The New Business Agenda (2): The Need for New, True Pricing Paradigms

Fundamental to the new agenda for business is the willingness to invest in long term gains for the collective over short-term returns.  One of the key elements of classic economics is the fact that we have accounted for natural capital at its extraction cost, not at its renewal or replenishment cost.  Depletion costs are an externality in this analysis and thus the cost of natural resources is set to be at or near zero, essentially free.  

True pricing includes these externalities whether they be applied to forest, land use, mineral or oil reserves, appropriately requires that a new perspective on discount rates also be incorporated into the new business agenda.     One can argue that typical (under 10%) discount rates do not fairly value the future and lead to decisions that favor short term profit maximization.  Therefore, true discounts rates are in fact much higher.

Getting the pricing right may in fact be possible for assets where there are clear property rights, the the asset is owned or controlled by individual or corporate entities.  The issues gets much muddier when dealing with the commons where pricing mechanisms or markets don't exist and complex issues of social equity/justice become large considerations. These factors are what makes the issues of climate change, conservation and environmental stewardship so complex.

The need for new pricing paradigms is not universally accepted, this change will not come easily.  Over the next 5 years, I expect continued economic and social turmoil along with moves toward both significantly increased balkanization along with increased rhetoric toward multilateralism without much progress toward resolution. During this period of turmoil in another 5 years or so when the consequences of inaction are more evident will our collective behavior change.  Hopefully, it will happen before the tipping point is reached.  

The New Business Agenda (1): The Need for a Strong, Sustainable, Balanced Economic Growth

The New Macroeconomic Reality

A shift is beginning to decouple economic growth from ecosystem destruction, natural resource depletion and material consumption toward a concept of sustainable economic development where environmental externalities (true costs) are incorporated and prosperity and societal wellbeing are the goals and define success. In future months, look for structural/behavioral economics to become increasing prominent in the discussion. 

The G8's "RESPONSIBLE LEADERSHIP FOR A SUSTAINABLE FUTURE" declares:

"The interlinked challenges of climate change, energy security and the sustainable and efficient use of natural resources are amongst the most important issues to be tackled in the strategic perspective of ensuring global sustainability. A shift towards green growth will provide an important contribution to the economic and financial crisis recovery. We must seize the opportunity to build on synergies between actions to combat climate change and economic recovery initiatives, and encourage growth and sustainable development worldwide."

Recently, France, Germany and Australia as pushing the G20 to adopt a new framework for sustainable growth, the G20 Sustainable Growth Accord.  At the same time, the field of economics is moving beyond its 500 year old roots in classical/neoclassical macroeconomics to embrace new models and methods.   

The focus at the recent G20 meeting in Pittsburgh, Pennsylvania was on the current financial crisis including much discussion on the issue of sustainable growth. The following is an output of the Pittsburgh meeting on this topic: 

G-20 Framework for Strong, Sustainable, and Balanced Growth*

1. Our countries have a shared responsibility to adopt policies to achieve strong, sustainable and balanced growth, to promote a resilient international financial system, and to reap the benefits of an open global economy. To this end, we recognize that our strategies will vary across countries. In our Framework for Strong, Sustainable and Balanced Growth, we will:

• implement responsible fiscal policies, attentive to short-term flexibility considerations and longer-run sustainability requirements.
• strengthen financial supervision to prevent the re-emergence in the financial system of excess credit growth and excess leverage and undertake macro prudential and regulatory policies to help prevent credit and asset price cycles from becoming forces of destabilization.
• promote more balanced current accounts and support open trade and investment to advance global prosperity and growth sustainability, while actively rejecting protectionist measures.
• undertake monetary policies consistent with price stability in the context of market oriented exchange rates that reflect underlying economic fundamentals.
• undertake structural reforms to increase our potential growth rates and, where needed, improve social safety nets.
• promote balanced and sustainable economic development in order to narrow development imbalances and reduce poverty.

2. We recognize that the process to ensure more balanced global growth must be undertaken in an orderly manner. All G-20 members agree to address the respective weaknesses of their economies.

• G-20 members with sustained, significant external deficits pledge to undertake policies to support private savings and undertake fiscal consolidation while maintaining open markets and strengthening export sectors.
• G-20 members with sustained, significant external surpluses pledge to strengthen domestic sources of growth. According to national circumstances this could include increasing investment, reducing financial markets distortions, boosting productivity in service sectors, improving social safety nets, and lifting constraints on demand growth.

3. Each G-20 member bears primary responsibility for the sound management of its economy. The G-20 members also have a responsibility to the community of nations to assure the overall health of the global economy. Regular consultations, strengthened cooperation on macroeconomic policies, the exchange of experiences on structural policies, and ongoing assessment can strengthen our cooperation and promote the adoption of sound policies. As part of our process of mutual assessment:

• G-20 members will agree on shared policy objectives. These objectives should be updated as conditions evolve.
• G-20 members will set out their medium-term policy frameworks and will work together to assess the collective implications of our national policy frameworks for the level and pattern of global growth, and to identify potential risks to financial stability.
• G-20 leaders will consider, based on the results of the mutual assessment, and agree any actions to meet our common objectives.

4. We call on our Finance Ministers to develop our process of mutual assessment to evaluate the collective implications of national policies for the world economy. To accomplish this, our Finance Ministers should, with the assistance of the IMF:

• Develop a forward looking assessment of G-20 economic developments to help analyze whether patterns of demand and supply, credit, debt and reserves growth are supportive of strong, sustainable and balanced growth.
• Assess the implications and consistency of fiscal and monetary policies, credit growth and asset markets, foreign exchange developments, commodity and energy prices, and current account imbalances.
• Report regularly to both the G-20 and the IMFC on global economic developments, key risks, and concerns with respect to patterns of growth and suggested G-20 policy adjustments, individually and collectively.

These are important steps in addressing the financial crisis and moving toward strong, sustainable, balanced growth.  Despite the current fiscal challenges it is possible to make significant strides towards these goals if nations are effective in execution of policies.  The OECD has done extensive work and shown there is clear benefit in job creation and growth when policies incorporate sustainability components. OECD studies have found reforming education systems could raise living standards significantly. In one finding, an additional year of education can raise GDP/capita by 4 and 7 per cent through increasing the labour supply.  This directly impacts standard of living, is a coordinated program of job creation is also put in place to create a virtuous cycle of growth.

Where will the growth and jobs comes from? ALong with the G20 frame work above. The G8 Declaration “Responsible Leadership for a Sustainable Future” includes significant and detailed language along the following theme:

"New sources of growth will have to be supported by investments in infrastructure, innovation and education to facilitate productivity growth, while ensuring sustainable use of resources in a greener economy, within a context of open markets."

While the OECD “Declaration on Green Growth” recognizes and specifically targets the opportunities for tackling global financial, environmental and social crises together in transparent and accountable ways. Specifically:

"The OECD can, through policy analysis and identification of best practices, assist countries in their efforts to respond to the growing policy demands to foster green growth and work with countries to develop further measures to build sustainable economies.

DECLARE that we:

STRENGHTHEN our efforts to pursue green growth strategies as part of our response to the current crisis and beyond, acknowledging that “green” and “growth” can go hand-in-hand.

ENCOURAGE green investment and sustainable management of natural resources. In this respect, we are resolved to make further efforts to use efficient and effective climate policy mixes, including through market-based instruments, regulations and other policies, to change behaviour and foster appropriate private sector responses. We will consider expanding incentives for green investment, in particular in areas where pricing carbon is unlikely to be enough to foster such private sector responses. Such areas may include smart, safe and sustainable low-carbon infrastructure and R&D technologies that can contribute to building a sustainable low-carbon society. Approaches to recognise the value of biodiversity should be encouraged through appropriate instruments and consistent with relevant international obligations. We are resolved to share information on green investment flows and policies, and best practices.

ENCOURAGE domestic policy reform, with the aim of avoiding or removing environmentally harmful policies that might thwart green growth, such as subsidies: to fossil fuel consumption or production that increase greenhouse gas emissions; that promote the unsustainable use of other scarce natural resources; or which contribute to negative environmental outcomes. We also work towards establishing appropriate regulations and policies to ensure clear and long-term price signals encouraging efficient environmental outcomes. We call on other major economies to follow the OECD countries’ lead.

ENSURE close co-ordination of green growth measures with labour market and human capital formation policies. We note that these can support the development of green jobs and the skills needed for them, and ask that work on implementing the Reassessed OECD Jobs Strategy pays due attention to this objective."

* Source: Leaders' Statement: The Pittsburgh Summit, September 24 – 25, 2009

I am 3,996,308,755 people old

According to UN estimates, global population is expected to increase from 6.9 billion to more than 9 billion by 2050. Roughly the same increase in population as since I was born in 1956. I find it hard to relate to these figures as they feel rather abstract but when juxtaposed against life events, as in the chart below, they seem much more concrete. Using UN population estimates, I was born when the world population was about 2,834,078,230 people. With the current world population estimate at 6,830,386,985, that makes me now about 3,996,308,755 people old.

What I Do and Why

As a teacher across two departments; one which focuses on issues of Policy, Law & Ethics and the other on issues of Strategy, Innovation & Entrepreneurship, you can say I live at the intersection of two worlds. That is my nature. Within that intersection, that confluence of thoughts, ideas, principles and disciplines, I concentrate on what I feel are the most important policy, strategy and development problems of the world today. At a time when society, individuals and education are becoming ever more specialized, I pursue the development of “the mind” at a time when great business minds are desperately needed.

We live in an age of great political, social and economic challenge on one hand and seemingly insurmountable opportunities on the other. To paraphrase Bill Clinton, the challenge before us in the 21st century is:
“… whether the 21st century will be marred by scarcity, deprivation, environmental degradation, terrorism and conflict of all kinds or whether it becomes the most peaceful and prosperous time the world has ever known.”

My ambition is to create the latter.

As Thucydides suggested in the fifth century BC, “The events which happened in the past will at some time or other and in much the same way be repeated in the future.”. The past can suggest much about the future – the nature of change, progress and its impact on society and our environment, and the interplay among human societies in times of peace and conflict. While much will change, human nature being what it is will continue to be a driving force in the affairs of the world. We must work with this nature, these instincts, not against this them in shaping the future.

The challenges faced demand the best from us as individuals, organizations and as a society. Solutions will require integrative, systemic thinking, the ability to take on and reconcile seemingly intractable problems combined with the confidence to lead change and act amidst great uncertainty. Quoting Einstein, "We can't solve problems by using the same kind of thinking we used when we created them." Thus our current challenges demand the development of great minds, engaged minds, minds with the awareness of, understanding of and commitment to solve the challenges before us. This is why I do what I do.

Dare we be optimistic about the future? To answer the question with a question, "Is there any other choice?". To address the question directly, my answer is a resounding yes.

Shifting Gears: Moving Beyond Copenhagen

In 2050, just 40 years from now, it is estimated the some 30%, about 3 billion, more people will be living on this planet. For classic growth-oriented development, the good news is that this growth will deliver billions of new consumers who want a better lifestyle. For sustainable development, the bad news is that shrinking natural resources, environmental degradation, and climate change will limit the ability of all 9 billion of us to attain or maintain the consumptive lifestyle that is commensurate with the middle class in today’s affluent markets. To resolve this conflict one must redefine the political, economic and social agenda where the global population is not just living on the planet, but living well and within the limits of the planet. “Living well” describes a standard of living where people are secure and have equitable access to and the ability to afford education, healthcare, mobility, the basics of food, water, energy and shelter, and consumer goods. “Living within the limits of the planet”, means living in such a way that this standard of living can be sustained with the available natural resources and without further harm to biodiversity, climate and other ecosystems.

Areas of focus toward a vision of a sustainable economy in 2050:

• Population growth, migration/urbanization and demographics shifts.
• Evolutionary economics the toward structural/behavioral true-value economics that include true cost of the classic externalities of natural resource depletion and environmental impact.
• Property ownership rights of both hard assets (primary property vis-à-vis De Soto) and intellectual property.
• The definition of State, the boundaries of sovereignty, the effectiveness of governance and the role of existing and emerging multilateral institutions.
• The social and economic drivers of conflict and terrorism.
• The systemic and integrated (co-dependent) nature of economic and the food, water, energy and environmental ecosystems.
• The social systems of healthcare, education, social services and urban development.
• Globalization opportunities, threats and regulation related to trade systems, financial markets, healthcare (pandemic), environmental impact, wealth creation and social/cultural diversity.
• Social and technological creativity, breakthrough invention and disruptive innovation related to products services and business models and their diffusion.
• Entrepreneurship and risk capital as an engine of sustainable development in both developed and developing economies.
• Empowerment of individuals, particularly women and youth in the developing world, the development of leaders to create radically more eco-efficient solutions for improved business competitiveness, enhanced social equity and sustainable economic development.

Each area unto itself is technically challenging, socially complex, and presents potential intractable problems. Even understanding these problems requires the integration of diverse perspectives, insight into the interconnectedness and interdependencies and the factors that amplified or attenuate efforts to implement change.

This is the path we are about to embark upon. Hope you enjoy the journey.

Copenhagen Accord Update: Good News and Bad News

The good news first:

More than 50 nations including major greenhouse gas emitters China and the United States have submitted voluntary commitments for greenhouse gas emissions under the Copenhagen Accord's January 31, 2010 deadline.

The bad news:

While the Copenhagen Accord reaffirms the goal of limiting the rise in global temperatures to below 2 degrees Celsius above pre-industrial levels, analysis of the voluntary commitments submitted will miss this goal by a wide margin. Pledges submitted to the UNFCC would allow a temperature increase to 3.9 degrees Celsius (7.0 degrees Fahrenheit) by 2100.

Much work remains to be done before COP16 in Mexico later this year.

The United States, Post-Copenhagen: Where do we go from here?

The UN COP15 climate change conference in Copenhagen ended with disappointing results but the challenges to find solutions to mitigation and adaptation continue. The UN process has no formal agenda in the near term and will not likely begin the preparation meetings for COP16 before mid-year.

The focus in the United States leading up to COP16 will be on legislation. With Waxman-Markey off the table, the focus is on the compromise Boxer-Kerry Senate bill.

1. General Cap & Trade or Cap & Trade II - Without binding agreements with specific targets and methods, cap and trade legislation is facing an uphill battle in the United States. (One could argue that a treaty wasn’t achieved in Copenhagen because the U.S. and others didn’t have legislation in place at home prior to the conference.) The Boxer-Kerry bill is seeks to bridge gaps and is looking at coupling cap and trade with new incentives for expanding nuclear power and oil and gas drilling in the United States. Essential elements for Republicans and a lightening rod for Democrats. Look for the messages to focus on national security, energy independence and job creation.
   
2. General Carbon Tax - Anything called tax is unlikely to gain any traction in the U.S. Legislature.
   
3. Limited/Focused Programs - Should general carbon legislation not pass in the U.S. Congress, other alternatives actions include:

• Incentives for Clean Energy - American Clean Energy Leadership Act of 2009 was approved months ago by the Senate Energy committee encouraging utilities and others to use more alternative, clean energy sources. These programs could be expanded although this approach but alone would not be enough to achieve the 2 degree target.

• Industry Specific Programs - Bringing high carbon industries such as utilities, cement iron and steel up to state of the art technologies and best practices. Such programs would limit emissions in specific high emission industries, while providing funding for R&D in those specific industries. Critics say it's unfair to single out one industry.

• EPA Regulation - The Environmental Protection Agency has begun taking steps to regulate carbon, in case Congress fails to pass legislation. This approach is less comprehensive than legislation and already is being hit with legal challenges.

4. Do Nothing - Do nothing at the national level. Leaving action to the sub-national regions and states. Hope for the best.

Climate Change Comes of Age: Reflections of the 15th Conference of the Parties, Copenhagen 2009

Forty-five thousand people descended on the fifteen thousand person, Bella Center in Copenhagen in early December to participate in the COP15, the UN’s Climate Change Summit. A logistical nightmare on the outside; needless to say, not all the pre-registered and credentialed attendees got into the venue. After standing in line in snow and subfreezing temperatures for 13 hours over two days, I was one of the lucky ones who got in. A failed result on the inside; the acknowledgment of the creation of the non-binding, BASIC Copenhagen Accord. A step forward…yes, progress…yes, but not what the, perhaps unachievable, pre-conference rhetoric called for. The conference was unprecedented in many ways. Every one of the 192 UN member states was represented at the meeting, which was attended 119 heads of state, the largest such gathering outside of the UN’s New York City headquarters. In many respects, this was the “coming of age” event for climate change on the global stage. What follow are highlights of my personal thoughts and reflections from participating in this amazing event and what lies ahead:

1. What happened in Copenhagen was a failure of the process, not a lack of commitment by the Parties.
   
   Attempting to create a binding treaty of this complexity with unanimous vote of 192 highly diverse members is challenging in the face of a clear and present threat, impossible on a complex issue such a climate change. First, look for the structure to evolve toward that of the WTO & WHO, smaller consensus-based subgroup, with clear voting rules and the focus to be sharper on the development of the framework of goals, monitoring, verification and enforcement policies. Second, look for increased emphasis on building financial, intellectual resources and knowledge sharing capabilities to effectively and equitably deal with climate change as a “commons” problem. There’s a big role for business schools in this arena.
   
2. COP15 was more about development than about climate change.
   
   Several countries, particularly poor low-lying or drought-stricken countries are feeling the effects of climate change now and are intensely focused on the CO2 emissions issue. For most others, the fundamental discussions in Copenhagen always revolved around questions of economics. How could development nations balance their responsibilities while protecting job and economics competitiveness? How can poor countries protect financial subsidies promised by developed countries in Kyoto and Bali? How do fast growing emerging economies minimize restrictions and continue to grow? If Copenhagen taught me anything, it taught me that economics and climate charge are even more inextricably interwoven than I have understood in the past. All of which is context for business.
   
3. Sub-national regions step into the spotlight.
   
   Arnold Schwarzenegger generated more buzz than Al Gore. Schwarzenegger along with Jose Serra Mayor of Sao Paulo spoke of the future and how sub-nationals regions such as California, Sao Paolo and others are paving the way toward green economies that are delivering both economic growth and reduced environmental impacts in advance of national initiatives. Yes, an emotional story of hope and promise, Arnold never the less spoke of actions being taken, results being delivered now and path for moving forward. Given, the outcome of COP15 and the time it will take to move to the next step, look for the groups to become immediately more active taking action on their own.
   
4. Climate Change involves politics, get used to it.
   
   Much of the world looks to the U.S. for leadership and to take a leadership role, not because it is the biggest, the most powerful or bears the greatest responsibility, but because it is one to the few nations that can and historically its record of success if pretty good. As the World looks to the United States for leadership, transparency is critical, such that its intentions and actions are clear and coherent. What others must keep in mind when looking to the U.S. for leadership is that our leaders in the Executive Branch much work with the Legislature and within the Constitution when making promises and commitments to its nation partners. This is the political process. It requires procedure and must follow protocol to be effective, and must ultimately answer to the electorate. This is true in many of the other 192 countries that have effective, representative government.
   
5. China came to play
   
   Much has been made of China’s role in the negotiations in Copenhagen and only those close to the discussions really know what went on behinds closed doors. That said, let there be no doubt, China came to play. Flexing its political and economic muscles on the world stage, China firmly established that the climate change negotiations are in integral part of an overall strategy to gain the leadership position for the coming Low Carbon Economy. Game on.
   
6. The Elephant in the Room
   
   Battling climate change is a global challenge where technology will play a central role, in many ways analogous to that of vaccines and pharmaceuticals in fight for global health. Most fundamental research and technology development will occur in the developed world with a need to be transferred and deployed, whether in its original or locally modified form, in many third world countries. As with the intellectual property issues of pharmaceuticals in global trade environments, I expected to learn about Intellectual Property Rights (IPR) issues being central to the discussion in Copenhagen.
   
   While IPR was not a prominent theme of the week and language was not explicitly included in the Copenhagen Accord IPR is the elephant in the room. Moving forward beyond Copenhagen IPR solutions could follow a number of paths ranging from; developed countries having no patent protection on green technology, to setting up a patent pools for green technology, to ensuring that developing countries can make full use of the flexibilities found in the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) - including compulsory licensing - and cooperation on future research and development of green technology. Stay tuned.
   
   7. For Want of a Price
   
   Governments want it. Economists want it. Regulators wanted it. Investors want it. Industry wants it. NGOs want it. What is it? Honest, fully–cost pricing, where environmental costs (carbon emissions) are incorporated in product pricing. Copenhagen didn’t provide it. Without a regulatory framework in place and resulting price set for carbon emissions, market forces cannot be leveraged to address these challenges on a universal basis. While pricing was not to be and should not be set in a forum such as the UNFCC, the failure to achieve a binding agreement puts the carbon markets into limbo for at least another year, until COP16 in Mexico.

Climate change came of age in Copenhagen, but much work remains to be done. Research-oriented business schools in large universities, such as Boston University, are in a unique position to participation in the coming transformation to a sustainable economy. Not only will this experience find its way directly into my teaching this spring and it also shines a light on emerging field, rich with research opportunities and new curriculum development in areas such as, of policy, economics, finance, operations, innovation and technology commercialization, while shaping a vision of the future an the role academic institutions will play in the development of the sustainable economy.

Is the concept of the nation-state getting in the way?

On the 12th day after Copenhagen a final conclusion came to me….

Will climate agreements will follow the evolution of trade agreements? I believe as trade agreements have evolved beyond the multilateral agreements envisioned when the WTO was formed in 1995 toward a wide variety of regional/local trade agreements, so too will, will climate agreements.
Multilateral negotiations need to focus on getting the policies/infrastructure right, establishing emissions targets, timing and carbon pricing policies, (managing the commons) but leave bottoms-ups implementation to entities at the local level. A combination of clears goals with flexible execution will address the technological investment challenge, prove to be economically feasible and politically the most practical.
Success in has been achieved at the regional level, in the U.S. California and Sao Paulo, Brazil were strict climate legislation has been put in place in advance of national level legislation without dampening economic development. Many other regional initiatives are being formed, in Asia, Latin America and most recently in New England/Mid-Atlantic regional in the United States. The EU is also moving in this direction as it tries to cope with differences between the oil dependent west and the natural gas dependent east.
Is the concept of the nation-state dead and ready to be cast aside? No, not in our lifetimes, but as with trade & natural resources, there is there is comparative advantage in regional areas on energy & energy resources that dictate a regional approach to implementation within the larger multilateral frame work.

For Want of a Price... A Climate was Lost

Much of the focus and cause of the non-result in the Copenhagen climate negotiations has on the “how” of climate change and opposed to the “what” in terms of targets. (We Have It Backwards - Dec 21, 2009). Focusing exclusively on reductions from historical emissions has greatly hampered the negotiations thus far, but is in fact only half the problem. While targets may satisfy the need on the policy side of the issue, they do not satisfy the need on the market side. A price signal in needed to make the market work, but way the negotiations are going now, the markets must wait for the political process to set pricing on carbon. Focusing on energy as a driver of climate change, the lack of pricing hampers mitigation efforts in three profound and related ways in terms of production, distribution and consumption.

First, on the consumption side, the lack of a price on carbon is leaving the low hanging fruit of energy efficiency investments still hanging on the tree. The now famous Mckinsey study demonstrates approximately 40% of the emission reductions could be achieved by conservation/efficienty investments that have a positive NPV. (Left half of Exhibit 1 below.) While these investments currently have a positive NPV without carbob porcing, setting a price for carbon will give consumers a complete picture of the true cost of their energy, demonstrate even shorter payback periods and should drive more rapid adoption of conservation/efficiently measures. At the same time, it will justify investment in the information infrastructure necessary support this implementation of these systems.

Source: McKInsey Study "Unlocking Energy Efficiency in the U.S. Economy"

Second, the economic uncertainty surrounding investments in new technologies, be they wind, solar, electric vehicles, carbon sequestration or others, is a significant barrier to investment in the potentially beneficial technologies. Here again, carbon pricing establishes true cost and allows industry players to develop confidence in their risk-adjusted return models for investments in these areas. A price on carbon makes investments on the right side of the chart (Exhibit 1) more attractive.

Finally, lack of discussion on carbon pricing has greatly hampered negotiations on climate commitments form the standpoint of developing countries where the uncertainty about the future and the cost is greatest. Carbon pricing offers a transparent and verifiable assurance of the comparability of effort across countries and incorporating price-based commitments into the treaty along with an emissions goal also establishes a basis for compliance during, as well as after, the treaty has expired. Ultimately, carbon pricing would clearly establish a leapfrogging strategy to clean emerging technologies in developing countries would be a clear advantage while diminishing the need for aid or new financing mechanisms beyond traditional sources from the World Bank/IMF.

Moving forward, a price-based framework has several advantages over the historical emissions based approach. It would get investment moving now rather than later, could break the log jam in the current negotiations and be enacted by COP16 in Mexico City next year.