Interview

Mindset Shift

Professor Steve Keen says asset owners should dedicate more investments to the climate transition, while prioritising scientific predictions over economic ones.

Institutional investors are ill-prepared for the impending societal and economic changes likely to be triggered by climate change and have their priorities all wrong.

Or at least, so thinks Professor Steve Keen – Honorary Professor at University College London, and Distinguished Research Fellow at the Institute for Strategy, Resilience & Security.

In recent years, Keen has increasingly focused on debunking the climate scenarios based on economic modelling widely used in the financial sector, saying they lack credibility and are largely misaligned with scientific findings – and as such, with reality.

A self-described critic of mainstream economics for “half a century”, Keen started delving into ecological and climate data around 2019. Over time, he found out that economists were giving what he describes as “fairly low estimates” of the financial damages caused by climate change.

“Most people assume that economists have taken scientists’ empirical estimates and put a price on them, and then discounted that by the time value of money,” he said. “But in fact, they’ve created their own models, commonly known as global circulation models (GCMs) – which have temperature, precipitation, and quite a range of other factors built into them.”

GCMs became more sophisticated over time, evolving to take into account elements such as differences in temperature and precipitation over land and water, and are regularly tested against data. Despite this evolution, Keen argues that they remain largely unreliable and at odds with climate science.

“It is a completely different model to what scientists are using,” he said. “The main danger is that scientists have a sense of proportion and of where they can or can’t make comments – so they don’t go and assess economic reports. But when they start looking at them, they get horrified.”

Economists typically use data on employment, economic activity and temperature to predict the damages from climate change – assuming that what applies over space will apply over time, Keen explained.

However, that assumption implies that climate change isn’t a primary driver of economic performance – which the professor describes as “disastrous”.

“Our main danger is that nonsensical papers get published,” he added. “Around 40 papers have been published by economists, which try to estimate the overall cost of climate change to the economy. It’s quite a small number, but I don’t think any one of them would have been published if they’d been refereed by scientists.”

Fixing the machine

Alongside peers, Keen is now trying to get funding to close this discrepancy, and drive more coherence between scientific and economic findings on climate change.

“The first thing I want to do is collect £1-1.5 million to cover the needs of a research group of scientists who can referee economic papers and reject them accordingly,” he said. “We would then also develop a science-based damage function. The economists have assumed growth in GDP over time, and multiplied that by a damage function based on temperature levels – but they’re using trivial estimates that give a gradual increase.”

Several surveys conducted by economists have projected that a 7°C increase in global temperatures over the next two centuries would reduce global GDP by 20% – the equivalent of a 0.02% fall in annual growth rate. Such predictions can, however, seem ludicrous in light of scientists’ predictions that human civilisation would be extinct between 3-5°C.

“The trouble is thar people in finance think economists have done the right thing and are trusting their estimates – but they couldn’t be more wrong,” said Keen. “Investment consultants have taken some things at face value, which in one sense is understandable – they’re not academics. But the analysis is dreadful and should never have been published in the first place – that is the real reason we’re in deep trouble now.”

By continuing to follow predictions from central banks and other established sources of economic wisdom, companies and investors are making the wrong calls on their sustainable investment policies and climate transition plans, Keen argued. According to him, this is also the main reason “real action” has been taken at policy level.

“Those who make policies are trained in economics – not in science,” he said. “Scientists and academics live in silos. You have people who should never have refereed these empirical assumptions arbitrating them and passing them.”

By way of example, the Intergovernmental Panel on Climate Change’s 2022 report on Mitigation of Climate Change mentions that a 4°C global warming by 2100 would reduce global GDP by 10-23% compared to what it would be in the absence of climate change. But the prediction is moot alongside the scientific observation that anything beyond that level of global warming would signify the end of humanity.

What investors can do

In this context, one may consider the role of investors in changing the finance sector’s current ethos.

In a report he authored for think tank Carbon Tracker, Keen argued that pension funds were risking the retirement savings of millions of people by relying on economic research that ignores “critical scientific evidence” about the financial risks associated with global warming.

“Many pension funds use investment models that predict global warming of 2-4.3°C will have only a minimal impact on member portfolios,” he wrote. “Behaving cautiously now and acting to avoid a 1.5°C increase – let alone the 4°C outcome – will enable future generations to secure the prosperity and quality of life that comes from a healthy planet.”

The report called on investment professionals to look at the “compelling” evidence found in climate science literature, and implement investment strategies on that basis – including a rapid wind-down of the fossil-fuel system, based on a “no-regrets” precautionary approach.

“We’re getting the message through to pension groups: pensioners themselves, who are lobbying their financial institutions, are the main point of pressure we’re going to observe in the opposite direction,” Keen told ESG Investor. “The pension lobbies are looking at the data and saying – you’re not taking care of our future, you’re endangering it by continuing to fund the oil and gas industry.”

Concern is mounting, with the Institute and Faculty of Actuaries (IFoA) calling this week for use of more realistic climate risk assessments, floating also the concept of a ‘planetary solvency’ framework. In an earlier collaboration with the University of Exeter, the IFoA warned of a disconnect between climate science and the climate scenario modelling used by the financial sector.  

But investors have a limited scope for action, Keen recognised.

“This is not the sort of thing you can decentralise decisions about,” he said. “Pension funds are under enormous short-term pressure: they’ve got to invest in oil and gas because the prices are rising, and if they don’t, they’ll lose out.”

He did, however, suggest some ways ways in which investors could help – one of which is to increase awareness of the issue through their networks.

“First of all, let it be known to the political links you have – the finance sector has enormous access to politicians – that there’s something seriously wrong with what economists have done,” he said. “Get that message across as loud and clear as you can.”

Internally, investors should strive to apply the 80-20 Rule (also known as the Pareto Principle), which dictates that 20% of one’s portfolio holdings should generate 80% of its growth. Applied to this issue, it would mean that investors should devote 80% of their holdings to maximising returns, Keen explained – while the remaining 20% should go towards climate mitigation efforts.

This could include funding groups such as the Mirrors for Earth’s Energy Rebalancing (MEER) initiative, which aims to reduce global temperature by 1-2°C while delivering local heat relief by deploying surface solar reflectors made from recycled materials.

“There’s a whole range of groups trying to find ways to attenuate the damage from climate change – some are working on small nuclear reactors, while others are trying to capture and amplify solar energy more effectively,” said Keen. “Most of them get trivial funding, but if pension funds and insurance companies provided part of it, it would be very worthwhile and certainly much better than the government not doing it at all.”

The professor stressed the need for such funding to happen on a large scale in the near future, pending what he described as an imminent “massive catastrophe” that would soon befall humanity.

“Whether that comes from the finance sector first, or from the real world, is an open question,” Keen argued. “But if we’re not prepared for it, we won’t be able to do anything about it. The government is missing in action for the same reason it was during Covid-19: they’re not the sort of people who make sensible decisions.”

Hopeful horizons

Looking ahead, Keen said a crucial change in mindset – in the investment world and beyond – would be needed to effectively modify the course of human life on Earth. Fear and greed have long been considered the primary forces at work in the financial markets, but Keen suggests the former should outweigh the latter in future.

“We need less worry about greed and more about survival: everybody is talking about getting the maximum return they can out of their investments, but it should be about maintaining human civilization first and foremost,” he said. “That probably means de-growth, less growth, or even negative growth – but you want to do it in a way that society doesn’t break down.”

Rather than focusing on outperforming competitors and indices, investors should now devote as much of their resources as possible to the climate transition, the professor suggested.

“Investors are completely unprepared for the situation they find themselves in,” he added. “You’re expecting returns over time, but you might find that they disappear as the assets you are relying upon get confiscated by the state to address climate change.”

To take one example, reducing air travel helps to reduce carbon emissions significantly, as demonstrated during the pandemic. As such, investors should be wary of any ensuing implications and plan accordingly, says Keen.

“If we have a serious realisation that we must reduce energy levels, one of the easiest ways to do so is to abolish tourism – and there go the airline and hotel industries,” he warned. “This type of thing is feasible in the near future, and we’re not at all prepared for it. Nobody’s prepared for that sort of situation.”

Although Keen is hopeful he will be able to contribute to a mindset change among the investment community and beyond, his outlook remains negative in the short term.

“The main thing I want to do is get people to realise how serious this is, but I’m quite pessimistic,” he said. “I don’t think we’re going to get this sort of consciousness, either at the public policy or private level, until we witness some truly terrifying impacts of climate change.”

Although this has arguably already occurred in some parts of the world, notably the extensive flooding in Pakistan in 2022, Keen stressed meaningful action would only result from such a disaster striking the northern hemisphere – as those in power in developed countries will only act if local populations are hit directly.

“It is only a question of time as to when that comes: most climate scientists are now of the opinion that something serious is going to happen in the next decade,” Keen said. “If something catastrophic that really terrifies people occurs, they may realise they have been misled. Then, it will be a question of what can be done when major tipping points have already been triggered, and the consequences of that are being suffered.”

Professor Steve Keen is one of the keynote speakers at ESG Investor’s Stewardship Summit 2024 on 10 April.

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