Income inequality is limiting economic growth, creating more frequent and deeper recessions, and increasing social instability. While the social challenges and issues stemming from inequality have been understood for decades, the economic impact of extreme inequality has only recently been studied.
According to the IMF, when the income share of a country’s wealthiest 20 per cent of people increases by just 1 per cent, GDP growth is 0.08 per cent lower in the subsequent five years, whereas an increase in the income share of a country’s poorest 20 per cent of people is associated with 0.38 per cent higher growth.
Disparities between population segments can also limit growth. The wage gap between black and white Americans accounts for as much as 0.2 per cent in lost GDP each year. By addressing the wage gap between men and women globally, countries would add 0.6 per cent to their GDP annually.
Clearly, income inequality hurts long-term profits and weakens our financial system, and it is past time for investors to take on this challenge. This is a broad, systemic challenge we are facing as a society, and it requires equally ambitious action from investors to change their investment approaches to address income inequality, improve the long-term health of the markets, while also still operating profitably and enjoying competitive returns.
A new toolkit from The Investment Integration Project, with support from the Generation Foundation, applies principles of systems-level investing to show how investors can confront income inequality and take actions that enhance their current policies and practices. The toolkit, Confronting Income Inequality, reviews a range of conventional and advanced techniques and tools at the disposal of asset owners and asset managers to address income inequality.
Conventional techniques – such as portfolio construction, engagement, manager due diligence, and policies and beliefs about the functioning of markets – are a part of daily practice for all investors. These familiar activities can be extended beyond portfolio construction and risk management to encompass the systemic risk of income inequality as well.
Advanced, system-level investing techniques can be used to influence the rules of the game and the culture within which the investment community operates to minimise the systemic risk and maximise potential rewards. These techniques can be grouped according to three broad or overarching tactics: field building, investment enhancement, and opportunity generation. As broad categories they show the path forward for the practice of system-level investment: first, investors start working more collectively (field building), then change the way they make investments (investment enhancement), and then create investment opportunities that will improve systems (opportunity generation). These techniques, which are the foundation of system-level investing, vary in their usefulness from asset class to asset class, and in how they can be applied to specific systemic issues.
One clear opportunity for investors in these advanced investing techniques is around calls for fair compensation and a living wage. The Platform Living Wage Financials (PLWF) is a collaborative effort of 15 financial institutions with more than $3 trillion in assets that encourages companies using manual labor (e.g., garment and footwear, food, and beverage) to pay workers a living wage that enables them, at minimum, to cover basic living expenses in accordance with International Labour Organisation (ILO), OECD, and UN guidelines and principles. The PLWF investor members identify and highlight companies with best practices and encourage progress in consideration of this issue throughout entire industries. In 2019, the UN’s PRI singled out the PLWF for praise for this active ownership project, which has led to various firms incorporating living wage policies into their management practices.
Another area of opportunity is decreasing the pay gap between men and women and other underrepresented groups. In 2017, the United Kingdom required companies with more than 250 employees to report on and publish their employee pay gaps each year. Companies must disclose the disparities in hourly, bonus, and overall pay between men and women. The UK government enforces these mandates and failure to comply can result in legal action and fines. In 2019, 100 per cent of these companies with over 250 employees reported this data to the UK government, with the gender pay gap for all workers falling from 17.4 per cent in 2019 to 15.5 per cent in 2020. Investors can and should support these types of disclosures within their investment portfolios.
Investors can also support the strengthening and improvement of workforce policies and practices through the disclosure of labor-related data. The UAW Retiree Medical Benefits Trusts’ Human Capital Management Coalition, supported by 32 institutional investors with $6 trillion in assets under management, petitioned the Securities and Exchange Commission in 2017 to require companies to disclosure human capital management policies and practices, asserting that such disclosures are “fundamental to human capital analysis.” These policies and practices included workforce culture and empowerment, workforce health and safety, human rights, and workforce compensation and incentives.
Lastly, investors can support the right of workers to organise unions and engage in collective bargaining, adopt and enforce responsible contractor policies, and utilise collaborative techniques. In 2019, the Committee on Workers’ Capital (CWC), an international network of unions, initiated an Asset Manager Accountability Initiative to support asset owners wishing to increase asset managers’ attention to workers’ rights considerations. CWC plans to issue reports on the progress of the current status of the world’s largest asset managers on these issues. In October 2020, it published a report on BlackRock. Among its recommendations for BlackRock’s private equity investment program were that it improve its project-specific agreements and enforcement in its Responsible Contracting Policy programs for real estate and infrastructure, join the Cleaning Accountability Framework in Australia, and enter into dialogue with global service unions on working conditions and workers’ rights in the private nursing industry.
These and other opportunities are detailed in the Confronting Income Inequality toolkit, which can help you apply these and similar approaches throughout your portfolio. Because, as the COVID-19 pandemic laid bare, we are operating within weak and vulnerable social and economic systems, highlighting the need for investors to act on income inequality and other systemic issues. We hope this toolkit can help investors do so.
William Burckart leads TIIP (The Investment Integration Project) and is co-author of the book 21st Century Investing: Redirecting Financial Strategies to Drive Systems Change
Michael Musuraca is senior advisor at TIIP