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Our Insights 10 Mar 2015

In Focus: Pavan Sukhdev & Valuing Externalities

By Denise Delaney

Environmental economist Pavan Sukhdev

This piece was originally published in the spring issue of Radar Magazine – Issue 06: The Place of Sustainability.

SustainAbility is pleased to shine a spotlight on the work of environmental economist Pavan Sukhdev, CEO of GIST Advisory, an environmental consulting firm focused on enabling governments and corporations to measure and manage their impacts on natural and human capital. At the end of 2014 he joined our Engaging Stakeholders workshops to share his knowledge on the importance of, and emerging methodologies in, valuing externalities, including social, environmental and financial impacts.

Sukhdev challenges business to evolve to a Corporation 2020 mind-set, valuing impacts and opportunities far beyond financial performance and growth alone. Why Corporation 2020? Some of the greatest negative corporate externalities – greenhouse gas emissions, water abstraction, consumption of natural resources, etc. – are pushing our planetary boundaries to their limits. Sukhdev sees these planetary boundaries as, “‘time-bombs’ whose fuses have been lit.” He urges CEOs to get their boards to realise, “They and their company are sitting in a room with lighted fuses of uncertain length and need to discuss what their company should do, and how, in order to contribute to defusing these planetary time-bombs.” Sukhdev calls for the measurement and disclosure of externalities to ensure that companies can no longer sell goods at the expense of the environment and society. The dominant economic agent of the past, Corporation 1920, did exactly this: hiding the true costs of production and supply.

“Re-directing just one-tenth of annual investment towards a ‘green economy’ will succeed over time to deliver a greener and comprehensively better economy.” In order to progress to a green economy at the ‘macro’ level, Sukhdev identifies his four most vital ‘planks of change,’ or policy-based mechanisms at the ‘micro’ or corporate level, as follows:

  1. Disclose corporate externalities so that environmental and social performance can be factored into investment decisions. This is less a question of if, but when and how: “Externalities will come home to roost and get internalized. It only depends when and how – by design, decree or disaster.” He sees the time horizon for mainstreaming the disclosure and valuation of externalities approaching sooner than many think: he envisions 2020-2025 as the point at which climate change will really come to a head, and with it, the valuation of externalities. As Sukhdev explained at SustainAbility’s Engaging Stakeholders workshop, “A key urgency is how to get accountancy regulators to think about externalities. CFOs will get it once CEOs get it and there are disclosure requirements for material externalities.”
  2. Tax resource extraction – rather than profits – which will lead to greater efficiency in the use of materials and energy as companies rewire their operations to use fewer resources while delivering the same or higher levels of products and services.
  3. Limit financial leverage, introducing capital adequacy requirements for companies likely to cause disruption and public losses due to their failures as the banks and financial institutions previously thought to be “too big to fail.”
  4. Make advertising accountable through simple rules about product advertising and point-of-sales information, rather than merely fueling consumerism and allowing advertisements to convert wants into needs that put further pressure on the environment and ecosystems.

Our research report published in 2014, See Change: How Transparency Drives Performance, identifies the valuation of externalities – Sukhdev’s first mechanism – as one of three priority areas of transparency that can drive corporate performance. We explore this in two case studies of natural capital valuation. The environmental profit and loss (EP&L) undertaken by Novo Nordisk and the Danish Ministry of the Environment published in 2013. Novo Nordisk reported benefiting from seeing data in a way that they never had before and leveraging it as part of an environmental strategy review. The Dow Chemical Company was also an early adopter, known for its collaboration with The Nature Conservancy that began in 2011 to better understand ecosystem services in relation to its facilities. At a pilot site, the company was able to demonstrate that reforestation was a viable and cost-effective complement to traditional smokestack scrubbers to improve air quality affected by Dow’s operations.

With experiments around measuring and valuing cost and impacts of corporate operations on the environment and society underway, there are early signals that we are progressing towards Corporation 2020. Sukhdev believes that if we can successfully implement all four of the mechanisms he set forth, a new type of corporation will emerge that better aligns social benefit with profit generation, and as a result drives the transition towards a ‘green economy.’

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