In this episode, host Chris Linnane and Harvard Business School Professor Forest Reinhardt discuss the tragedy of the commons and how businesses can navigate the complex challenges of climate change.
Forest Reinhardt, John D. Black Professor, Senior Associate Dean for Faculty Promotions and Tenure
Professor Reinhardt's HBS Online courses:
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Chris Linnane:
The Parlor Room is an official podcast of Harvard Business School Online.
Forest Reinhardt:
If the government demands that I reduce my emissions from 10,000 to 9,000, then I have a responsibility to do so. If the government tells me that it thinks it would be a good idea for me to do that, or if some other social actor tells me it would be a good idea, it's a little bit less clear that I actually have the responsibility to do that.
Chris Linnane:
Welcome to The Parlor Room, where business concepts come to life. My name is Chris Linnane. I'm the creative director of Harvard Business School Online. On this episode of The Parlor Room, I'm joined by HBS Professor Forest Reinhardt. Professor Reinhardt has two courses with HBS Online: Global Business and Business and Climate Change. We discuss the tragedy of the commons and investigate the challenges of making a brewhouse carbon neutral. It was a great discussion. So let's get to it. Welcome to The Parlor Room.
So you've done two courses with us at HBS Online: Global Business and Business and Climate Change. Can you tell us a little bit about both of those courses?
Forest Reinhardt:
I'd love to, Global Business is about how the international economy works and how within it firms can create value for their shareholders and their customers. So it talks about exchange rates, it talks about monetary policy, it talks about trade policy, and it even talks a little bit about climate change because climate change is one of the ways in which national economies relate to one another. In any case, it was so much fun to put that together, and it's such a privilege to be able to use all this amazing technology to communicate with and teach people all over the world—whether or not they can buy a plane ticket to come to Boston—that I asked the team if they would let me do another course. And, as it happens, Mike Toffel—my colleague who's been studying climate change now for a decade or so—and I decided that we would create this second course about business and climate change, about which I'm also extremely excited.
Chris Linnane:
Great. And the Business and Climate Change course, maybe a little bit about what's covered in that course.
Forest Reinhardt:
So, as you know, firms all over the world are being called upon to manage the risks created by climate change. Both the risks of climate change itself, like more storms and droughts and floods and things like that, but also the risk of regulatory policies that are changing the cost of energy and changing the way that the firms are required to do business. And so, in order to make sense of those problems, we have to start from the basic science and work through the economics to the business strategy and the business policy.
Chris Linnane:
Climate change is obviously the top of everybody's mind right now. Is this unprecedented where we are right now?
Forest Reinhardt:
Well, it's unprecedented in human terms in that it's been many hundreds of thousands of years since CO2 levels in the atmosphere were anything like where they are now. So it's unprecedented in that sense. But, in a different way, we're confronting another resource constraint of the sort that we've encountered in other arenas of human endeavor. I mean, if you think about human history on this planet, it is a process of discovering resources, which at a given moment seemed super abundant. And then, through our use of them, making them scarce and having to figure out how to adjust to that scarcity.
For example, we're in Massachusetts, the waters off the shores of Cape Cod a few hundred years ago were just teeming with fish. That's why it's called Cape Cod. And the first Europeans who came to these waters were just amazed at the abundance of the fish.
They said you could just drop a basket over the side of your boat and pull it up, and it would be full of fish. Fantastic, super abundance. And so they treated it as though it were free. They had to pay for the boats, of course; they had to pay for the nets. But they didn't have to pay for the fish themselves. And so they wasted them. And they didn't realize that by overfishing today, they might create problems for their children or their grandchildren later. But of course, that's exactly what happened because if you treat something as though it were free, you'll overuse it. And by their own behavior, they took a super-abundant resource and made it scarce.
And now, we have systems that allow people to own property rights to fish in the sea, like they have quotas and they can trade the quotas against each other so that the more efficient fisher people can buy the quotas of the people who aren't so efficient, and basically create a system of property, right, a market for fish swimming around in the sea, which they didn't need to have in 1700 because the fish were so abundant.
Chris Linnane:
The fish industry is a great example. Are there other examples like that we can...
Forest Reinhardt:
Well, so you can think about something as fundamental as water, like water in the American West. When the pioneers first got there, they said, "There's water in these rivers. If you drill a well, you can tap into the aquifers." And they had to pay for the, well, of course, they had to pay for the pipe that ran from the river to the field, but they didn't have to pay for the water itself.
And so, we created, through our economic activity, through our own prosperity, a system in which the water which had been super abundant became scarce. And now we have to figure out how to allocate that resource. And one of the ways we might do it is with prices. If we don't use prices, we'll have to use some kind of top-down command-and-control thing, which will be extremely inefficient and which will result in less prosperity than we might otherwise be able to bring about.
So that sort of brings us to the atmosphere and the ability of the atmosphere to absorb our waste gases, the CO2, from our combustion of fossil fuels without disrupting the climate system. And that used to be abundant because there weren't very many of us and we didn't burn very much stuff. Now there are a lot more of us and each of us burns more stuff or has more stuff burned on our behalf, and we are altering the carbon cycle of the earth. And CO2 is building up in the atmosphere, and that's altering the climate with consequences that we're already beginning to see. And so now, yet again, we're going from a situation where something was abundant to a situation where now it's scarce, and we have to figure out what kinds of economic institutions we're going to create to manage it.
Chris Linnane:
Now is this a tragedy of the commons or is that a variation of this?
Forest Reinhardt:
These are all variations of the tragedy of the commons. And basically, the idea is if you have insecure property rights, if property rights aren't well established so that people can just take things without paying for them, then they will overuse them. And you can say, "Well, people should take better care of their stuff. People should take better care of their natural resources." But when something is commonly owned like that, it seems to be hard for us to take our responsibilities to safeguard it seriously. It's much easier for people to take those responsibilities seriously when they think they actually own the resource.
Chris Linnane:
Academically, this all makes sense. How do we apply it to the real world?
Forest Reinhardt:
Well, let's take an example. Let's be reasonably concrete about this. Let's suppose that you are a brewer, you make beer, and suppose you're a pretty big brewer. What do you need in order to be profitable?
Chris Linnane:
I would think you would need a quality product.
Forest Reinhardt:
Really? But if you look at the actual beer that gets sold in the United States or Canada, do you think it's good beer?
Chris Linnane:
I see your point. I guess you don't need a good product.
Forest Reinhardt:
Well, it seems maybe you need a consistent product.
Chris Linnane:
Oh, OK.
Forest Reinhardt:
OK, good. So you have to have a consistent product. And what else?
Chris Linnane:
You need distribution. You need ways to get it where it needs to be.
Forest Reinhardt:
Right. And where it needs to be is in the hand of some thirsty person.
Chris Linnane:
Correct.
Forest Reinhardt:
Yeah, so you need clout in the distribution channels because your fellow brewers are calling on the same tavern owners or the same retailers, and they want that tap space or they want that shelf space. And you have to have some way of winning that fight. And maybe one way you win that fight is by being able to offer better terms. So maybe you want to be able to produce your beer more cheaply than the other person. And so that means that you have a better chance of winning that fight in the distribution channels. And that might be counter to your idea that the beer should taste good because it might be more expensive to make better-tasting beer. That wouldn't be that surprising. And it seems like we've seen how the big brewers of the world approach that trade-off. They want low cost. OK, and yet, they want low cost, but they also seem to want brands. What's the point of having a brand then?
Chris Linnane:
With a good brand, with a powerful brand, you win that distribution fight because your customer's looking for your product.
Forest Reinhardt:
Right, so you're using, the brand is a way of capturing the ultimate consumer so that you have more clout with respect to your customer. Because the brewers don't normally sell beer directly to the person who drinks it. There's normally at least one intermediate step. So you need a brand. Absolutely. And you need anything else?
Chris Linnane:
Volume?
Forest Reinhardt:
There are huge...some of the breweries will let you go on tours, and it's staggering the scale of those plants, thousands of containers per hour. I mean, they measure their output in Olympic swimming pools. It's extraordinary. And why do they do that? They do that because that drives down the cost. They get economies of scale in production, which then allows them to have more economies of scale in distribution. But all of this beer has to come from somewhere, and it's mostly water, but they also need barley and hops and things like that. And maybe there are economies of scale and purchasing, too.
So it's interesting. I mean, we've talked about beer for a few minutes now, and the things you need to be a profitable brewer, and we haven't mentioned sustainability or climate a single time, right? But if you look at the brewers, they are quite eager to persuade us that their products are environmentally sensibly produced.
And so interesting to think about why that is, because that's really the crux of this whole thing. So climate stability is a public good. It's either we all enjoy it or none of us enjoys it, and we're not excluded from enjoying it if we don't help pay for it. And that means it's very hard to persuade people to pay for it. So here are these poor brewers, they're just trying to make an honest living. And now people are saying, "Well, that's all very well; your beer is of consistent quality, and I can get it wherever I want it, and it's pretty cheap. But I want it to be able to feel good about the environmental characteristics. I just don't want to pay for it. I just don't want to pay extra for it." So then the question is, "Well, who's going to pay for it?" And that's a fundamental problem.
And there are only so many people who might pay for it. Maybe it's the suppliers, maybe it's the shareholders of the brewer itself. Maybe it's the distributors, maybe it's the consumers. None of them is lining up. It seems like the fundamental challenge for the brewer is to figure out whether or not the end consumer is actually willing to pay a price premium for environmentally preferable beer, like carbon-neutral beer say, which seems weird to start with because I mean, most beer, at least most beer you'd want to drink has CO2 in the actual bottle, right? It's carbonated. So how can you make a carbon-neutral beer? It seems like an oxymoron.
Chris Linnane:
Flat beer.
Forest Reinhardt:
Right? You could make all your beer flat. That probably wouldn't be so good from a business standpoint.
Chris Linnane:
Consumer standpoint.
Forest Reinhardt:
Right.
Chris Linnane:
No one's lining up for that either.
Forest Reinhardt:
I don't think so. So what do you do? Well, maybe you can reduce the carbon emissions of some other part of your value system, or you can buy offsets, or you can do some other deal with some other producer, all of which are things that Mike and I talk about in this course. But what all those things are going to have in common is that they're going to cost you money. And so if you can find a consumer who's willing to pay you for that extra cost, then that's fantastic. Then it's another differentiator. And marketers are all about differentiation. So if they can do that, they'll think that's a great idea.
And Mike, in the course, actually talks about a brewer that is trying to do exactly that thing: to make a carbon-neutral beer and get a premium for it. But in the mass market so far, it seems like mostly people aren't that interested. So then you have kind of a classic collective action problem, and you can try to solve that if you're a brewer, either by working with the other brewers to kind of establish some industry practices that are better for the environment. Or if you're a little bit more radical, you can work with the government to try to get the government to impose that on everybody. With the idea that the cost disadvantage will be less important for you if all your competitors have to match it.
Chris Linnane:
Can companies that have more of a lower-income or middle-income customer base, can they still succeed? Can they get people to pay more? Or what if that's not an option?
Forest Reinhardt:
That's a great question. Maybe they have to place more modest demands on their customer's willingness to pay. Maybe they have to look differently or harder for private cost savings within their own supply chains. Maybe they have to figure out some other market in which to differentiate themselves. There are as many ways of figuring out how to square this environmental circle as there are firms who have done it. I would say there's no one-size-fits-all recipe.
Chris Linnane:
Right, are you ready for some questions?
Forest Reinhardt:
Sure.
Chris Linnane:
Forest Reinhardt:
I am really glad, Melissa, that you asked that question because that's exactly what the course that Mike and I just created is about. The challenges include just figuring out where you are. This is not a topic that firms have spent a lot of time studying in the past, so maybe they don't even know exactly what their emissions are. Maybe they don't even know approximately what their emissions are. And if they're burning coal and turning it into electricity, then there are coefficients that they can find in engineering textbooks, which we'll tell them. But if they're raising free-range chickens on an organic poultry farm in western New Jersey, then the coefficients might not be all that accurate. So they need to establish some kind of baseline, and then they need to figure out how to set targets for emissions reduction, and figure out how much it's going to cost them to achieve those targets, and figure out who's going to compensate them for those expenditures.
And it's interesting that lots of firms, big sophisticated firms, have set the targets and then tried to figure out how they're going to meet them and what the cost is going to be. That seems extraordinary to me, actually, because it's not the way firms make decisions about most aspects of their business. They don't say, "I'm going to produce one million pickup trucks next year, and now I'm going to figure out how I'm going to pay for it." They do some kind of interactive thing where they say, "How much would it cost to produce a million? How much would it cost to produce 900,000? Maybe we should produce 950,000. What are the potential cost savings?" Et cetera. They start a dialogue with themselves about the price and the quantity and how they interact instead of just having this quantity fall from the sky and then deciding they have to meet at any cost. It seems a little funny.
So understand where you are, understand where you want to be, understand how much it's going to cost, understand how you're going to get there, understand how you're going to get compensated, and then importantly, understand what sort of political positions you're going to take. What's your stand going to be in the political arena? And it depends, in part, on whether you think the customers are going to compensate you for the extra cost. If they are, then you should differentiate the product and carve out a little niche where you can create that extra value. If you don't think that your consumers are going to compensate you for it, then maybe you better figure out some other way which might involve some kind of collective action with the other members of your industry.
Chris Linnane:
Louisa in Spain: What responsibilities do companies have to reduce emissions and transition to more sustainable practices?
Forest Reinhardt:
I think that turns out to be a very complicated and difficult question because it turns on what you think the word "responsibility" really means, and where we think our responsibilities come from. We live in a society that creates expectations for us both as individuals and as firms. And sometimes those expectations are couched in the language of responsibilities because the responsibility sounds more meaningful and more impactful and more imperative than an expectation.
But it turns out, the more you think about it, the more slippery this concept of responsibilities seems to become. I mean, it seems to me that in well-functioning societies, we have a responsibility to obey the laws. And so, if the government demands that I reduce my emissions from 10,000 to 9,000, then I have a responsibility to do so. If the government tells me that it thinks it would be a good idea for me to do that, or if some other social actor tells me it would be a good idea, it's a little bit less clear that I actually have the responsibility to do that.
And I think one way of getting a little bit of traction on this is just to ask ourselves, "Well, what responsibility do we have as individuals to reduce our carbon emissions?" If we live in prosperous places like the United States and Spain, emissions direct and indirect are almost certainly above the global average? Do we have a responsibility to bring those down? And if so, where does that responsibility come from? It's a hard thing to know.
I think that all of us should think about what our emissions are and how we might bring them down, and how we might contribute to the creation of a system in which aggregate emissions fall. But to go beyond that and assert that there's a particular responsibility for a particular firm, for a particular amount of emissions reduction in the absence of a legal requirement to do so, I think is a difficult statement to make.
Chris Linnane:
Alright. This one's from Molly in Belgium: What industries or business models are particularly well-positioned versus vulnerable in a carbon-constrained world?
Forest Reinhardt:
So if you think about the whole history of human development, it's kind of been the substitution of ideas and brainpower for materials and energy and stuff. We used to be really inefficient at getting stuff done, and we used a lot of brute force, and it was because we didn't have the many centuries of intellectual development on which to rely that we do now. So I think that the biggest opportunities will continue to be in the substitution of ideas for stuff or for energy.
So for example, if we use the new biochemistry that we've learned over the past couple of decades to create better seeds that can produce the same amount of food stuffs with less nitrogen fertilizer, then that will be a win. And firms that are in that business of the biochemistry of seeds are well-positioned to profit from that transition.
It would follow, you'd think, that the firms that are just in the business of brute force cranking out ammonia and urea molecules are going to be disadvantaged. And I think that would be right.
Similarly, if in the energy arena, if we can create systems that allow us to have decentralized electricity sources that can feed electricity into the grid when the sun is shining, and maybe take it back out when the sun isn't shining, and as a result, we have to build fewer big central power stations, I think that would be a beneficial thing. Again, the value creation is, it's not in a solar panel itself. Solar panels are just low machines, but it's in the design of the systems and the software that will enable those decentralized systems to be harnessed to the collective good. So I think that there are examples like that in every arena of human endeavor.
And you could say that this course that we're doing at HBSO is even an example of that, right? It used to be that people had to, if they want to get a Harvard education, they had to buy a plane ticket and they had to buy a winter coat to live in Cambridge over the bad months, and they had to invest a lot in materials and energy in order to do it. And now with the click of a mouse, you can get the same kinds of educational services delivered over your computer at a fraction of the cost and a tiny fraction of the environmental burden.
Chris Linnane:
That's a good point. Didn't think of it that way. That's pretty good.
Forest Reinhardt:
I didn't either until just now.
Chris Linnane:
Well, Forest, thanks so much for taking the time to be on our show. I really appreciate it.
Forest Reinhardt:
Thanks for having me over. It's been a lot of fun.
Chris Linnane:
I hope we can get you in for a third course.
Forest Reinhardt:
I'm looking forward to it.
Chris Linnane:
If you'd like to learn more about Professor Reinhardt or either of his HBS Online courses—Global Business or Business in Climate Change—please visit us at theparlorroompodcast.com. Remember to follow us on LinkedIn, Facebook X, Instagram, and TikTok.
My name is Chris Linnane. Thank you for listening. If you're enjoying The Parlor Room, please share the show with your friends and subscribe, rate, and review it wherever you get your podcasts. Thank you.
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