Mark Carney is without doubt one of the most respected central banker in the 21st century. His career spanned globally from Canada to Britain, and his breadth of knowledge is not limited to economic and financial world. In his book, Value(s), he outlined the how what we value could become values and invite readers to revisit both concepts in relation to the impact of capitalism and social justice. In the last part of the book, he outlined the case for global cooperation in fighting climate change and to reach the goals under Paris Climate Agreement. Below are some key points I highlighted in the book.

The gold lies pointlessly in our vaults, a vestige of a bygone era when it backed the value of money – a link that became a cross, inspiring booms before triggering busts. Financial markets value gold for its perceived safety not for its revealed beauty. The gold price surges with fears of financial distress or geopolitical conflict. In such times of turbulence, faith in a commodity replaces trust in institutions.

Pope Francis surprised us by joining the lunch and sharing a parable. He observed that: Our meal will be accompanied by wine. Now, wine is many things. It has a bouquet, colour and richness of taste that all complement the food. It has alcohol that can enliven the mind. Wine enriches all our senses. At the end of our feast, we will have grappa. Grappa is one thing: alcohol. Grappa is wine distilled. He continued: Humanity is many things – passionate, curious, rational, altruistic, creative, self-interested. But the market is one thing: self-interest. The market is humanity distilled. And then he challenged us: Your job is to turn the grappa back into wine, to turn the market back into humanity. This isn’t theology. This is reality. This is the truth.

Values and value are related but distinct. In the most general terms, values represent the principles or standards of behaviour; they are judgements of what is important in life. Examples include integrity, fairness, kindness, excellence, sustainability, passion and reason. Value is the regard that something is held to deserve – the importance, worth or usefulness of something. Both value and values are judgements. And therein lies the rub.

market fundamentalism contributed directly to the global credit crisis, in the form of light-touch regulation, a belief that bubbles cannot be identified and a misplaced confidence in a new era. Authorities and market participants fell under the spell of the three lies of finance, believing that ‘this time is different’, that ‘markets are always right’ and that ‘markets are moral’.

Markets are essential to progress, to finding solutions to our most pressing problems, but they don’t exist in a vacuum. Markets are social constructs, whose effectiveness is determined partly by the rules of the state and partly by the values of society. If left unattended they will corrode those values.

But with what does economic value theory properly concern itself? After all, value is also a property of literature, art, education and religion. At their core, economic theories of value seek to explain why goods and services are priced as they are and how to calculate their correct price, if such a value is thought to exist.

Much of historical thinking about economic value concentrates on the process of value creation, with different conceptions of value rooted in the socioeconomic and technological conditions of the time. Many value theorists give heavy consideration to distributional consequences, and distinguish between productive and unproductive activities, with the aim of increasing the ‘wealth of the nation’. In these regards, historical approaches to economic value embody values relating to ‘what is important in life’. The various approaches to value also usually differentiate between value creation and value extraction, or rent seeking. Value creation results from combining different types of resources (human, physical and intangible) to produce new goods and services. Value extraction can be thought of as the product of ‘moving around existing resources and outputs and gaining disproportionately from the resulting trade’.5 ‘Rent’ is the return to this activity, and it has been at best viewed as unearned income or, at worst, theft.

In objective theories of value, value is determined by the production of goods and services. Objective approaches contend that, although the price of a product results from supply and demand, its underlying value is derived from how that product is produced and how that production affects wages, profits and rents. In objective theories, value is tied to the nature of production, including the time required, the quality of labour employed and the influence of new technologies and ways of working. Proponents span Aristotle to Adam Smith and Karl Marx. In contrast, subjective theories of value place greater weight on how exchange value (the price of goods and services in the market) reveals underlying value. In subjective theories, value is in the eyes of the beholder, driven by preferences and to a lesser extent scarcity. This approach is most clearly associated with neo-classical economists of the nineteenth century, such as William Jevons and Alfred Marshall, and it is dominant in our time. This has a variety of consequences, especially the implication that something which is not priced is neither valued nor valuable; it is as if the price of everything is becoming the value of everything.

The fifteenth and sixteenth centuries brought new technologies and modes of organisation that gave rise to commercial society. Maritime trade grew with the new navigational instruments; farming began to lose its feudal characteristics; and the economy moved towards large, organised markets, under guilds and the great trading companies (such as the East India Company) that were monopolistically controlled under official protection. In response, a new economic doctrine – mercantilism – was born. At its heart, mercantilism was the view that maximising net exports was the best route to national prosperity, and that a country’s wealth was measured by gold, the by-product of these surpluses.

According to Petty, ‘natural value’ was determined by the factors of production – land and labour – and the market price (‘actual price’) of any commodity would fluctuate around its natural value (‘natural price’). Petty simplified his theory of value to one based on labour, by solving for a ‘par’ value for land in terms of labour.15 That labour value, in turn, was determined by a form of subsistence wage, which was the unit of measure consisting of ‘The easiest-gotten food of the respective countries of the world’.16 In this respect, Petty foreshadows the labour theories of value of Adam Smith, David Ricardo and Karl Marx.

Quesnay’s Tableau supported farmers against the mercantilists, as it showed that all value arose from the land.21 His classification overturned the mercantilist approach which had placed exchange and what was gained from it – gold – at the centre of value creation. Now value was linked inextricably with production, albeit only agricultural production.22 In Quesnay’s tableau, as long as what is produced is greater than what is consumed, the resulting surplus could be reinvested, and the economy would grow. Conversely, if value extraction by unproductive sectors exceeds value creation by agriculture, the economy would decline. This conception of surplus and reinvestment driving the economy forward would be adopted by the classicists.

The focus of the classicists was political economy, with the study of economics integral to their study of society. Their approach centred on the development of markets and placed the growth and distribution of value squarely in the context of the enormous social and technological changes then underway. They worked during an unprecedented period of growth, urbanisation, industrialisation and globalisation. The classicists would have found profoundly alien the view – widespread today – that economics is a neutral technical discipline which can be pursued in isolation from such dynamics.

Smith, in contrast, was concerned with exchange across the entire economic and social spheres. To Smith, all of human life involved exchange, with the consequence that we can no more extricate his theories of markets and value creation from their broader social context than we could separate the views on value of the canonists from their systems of social philosophy and ecclesiastical jurisprudence.

Smith addressed too the question of what happens when markets go wrong. He was well aware of the damage that monopolies could do, and he viewed a free market as one that was free of rent. He included a searing attack on mercantilists – or what we would now refer to as crony capitalists. Like Quesnay, he argued that mercantilist policies restricted competition and trade, and undercut industry, which was the true source of value creation in the economy.

Smith adopted the same systematic approach to economic growth as the physiocrats, he widened the concept of the productive sphere of the economy from agriculture to include industry. In both systems, growth arises because of surpluses that are reinvested in productive activities (in Smith’s case manufacturing) rather than in unproductive consumption of luxuries or rent seeking.

Smith was wary of the dangers of capture of government by business. He consistently warned of the collusive nature of business interests, including fixing the highest price ‘which can be squeezed out of the buyers’. He cautioned that a business-dominated political system would allow a conspiracy of industry against consumers, with the former scheming to influence politics and legislation.32 Consistent with this view, he promoted free trade to break the power of the mercantilists and increase the share of manufacturers in a competitive market.

Smith acknowledges that differences in labour quality mean that simply measuring the hours of work that went into producing an object is not equivalent to the effort. And he highlights the ways in which a good’s ‘real’ value (determined by labour) can be distinct from the money price of the good, which he calls its ‘nominal’ price: ‘Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price.’34 In a barter economy, Smith argues, goods could be more easily traded at ratios that directly reflect the labour required to produce them, as in his famous example: ‘If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.’

Ricardo took Smith’s ideas further. First, he articulated what came to be known as the ‘law of diminishing marginal returns’, one of the most important in economics. It holds that as more and more resources are combined in production with a fixed resource – for example, as more labour and machinery are used on a fixed parcel of land – the incremental increase in output will diminish. Restricting foreign imports would bring more marginal land into production, raising grain prices, increasing rents to landlords, reducing the profits of manufacturers and, as a consequence, lessen their capacity to invest in new production. As we shall see in the next chapter, the analogue on the demand side is diminishing marginal utility, which holds that the more of a good one consumes – such as ice cream on a sunny day – the less the enjoyment derived from each additional scoop.

Ricardo began his most famous work, Principles of Political Economy and Taxation (1817), with his labour theory of value: The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour.37 He distinguished between the price of a good or service and its underlying value. Like Aristotle and Adam Smith, he held that the relative values between two goods are determined by the relative quantities of labour needed to make them.

At a minimum, workers need to work for long enough to regenerate their labour power: receiving an amount equivalent to a subsistence wage. But their labour power is such that they can work longer and, if they do, surplus value is created. The genius of capitalism is to make this happen, and for capitalists to then pocket the vast majority of the associated surplus value, paying workers only a wage sufficient for workers to buy commodities like food and housing to restore their strength to work.

Marx also saw that the growing general commercialisation and financialisation of the economy could ultimately undermine the growth of production. In his view, commercial and speculative financial firms do not add value to capitalist production. By capturing an increasing share of the surplus, they diminished the profit in the economy available for reinvestment. Finally, the social dimension of capital would feed instability. Capital gives capitalists their power over workers who cannot realise their labour power in isolation from the means of production. Workers become alienated from their work because they do not own the means of production, and the surplus they create is taken away from them. For Marx as for Aristotle and Aquinas, the exchange of value, or more appropriately the exchange of ‘just’ value, had moral as well as economic implications.

As we have seen, in objective theories of value, the value of the inputs, such as labour, determines the value of the output. With the neo-classicists, that causality is reversed. People value final goods that satisfy specific wants, and it is because those final goods are valued that the inputs that went into making them also have value. Labour does not give goods value; labour is valued because the final good it helps create is valuable. In its simplest variant, value flows from consumption to production, not in the opposite direction. The value of inputs is derived from the value we attribute to the outputs.

Take for example, a consumer who is willing to buy a pair of shoes to wear to work for $100 even though the retail price is only $60. In addition, they are willing to buy an extra pair of the same shoes to wear on the weekend, but are only willing to pay $80 for this second pair because overall they offer less additional benefit given they already have one pair. This consumer receives a total utility of $180 from the two purchases but only pays $120. This $60 difference is considered the ‘consumer surplus’. If the consumer was willing to buy a third pair of shoes (as a back up for when one wears out) but valued this pair at only $60, the total value of the shopping spree would rise to $240 and payment would rise to $180. Consumer surplus, however, would remain at $60 as the third pair was purchased for the exact amount at which the consumer valued them. The value of each subsequent pair of shoes is its ‘marginal value’ and is different from the average total value of the purchases as each pair of shoes is valued differently. Subjectivism says that utility is based on the preferences of the consumer at a given time and place. And diminishing marginal utility means that additional utility decreases with the additional amount consumed or held.

Marshall divided his analysis into four time periods. First, in the market period where time is short and supply is therefore fixed, the value of a good is determined solely by demand. Second, in the short run when firms can change their production runs but not their plant size, supply and demand jointly determine value. Third, in the medium term, where plant size itself can be altered, the effects of supply on value depend on whether the industry of a particular good has constant, increasing or decreasing costs to scale. Finally, in the long run in which technology and population vary, the supply-side conditions dominate.

First, with basically everything priced counted as GDP16 – the shorthand widely used as a measure of national prosperity – there is a risk that the relative value of the future drivers of prosperity is obscured. Objective-based theories of value were careful to make the judgements concerning what was productive. But all that is valued today – that is, what has a market price – is not equally productive or important to future value creation. Moreover, what is considered productive versus unproductive becomes self-fulfilling, as being included in GDP is a marker of productiveness itself. For example, the economist Diane Coyle notes that the view that finance is a strategically important sector of the economy developed alongside changes in statistical methodology that designated it part of national production.

extensive research on the science of wellbeing finds that a wide range of determinants of human happiness (I will use these terms wellbeing and happiness interchangeably) are not priced. These include mental and physical health, human relationships, community and general social climate. This reality means that, even if markets were perfectly competitive and complete, information were equally shared, there were no transaction costs and people were rational, then the sum of their individual utility-maximising transactions would not maximise welfare.

The allocation (or ‘incidence’) of costs and benefits matters, and even ‘if losers lose more than gainers gain in monetary terms, we cannot exclude the possibility that the losers lose less than the gainers gain in welfare terms’. Or in other words, an extra £1,000 means less to Mark Zuckerberg than £500 does to someone on the dole. In part, this can be explained by the diminishing marginal utility of money. There is widespread evidence that, above certain thresholds, small additional monetary gains or losses are relatively immaterial from a welfare perspective, whereas for the least well off they are material.

In the modern financial system, the private financial sector creates most of the money in circulation. The reality of how that happens is different from the standard textbook depictions in ways that are important to maintaining money’s value. Textbooks often state that money is created by new deposits. In this world, the ‘saving’ decision of households creates new money, which banks then lend out. But these deposits have to come from somewhere, and when a household chooses to deposit at a bank, those savings come at the expense of purchases of goods and services of companies (who would then in turn deposit the money in their bank, meaning no net money creation).8 The principal way banks create money is by making a loan. When the bank decides a borrower is creditworthy (that they are likely to pay the loan back), it credits their deposit account for the amount of the loan and new money enters circulation. In making that lending decision, the bank relies on a degree of trust, which after all is the meaning of the Latin credere, the root of our word for credit. Supplementing that trust is the bank’s due diligence of the borrower’s information as well as prudent assessment of the risk. In the words of Mikhail Gorbachev, ‘Trust, but verify.’

Over the ages, the various forms of private money, such as the notes issued by European banks and American banks in the eighteenth and nineteenth centuries, have inevitably succumbed to oversupply and eventual collapse. Initially strong commitments to back their value, by pledging assets and establishing ‘binding’ rules for their issuance, have given in to temptations to increase profits by relaxing these strictures and drawing on credibility built up over time. The decline in public trust and with it the value of the private currency comes, as Hemingway once wrote about bankruptcy, ‘gradually and then suddenly’.

Given the experiences of private banks issuing notes on the basis of ‘their good name’, most observers would agree that laissez-faire is not a good foundation for sound money. There have been two approaches to maintaining public confidence in money and guarding against debasement: i) backing by a commodity, principally gold (and occasionally land or oil) and ii) backing by institutions led by independent central banks.

The system of metal-backed money was plagued by reliance on the unpredictable supply of precious metal. Shortages of silver helped explain why the Roman system of coinage endured to outlive the Roman Empire so that prices were still quoted in denarii in Charlemagne’s time at the beginning of the ninth century. The Spanish conquest of the New World led to the opposite problem. Such was the plunder of gold and silver that the sixteenth century saw a huge monetary stimulus that spread across Europe, pushing up prices sevenfold between the 1540s and the 1640s during the so-called ‘price revolution’.19 The Spanish learned the hard way that acquiring money did not make you rich; the value of precious metals was not absolute. If its supply increased, its purchasing power would fall.

Throughout the period of the Napoleonic Wars, a robust dispute raged over the merits of reinstating convertibility. The Bullionist group – led by David Ricardo and Sir Henry Parnell – argued that if banks were not required to convert into gold, they would issue too many notes, causing inflation and the debasement of money. These arguments anticipated many of those of the monetarist school of economics. The opposing side appealed to the ‘Real Bills Doctrine’, associated with John Law, Adam Smith and James Stuart. They argued that the banknotes would be credible provided the assets that backed them were creditworthy. At this time, those assets were largely gold and bills of exchange (which were used by companies for trade). Since the demand for bills of exchange would be dictated by the activities of commercial firms, it was contended that there would not be excess note issuance, and if any temporary one occurred it would be quickly mopped up. Conversely, if the money supply were restricted to the available gold, it could prove too meagre for commercial activity.

David Hume first described the workings of the gold standard more than a century before it fully came into being. Each time goods were exported, the exporter received payment in gold, which was brought to the mint to be coined. Each time an importer bought a good, they made a payment by exporting gold. For a country with a trade deficit, gold flowed out on net, setting in train a self-correcting mechanism of falling domestic prices because less gold was chasing the same amount of goods. In the foreign country, prices rose because there was more gold chasing the same amount of goods. With imports more expensive, people would consume less of them and more of the now cheaper domestic produce. The trade deficit would shrink and balance would be restored.

By the end of the nineteenth century, global economic power was becoming more dispersed and the gold standard therefore tougher to manage. As international trade and financial integration steadily grew, the UK economy became relatively less important. At the same time, an inherent flaw of the system – its dependence on new supplies of gold – exerted a renewed deflationary bias that put pressure on domestic wages, prices and banks across the membership of the international gold standard. When the supply of gold grew more slowly than the economy, the price level needed to fall to restore equilibrium in purchasing power. This was starkly illustrated when a number of countries adopted the gold standard in quick succession in the 1870s. With less money chasing more goods, the system was highly deflationary, with the British price level falling by more than one-third between 1873 and the end of the century.29 An environment of sharply falling prices and wages would increase the real burden of debts and make it more difficult for banks to remain solvent.

Political pressures began to emerge as suffrage was extended, labour began to organise and political parties representing the working classes began to gain popularity. A single-minded focus on convertibility to the exclusion of the impacts on the domestic economy, particularly on wages and employment, became increasingly untenable. This undermined the credibility of the system, emphasising that the gold standard was ‘a socially constructed institution whose viability hinged on the context within which it operated’.

The value of money requires not just the belief of the public at a point in time but, critically, the consent of the public at all times. That dictates not just what the central bank does to maintain the value of money but how it does it, how it accounts for its actions and how it takes responsibility for any mistakes. In just this way, the effectiveness of the gold standard was ultimately determined by how long it was accepted. When it comes to money, the consent and trust of the public must be nurtured and maintained.

Even to a thirteenth-century Englishman, global monetary conditions mattered. Would Britain’s constitutional history have been different had King John lamented, ‘A central bank! A central bank! My kingdom for a central bank!’? He needed one because other factors reinforced monetary developments, including the usual suspect – financial innovation. Specifically, developments in the common law made land an increasingly liquid asset, and therefore one capable for the first time of being used as a store of wealth.13 This set a medieval financial accelerator in train (about 750 years before Ben Bernanke coined the term)14 by providing an alternative to storing one’s wealth in silver coin (prone to being whisked away by the King). This led to a reduction in the demand for silver money balances. An increase in money velocity would have followed and with it, all else being equal, price inflation until the transactions demand for silver had risen sufficiently to equal its supply. At the very least, the existence of an alternative store of wealth provided an environment in which money velocity could take off, were it to be nudged in that direction.

Magna Carta has become the icon of the principle that the exercise of authority requires permission from those subject to that authority – and that, once granted, this permission can just as easily be withdrawn.

Modern money is not backed by gold, land or some other ‘hard’ asset. Modern money is all about confidence. Confidence that: – the banknotes that people use are real not counterfeit; – money will hold its value and that it will not be eroded away by high inflation; – the burden of debt won’t skyrocket because prices and wages fall in a deflation; – money will be safe in banks and insurance companies, and that it won’t disappear even if there’s a depression, a financial crisis or a pandemic.

The global financial crisis was a powerful reminder of the imperative of financial stability. Advanced economies were in the midst of an era known as the Great Moderation: a long period of uninterrupted growth combined with low, stable and predictable inflation. The crisis made it obvious that central banks had won the war against inflation during this time only to lose the peace.

Conversely, there are no obvious or immediate rewards to the tough decisions necessary to avoid future crises. The costs of macroprudential interventions can be felt today but their benefits are often realised far into the future. These benefits – moderating downturns and avoiding crises – are not directly observable. The bad outcomes that macroprudential policies prevent have to be estimated. But counterfactuals are difficult to sell: ‘it could have been worse’ doesn’t quite have the ring of ‘you’ve never had it so good’.

Just as the gold standard failed when it lost public confidence, the effectiveness of independent central banks will not stand the test of time without continual public support.

Today, this economic approach to value has spread widely. Market value is taken to represent intrinsic value. And if a good or activity is not in the market, it is not valued. We are approaching the extremes of commodification as commerce expands deep into the personal and civic realms. The price of everything is becoming the value of everything.

there is growing evidence that relative equality is good for growth. More equal societies are more resilient, they are more likely to invest for the many not the few, and to have robust political institutions and consistent policies.6 And few would disagree that a society that provides opportunity to all of its citizens is more likely to thrive than one which favours an elite, however defined.

While some studies have found a short-term positive relationship between economic growth and inequality,11 a wide range of research has found that inequality is associated with both slower and less durable growth particularly over the long term.12 This holds for rates of growth over long periods of time,13 the level of income across countries and the duration of growth spells.

The evidence backs the intuition that greater inequality can be self-reinforcing and growth limiting, with fewer investments in their skills by those who are less well-off and less public investment in education and infrastructure to benefit the many.15 Moreover, these negative effects of inequality on growth are self-reinforcing. Income inequality exerts a greater drag on growth in economies characterised by low equality of opportunity (as measured by intergenerational mobility).

There has certainly been no improvement in happiness alongside the spread of markets into more walks of human interaction, and there is no definitive relationship between growth and happiness.20 While there is a variety of potential explanations for these results, one plausible candidate is the steady expansion of the competitive sphere into our lives. Richard Layard bemoans the increasing prevalence of the testing of children and the ranking of education and health professionals. These are approaches that make success personal and individualistic rather than the result of improving the happiness and welfare of others. Evidence suggests that it breeds stress and dissatisfaction, even among the ‘winners’.

Sunstein underscores the importance of a broad concept of welfare: ‘People care about other things, including a sense of meaning or purpose. A good life is not merely “happy”.’25 He uses a series of real-world examples to demonstrate how a simple but common economic application of utilitarianism that focuses on maximising net monetary benefits (and thereby equating money with value) may be inconsistent with net welfare benefits, as a result, for example, of: – the distribution (or incidence) of the gains and losses (recall the non-linear contribution of income to happiness), or – unpriced benefits and costs related to the dignity of life, the avoidance of mental anguish and the hedonic benefits of increased convenience.

The genius of the market rests on a series of attributes that share what John Kay calls the disciplined pluralism of capitalism. This starts with the familiar invisible hand with prices as signals acting as far superior guides to resource allocation than central planning. And it extends to two other key, but less widely acknowledged, qualities. First, markets are forces of discovery via the chaotic process of experimentation through which the market adapts to change. Markets facilitate a process of trial and error where the successful ventures thrive and the unsuccessful are terminated. Second, markets diffuse political and economic power such that entrepreneurial energy is focused on the creation of wealth rather than its appropriation from others.

When our discussion shifted to exchange rates and Tommaso held forth on how the dollar was misaligned, a colleague interrupted, ‘Misaligned to what? The dollar is priced in the world’s deepest market.’ Tommaso drew in a short breath and lamented how far the received wisdom of market efficiency had come. The doctrine held that if a market is deep and liquid, it should always move towards equilibrium, or, said another way, ‘it was always right’. The policymakers have nothing to tell the market, they had only to listen and learn. If markets move sharply away from a range that seems appropriate, the policymakers must humbly admit that there must be something they are missing that causes the market ‘in its infinite wisdom’ to behave the way that it does. But as Tommaso observed, ‘when we grant an entity infinite wisdom, we enter the realm of faith’.

There has been a steady commodification of assets and activities – putting them up for sale – including of our free time.36 Activities as diverse as cooking, essay writing, gardening and child-rearing can now be hired in the gig economy. This is the latest phase in the historical progression of commodification: first agriculture through the commercialisation of surplus production, then manufacturing, then industry and now services, with many people encouraged to do many jobs flexibly. The logical extreme predicted by Paul Mason, in his book Postcapitalism, is that the whole of society becomes the factory.

An essential point is that, just as any revolution eats its children, unchecked market fundamentalism devours the social capital essential for the long-term dynamism of capitalism itself. All ideologies are prone to extremes, and capitalism loses its sense of moderation when the belief in the power of the market enters the realm of faith. In the decades prior to the crisis, such radicalism came to dominate economic ideas and became a pattern of social behaviour.

Yet when the means – money – become the ends, society suffers. Marx saw greed as a stage of social development. In other words, it was neither intrinsic nor natural. Money is an accelerant giving greed an abstract hedonism because the pursuit of its accumulation ‘possesses all pleasures in potentiality’.45 Greed itself is reinforced by the commodification of life as there is more and more that money can buy. Milanović observes that when money becomes the sole criterion by which success is judged, society sends the message that ‘being rich is glorious’ and ‘the means used to achieve glory are largely immaterial – as long as one is not caught doing something illegal’.46

For thousands of years, religion was able to preserve the entrepreneurial spirit necessary for the flourishing of commercial society while internalising certain forms of acceptable behaviour. Protestantism eschewed ostentation, limiting the consumption of the elites and their displays of wealth.47 This in turn encouraged the necessary reinvestment in social and economic capital, as profits were to be used for God and the community or to pursue further gain as was God’s will. To quote Weber: ‘the inevitable practical result is obvious: accumulation of capital through ascetic compulsion to save. The restraints which were imposed upon the consumption of wealth naturally served to increase it by making possible the productive investment of capital.’48 This moderating force was complemented by what Rawls termed a tacit social contract which reaffirms in its daily actions the main beliefs of society.49 Neither of these constraints binds today. The steady decline of religion in the west is well documented. From a commercial perspective, it has reached the point that the Archbishop of Canterbury, the Pope and Rabbi Jonathan Sacks have all sought to reinforce ethical considerations in business life.

As markets reach into spheres of life traditionally governed by non-market norms, the notion that markets never taint the goods or activities they touch becomes increasingly implausible. Consider three examples with respect to children. The first is the famous case of a day-care centre in Israel, where it was decided to introduce fines for parents who were picking up their children late and inconveniencing the day-care staff who had to stay late.56 In response, the incidence of late pick-ups rose sharply. The fine was viewed as a fee, removing the social stigma of making teachers wait. Instead, parents were covering the cost and optimised their time accordingly. The second (referenced by Sandel) is giving in to the temptation to pay a child to read a book. This not only puts a relative price on reading compared to staying on their mobile phone but also signals that reading is a chore that must be compensated for rather than an intrinsic good to be enjoyed. When everything becomes relative, nothing is immutable. The third is paying children to raise money for charity. Building on their observations at the day-care centre, the economists Uri Gneezy and Aldo Rustichini conducted an experiment to determine the impact of financial incentives on student motivations.57 They divided high-school students into three groups. The first was given a motivational speech about the good cause they would be supporting as they canvassed their neighbourhood for money. The second and third received the same speech but were offered incentives (paid by a third party, so with no impact on net proceeds) of 1 per cent and 10 per cent of proceeds raised, respectively. Not surprisingly, the group with the higher incentive was more motivated and raised more money than the lower-paid cohort. But the group that responded only to charitable and civic virtue raised the most. Money had crowded out civic norms. These examples suggest that, before putting a price on a good, consideration should be given to whether this will alter its meaning.

when bankers became detached from the end users of financial products, their only reward was money. But purely financial remuneration ignores the non-pecuniary value of employment, such as satisfaction from helping a client or colleague succeed. This reductionist view of the human condition is a poor foundation for ethical financial institutions needed to support long-term prosperity. The global financial crisis was as much a crisis of culture as of capital.

Early on in my career in finance, I was taught an invaluable rule by Bob Hirst, one of the partners at Goldman Sachs: ‘If something doesn’t make sense, it doesn’t make sense.’ Beneath the Popeye-esque tautology was real wisdom. Bob’s point was that if someone explains something to you in finance – such as a flashy new product or why a company’s valuation should be orders of magnitude higher than others in their sector – and it doesn’t make sense, ask the person to repeat the rationale. And if following that response, it still doesn’t make sense, you should run. Run because in finance you should never buy simply on trust, just to go along with the crowd, or least of all to pretend that you understand something for fear of looking foolish. Run because there are really only two possibilities. The first is that you’re being sold something that really doesn’t make sense. It’s merely a form of financial alchemy in which debt is being turned into equity, the newest version of the mythical risk-free return, or the latest variant of the four most expensive words in the English language, ‘This time is different.’

Whether it made sense for investors to buy ABCP boiled down to two risks. The first, liquidity risk, refers to the ability to sell an asset or to borrow against its value. In deep markets, sales by individual investors will have a minimal impact on the asset’s price, and in many cases the asset can even be turned into cash by borrowing against its value. But when markets are thin or shallow, it can be tough for investors to realise cash when they need it. In the extreme, liquidity risk is the market analogue of a bank run, except that in markets there are no lenders of last resort like central banks and investors aren’t protected by a safety net, whereas retail depositors in banks benefit both directly from deposit insurance and indirectly from central bank facilities that help banks to weather storms.

the lifeblood of markets is transactions. Markets act as intermediaries between savers and borrowers but maintain relationships with neither. Consequently, market instruments are more robust when the underlying product is more standardised. Determining whether an activity is best financed through a bank or a market depends on the relative benefits to that activity of specialisation versus standardisation. In response to rising competitive pressures from markets, banks increasingly became direct participants in them, in ways that ultimately sowed the seeds of the crisis. First, banks relied more and more on short-term markets to fund their activities and, in the process, substantially boosted their leverage. This made banks dependent on continuous access to liquidity in money and capital markets. That reliance was brutally exposed when markets turned in the autumn of 2007. Second, banks used securitisation markets, like ABCP, to straddle relationship banking and transactional market-based finance. Under the originate-to-distribute business model, banks originated a set of loans, repackaged them as securities and sold them to investors. In essence, banks took specialised loans and sold them in standardised packages. While securitisation promised to diversify risks for banks, this risk transfer was frequently incomplete. Banks often sold securities to arm’s-length conduits, like SIVs, that they were later forced to re-intermediate or they held on to AAA tranches of complex structures that proved far from risk-free.

the market can be wrong longer than you can stay solvent. Appeals to fundamental values in a panic fall on deaf ears. Not least because people find it tough to hear when they’re screaming. This causes a number of challenges. When markets collapsed in the autumn of 2008, markets were hoist on their subjective value petards. If the market was always right and the market said subprime was worth one-third of its former value, then the balance sheets of many US and European banks were insolvent, even if most of the mortgagees were making their payments. The big institutions that lent to banks in the capital markets began to perform such mark-to-market calculations, and then withdrew their funding, turning liquidity problems into solvency ones overnight.

This leads to the final lesson I learned about managing crises: the importance of overwhelming force. Fighting a financial fire with half-measures is futile. Whether it was Hank Paulson’s $750 billion bazooka in 2008, or Mario Draghi’s ‘whatever it takes’ pledge a few years later at the height of the euro crisis, effective crisis-fighting measures need to be massive, institutionally grounded and credible. Ultimately, overwhelming force can only come from the state. This is when public values come into their own. Resilience, responsibility and solidarity. Taking tough action in the public interest was essential to restoring confidence.

some of the mistrust in globalisation arises from what Dani Rodrik termed an impossible trinity – a trilemma – between economic integration, democracy and sovereignty.

A major bank CEO once told his daughter a financial crisis is ‘something that happens every five to seven years’.7 In no other aspect of human endeavour do people not strive to learn and improve. And in no other industry would such weary fatalism be tolerated. This depressing cycle of prudence, confidence, complacency, euphoria and despair reflects the power of the three lies of finance: this time is different, markets always clear, and markets are moral. To break their seductive power, we need to reinforce the underlying values required for the financial system to fulfil its role as a servant, rather than master, of society.

The second lie is the belief that ‘markets always clear’. That is, the supply of whatever is traded will always equal demand for it, and at the ‘right price’ there will never be excess supply or demand. This belief that markets always clear has two dangerous consequences. First, if markets always clear, they can be assumed to be in equilibrium – or, said differently, ‘to be always right’. If markets are efficient, then bubbles cannot be identified nor can their potential causes be addressed. Second, if markets always clear, they should possess a natural stability. Evidence to the contrary must be the product of either market distortions or incomplete markets.12 Such thinking dominated the practical indifference of policymakers to the housing and credit booms before the crisis.

A truth of finance is that the riskiness of an asset depends on who owns it. When markets don’t clear, agents may be surprised to find what they own and for how long. When those surprises are – or are thought to be – widespread, panic ensues.

Cass Sunstein’s work on social movements could help explain why (what appear to have been) widely held beliefs can be subject to sudden reappraisals. There is considerable evidence that changes in social norms, like reported attitudes to same-sex marriage or even political revolutions, often happen suddenly. Sunstein identifies several factors that explain this phenomenon. These include preference falsification, which is when what we are willing to say publicly diverges from what’s inside our heads, and interdependencies, which is when what we are willing to say or do depends on others. These characteristics mean that once conditions ripen, a critical mass of new opinions can form quickly, sometimes with brutal consequences. And so it is with financial markets.

As the old fault lines close in advanced economies, however, they are widening in some emerging market economies. For example, while China’s economic miracle over the past three decades has been extraordinary, its post-crisis performance has relied heavily on a large build-up of debt and an associated explosion of shadow banking. The non-bank finance sector has increased from around 10 per cent of GDP a decade ago to over 100 per cent now, with developments echoing those in the pre-crisis US such as off-balance-sheet vehicles with large maturity mismatches, sharp increases in repo financing and large contingent liabilities of borrowers and banks.

Under the SMR, the most senior decision makers of banks, insurers and major investment firms are now held individually accountable if they fail to take reasonable steps (including training or proper oversight) to prevent regulatory breaches in their areas of responsibility. Whether actions taken by a senior manager were reasonable can be determined by reference to select voluntary codes that the FCA has publicly recognised. And under the related Certification Regime firms must annually assess and certify the fitness and propriety of a wide range of risk-taking employees.

The most fundamental duty of the state is to protect its citizens. In his classic text, Leviathan, Thomas Hobbes (1588–1679) described how citizens give up certain liberties in exchange for state protection ‘from the invasion of foreigners, and the injuries of one another, and thereby to secure them in such sort as that by their own industry and by the fruits of the earth they may nourish themselves and live contentedly’.

Our brains often work against us when it comes to making the longer-term investments necessary to withstand catastrophes when they strike. Research in behavioural psychology has established that humans have a host of cognitive biases that mean we undervalue resiliency. We display a present bias and discount problems and benefits that will occur in the future, preferring immediate rewards even if they are lesser in overall value.

First, unlike most consumer goods, life is what some economists term a non-positional good. That means that no part of a life’s value stems from the ownership of comparable goods by others. We do not feel any better off when those around us have less life, though we may feel better off when we have a nicer car. In contrast, drawing on a host of evidence from behavioural trials, Robert Frank posits that the value of many consumption goods is partly based on how they affect the person’s actual or perceived position.

The role and duties of government are formulated by citizens, yet we increasingly rely on market-based metrics of value to dictate policy instead of societal values driving government action. At the heart of Covid policy decisions have been forms of valuation of life, quality of life and dignity in death, even if those determinations have been implicit. Framing these in terms of cost–benefit analysis immediately brings challenges with estimating monetary values for these sacred values. Policy decisions must also weigh fundamental issues of fairness including the incidence of the disease and of economic hardship as well as the importance of preserving economic dynamism.

state’s actions are judged for their proportionality and against a standard in which trustworthiness, solidarity and a sense of fairness form the basis of an effective response. States embodying these values can weather crises not by threatening punishment but by relying on the voluntary contributions of their citizens. This is where the soft powers of the state such as legitimacy and reciprocity, as well as broader social capital, matter most, and where the values of government and citizens take on a life-and-death importance.

A state’s legitimacy derives from the beliefs its citizens hold about the structure of government, its officials and processes. Whether a state’s rules and regulations merit compliance depend on how those rules were decided upon and by whom.8 Behavioural compliance by citizens stems from their sense of obligation and willingness to obey authorities, particularly in cases where compliance is against the citizen’s immediate self-interest. This value-based legitimacy stems in turn from judgements and perceptions of the extent of procedural justice present and the general trustworthiness of government, with trustworthiness in government formed by views on government performance, leadership motivations and administrative competence.

First, the crisis will likely accelerate the fragmentation of the global economy. Until a vaccine has been widely applied, travel restrictions will remain. Even afterwards, local resilience will be prized over global efficiency. Second, much of the enterprise value of companies will be taken up by lost cash flows and extraordinary financial support. This higher debt – unless it is restructured, extended on concessional terms or forgiven – will increase the riskiness of the underlying equity and weigh on capacity for growth. More profoundly, the financial relationship between the state and the private sector has already expanded dramatically. How smooth will be the exit? Or will the state remain enmeshed in commerce, restraining private dynamism? Third, the searing experience of the twin health and economic crises will change how companies balance risk and resilience. We are entering a world where businesses will be expected to prepare for black swans by valuing anti-fragility and planning for failure. The financial sector learned these lessons the hard way during the global financial crisis, which is why banks can now be part of the solution. Going forward, which company will operate with minimal liquidity, stretched supply chains and token contingency plans? Which governments will rely on global markets to address local crises? Fourth, people’s economic narratives will change. After decades of risk being steadily downloaded on to individuals, the bill has arrived, and people cannot even begin to pay it. Entire populations are experiencing the fears of the unemployed and sensing the anxiety that comes with inadequate or inaccessible healthcare. These lessons will not be forgotten quickly. This will have lasting consequences for sectors that rely on levered consumption, a booming housing market and a vibrant gig economy. This points to a final, deeper issue. In recent decades, subtly but relentlessly, we have been moving from a market economy to a market society. Increasingly, to be valued, an asset or activity has to be in a market; the price of everything is becoming the value of everything. This crisis could help reverse that causality, so that public values help shape private value. When pushed, societies have prioritised health first and foremost, and then looked to address the economic consequences. We have acted as Rawlsians and communitarians not utilitarians or libertarians. Cost–benefit analyses, steeped in calculations of the Value of Statistical Lives, have mercifully been overruled, as the values of economic dynamism and efficiency have been joined by those of solidarity, fairness, responsibility and compassion.

Among the greenhouse gases (including methane, nitrous oxide and fluorinated gases), CO2 is the most problematic. It accounts for three-quarters of the warming impact of emissions, and it is the most persistent of the greenhouse gases, with a significant proportion of the carbon emitted today remaining in the atmosphere for centuries.

The size of the carbon budget depends on (i) the temperature outcome, and (ii) the degree of uncertainty (that is, probability assumed to the outcome). The IPCC reports are the most well-respected and commonly cited source on carbon budgets. In 2018, the IPCC estimated a range from 420 Gt (to achieve 1.5°C with 66 per cent probability; this would be exhausted in less than a decade at current emissions) to 1,500 Gt (to achieve 2°C with 50 per cent probability; this would be exhausted in about three and a half decades at current emissions). Limiting temperature increases to 1.5°C from pre-industrial levels keeps the earth’s climatic and natural systems from tipping into a dangerous feedback loop. For example, the IPCC projects that if temperatures increase even by 2°C, 1.7 billion people could experience more severe heatwaves, sea levels could rise another 10 centimetres, coral reefs could decline by as much as 99 per cent.

The biggest contributors to emissions and those with the most distance to travel to get to net zero are: – Industrial process (32 per cent of current emissions), such as the production of manufactured goods, chemicals and cement. These emissions have increased 174 per cent since 1990. – Buildings (18 per cent of current emissions), which use energy for electricity and heat generation. – Transport (16 per cent of current emissions), which includes energy used by cars, heavy goods vehicles and the shipping and aviation industry. Transport emissions alone have grown by 70 per cent in the past two decades. – Energy generation (11 per cent of current emissions) – the production and supply of energy, not its end use. – Food and agriculture/nature-based sources (10 per cent of current emissions), of both crops and livestock.

The entrepreneur and engineer Saul Griffith argues that the carbon-emitting properties of our committed physical capital mean that we are locked in to use up the residual carbon budget, even if no one buys another car with an internal combustion engine, installs a new gas-fired hot-water heater or, at a larger scale, constructs a new coal power plant.12 That’s because, just as we expect a new car to run for a decade or more, we expect our machines to be used until they are fully depreciated. If the committed emissions of all the machines over their useful lives will largely exhaust the 1.5°C carbon budget, going forward we will need almost all new machines, like cars, to be zero carbon. Currently, electric car sales, despite being one of the hottest segments of the market, are as a percentage in single digits. This implies that, if we are to meet society’s objectives, there will be scrappage and stranded assets.

Climate change creates both physical and transition risks. Physical risks arise from the increased frequency and severity of climate- and weather-related events (such as fires, floods and storms) that damage property, destroy crops and disrupt trade. When physical risk crystallises it can damage real property, disrupt human and natural systems and impair financial values.

Although few outside the industry know it, the Bank of England regulates the world’s fourth-largest insurance industry. When I became Governor, I soon realised that insurers are on the front line of climate change. With their motives as global citizens sharpened by commercial concerns, insurers have some of the greatest incentives to understand and tackle climate change in the short term. For example, Lloyd’s of London underwriters are required to consider climate change explicitly in their business plans and underwriting models. Their genius has been to recognise that past is not prologue and that the catastrophic norms of the future are in the tail risks of today. With such insights, it is perhaps not surprising that the insurance sector has been particularly active in organising itself to address these existential issues.

The second category of climate-related financial risk is transition risk. These risks arise as the result of the adjustment towards a lower-carbon economy. Changes in policies, technologies and physical risks will prompt reassessments of the value of a large range of assets as the costs and opportunities of the transition become apparent. The longer meaningful adjustment is delayed, the more transition risks will increase. The speed at which the adjustment to a net-zero economy occurs is uncertain and could be decisive for financial stability. There have already been a few high-profile examples of jump-to-distress pricing because of shifts in environmental policy or performance. The combined market capitalisation of the top four US coal producers has fallen by over 99 per cent since the end of 2010, with multiple bankruptcies. To meet the 1.5°C target, more than 80 per cent of current fossil fuel reserves (including three-quarters of coal, half of gas, one-third of oil) would need to stay in the ground, stranding these assets. The equivalent for less than 2°C is about 60 per cent of fossil fuel assets staying in the ground (where they would no longer be assets).

Importantly, current estimates are incomplete as the impact of climate change on numerous important issues – water resources, transport, migration, violent conflict, energy supply, labour productivity, tourism and recreation – has received limited attention, and no estimate includes them all. These omissions bias downwards the estimates and strengthen the case for GhG emissions reductions.

The classic problem in environmental economics is the tragedy of the commons. This arises when individuals, acting independently in their own self-interest, behave contrary to the common good of all users by depleting or spoiling the shared resource through their collective action. There are many examples, including overfishing, deforestation and the original unregulated grazing on the common lands of England and Ireland in the early nineteenth century. The tragedy of the commons is an extreme example of negative externalities: when an action affects third parties who did not directly participate in (nor benefit from) that action. Such is the case with the ultimate global commons – our climate and biosphere, where producers generally do not pay for the carbon dioxide they emit nor consumers for the carbon they consume. There are three solutions to the tragedy of the commons: pricing the externality, privatisation (through the assignment of property rights) and supply management by the community that uses the commons.

In a net-zero-carbon economy, electricity’s share of total final energy demand could rise from today’s 20 per cent to over 60 per cent by 2060. That means total global electricity generation must increase almost fivefold by mid-century, while ensuring it is generated by renewables.

These developments suggest that, in a number of societies, demands for sustainability are reaching tipping points that, while not predestined, can be achieved. Research into social movements shows how they can lead to multiple equilibria. Many social movements that had seemed improbable unexpectedly gain traction due to a combination of factors including preference falsification (what we say publicly diverges from what is inside our heads), diverse thresholds (different people are more willing to speak out before others), interdependencies (what we are willing to say depends on others) and group polarisation (people tend to become more extreme when they come together with like-minded people).14 Within a few years, views that were publicly on the fringe become mainstream. Just as de Tocqueville believed that ‘no one foresaw the French revolution’, John Adams and Thomas Payne were surprised when the American colonies revolted. Yet diary writings at the time in both countries reveal the breadth of private dissatisfaction.15 What people thought and said were very different, until a focal point emerged and the private became public and was radicalised. Interdependencies – once a critical mass had formed – fanned the rapid spread of the Me Too movement, so that a host of crimes long concealed suddenly came to light. Behavioural science has also shown that, if people learn about a new or emerging social norm, they are more likely to adopt it (for example, the current spread of veganism in some countries).

The precise combination of physical or transition risks that materialises depends largely on the policy responses to climate change. For example, a decisive shift in policy will limit the size of physical risks but create some transition risks, while a business-as-usual scenario will be dominated by more severe physical risks.

In order to support an efficient global response to climate change, the level of ambition of national strategies will need to converge over time. In the meantime, carbon border adjustments (a form of tariff linked to relative climate effort) would allow leading countries to pursue more ambitious targets, while avoiding carbon leakage. These adjustments should be designed in a way that is fully consistent with World Trade Organisation rules.

Credible policy frameworks reduce the risk that businesses form wrong expectations about future policies and continue to invest in obsolete technologies. By setting out clear strategies, politicians can provide forward guidance on the policies they plan to put in place. Such predictability of climate policy helps companies start adjusting to the reality of a net-zero world today, and ensures that this adjustment is orderly.

Bernard Bass identified four components of transformational leadership: 1) Intellectual stimulation. Transformational leaders not only challenge the status quo; they also encourage creativity among colleagues. 2) Individualised consideration. Transformational leaders support and encourage individual followers by keeping lines of communication open so that colleagues feel free to share ideas and receive direct recognition of their unique contributions. 3) Inspirational motivation. Transformational leaders articulate a clear vision and inspire passion to fulfil these goals. 4) Idealised influence. The transformational leader serves as a role model, encouraging colleagues to emulate and internalise the leader’s ideals.

So, rather than professing false certainty and risk being wrong, it is argued that being candid about uncertainty could build the credibility of experts over the long term. As André Gide said, ‘Trust those who seek the truth but doubt those who say they have found it.’

Many of the ways to rebuild trust in experts resonate with what is required of effective leaders. Humility, candour about the limits of expertise, effective transparency and clearer communication. Engaging widely and seeing issues from the perspectives of others.

True leadership is not an end in itself but rather a means to accomplishing a worthwhile goal.

During the global financial crisis, some fretted that actions to save a crumbling system would encourage reckless behaviour in the future. But Ben Bernanke was clear that invoking moral hazard in the middle of the US financial crisis was misguided and dangerous. Using the power of narrative, he challenged the arguments of the ‘moral hazard fundamentalists’ in his oft cited and simple hypothetical example: do you let the man who smoked in bed die in the burning house to teach him a lesson? Or do you save him, stop the risk of surrounding houses catching fire and then reprimand him for reckless behaviour?

Now authorities need to apply these lessons to the climate crisis by stress-testing banks and insurers against different climate pathways from a smooth transition to net zero to the catastrophic business as usual. Critically, this will help banks think through potential risks associated with both the transition to net zero and continuing business as usual. With three-quarters of the world’s known coal reserves, half of gas reserves and one-third of oil unburnable if we want to keep emissions below 2°C,8 uncovering information about company exposures to stranded assets will be critical. Climate stress-testing will reveal the financial firms – and by extension the companies – that are preparing for the transition. And it will expose those that have not.

Shareholders may not be owners in the classic sense but they are the residual claimants in a company. Simply put, they get paid after everyone else – creditors, employees, suppliers and governments (in the form of taxes). This position in the hierarchy has underpinned much of the legal approach to entrenching shareholder primacy. Whether the shareholders take the most risk is a more open question. As Martin Wolf has argued, employees cannot diversify their exposure to a company.13 The same truth can hold for key suppliers or communities in which a company is dominant. When this is combined with the doctrine of shareholder primacy, there are incentives for firms and management (if their compensation is heavily weighted towards short-term equity incentives) to take excessive risks.14 There is an incentive for shareholders to take on greater risk since their downside is limited (they cannot lose more than all of their money under limited liability), but their upside is unlimited. This shifts risk to other claimants, notably employees and creditors.15 A similar dynamic holds for externalities, such as pollution.

Corporations own themselves, and central to British company law (since the nineteenth century) and American company law is the doctrine of corporate personality. The company is an entity independent of its managers, shareholders, employees and creditors. Its directors thus serve its interests; they are not merely agents working on behalf of shareholders.

Thus purpose operates on a number of planes. First, internally, it creates the necessary social capital within the firm to underwrite foundations of value creation: tightly functioning teams, and high employee participation and engagement. Second, externally, it operates as a means of generating focus on customer service and alignment. The company’s external focus relates to the traditional purpose of a company: to serve its customers.50 If a firm does this well, it generates customer loyalty, and with time the consumer will become a stakeholder, reinforcing trust, good faith and fair dealing. Third, purpose operates as a social narrative, in communities and societies beyond the firm, helping to create and sustain the firm’s social licence to operate. At the highest level, purpose captures the moral contribution of companies to the betterment of the world now and in the future.

The vast majority of ESG assets seek to ‘do well by doing good’ by using ESG criteria to identify common factors that support risk management and value creation in order to enhance long-term risk-adjusted returns in a form of divine coincidence. These strategies encompass both responsible investing, which largely uses ESG for risk mitigation, and sustainable investing, which adopts progressive ESG practices that are expected to enhance long-term economic value. Impact investing seeks to support positive social or environmental benefits alongside financial returns. It is distinguished by measuring social and environmental outcomes as rigorously as financial outcomes, and by pursuing additionality which means concentrating on investments that catalyse social or environmental change. So an impact strategy focused on accelerating the transition to a net-zero economy would not simply invest in existing green assets but rather develop new renewables projects or help companies invest to reduce their carbon footprint.

In order to achieve their objectives, investors pursue different strategies such as positive screening for best-in-class performance on ESG factors; negative screening for those that perform poorly; and momentum investing in companies that are improving aspects of their ESG performance. Deeper analytics can support systematic approaches to shared value that identify the social impacts that are closely tied to a company’s competitive advantage. Within these strategies, there are three main approaches to applying ESG factors: – ratings-based where assessments of ESG performance are outsourced to a third-party provider; – fundamental value in which raw ESG data is analysed, as part of an integrated assessment of the relationship between the creation of sustainable and enterprise value; and – impact assessments which measure and report the wider impacts on society while targeting specific positive social impacts alongside financial returns.

The rating systems of data vendors can vary dramatically, leading to substantially different ratings of the same company. For example, a 2020 study found that the correlation between the overall ESG ratings of six rating providers is about 0.46, so only about half the time would a rating provider come up with the same assessment.24 The average correlation is lowest for the governance (0.19) and highest for the environmental factors (0.43). More profitable firms are subject to lower ESG rating disagreements, while firms without a credit rating have higher disagreements. A 2019 study found the level of ESG disagreement for a given firm has increased over the same period.

Shared-value companies make a different set of choices from their competitors, building a distinctive social impact into their business models. Shared value can affect strategy on three mutually reinforcing levels: (1) creating new products that address emerging social needs or open currently unserved customer segments; (2) enhancing productivity in the value chain, whether by finding new efficiencies or by increasing the productivity of employees and suppliers; and (3) investing to improve the business environment or industry cluster in the regions where the company operates.27 Note the contrast to a ratings-based approach which leads many investors either to adopt a mechanistic index strategy or to use a company’s overall ESG performance as a final screen to reduce risk.

The ten years following the global financial crisis marked the first lost decade for real incomes in the UK since the middle of the nineteenth century. Substitute platforms for textile mills, machine learning for the steam engine, and Twitter for the telegraph, and current dynamics echo those of that era. Then, Karl Marx was scribbling the Communist Manifesto in the reading room of the British Library. Today, radical viral blogs and tweets voice similar outrage.

We are living Lenin’s observation that there are ‘decades when nothing happens and weeks when decades happen’.

The following conclusions of Tharman Shanmugaratnam, Singapore’s Senior Minister, put fiscal trends into a disturbing longer-term context: There has been a drift in fiscal policy, in a whole range of countries, towards individuals rather than public goods and towards the short term or the next electoral cycle rather than the long term. For instance, in the 1960s 75% of the US budget went into public goods of one form or another – infrastructure, schools, hospitals, transport and so on. And 25% went in some form of benefits to individuals. Today it’s exactly the other way around – 75% to individuals, and 25% on public goods. That is inherently short term. It sometimes solves immediate problems – but it doesn’t lead to a better long-term future and it doesn’t lead to optimism. If you don’t invest in public goods, and people can’t see that you’re investing for the long term, then it’s very hard to get a more optimistic society. You get a society where people are constantly concerned about ‘how much do I get compared to someone else’.

At the same time, authorities need to recognise that inflation will return, particularly because Covid represents a major negative supply shock. Significant capacity has been destroyed, and a tough adjustment is underway. The twin risks of fiscal dominance – where central bank policies are dictated by the spending priorities of the state – and financial dominance – when central bank policies are driven by a perceived need to support financial markets – will rise over coming years. In this environment, it is more important than ever that independent authorities assess and address risks to monetary and financial stability. In an environment where many assume that interest rates will stay low forever and that authorities will always bail out markets under stress, a more active and holistic approach to managing risks in market-based finance is imperative.

Institutions have been found to be more important than either geography or international trade in explaining economic growth.17 Good institutions encourage productive activity, lower transaction costs by establishing norms, reduce uncertainties and discourage behaviours that impair economic growth. Bad institutions lead to a culture of corruption and rent seeking.

stagnation in western nations can be attributed to institutions that protect the status quo and inhibit growth.24 His examples include banks that were overregulated and too big to fail, and US public schools captured by teachers’ unions. To Ferguson, western businesses suffer not from a culture of unofficial rent seeking but from onerous regulation and expensive legal fees that restrict economic activity.

There is reason to worry that leading technology companies could decide how institutions evolve, thereby locking in their advantages and discouraging creative destruction. Nations – not companies – must set these ground rules for markets to be fair and for market participants to take their responsibilities. States need fair rules enacted and maintained by fair processes, held together by both formal structures and informal conventions, resistant to capture and adaptable to changing circumstances.

Financial markets can be particularly vulnerable because of the temptations of liquidity illusion and the reliance on a strategy of being able to get out before the greater fool. For example, asset-management vehicles that promise daily liquidity to their clients while investing in fundamentally illiquid assets (like corporate loans) were prone to fire sale risk and were saved only by the prospect of massive Fed intervention in the spring of 2020. I know from experience that a booming economy can give the illusion of lower risk, feeding beliefs that potential growth is both stronger and more sustainable than it is. Risks are often the greatest when they seem the least.

The green investment opportunity – amounting to tens of trillions of dollars over the next decade – brings together a unique combination of factors: – potential consumer caution, pressures on employment and weaker export markets could all mean that investment will determine the strength of most economic recoveries; – the low-for-long interest rate environment means large-scale public investment is possible, despite record fiscal expenditures to fight the Covid crisis (provided the transition from Covid to Capital begins soon); – the largest investment opportunities for the next decade all involve accelerating the transition to a net-zero economy; in parallel, these investments will create high-paying jobs across the country while advancing competitiveness in the industries of the future; and – the global private financial sector increasingly sees the transition to net zero as the future of finance.

Many remember Schumpeter’s phrase ‘creative destruction’ but forget its context. The core of his voluminous writings was his view that capitalism was prone to ossification. In ‘the treason of the clerks’, large companies tend to become self-perpetuating bureaucracies. When coupled with the natural tendencies of incumbents towards rent seeking – seeking the rewards of value created by other people – the treason of the clerks can quell the creative gale. This is more likely to happen if public policy is pro-business rather than pro-market – that is, if it concentrates on the needs of incumbent firms to the detriment of new entrants. The more decentralised an economy is, the more dynamic it can be, and, by definition, the more the leaders in economic sectors change as good new ideas come to market. In contrast, concentration leads to rent seeking and efforts to entrench existing advantages.