, the Fed must rein in excess liquidity, as it is now doing. But that alone won’t be enough. Businesses, investors and those advising them must push back on ideas such as ESG that undermine corporate productivity.