ESG Special – Inequality

Too high inequality hampers growth, as does too low inequality. Clearly, this matters for investors. If the right amount of inequality can drive a better outcome in an economy, then that ought to make these countries more attractive for capital allocation too.
But investors should look at inequality also from a social, a humanitarian, a Rawlsian, and a societal acceptance perspective. To this end, we construct an index that incorporates these perspectives.
In addition, our results are of interest to investors and companies seeking to leverage their capital and influence for positive social change.

Equality – it’s not just justice

This is the second paper of our series on the critical topic of inequality.

The first paper of the series (ESG Special – Societal Inequality) dealt with inequality conceptually, looking at it from three different perspectives - as an economic, a social, and a political problem.

Building on that analysis, the key question that we want to tackle in this piece is why (and how) an investor should think about, and aim to address, inequality. In our view, there are three main reasons. First, inequality matters from a return perspective. If there is a relationship between inequality and growth – and we will demonstrate that there is – then investors should add this to their criteria for country evaluation and consider over-weighting countries with “superior” levels of inequality. This question is addressed in the first part of this paper where we will explain, perhaps counterintuitively, why some inequality is optimal.

Second, investors might want to weigh questions of inequality from an ESG perspective. Among the United Nations’ 17 Sustainable Development Goals (SDGs), one explicitly calls on states to “reduce inequality within, and among, countries”. Other goals also touch on inequality, such as the first which has the simple, laudable aim of “no poverty”, or the eighth which calls for “decent work and economic growth”. ESG investors might prefer to invest their money in countries where inequality is low – or at least where governments are credibly trying to reduce it to a tolerable level.

Third, in a forthcoming report “Engaging for change from micro to macro“, DWS colleagues highlight how investors are increasingly aiming to use their capital and influence to accelerate real world change on environmental and social issues. Investors are increasingly focusing on macro or systems level engagement aiming to shift the ‘rules of the game’ to increase the chances of humanity achieving the Sustainable Development Goals. Investors are taking this approach due to the Universal Ownership theory and the financial importance of market or ‘beta’ returns which are increasingly influenced by environmental and social factors.

The Equaity report you are reading now, thus complements the Engaging for change DWS report and the Principles for Responsible Investment (PRI)’s case for why and how investors can respond to income inequality (UNPRI, 2018). Namely, we will guide investors on how different countries perform in the context of inequality by constructing a simple ranking system which combines different aspects of inequality into a single score.