Facing hard truths: The material risk of rising inequality
Inequality: A long-term trend
In the US, there has been little-to-no real wage growth for a majority of the population since the 1970s¹, and the wage gains that have manifested have flowed to the highest-paid Americans. The effects on wealth have been severe – the bottom 50% of wealth owners have experienced no net wealth growth in real terms since 1989. At the other end of the spectrum, the top 1% has seen their wealth grow by almost 300% in real terms over the same time frame.² Predictably, this has grown overall wealth disparity (Exhibit A). This is a pattern that repeats across most developed English-speaking countries³ even as country-level inequality on the world stage has shrunk.
Looming fiscal austerity measures from the economic effects of the pandemic are also likely to impact safety nets and social services. Citizens of countries in earlier stages of development may face a different set of factors such as food insecurity, or limited access to utilities and housing. But in all countries, lower-income households face a set of barriers that stack the deck against them. Racial, gender and cultural biases only add to the disparity in opportunities that many victims of inequality must overcome.
Inequality in the national spotlight
Although inequality has been a pressing issue for decades, it has come to dominate our current national conversation. Consider:
- The killing of George Floyd forced a widespread reappraisal of how racism and inequality continue to disadvantage Black Americans and other minorities in every aspect of society.
- The COVID-19 pandemic revealed how the gulf between those who have been able to safely work at home and workers who have borne the brunt of the exposure to the virus have highlighted risk inequalities in the labor market.
- Data show that the victims of economic inequality are about 10% likelier to have a chronic health condition, and people with lower incomes tend to develop these conditions between five and 15 years earlier in life. These chronic conditions increase the deadliness of a COVID-19 infection.⁶
- Millions of people have no access to affordable health care after losing their jobs.
The stresses and dislocations to society imposed by COVID-19 and social justice issues have both created new fault lines and exacerbated long-standing tensions. And although the solutions are complex, the private sector must do more to address this issue.
Inclusive economic growth is more sustainable
Research has found that more inclusive economic growth is also more sustainable economic growth. At a macro level, greater inequality can reduce aggregate demand, pulling down a country’s GDP growth while increased leverage can lead to greater market volatility (as discussed below).
Reduced aggregate demand
Research by the World Bank Group has found that, on average, a 1% increase in inequality (as measured by the Gini coefficient)⁸ reduces GDP per capita by around 1.1% over a five-year period. The Economic Policy Institute (EPI) estimates that the shifting of an ever-larger share of US income to high-income households since the late 1970s has reduced aggregate demand (spending by households, businesses and governments) an estimated 2 to 4 percentage points of GDP annually in recent years.⁹
The impact of reduced demand has been offset primarily by falling interest rates, but this is not a sustainable solution; in a different environment, lower demand translates more directly to slower GDP growth. Since corporate earnings growth has been correlated with GDP growth historically, corporations are exposed to the risks posed by growing inequality and have a key role to play in addressing it.
Despite large transfers of wealth to the top 10%, spending among lower-income Americans has not decreased proportionately, resulting in increasing levels of household debt.¹⁰ While the causes for maintained spending likely include the welfare loss that would be induced by proportionate consumption cuts,¹¹ another fact is clear – the cost of living has gotten more expensive. In the US, real wage growth for the bottom 90% of American workers since 1998 has been vastly outstripped by the growth of costs such as housing, health care, and public and private college (Exhibit D).¹² As a result of increased debt, the bottom 90% of Americans have been saving 0% of their income over the last 30 years.¹³
Recent research suggests that as lower-income households have increased their debt, increased leverage may produce economic bubbles.¹⁴ There is some evidence this occurred during the housing crisis that led to the financial crisis in 2007-2008. Increasing levels of leverage by lower-credit borrowers led to unsustainable rise in housing values, which further fueled leverage consumption.
It has been suggested by the International Monetary Fund that excessive inequality can erode social cohesion and lead to political polarization.¹⁵ While these effects are by their nature not well defined, they represent another systemic risk of inequality. Internationally, widespread and long-standing inequality has been a driving force behind recent political upheaval and social unrest throughout history.
Moving forward: factoring in inequality
Companies, as key members of society and the global economy, can be both exposed to inequality’s risks and contribute to its worsening. In 2018, the largest 500 corporations in the world directly employed more than 45 million people, indirectly controlled hundreds of millions of workers in their supply chain, paid more than $700 billion in taxes, sold products and services worth over $22 trillion, controlled assets valued at more than $110 trillion, and spent around $1.4 trillion and $540 billion in capital and research and development expenditures, respectively.
To understand the financial materiality of inequality at the level of a corporation or investor, it is useful to note Calvert’s foundational beliefs for Responsible Investing. First, a core assumption is that all companies – whether implicitly or explicitly — must address a range of ESG factors that materially affect corporate outcomes.
Second, companies that most successfully manage those factors may gain an edge in long-term financial performance and create positive societal change – they are, in our view, mutually reinforcing goals. Indeed, past research shows that companies with improving performance on industry-specific material ESG issues outperformed their competitors following the improvement both in terms of accounting and stock market performance.¹⁷
Why is inequality one of these material issues?
- Outcomes resulting from inequality may have a material negative effect on long-term corporate and investment performance through its effect on underlying value-drivers.
- Changing societal recognition of this problem, and corresponding efforts to address it, may materially change the risks and opportunities of different investment opportunities, both internally at the company level and broadly for investors.
- Unchecked inequality may destabilize the financial and social systems within which investors operate.
Connecting inequality to material ESG factors
In order to contextualize the materiality of inequality, Calvert has identified a subset of industry specific indicators in our data pool that we believe measure performance on issues that contribute to “inequality of opportunity” – a broad designation comprising a number of major drivers of inequality such health and access to education and the labor market. By demonstrating the extent to which these indicators are financially material for different Calvert subindustries, we can illustrate the importance of this issue and allow for a broader consideration of how material inequality may be across the entire economy.
- The distribution bars show that all Calvert models have at least some inequality-related KPIs, while the majority of models have at least a third of their weight in inequality-related KPIs.
- The broad distribution of weightings highlights the fact that companies in different segments of the economy vary widely in their exposure to financially material ESG issues related to inequality.
Seeking corporate leaders to fight inequality
Inequality, especially in the US, may be seen as a tragedy of the commons in which those with the power to change the system act myopically due to the benefits they derive from the current system, and a belief that others would exploit short-term opportunities in their stead. Unless actors in such a system think strategically and act with long-term interests in mind, exploitation of resources, including human capital, can result in system collapse or degradation.
Considering the long-term risks to systemic and individual corporate growth that inequality presents, Calvert seeks to identify issuers that can successfully manage inequality-related issues. As our societies and governments reckon with this issue, Calvert believes that companies and investors that demonstrate a willingness to adapt, build strong relationships with key stakeholders and clearly communicate strategies to address these issues will be more resilient.
For the full article, including a list of specific strategies to help companies address inequality, please visit https://institutional.eatonvance.com/calvert-institute.php
¹This stagnation has not been even - Real wages for production and nonsupervisory employees in the USA declined from the 1970s to the mid-1990s. They have climbed unevenly since then, only now reaching levels comparable to the late 1960s and early 1970s. (https://www.factcheck.org/2019/06/are-wages-rising-or-flat/)
²US Federal Reserve, “Distributional Financial Accounts: Levels of Wealth by Wealth Percentile Groups,” 3/31/20. Available at: https://www.federalreserve.gov/ releases/efa/efa-distributional-financial-accounts.htm
³Roser, Max and Ortiz-Ospina, Esteban, “Income Inequality,” Our World in Data, October 2016. Available at: https://ourworldindata.org/income-inequality.
⁸The Gini coefficient is a measure of statistical dispersion intended to represent the income or wealth distribution of a nation’s residents, and is the most commonly used measurement of inequality.
⁹Bivens, Josh, “Inequality is slowing US economic growth,” Economic Policy Institute, December 12, 2017. Available at: https://www.epi.org/publication/secular-stagnation/.
¹⁰Piketty, Thomas and Saez, Emmanuel, “Top Incomes and the Great Recession: Recent Evolutions and Policy Implications,” IMF Economic Review, Vol. 61, No. 3, 2013. Available at: https://eml.berkeley.edu/~saez/piketty-saezIMF13topincomes.pdf.
¹¹Bertrand, Marianne and Morse, Adair, “Trickle-Down Consumption,” NBER Working Paper Series 18883 , March 2013. Available at: https://www.nber.org/papers/ w18883.pdf.
¹²Eidelson, Josh, “How the American Worker Got Fleeced,” Bloomberg, LLC, July 2, 2020. Available at: https://www.bloomberg.com/graphics/2020-the-fleecing-of-the-american-worker/.
¹³Saez, Emmanuel, “Income and wealth inequality: Evidence and policy implications,” Contemporary Economic Policy, 7-25, January 2017. Available at: https:// eml.berkeley.edu/~saez/SaezCEP2017.pdf.
¹⁴Wood, David, “Discussion Paper: Why and how might investors respond to economic inequality?” The Principles for Responsible Investment,” 2016. Available at: https://iri.hks.harvard.edu/files/iri/files/pri_inequality_discussion_paper.pdf.
¹⁵“IMF Fiscal Monitor: Tackling Inequality,” October 2017. Available at: https://www.imf.org/en/publications/fm/issues/2017/10/05/fiscal-monitor-october-2017.
¹⁷Khan, Mozaffar and Serafeim, George and Yoon, Aaron. “Corporate Sustainability: First Evidence on Materiality.” The Accounting Review, Vol. 91, No. 6 (2016), pp. 1697-1724. Available at SSRN: https://ssrn.com/abstract=2575912.
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