National Review Online, August 8, 2022

The Financial Times’ Moral Money section is so nauseatingly named that many will be tempted to look away after one glimpse of its title. That would be an error. Grimly fascinating, Moral Money is an invaluable window into the orthodoxies of the corporatist elite, particularly — but of course — when it comes to planetary catastrophe. The FT being what it is, Moral Money’s climate message (in reality an updated version of an ancient blend, millenarianism and rent–seeking) is camouflaged, with the crazy played down. It is earnest and preachy, but — underpinned by the comfortable assumption that writer and reader alike see things the same way — not too preachy.

And it is nothing if not revealing.

Perhaps no place on earth presents such a dilemma for ESG investors as the Chinese province of Xinjiang. It’s the scene of some of the world’s most serious and systematic human rights abuses — home to the mass imprisonment and “re-education” of Uyghur Muslims and other minorities. But it’s also, thanks in part to widespread forced labour, a massive supplier of materials for solar panels — giving it a central role in a sector crucial to fighting climate change.

This is a dilemma? Does the “g” in ESG stand for genocide? Because that is what is taking place in Xinjiang. Regardless of climate change, investors who believe that ESG (a variant of “socially responsible” investing in which actual or prospective portfolio companies are scored against a series of environmental, social or governance — the real “g”, in case you wondered — benchmarks) is in some sense ethical surely should find it unacceptable to take a stake in any firm manufacturing (or using) solar-panel materials (notably solar-grade polysilicon) processed in Xinjiang by forced labor.

But should that be the end of the matter?

Moral Money is, one way or another, often highly informative, and the FT’s Simon Mundy digs deeper:

As concern about the situation in Xinjiang has grown, the US and other governments have responded with economic sanctions against products linked to forced labour in the province. But are these measures doing any good?

The FT, I should say, has endorsed such sanctions.

Mundy cites a report by a team of academics from Britain’s University of Nottingham:

One central problem, the [Nottingham] report said, was that the sanctions focused on blocking exports of abuse-tainted goods from Xinjiang, rather than on financial measures. The main effect of the current approach, the report said, was to push up costs for western customers, while the exporting companies had little trouble finding buyers for their products in China and other Asian markets.

“Arguably, western import bans will not work to reduce forced labour in the Xinjiang solar sector,” it added, “but only to reduce western consumers’ complicity in it.”

James Cockayne, the report’s author, told me that the western drive for “slavery-free” supply chains could have a perverse effect. As it sought to retain its international dominance, he said, the Chinese solar sector was shifting towards running two parallel supply chains.

One part of a group’s operation would be verifiably free of forced labour, selling at premium prices to western customers. Another production chain, using cheap involuntary labour in Xinjiang, would service China and other countries with less demanding standards.

“The result is that you have western consumers subsidising the use of forced labour to make goods that are sold to others elsewhere,” Cockayne said. “And that’s already beginning to happen.”

Western governments should do more to support the development of new solar supply chains that don’t rely on Chinese inputs, Cockayne said.

So, should, one way or another, Western governments be doing more to support new supply chains? Yes: It makes sense both strategically and morally. And simply reorienting those supply lines in or around countries where Chinese solar materials can be “laundered” and then reexported should not suffice.

The FT’s Mundy (my emphasis added)

[Cockayne] also urged policymakers to broaden the scope of their sanctions. Financial sanctions had been underused in relation to Xinjiang, he said, despite the heavy reliance on equity and bond market financing of many companies linked to abuses — some of whose securities have found their way into ESG-branded funds run by some of the west’s biggest asset managers…

The report comes as some US conservatives are calling for the government to restrict Chinese access to the country’s capital market. “Many well-meaning Americans may inadvertently be propping up a genocidal regime because Wall Street does it for them,” Florida senator Marco Rubio wrote in May, urging measures such as a bar on Chinese companies listing in the US.

Rubio is not wrong. Even if we put the nature of the Chinese regime to one side, the current Chinese economic model — the harnessed capitalism more typical of fascism than communism — ought to mean that Chinese companies fail the basic governance standards (in the usual sense of governance rather than the more imaginative definitions of the term sometimes used by ESG enthusiasts) the New York Stock Exchange or NASDAQ normally might be expected to demand. De jure or de facto, the state is the controlling shareholder in all Chinese companies. It may not always exercise that power, but it’s always there. On top of that, Chinese companies listed in the U.S. do not provide regulatory access to audit papers required by the Sarbanes-Oxley Act, something that may well lead to their delisting. And then there is that tricky question whether investment in “variable investment entities,” a structure often used to channel Western capital into Chinese companies is, in many instances, actually in accordance with Chinese law.

But back to the FT:

Restricting capital flows into Xinjiang-linked companies could have much more impact than clamping down on exports, Cockayne argued. But he conceded that it was unclear whether even this would have any meaningful impact on the abuses happening in Xinjiang. For Xi Jinping’s government, he said, the logic behind the forced labour was not primarily commercial but a “strategic logic of social control in a province that’s seen as a potential source of domestic instability”.

I don’t know whether Cockayne would see it this way, but that logic is an example of Beijing’s fascist (or fascistic) economic model at its most unvarnished, and the regime’s adoption of that model does indeed have implications for the West’s ability to pressure China to mend its ways in Xinjiang.

Decades ago, Deng Xiaoping famously declared that “to get rich is glorious.” And while the Communist Party never had any intention of giving up its hold over China — as was made bloodily clear in Tiananmen Square, a massacre that took place towards the end of the Deng era — it was generally prepared to accept that the switch to a (sort of) market economy would mean some dilution of its power.

Beijing’s priorities have now shifted. To be sure, it still wants to foster GDP growth, but that objective is now far more aggressively subordinated to the needs of the regime, whether economic, strategic, or political. If the result is a more sluggish economy than would otherwise be the case, so be it. And so, if Beijing has to pick between changing course in Xinjiang or its solar sector taking a hit, it will opt for the latter.

Mundy asks Cockayne whether that calculation could be changed by imposing “sanctions heavy enough to cause economic disruption at a national level in China — rather than just for companies operating in Xinjiang.” It’s a good question, but so long as Beijing can sustain China’s economic performance at a level decent enough to avoid political trouble, it is likely that it will shrug off any disruption. Meanwhile, the regime is, like its fascist (or quasi-fascist) predecessors, increasingly stressing a form of autarky on the one hand, and securing supply lines on the other, a task that has been made much easier with resource-rich Russia now having become something between a partner and a client state.

For his part, Cockayne is skeptical how far any sanctions would be taken given China’s importance to the global economy. (For “global,” read “Western.”) The mistake that the EU and, specifically, Germany, made in building a dependency on (nominally) cheap Russian gas, has been repeated by the West across an astonishing range of Chinese goods. If the “transition” from carbon proceeds in the way that Western policymakers now intend, that dependency will deepen. Xi, who has, whatever Beijing may occasionally claim, no plans to leap off the same cliff, must find it hard to believe his luck.

The West needs to embark on a broad economic decoupling from China, a regional power now aiming for global hegemony. Such a divorce will take a while, and it won’t be straightforward. In the meantime, as Mundy notes, Keith Krach, a businessman who was an under secretary of state in the Trump administration, has called for, among other measures, Chinese-domiciled firms to be excluded from ESG-designated funds.

But this exclusion should be voluntary. Any action, whether legislative or regulatory, and however reasonable it may seem, to establish even the beginnings of a mandatory definition of what is or is not ESG-compliant will set a dangerous precedent, paving the way for, most probably, the SEC to step in with its own guidelines as to what is acceptable. This would extend its reach far deeper into corporate or investment management than any arm of government should go.

Its involvement in this area should be limited to ensuring adequate disclosure of the principles behind any ESG investment product, and then to check that they are followed. This disclosure regime would, as is the case with many investment products, also include disclosure of holdings above a certain size as well as their sectoral and geographical spread. Investors can then make a choice in line with their preferences.

And yes, the managers of any ESG investment product should forswear any investment in China. If those that decline to do so then take positions in Chinese companies, any serious ESG investor should shop elsewhere.

ESG, China: Choose one (or, better, neither).