BUS604: Innovation and Sustainability

Business' cooperation with governments on policies directed at the Global Goals will be critical to achieving them. Policies determining how to factor environmental and social costs into the prices that companies and customers pay will shape competition in expanding sustainable markets. So will public/private collaboration to accelerate innovation. 

Advancing policy on pricing externalities. All companies make decisions based on the economic signals surrounding them, such as the price of labor and materials and the cost of taxes, as do consumers. As noted in Section 2.4, today's prices don't tell companies or consumers the truth about environmental or social externalities. Until they are priced in, even businesses that want to be part of the solution are condemned to be part of the problem – stuck on the same, skewed playing field as everyone else.

Exhibit 12: 
Negative profit margins in most of the world's raw material industries if natural capital costs are included.

Profit margin (EBIT) before and after natural capital costs, based on top-two companies in Morgan Stanley Composite Index category, Percent, 2012

The numbers involved are immense (Exhibit 12). In 2012, a major analysis of unpriced environmental costs in the global economy looked at every primary production and processing sector – from agriculture, forestry, fisheries, mining, utilities, and oil and gas exploration to cement, steel, pulp, and paper, and petrochemicals. Across these sectors, it found total environmental externalities of US$7.3 trillion were unpriced in 2009 (the last year for which complete data was available), equivalent to 13 percent of global GDP in that year, or nearly half of US GDP at the time. The truth about social and environmental costs is also concealed by price subsidies. Economies across the world continue to subsidize fossil fuel consumption, in direct conflict with the urgent need to tackle climate risk. 2014 fiscal fossil fuel subsidies were estimated at US$550 billion, around 20 percent of the net cost of financing the Global Goals. In addition, local air pollution is costing the equivalent of between 2-10 percent of GDP across G20 countries, based on the most recent estimates of the WHO and IMF.

Some CEOs accept that an explicit carbon price of US$50 a tonne within the next five years, and up to US$100 a tonne by the second half of the 2020s, is essential to keep global warming below two degrees. The most forward-looking business leaders are anticipating the impact on their business costs when the true environmental costs of other activities is reflected in prices, for instance, the real cost of using unsustainable fresh water, sending waste to landfill, wasting food, polluting the air or ground, and producing the most resource intensive foods. (See Box 7: Sustainable development scenario drives Telefonica's energy strategy).

Box 7: Sustainable development scenario drives Telefonica's energy strategy

Major telco Telefonica has decided to source 50 percent of the company's energy consumption from renewable energy by 2020 and to grow that share in the longer term. Telefonica has pursued ambitious energy efficiency and emissions targets for many years largely because energy forms a large chunk of any telecommunication company's operating expenses. But new drivers lie behind its new energy strategy. First, clean energies are becoming more and more competitive as energy markets respond to mounting regulatory pressures arising from the Paris Climate Agreement commitments and reinforced by the Global Goals. Second, Telefonica's customers are demanding that the company reduce emissions linked to the services it provides.

Setting medium- and long-term targets for renewable energy allows the company to set itself science-based emissions targets, effectively decoupling company growth from emissions growth. It is also protecting itself from future regulatory shocks, such as mandatory carbon pricing. And while the strategy, of course, continues to aim for lower operating expense, it means Telefonica can focus on offering services that allow customers themselves to become more energy efficient, giving it a further competitive advantage. 

There is a good case for businesses to contribute to systematic approaches that tackle the set of issues linked to pricing externalities, which cross the public and private sectors. For instance, a number of governments, multi-lateral institutions, financial players, and companies have come together to form the Carbon Pricing Leadership Coalition. This encourages the development and international diffusion of best practices on carbon pricing. Getting carbon prices right will be critical to keeping global warming well below two degrees. It could also provide the test-bed for a more comprehensive alliance on externality pricing, especially given linkages between carbon pricing and food security.

The issue of pricing externalities is not limited to environmental challenges. Just as investors are increasingly concerned about stranded assets as a result of tougher environmental requirements, they may also become concerned about the earnings quality of companies that incur significant social risks to maintain profits, for instance by paying poverty-level wages or generating conflict with local communities over rights to access land and other resources. The World Business Council for Sustainable Development is developing a new Social Capital Protocol to enable businesses to measure and value their interactions with society. The Council is piloting the protocol approach in three areas: employment, skills, and employment conditions that meet safety standards which show respect for workers. Companies across a range of sectors – from mobile telephony through to pharmaceuticals – are also exploring forms of "social pricing" to make essential goods and services with relatively high margins available to poorer consumers at closer to cost price. For some products, such as drugs, there is a risk that the "socially priced" product will leak into the rest of the market. However, companies are finding more and better ways to handle this risk, expanding the scope for social pricing.

CEOs have a choice. They can do nothing and hope that governments won't regulate prices in their sector, although the trend towards more accurate pricing of environmental costs is emerging. They can try to prevent regulation through lobbying or financing the campaigns of politicians who oppose it, at the risk of damaging their reputation and losing stakeholders' trust. 

Or they can reduce the risks of regulatory change by leading it themselves – as in the run-up to 2015's COP21 climate summit in Paris, when enlightened CEOs came together under the unified umbrella of We Mean Business to demand governments set a more predictable, ambitious, and longer-term agenda. Progressive leaders are not waiting for governments to act on price before doing anything. Some have already started to "shadow price" social and environmental costs in internal accounting, in effect preparing for the future in which markets are sustainable. 

America's fourth largest craft brewery, the New Belgium Brewing Company, offers an example of the benefits of this approach. The company has adopted its own internal electricity tax – charging itself 2.4 cents for every kilowatt-hour of power generated from fossil fuels that it consumes. The tax creates a powerful incentive to use clean energy. Already, much of the firm's electricity is generated onsite, and all purchased power comes from wind. The "tax" revenue also provides a source of capital for future investment in sustainability – it goes into a fund for further renewable power development and energy saving measures. For more detail on this case see report.businesscommission.org.

Advancing public/private collaboration to scale innovation. Innovation partnerships between public, private, and academic partners have been critical to transforming scientific discovery into mass-market products and services in public health, clean energy, and nutrition among other areas. They will be essential to delivering the speed and scale of innovation needed to achieve the Global Goals. Economists have recently provided powerful evidence of how the public-private academic "innovation ecosystem" has led to astonishing social and private returns across a wide range of sectors. 

In pharmaceuticals, for example, the Global Alliance on Vaccines and Innovation (Gavi) provided strong incentives for private companies to come into developing vaccines for tropical diseases. It also provided "advance market commitments" that encouraged companies to invest in the manufacturing facilities and cold chain logistics needed to provide pneumococcal, rotavirus, and pentavalent vaccines, among others, in Sub-Saharan Africa. By taking away market and demand uncertainty from the vaccine suppliers, the Gavi facility also made it possible to bring down supply costs dramatically. The facility was largely financed through future overseas development assistance (ODA) commitments that were then translated into a social impact bond.

On clean energy, governments representing 20 participating countries have committed to doubling the average share of research and development on clean energy (currently around 0.1 percent of GDP) in public budgets. They have also set up a coordination mechanism – Mission Innovation – whose design will allow for much more strategic alignment and prioritization across countries. In parallel, 

a number of the world's leading philanthropists have come together to form the Breakthrough Energy Coalition. This is now creating a new kind of long-term innovation fund. With a 20-year lifespan, a 10-year investment period and very substantial resourcing from its founders and their networks, it is bringing the best scientific and commercial expertise together to back the next wave of clean energy technologies. The two initiatives – Mission Innovation and Breakthrough Energy – will coordinate their activities and expand their innovation ecosystem by inviting leading corporate, financial institutions, and other entrepreneurs to participate. For more detail see report.businesscommission.org.

These are examples of a wide range of mechanisms now being used to accelerate the development of new products and services aimed at specific societal goals. Many countries have very substantial public resources committed to this "mission-driven" approach to innovation – notably the US, whose DARPA and ARPA-E platforms have made critical, catalytic interventions in disruptive technologies ranging from the internet through to the autonomous vehicle. Another example is the Danish-led initiative Global Green Growth Forum (3GF), which currently convenes 23 such partnerships. The private sector has much to gain from partnering with such initiatives.