Commentary: An Unexpected Climate Hero is Equity Markets

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by Joakim Book


Joesph Stalin allegedly said that the “death of one person is a tragedy; the death of one million is a statistic.” Fitting neatly with his horrendous ideology, our brains are simply not equipped to understand suffering of astonishing proportions – for a single person suffering we feel empathy; with millions we blink cluelessly before looking away, dumbfounded.

Statistics is hard – and doing statistics carefully and informatively is rare. But it’s still our best way to understand the world.

Steven Pinker, the Harvard cognitive scientist and popular intellectual, has repeatedly made this point, for instance in his 2018 book Enlightenment Now!:

“the moral value of quantification is that it treats all lives as equally valuable,” (p. 173)

or his rejoiner to his critics, published by Quillette earlier this year:

“looking at numbers is the moral, compassionate, sensitive way to deal with human suffering. It treats every life as equally precious, instead of privileging members of the tribe or victims that are photogenic or conveniently nearby.”

In the preface to his book The Great Escape, Nobel Laureate Angus Deaton makes the same point:

“how little we can say without [measurement] and how important it is to get it right.” (p. xiv:)

It’s emphatically not the case that all numbers are wrong or all statistics is fishy (or “lies” as in the apocryphal Mark Twain quote). “Calculation,” Steven Landsburg pithily concludes, “like logic, is your friend.”

Activists, populists and extremists of every kind repeatedly fail this basic test. They don’t deal with numbers (sometimes they even take pride in rejecting them) and are totally untroubled with whether their factual statements about the world align with the best quantitative research.

A particular ill is the attachment to poorly made linear projections that doomsday-sayers and environmentalists unfortunately exemplify. In these times of globalization, winner-takes-all network effects, non-linear relationships become the new norm: “More is different,” as the physicist Philip Warren Anderson presciently wrote in the journal Science in 1972; believing that the world is linear and easily-extrapolated on the experience of the recent past is a huge mistake.

A good illustration of this is the belief about the number of fellow humans on Earth – a development we should cherish by the way, not lament. The growth rate of global population peaked in 1969 and the number of births per woman today (around 2.5) is approaching replacement rates. The number of children in the world has already leveled out at 2 billion and the human population will stabilize at around 9-10 billion people.

Untroubled by such mere quantitative quibbles, the view of the world in the 1970s was very different, a persuasion that remains with us today. It had taken humanity something like 200,000 years to reach 1 billion people, another 123 years to double, then 33 years to reach 3 billion and only 14 years to reach 4 billion in 1974.

The exponential trend here (actually, it was only briefly exponential in the mid-20th century, after which the growth rate has been steadily diminishing) fooled more than one demographer and environmentalist activist. In 1968 the doomsday prophet and biology professor Paul Erhlich pronounced imminent famines in his The Population Bomb!, the first Earth Day event took place in 1970, and the infamous The Limits to Growth report by the Club of Rome was published in 1974. Thanks to capitalism and technology and cheap access to life-saving medicine, none of their dire projections came true, as fertility rates dropped like a stone when billions of people got richer.

We are living through a similar time today, when “overpopulation” is making a comeback, runaway resource use (whatever that means) is allegedly threatening our civilization, and CO2 emissions and rising sea-levels will literally swamp us all.

Beware the mistaken linear projections. More is different and the profound insight of Simon Kuznet’s famous curve from the 1950s is more relevant than ever.

Even while developing countries fuel their growth with fossil fuels, the world as a whole is getting more economic bang for their CO2 emitting bucks, and rich countries have long since passed their peak use (demand-induced, mind you, not supply-constrained) of almost all raw materials. Economic growth trumps damage from climate change – and poor countries’ agricultural yields “depend far more on whether [they] get access to tractors, irrigation, and fertilizer than on climate change,” writes Michael Shellenberger in a thoughtful piece.

Harmful consequences of climate change are falling disproportionately on the world’s poorest, simply because they have fewer ways and financial resources to protect themselves; the best way to guard oneself, individually and as a country, against negative impacts of climate change is to get rich as fast as humanly possible.

One contribution may come from a surprising sector: financial markets. Take a recent paper by Ralph De Haas, Director of Research at the European Bank of Reconstruction and Development, and Alexander Popov, principal economist at the ECB. Using cross-country data from 48 countries over 24 years, they find that the more a country’s financing comes from stock markets (equity) rather than credit markets (debt), the lower per-capita CO2 emissions.

The authors’ main conclusion is that given the level of economic development, the size of the financial sector and a country’s environmental regulation, per-capita CO2 emissions are “lower in economies that are relatively more equity-funded.” The conclusion is pretty sensational. It

“suggests that equity markets have a genuine cleansing effect on polluting industries and do not simply help such industries to outsource carbon-intensive activities to pollution havens.” (p. 3)

The paper, like most papers, doesn’t lack in conceptual problems – can the equity financing of green tech really be captured by broad stock market capitalizations? Do we appropriately control for the right things and separate identification from Kuznets-curve trends? – nor in its rendition by the popular press. Yuko Takeo at Bloomberg summarized the paper too briefly and her editor misconstrued the title into buying stocks reduces CO2 emission, which is clearly not the case.

How big is this financial greening effect of which you speak?

As with everything in economics we have to ask “how much?” Statistically speaking, not only does the significance level of using an appropriate model matter, and the coefficient – how big is the impact?

According to De Haas and Popov’s paper, a 1 percentage point move in their main explanatory variable is associated with a -0.0024 kilo-tonnes reduction in per-capita CO2 emissions (discard the “kilogram” typo in their paper). An earlier version of the paper, using a different instrument, reported -0.0049, but how much is that anyway?

More concretely, controlling for the depth of a country’s financial market, incomes, population and environmental regulation, the move from, say Sweden – a country where bank-based financing constitutes around two-thirds of private sector lending – to the level of the UK – with almost equal parts equity-finance and bank-financed lending – would reduce per-capita emissions by about 36kg (75kg in the earlier version), or about 0.6% of the average Swede’s emissions. Not revolutionary, but neither is it nothing.

The authors hypothesize that an average move towards at least equal parts equity and credit financing across all 48 countries could involve a total reduction of CO2 emissions by around 12% (p. 20). Again, not life-changing, but definitely nothing to discard.

Interestingly, neither environmental protection nor GDP-per-capita contributed much (if anything) to reduce the emissions of the countries in the study. The deeper question is why equity finance has this greening effect on economies, and the authors offer a few potential reasons.

First, there are good reasons to believe that banks have shorter time horizons than equity markets (discount all future earnings vs simply earnings over the course of the loan).

Second, banks’ lending is probably more conservative while equity markets are more speculative, thus fueling growth at the technological forefront.

Third, the industry-level section of the paper shows that equity markets effectively reallocate investments “towards more carbon-efficient sectors.” (p. 26).

Fourth, deeper stock markets have more green patents and it seems likely that equity financing pushes innovations of green technology – an effect that was especially marked in carbon-intensive sectors.

Lastly, equity holders as residual claimants may price litigation risk in a way that bank lenders do not. We could quibble over whether this stems from companies or owners foreseeing strict environmental regulation and backward-induct, if they do this out of the “goodness or their heart” or simply because their consumers demand it.

The best way to protect vulnerable countries and communities from some of the inevitable impacts of climate change is to up their defenses – i.e., make them rich as quickly as possible. Financial markets are crucial for fueling The Great Enrichment and now some fresh research also suggests that they meaningfully contribute to greening our economies. If we let it work, the future looks bright.

– – –

Joakim Book is a writer, researcher and editor on all things money, finance and financial history. He holds a masters degree from the University of Oxford and has been a visiting scholar at the American Institute for Economic Research in 2018 and 2019. His writings have been featured on RealClearMarkets, ZeroHedge, FT Alphaville, WallStreetWindow and Capitalism Magazine, and he is a frequent writer at Notes On Liberty. His works can be found at and on the blog Life of an Econ Student;





Reprinted from American Institute for Economic Research CC4.0


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