Harry Geels: The hidden implications of sustainability taxonomies

July 25, 2023

^{This column was written in Dutch. This article is an English translation.}

By Harry Geels

Worldwide, international organizations in particular resort to taxonomies and standards to determine what green or brown energy is and, in the future, what good and bad social practices are. This has five deeper implications.

In late April, SEC Commissioner Hester Pierce gave a (personal) speech with the title ‘Tow truck Taxonomies’, in which she criticised the increasing regulation in the field of ESG and sustainability standards. In this lecture she expresses “three concerns” about the application of sustainability taxonomies and standards:

• They are based on a complex (and partly subjective) matter;
• They are static (and therefore not equipped for change);
• They promote herd behavior.

We can actually add two more to that:

• They are based on a mindset that assumes a (socially) engineerable society;
• They were created on the basis of flawed democratic decision-making.

Open to multiple interpretations

'ESG' and 'sustainability' are ambiguous terms. One person finds nuclear energy sustainable, the other does not. For one, wood construction is the ultimate way to make real estate more sustainable, while the other points out the necessary felling of trees. Biofuels seem sustainable, but then why does Milieudefensie give four reasons not to use food as fuel? According to one calculation, a new diesel engine is less of a burden on the planet than a fully electric car with its battery full of rare raw materials, according to the other calculation it is not.

We can also discuss the 'S' and the 'G'. I personally find companies anti-social if the highest earning employee earns more than 25x as much as the lowest earning. With such a requirement, the investment universe for a 'social' investor thins out considerably. In the EU, the standards are laid down in the EU Taxonomy initially focused on the E, because that was already quite a job. In the end, natural gas and nuclear energy were labeled as sustainable. The social taxonomy is yet to come. What will be reported there about income inequality?

Now let's take a closer look at the five deeper implications of taxonomies and standards, starting with Pierce's three concerns:

1) It's not black or white

Pierce argues that there are no simple black-and-white categories for classification: "That task is impossible. Even the most brilliant people (…) cannot accurately classify large amounts of (human) activity as categorically positive or negative. Collecting data to measure the unmeasurable and quantify the unmeasurable is an unreliable basis for deciding where to allocate capital, even if all this data creates the illusion that we understand the world and how people live and work in it.”

I would like to add the following: if ESG is complex, it becomes susceptible to 1) political discussions (think of the aforementioned labeling of gas and nuclear energy as sustainable), 2) greenwashing (something can have a high ESG score on average, but still have quite a few controversies), and 3) cover your rear practices (external data providers and consultants are hired to determine what is sustainable or not and the number of jobs in 'sustainability' is growing exponentially, and not just because the younger generations have suddenly become sustainable).

2) Taxonomies are (by definition) static

Pierce: “We have no idea which technologies (…) or which new problems will arise. Solutions to our greatest problems will come – in ways we cannot imagine – from people, many of whom are just now being born and educated. Could these people with truly original ideas be able to access capital in a fully taxonomized world? Inflexible taxonomies, updated through the slow political process, are static solutions to dynamic problems.”

In addition: we could even say that progressive insight is typically something that fits sustainability. By recording something permanently in a taxonomy, there is probably a delay rather than the desired acceleration.

3) Taxonomies lead to herd behavior

Pierce: “Moving capital into government-designated sustainable activities can create a green bubble within the financial system as investors uncritically pour money into green assets, as defined in the relevant taxonomy. We are already seeing signs of a problem: investors are complaining about the lack of investable investment and, as we have often seen, the search for limited investment opportunities can lead them to forego proper risk management.”

In addition: herd behavior as a result of sustainable laws and regulations has the risk that if those rules are wrong, this can quickly lead to system errors and thus also a system crisis.

4) Taxonomies are based on a mindset that assumes a (socially) engineerable society

Then two personal additions. Firstly, the EU Taxonomy was set up in part to give substance to the objectives of the Paris Agreement to live in a fossil-free society by 2050 with a maximum global temperature rise of 1.5 degrees. These 'precise' goals are the ultimate example of a mindset that assumes a (socially) engineerable society. Every climatologist can really only give a range of temperature results. Many new measures take many years to take effect. We also do not know, as Pierce states, which new technologies and problems will arise.

5) Taxonomies are based on flawed democratic decision-making

Many sustainable policies are not determined at country level. That also fails, because sustainable policy encounters electoral problems. The UN is an important sustainable instigator with the Social Development Goals (SDGs), among other things. In Europe, the EU is leading the way. The question is how democratically the global agenda has been voted on by all world citizens. But even if that were the case, another problem arises, as Pierce also points out: “if every country pursues the same sustainable agenda, the risk of inefficient capital allocation and bubbles increases.”

The different paths of the climate transition

With this column I am not denying the need for ESG. In fact, I myself have a laundry list of companies in which I prefer not to invest. I mainly wanted to expose the implications of the current (global) sustainability policy. It goes without saying that we have to pay attention to the planetary boundaries. Another important question is the extent to which processes are democratic or technocratic, practical or dogmatical, top-down or bottom-up.

The presented climate paths are usually: degrowth, green growth or free market. However, it is not black or white. It probably will be the best of all three. After all, it is also important to take in opposing views. For example, it is good for those who have made ESG and sustainability their profession, for example by drawing up policies and standards, to know the opinion of someone like Hester Pierce, if only to eliminate any blind spot. "Keep your friends close, but your enemies closer."

This article contains a personal opinion of Harry Geels. He is politically independent.

More columns by Harry Geels