Towards a Theory of Sustainable Finance

United Nations Environment Programme (2015)

Recent years have displayed a growing discontent in society regarding the functioning of financial agents and markets. This is leading to an emerging consensus that the financial system is in need of reform. The crisis of 2008 and onwards has demonstrated how misaligned incentives and poor regulations impose extreme and detrimental risks on both the financial system itself and society at large. But a more general problem is the seemingly inability of financial markets to address the more pressing sustainability challenges of our time, such as global poverty and the threat of climate change. These systemic flaws do not only pose a practical challenge for the world’s leaders, but they also pose a theoretical challenge for contemporary researchers

to rethink the role of financial markets in society. If this role can no longer be defined solely in terms of profits and economic efficiency, then how should it be defined? In his acclaimed book on the financial crisis, Joseph Stiglitz (2010) stresses the need for a new vision for the financial system. Rather than just “muddling through” – that is, putting out the most immediate fires but not addressing the root of the problem – we should seize the opportunity to rethink the system from the ground up. This paper is an attempt to do just that

to “think outside the box”. The paper presents a theoretical model of a different and more sustainable role for financial agents and markets that is justified by systematic philosophical arguments and reasoning. My main locus of interest is to reflect on the aims and activities of financial agents themselves and how they may become a more positive part of society. However, the paper also reflects on the place and content of financial regulations and public policy. The aim of the model is to stake out a middle ground between the dominant view of finance, focusing only on profits, and contemporary calls for either more regulation by the authorities or greater social responsibility by agents themselves. In doing so, the aim is to present a vision that is both desirable and achievable. A first a note on the methodology: The paper is normative rather than descriptive. It does not review how the financial system currently functions, but rather how it ought to function in the future. For this reason, I draw upon concepts, theories and arguments from the literature in both theoretical economics and normative philosophy. Some readers may feel that the models and suggestions under discussion are rather detached and abstract. But I should stress that this is not a good reason for dismissing them. Instead the suggestions should be evaluated for how robustly and effectively they provide a sustainable and plausible alternative to the current regime. The goal is to identify a new direction for finance which the majority of commentators will recognize as both desirable and achievable. It should thus come as no surprise if, despite the abstractness of the models and reasoning, the end result is a fairly straightforward idea about how the financial system can be improved. The paper proceeds as follows: It first outlines the dominant view of finance and notes some of its strengths and weaknesses. Thereafter it introduces and evaluates contemporary calls for either more regulation by the authorities or greater social responsibility by agents themselves. In light of current evidence with both of these suggestions, a new theory is presented which I tentatively call the two-level model of sustainable finance. Finally, the paper closes with a discussion on what the theory implies in terms of both adequate behaviour by financial agents themselves and effective regulation by the authorities. The main results are summarized at the end of the paper.