The Ultimate Domino Effect

October 2008


Why the financial crisis prefigures the looming ecological credit crunch

Editorial by John Elkington and Mark Lee



It's a long while since we played dominoes, and neither of us remembers much about the rules, but it has been interesting to see commentators polish up the Vietnam-era metaphor of the 'Domino Effect' to describe what has been happening in financial markets in recent weeks. Turn to Wikipedia to find a definition of the Domino Effect, and it suggests that it is "a simple chain reaction that occurs when a small change causes a similar change nearby, which then will cause another similar change, and so on in linear sequence". This suggests a flaw in the metaphor as currently used: the financial crisis—and several other challenges we now face—are non-linear. Maybe the appropriate metaphor for the moment lies in Chaos Theory instead. Relying on Wikipedia again, we are reminded that while the behavior of chaotic systems appears to be random, their dynamics are “fully defined by their initial conditions, with no random elements involved”. How close are we to understanding the ‘initial conditions’ of the recent chaos in global financial markets? And what lessons can we draw from it for the sustainability agenda?

SustainAbility used another gaming metaphor based on suits of cards when it completed a set of scenarios in the 2007 report Raising Our Game. These scenarios pictured futures in which society and the environment either win or lose, usually dramatically. The lose-lose world of Diamonds is bleak—we described it as "a domino-effect world, in which, instead of Adam Smith's invisible hand, our invisible elbows knock over a series of economic, social and environmental dominoes". By contrast, under the Clubs scenario, we foresaw "a world in which, among other things, elites learn how to use environmental sustainability as an excuse for denying the poor access to their fair share of natural resources".

Our third scenario, Spades, envisaged trends that have been strikingly apparent in the energy and minerals fields. "Democratic societies open out higher living standards to growing populations", we headlined this ‘society-wins-environment-loses' future. "One key consequence", we noted, "is that natural resource prices rise, but another is that ecosystems are progressively undermined, with most governments unwilling to take the political risks of asking voters to make sacrifices in favor of the common good. The challenges are managed to a degree, thanks to more open societies, but not well enough. Deteriorating environmental conditions gnaw at the islands of affluence."

Is democracy the problem?

This work—and we will come on to the fourth scenario at the end of this piece—led us to query whether democracy has any chance of driving the transition towards more sustainable patterns of production and consumption. Will we see growing democracy vs. sustainability tensions? Can we vote our way to a sustainable future for a world of 9-10 billion people? Are the time-scales of democratically elected governments appropriate for delivering sustainable development?

The political world is full of evidence that can be used to argue for and against the notion that democracy is necessary (or better) for sustainable development. The lengthy and lively United States presidential competition between Senators Hillary Clinton, John McCain and Barack Obama, for example, has engaged an unusually high proportion of citizens in debate on some of the great issues of the day—and it has offered the unprecedented and hopeful spectacle of the main candidates for the presidency acknowledging the vital importance of global climate change.

At the same time, the way much of the campaign has been conducted—the point-scoring, the attack ads, the media concentration on stray remarks and surface details—highlights the way that modern democratic conduct can sideline environmental issues at the very moment when they should be central to the debate.

Democracy, of course, is only one of the factors feeding into our basic problem, which is an oft-repeated inability to act on early weak signals of impending threats, compounded by institutional paralysis until the roof falls in.

The credit crunch

Take the credit crunch as an illustration of what is very likely to happen (or not happen) as we move towards the inevitable ecological credit crunch. On the financial front, there were plenty of early warning signs—over time, almost too many to count. Nearly everyone with relevant experience and a long view of history said such bubbles always end. The growing body of evidence was complimented by early shocks, the collapse of once-venerable institutions, the sudden emergence of unexpected new players, huge financial costs and sudden shifts in policy that re-arranged the normal political spectrum, making new fans of regulation even among those traditionally believing it at best the last resort and at worse an abrogation of free market principles.

After a decade of housing equity excess fuelled by questionable lending practices, Alan Greenspan's assurances regarding the (low) likelihood of a widespread housing bubble proved meaningless. Property markets fell first in the US, then in parts of Europe like the UK and Spain, and more recently have begun to drop in China and other parts of Asia. (This last, combined with the 60% 12-month decline in the Shanghai Composite Index, going a long way to answering questions about the decoupling of global markets.) Even Middle Eastern boom towns like Dubai are feeling the pinch of falling real estate values now. Bear Stearns was perhaps the first institutional casualty to rivet attention on how bad this could really become, but analysts and other experts assured investors of the fundamental strength of markets even while participating in gossip about how quickly Lehman Brothers might follow Bear Stearn’s path.

The chatter continued until Fannie and Freddie failed, Lehman imploded, and AIG had to be bailed out to prevent far greater damage. HBOS disappeared in the UK and Icelandic banks went into a freefall that now threatens to bankrupt the nation. With Fortis and Hypos Real Estate underscoring the uncomfortable fact that institutions on the European continent may be no more able to withstand the pressure than their American cousins, and the Russian government scrambling to keep that nations banks solvent, there is every sense that we don't nearly know the full extent of the fallout that may still lie ahead. While the US now has a number in front of it—$700 billion in taxpayer money—that has allowed concrete discussion of just how much it may cost to solve this and a bill to be created to allow this money to be spent, other nations almost certainly have not calculated what this will cost their markets yet. Worse, in Europe in particular, lack of cross-border regulatory oversight to match the continent’s monetary and economic integration is likely to make addressing the situation much harder than in the US, and we know, from the simple fact that three quarters of AIG's derivatives coverage was attached to European institutions, that the system is far more complex, mutually dependent and vulnerable than nearly anyone had realized possible.

So with even after all the warnings about bad credit and poor oversight, we are having to relearn the basic facts of human nature—and specifically that, as a species, we are quite good at spotting threats coming at us head-on and noisily, but seriously bad at picking up low-key problems that sneak up on us over time and in peripheral vision. In the process, we urgently need to consider the non-linear effects playing out in financial markets—and whether we will see something very much akin playing out in the coming years in relation to climate change and to the cascade of environmental, economic and social impacts likely to follow in its wake.

Climate change

Chances are that climate change may offer us the ultimate lesson in Chaos Theory. Initial conditions (man-made increases in greenhouse gas—GHG—concentrations beyond pre-industrial levels) are well known, and the expected consequences dire enough to command our full attention, but still we seem socially and politically unable to make the necessary changes to forestall calamity. This will be increasingly debated (and we hope turned to action) as the world cranks up to the COP14 climate summit in Poznan this December and the real crunch-point of COP15 in Copenhagen a year later.

This agenda has been around for decades—indeed John Elkington wrote his first report on climate change back in 1978, for the Hudson Research Institute, at the time run by Herman Kahn. Kahn’s view then was that the problem with environmentalists is that they see a chasm coming, stamp on the brakes and try to steer away. What if that isn't the answer, he challenged? What if the only answer is to slam your foot to the floor to accelerate across the divide?

To be honest, Kahn came across as near insane—a bit like Dr Strangelove, whose central character was once said to have been partly modeled on Kahn. But as the asymmetric threats associated with climate change become ever-more urgent, is it possible that he had a point? Indeed, it's interesting to see no less a champion of climate awareness than Al Gore now encouraging us to slam our foot to the steel—with his speech on 17 July, A Generational Challenge to Repower America, suggesting a vision that could help us rebuild from the rubble of the Bush years.

It's worth quoting a few things he said:

"There are times in the history of our nation when our very way of life depends upon dispelling illusions and awakening to the challenge of a present danger. In such moments, we are called upon to move quickly and boldly to shake off complacency, throw aside old habits and rise, clear-eyed and alert, to the necessity of big changes. Those who, for whatever reason, refuse to do their part must either be persuaded to join the effort or asked to step aside. This is such a moment. The survival of the United States of America as we know it is at risk. And even more—if more should be required—the future of human civilization is at stake."

And his proposed solution?

"Today I challenge our nation to commit to producing 100 percent of our electricity from renewable energy and truly clean carbon-free sources within 10 years. This goal is achievable, affordable and transformative. It represents a challenge to all Americans—in every walk of life: to our political leaders, entrepreneurs, innovators, engineers, and to every citizen."

There is no way the climate emergency should be allowed to catch us off guard. The Nobel Prize-winning Intergovernmental Panel on Climate Change (IPCC) has been telling us about these dangers for years—decades, actually. The global scientific community basically could not be more unanimous in its assessment of the risks of accumulated GHGs in the atmosphere and humankind's role putting them there. We have already had significant early warnings—receding glaciers, Hurricane Katrina, prolonged droughts in agricultural regions—and elections have begun to be won and lost around climate positioning, with Kevin Rudd of Australia arguably the first national level electoral winner propelled to office at least significantly on a climate platform. Astonishingly, groups of major, energy-intensive businesses like the US Climate Action Partnership signatories are lobbying for regulation on this issue.

We know, too, what avoiding a 2 degrees Celsius increase in global mean temperatures (2 degrees being the point beyond which global environmental systems and all that depend on them—including us—are expected to exhibit significant strain) will take. We need massive cuts in CO2e emissions beginning no later than 2015 and about 85% reduction in annual global emissions by 2050. Make no mistake: this will mean basically a zero-carbon economy in the developed world, while developing nations preserve some fossil fuel leeway to support their development efforts.

In spite of all this, will we hold to our present lifestyles and patterns of economic development until the climate impacts being felt are the equivalent of the Fannie-Freddie-Lehman-AIG panic-inducing, system-changing failure?

Navigating new Cs

As we thought all of this through, several pairs of Cs swarmed around our heads. The first pair, standing for the Credit Crunch, reminds us—if reminder were needed—that our natural and economic worlds are fundamentally non-linear (and that humans remain very poor at modeling complexity, else we would not have ‘100 year events’ in financial markets every decade or so). The second pair, representing Climate Change, suggests that we haven't seen anything yet. The third pair, for Corporate Citizenship, raises a set of thorny questions for the corporate social responsibility movement globally. The central point that we made in our 2007 Raising Our Game scenarios work is that it is time to radically upgrade our ability to work with business and through markets at a time of massive change.

So, what are we betting on—what are we playing towards? And what about our fourth Raising Our Game scenario? Many of you will have concluded by a process of elimination that this was Hearts. "This is a world", we began, more in hope than expectation, "in which demography, politics, economics and sustainability gel. It is the future that the Brundtland Commission pointed us towards way back in 1987”.

"The early years of this scenario, however, are rough", we continued, "with a global pandemic shutting down global trade. But in this case the challenges come in forms that drive positive responses, underlining the importance of shared solutions and inclusiveness. Over time, virtuous spirals of improvement set in, in most places. The outcome, a second renaissance, but across a larger canvas."

For there to be any chance of something like the positive conclusion to Hearts happening, the rich world will have to develop a much greater sense of accountability and urgency than it has displayed to date. For while our fourth pair of Cs stands for China and Coal, or perhaps (and more optimistically) Clean Coal, it is countries like the United States, EU Member States and Japan which need to take nearly all responsibility for historic emissions. In fact, it’s only going to be principled leadership backed by action that attracts sufficient support from China and the rest of the BRICS to participate in finding the climate solutions whose potential are so literally dependent on a compromise with the so often coal-fired energy needed for development by so much of the world.

While we unfairly single out China among nations in our last pair, we do it not to absolve others of their (often greater) responsibilities, but to underscore how very much depends on where this giant country—now the largest GHG emitter—heads. This will be true of its response (and resilience in the face of) the economic shock-waves emanating from western financial markets and even more so in terms of how it decides to position itself in relation to climate change. China’s own thinking and policy positions will send powerful signals about its willingness to play a (constructive) long game in terms of global politics and development, and, crucially, how others choose to negotiate development versus emissions trade-offs, with China likely to set the stage for how this is handled globally. Will the developed world clean up its own act and find greener ways to help emerging markets increase the health and economic security offered their citizens, or leave them the dilemma of trading short term development needs against long term planetary environmental health?

We desperately hope we are wrong, but our analysis is that the current meltdown is not yet the sort of crisis that will force our leaders to the point where, like the United States launching the Marshall Plan in the 1940s, they (and we) break frame, do the completely unexpected—and invest in the future as if our futures depended on it. Meanwhile, there is a growing (if unwelcome) opportunity to learn and spread the relevant lessons from the still-evolving credit crunch, both in terms of how to develop and run our economies in ways that are financially sustainable and, longer term, in ways that are also socially and environmentally sustainable.

John Elkington is Co-Founder of SustainAbility and Volans. Mark Lee is SustainAbility's CEO.