Ecological Finance Theory: An Answer to the Climate Crisis

This post is the latest in our special issue: “Climate Change and Financial Markets – Risk, Regulation, and Innovation.” To learn more about the special issue and the work of the Global Financial Markets Center around climate change and financial markets, please read the special issue’s introduction here. And to review all The FinReg Blog posts that touch on climate change, go here.


According to the International Geosphere Biosphere Program, “the Earth System has recently moved well outside the range of the natural variability exhibited over at least the last half million years”. This destabilization has also come to threaten the reproduction of life on Earth.  The rate of extinction is currently tens to hundreds of times higher than the average over the last 10 million years. About 1 million species face possible extinction within decades because of deforestation, climate change, global pollution, and global transport. Between 2030 and 2050, climate change is expected to cause approximately 250,000 additional deaths per year, from malnutrition, malaria, diarrhea, and heat stress alone.

The international scientific consensus unambiguously indicates that reforming our socioeconomic model is urgently needed if humanity is to confront these challenges.  In particular, a deep modification of global financial systems is needed. Earth scientists have identified financialization (defined as the increasing importance of financial markets, motives, institutions and elites in the operation of the economy and its governing institutions) as one of the key mechanisms by which human activity undermines the biosphere. Multilateral institutions have also fully acknowledged the need for a structural reform of the global financial system. Even before the COVID-19 crisis, the European Commission High-Level Expert Group on Sustainable Finance (HLEG) famously underlined that “reaching our Paris agreement goals requires no less than a transformation of the entire financial system, its culture and its incentives”.

Finance is often seen as a “science”.  However, despite its numerical content, it is mainly a social language. Financial models fabricate institutions, legitimize corporate decisions, and sometimes conceal conflicts, oppositions, and power relations through the superposition of a veil of scientific-ness.

The crux of the problem in the current crisis is that the dominant financial language (modern finance theory), superimposes financial logics on to the analysis of the environment, when we need instead to turn the order upside down. The biggest obstacle to tackling the climate crisis may not be the scarcity of money, or the unavailability of policy options, but, rather, our economic zeitgeist.  Our current inability to find solutions to the climate crisis is the result of an optical illusion created by looking at sustainable finance through the prism of the neoclassical finance theory (also known as “modern finance theory”) which has come to dominate academic and policy discourse in the past decades.

This becomes apparent when one looks at the fundamental hypotheses of neoclassical finance theory. These hypotheses are often tacitly accepted and rarely debated in the academic community. One of these hypotheses is that financial markets always provide an accurate image of reality, through ‘efficient’ prices. This implies not only that the biosphere has a monetary value, but also that this value can be automatically determined through the rational decisions of investors in financial markets.

This “magical” vision of the market has disastrous ecological, social, and economic consequences. Look at the global economy. For all the talk about “competition” and “free markets”, it is steered by a set of vertically and horizontally integrated transnational corporations. These corporations control the whole supply chain and have a disproportionate influence on decision-making globally through their subsidiaries. As a collective, the “Financial Giants”, through their common block holding power, currently shape biomes that are critical for the stability of the climate system (such as the Amazon forest in Brazil and the boreal forests in Russia and Canada). Their governance is regulated by the ‘shareholder value’ principle (an outgrowth of the neoclassical “agency theory”) which emphasizes short-term financial performance, and the concentration of earnings in financial markets through mechanisms of short-term capital appreciation. This erroneous view of “value,” which ignores non-monetary aspects essential to life as well as social welfare, has dramatic consequences for the biosphere and has come to endanger the reproduction of life.

Due to the domination of the neoclassical paradigm and the pressure to “publish or perish” in mainstream finance journals, academia has unfortunately failed to tackle this problem. Even the more environmentally-aware finance researchers analyze sustainability through the lens of investments and monetary return, rather than questioning the ability of existing financial regulations and instruments to respond to the sustainability challenge. Academic papers typically model ‘sustainability’ as an independent variable linked to ‘investor preference’ and then analyze its impact on the variations of monetary indicators of ‘return’ (typically modelled as a dependent variable).

If we are to tackle the crisis, a scientific revolution is needed in the field of financial economics. Rather than superimposing a financial logic to the analysis of sustainability concerns, we need to start from the other end and identify which financial instruments and policies are needed to confront the ecological challenges we face.  The efficacy of a financial system can no longer be evaluated based on monetary signals, but by examining feedbacks with the biophysical and socioeconomic spheres.  This entails breaking away from the ‘methodological individualism’ of neoclassical finance theory (which brings down issues social choice to the shareholder’s utility function) and recognizing that humankind is subject to ‘macrofoundations’ in the form of environmental, historical and societal forces that define and constrain modes of economic activity.

In recent years, members of the Post-Crisis Finance Alliance (SDSN France) have pointed out the contradictions between mainstream hypotheses and the global ecological, social, and economic crises. They have also systematically engaged with transformative investment platforms and policy networks in an effort to carve out new theoretical and applied perspectives to confront the challenges of the 21st century. This group has recently proposed Ecological Finance Theory as a functional conceptual alternative to neoclassical finance theory. Ecological Finance Theory is not a purely academic project but should be highly relevant for practitioners wishing to understand the complexity of the new context. Ecological Finance Theory looks at finance from the triple perspective of earth science, financial economics, and social studies. Its main objective is to maintain social resilience by aligning financial models, tools, and policies with social and biophysical constraints. Ecological Finance Theory is a work in progress, which shall lead to reformed financial management, instruments, policies, and teaching for the age of the Anthropocene.

We invite all researchers – especially junior researchers and students – as well as practitioners and policy makers to join the discussion and contribute to the development of this new body of knowledge, which, we hope, will carve out pathways for global ecological, social, and economic resilience.


Thomas Lagoarde-Segot is Professor of Economics and Finance at KEDGE BS and director of the Sustainable Finance group of SDSN France. This post is adapted from his paper (co-authored with Enrique A. Martinez) “Ecological Finance Theory: New Foundations,” available on SSRN.

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