N°23-83: Sustainable Investing in Imperfect Markets

This paper analyses sustainable investing in terms of impact and ESG investing. Using a parsimonious general equilibrium model, we integrate the different effects of sustainable investing into welfare analysis. Given that the price for polluting the environment is too low, we show that impact investing can lead to a second-best solution. If at the margin the technology is ”clean” investment should be increased while a capital reduction is appropriate if at the margin the firm’s technology is ”dirty”. However, sustainable investing requires households to anticipate the firm’s pollution activity. Therefore we show how the same solution can be implemented with ESG investing in which the burden of knowledge lies on the rating agency. Finally, we indicate that the first-best solution can be achieved by sustainable consumption.