Can we reasonably argue whether businesses alone can fix the problems of this world today?
Well, some investors working under the banner of “impact investments” can say that businesses are the only solution possible for fixing the ailing worldwide economy. The purpose of impact investments is such that it does not sacrifice commercial returns while maintaining sustainable development for problems such as female literacy, climate change, hunger, education etc.
There are plenty of successful examples where impact investing has proven to be beneficial at bringing both commercial returns and also creating a positive impact. But at the same time, some argue that there is a trade-off in profitability along with creating impact.
The approach towards creating an impact has garnered interest from major banks, business lobbies, consultancies and even former political figures. One of the most influential figures in impact investment, Sir Ronald Cohen believes that this could become a “revolution” that will not only solve the greatest of global challenges but also flourish capitalism. However, if we look forward to reforming capitalism, then the traditional ways of conducting impact investments are not enough. Therefore, we need to review the rules that are governing how global economies work — and in doing so, impact investors have a significant role to play.
Changing the Rules of the Game
If we talk about the rules that govern our economies, we will not be surprised to see that even though there have been initiatives focusing the shift from shareholder capitalism to stakeholder capitalism. It will still not be false to say that even with all these efforts, shareholder capitalism is what truly entrenches the rules of the game. As previously argued, businesses must work hard towards gaining more profits because eventually, the less profitable will be muscled-out by the big giants over time.
Looking at the rules that businesses follow today, it is clear to see that harmful investments can offer inflated profits at the expense of the damage caused by them. This is because investors don’t have to bear the cost of the damage caused by their companies, for example, carbon emissions or how the polluted air is impacting the health of individuals. At the same time, many worthy investments are not as profitable or even unprofitable because investors are not being rewarded for any associated benefits, such as improving the quality of health by helping to reduce air pollution.
Therefore, going back to Sir Ron Cohen’s revolution, in which investment “does not require reducing profits in favour of impact,” the only choice left with us is to change the rules.
Knowing the Changes
Economists believe that to reduce the difference between investing and impact investing, we must be able to deal with externalities — whether these are carbon emissions, ocean dumps, illiteracy or poverty. We have succumbed to these global challenges for well over centuries now. If only investors get rewarded for the value they create versus the costs they have incurred; we can see this gap between investments and impact investments slowly disappear.
To put it in other words, once the externalities become internalized, then all investing will eventually become impact investing. Hence, a baker would make profits by feeding a community, a constructor will profit from housing the community, and similarly, a forester will profit by reducing emissions for the community. As Adam Smith put it two and a half centuries ago: when individual incentives are associated with actions that create economic growth for the entire society, the “invisible hand” is free to show its magic.
Shaping the Future of Impact Investment
What could this possibly mean for impact investors? I think they have a few of these critical roles to play.
- Find smart ways that are blocking below-the-line investments. Look at how Tesla’s first-ever utility-scale battery has set an excellent example in South Australia for investing in the innovation frontier. Now more than ever, we need plenty of such innovators to pave the way so that others may follow.
- Secondly, encourage philanthropists to aim high. According to Mike McCreless, this calls for “efficiency frontier”: that is when you’re seeking a particular impact, always find ways to achieve highest-returns. These returns may seem short when compared to commercial rates, but when they are the best there could be given the limits of the rules of the game, each dollar that you invest will have a far more significant impact.
- Finally, impact investors should lobby for bringing changes in the rules, and that is perhaps the most crucial role for them. Impact investors can become a powerful voice to support internalization of externalities through governments. So that all investments turn into impact investments. Offering incentives, such as a price on carbon or any other mechanism, can significantly expand the chances for marrying profitability with those of social returns. Something similar is done by Roots of Impact and the Swiss Agency for Development and Cooperation SDC in developing Social Impact Incentives (SIINC) framework.
Having a nuanced view about having impact investing as part of our economic system, we may find ourselves realizing Sir Ronald Cohen’s revolution: a world where impact and profit will walk hand-in-hand.
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Written By:
Sadia Mehfooz Khan
Chief Copywriter | Ylemer
