Updated: Jan 12, 2021
By Dror Etzion
Editor’s Note: The following article was written by Dror Etzion, an assistant professor of strategy and organizations at the Desautels Faculty of Management, McGill University, and an associate member of the McGill School of the Environment. His research agenda focuses in large part on metrics, primarily metrics for sustainability. He examines how metrics come into being (or remain unused), and then how they are used, misused, and even abused, before falling into disuse. This research integrates areas of scholarship as diverse as economic sociology, signaling theory, behavioral economics and social psychology. In other research, he examines the effects of industry affiliation and geographic location on firm environmental performance. His work has been published in Organization Science, Strategic Management Journal, Sloan Management Review, Academy of Management Perspectives and Journal of Management. He teaches the MBA core course on Markets and Globalization as well as an elective on Strategies for Sustainable Development.
As the dominant ideology of our era – capitalism – increasingly clashes with the carrying capacity of the earth, policymakers, businesspeople, activists and others inevitably find themselves deliberating upon the value of nature. Value, somewhat oddly, can be a synonym both for price and for pricelessness. Indeed, morally, many are inclined to perceive attempts to price nature as heretical. And it may be that such an approach is not only ethically right but also pragmatically wise: by keeping nature and economics as distinct as possible, perhaps we can avoid the ills that often follow commodification, be it of human lives, organs, or other sacred objects.
In practice, however, economics and finance are making inroads that ultimately place a price-value upon nature. Two approaches are particularly interesting: ecosystem services and catastrophe bonds. Ecosystem services is a label for an approach that affixes an economic value to services that well-functioning ecosystems provide to humanity. For example, a healthy mangrove forest in coastal tropical waters helps shield human populations from the powerful storm surges that accompany typhoons and hurricanes. As such, they provide real economic value to the communities they protect, as well as, indirectly, to insurance companies and governments which foot the bill of recovery from storm damages. Proponents of ecosystem services argue that by placing a value on these types of services provided by nature, policymakers can better weigh the costs and benefits of maintaining and even nurturing intact ecosystems, as opposed to having them converted into more recognizable economic assets, such as shrimp farms and marinas.
Catastrophe bonds are also situated at the interface of nature and the economy, but differently. Often issued by reinsurers (companies that insure insurance companies), catastrophe bonds are a financial tool that provides the issuer a payout in case of a catastrophe, such as a typhoon or a hurricane. Typically, a catastrophe bond requires investors to deposit a sizable principal for a duration of several years. Usually every quarter, they receive proceeds, and at maturity, they receive the principal back in its entirety. What’s the catch? If a clearly defined catastrophe occurs (e.g. a hurricane that hits a specific geographic region at a specific force ), then the bond defaults and the principal is transferred to the issuer, thus giving them the means to recoup their own expected losses as a result of the catastrophe. The appeal of catastrophe bonds lies in their low correlation with the global financial system: the timing of a hurricane has very little to do with the occurrence of recessions or government policy on interest rates. As such they have low “beta”, and offer a means for reducing risk in a portfolio, making them an attractive option for portfolio diversification.
Why are these two examples of financial engineering interesting, and how do they contribute to our thinking about systems of exchange? In essence, ecosystem services are predicated on the understanding that without functional ecosystems, economic systems wither. For example, if bee populations worldwide are dying off, economic gains from harvesting almonds, peaches, zucchini and other fruit pollinated by bees decline accordingly. The axiom underlying ecosystem services is that nature and the economy are closely and inevitably intertwined, or in other words that ecosystem stability leads to economic prosperity. Catastrophe bonds, on the other hand, are predicated on the opposite axiom; they value nature precisely because it is uncorrelated with the economic system. If natural catastrophes and the economic system were highly correlated, then these bonds would no longer be appealing for investors. The bottom line is that when economics meets nature, there is more than one narrative. Different financial tools are in fact rooted in contrary versions of what it is about nature that we value.