ESG Feeds Inflation, Hurts Economic Growth

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Under my contract with the Wall Street Journal, I am now free to post this article.

ESG Feeds Inflation, Hurts Economic Growth

When companies divert their attention to social goals, they produce less, driving prices higher.

By David R. Henderson and Marc Joffe

With inflation running at a four-decade high, it’s time to reconsider the idea that the economy will benefit if corporations sacrifice their bottom lines in favor of environmental, social and governance considerations. The truth is that diverting corporate attention away from long-term profitability depresses output and raises prices.

In 2019 the Business Roundtable, an association of large companies’ CEOs, abandoned its longstanding dedication to the idea that the “purpose of a corporation” is to maximize shareholder value. Instead, the group argued, businesses should follow a “multistakeholder” model. If corporate management gave a shifting set of ESG concerns priority over long-term profit maximization, the roundtable believed, firms could create “an economy that serves all Americans.”

It hasn’t panned out that way. 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.

Milton Friedman showed that raising the money supply’s growth rate increases the rate of inflation. But it’s also true that slowing the growth of overall output can increase inflation. If we think of the economy as one giant market in which we trade dollars for anything that dollars can buy, reducing the supply of available goods increases the price level, all else being equal. If enough companies focus on ESG priorities, then, they risk higher inflation and slower growth or stagflation.

That isn’t to say that the general principles ESG emphasizes are undesirable, but that it’s more important to do good than to be labeled good. A company can be profitable with a diverse workforce without having a formal DEI policy. And such a company will ultimately serve a diverse group of Americans better by providing them more goods at lower cost.

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.

Mr. Henderson is a research fellow with Stanford University’s Hoover Institution and editor of the Concise Encyclopedia of Economics. Mr. Joffe is a senior policy analyst with the Reason Foundation.

David R. Henderson and Marc A. Joffe, “ESG Feeds Inflation, Hurts Economic Growth,” Wall Street Journal, July 5, 2022 (July 6 print edition.)



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