Income inequality a global threat

The widening inequality gap is one of the most pressing challenges facing investors today. The rise of populist politicians, trade wars and the trend toward isolationism and protectionism that dominate daily news headlines are all signs of the stresses and strains of broad wealth and income inequality around the world.

And unfortunately, the problem continues to worsen, with income inequality within both developed and developing countries now growing at an alarming rate.

Currently, the world’s richest 10 per cent earn up to 40 per cent of total global income. In comparison, the poorest 10 per cent earn only between 2 and 7 per cent of total income. Of the increase in global income between 1988 and 2008, nearly half was captured by the top 5 per cent of the world’s population.

Such inequalities have arguably influenced the outcomes of elections in Britain and the US in recent times and impacted the political climate in many other countries. Growing support for anti-establishment parties and figures reflects the gradual erosion of trust in institutions— including governments— that are crucial to the effective functioning of the financial system.

While it can be argued that income inequality provides an incentive to work hard and encourages entrepreneurship, there is no doubt it can also be detrimental to society and economies as a whole. The International Monetary Fund, for example, estimates that if the share of total income of a country’s wealthiest 20 per cent increases by just 1 per cent, GDP growth will be 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 is associated with 0.38 per cent higher GDP growth.

Institutional investors have increasingly begun to realise that inequality has the potential to negatively impact their portfolios. Put simply, increasing inequality destabilises the financial and social systems upon which investors depend, lowering economic output, slowing growth and ultimately undermining investment performance. It also changes the risks and opportunities that affect the universe of investment opportunities in the portfolio. While the financial risks have become more crystallised, what is less clear until now has been how investors can begin to respond.

The Principles for Responsible Investment (PRI) is already tackling overly aggressive tax practices which can fuel inequality from an investor perspective in its engagement work, along with issues such as human rights, labour rights, executive pay and fair wages and conditions for all workers.

We have also made addressing inequality more of a focus within our 10-year blueprint for responsible investment, recognising the need for investors to contribute to a more sustainable and prosperous world for all and help realise the sustainable development goals.

Three places to start

More recently, our work with The Investment Integration Project (TIIP) has identified several areas for further research. Although the causes of income inequality are many and complex, we found three areas in particular are material to long-term investors where there is scope for further action: employee relations and the structure of labour markets; corporate tax policies and practices; and levels of CEO compensation.

In all three, existing frameworks promote the maximisation of short-term profits and ignore the external costs to society of the inequalities that current practices are fuelling. For each of these, we look at how investors can encourage the development of new frameworks that are more appropriate for the 21st century where inequalities are reduced, while still maximising returns.

As a starting point, investors need better data to understand the extent to which companies in their portfolio are reducing or exacerbating income inequalities. They can start by supporting the data-gathering efforts currently under way, such as those by the Human Capital Management Coalition and the Workforce Disclosure Initiative, that emphasise basic facts and consistent disclosure on wages, benefits, training, retention and union relations.

Investors can also examine the implications of this research for public policy. This includes helping to develop and drive regulation that facilitates meaningful investor input into the design of chief executive compensation packages, as well as encourage mandated, integrated reporting of corporate commitments to a broader range of stakeholders, including employees, as a means of ensuring chief executives pay proper attention to these issues.

In this way, for example, investors can help change existing frameworks in ways that result in greater income equity through improved worker wages, benefits and training; more effective unions and wider union representation; less disparity between the very wealthy and others in society; and more impactful public policies aimed at promoting these goals.

Addressing inequality is a challenging task, but investors can and should seize the opportunity to play a vital role in ensuring a stable and sustainable society for all.

Fiona Reynolds is chief executive of Principles for Responsible Investment.