The pandemic has revealed the short-term contradiction of companies taking from the public purse while continuing to pay or reinstating dividends. Investors are only just getting to grips with the long-term cost of social inequalities
- KEY POINTS
- Social inequalities are rising and are seen as an issue for investors concerned about uncosted externalities over the long term
- FANG companies are a case in point, with little political consensus about how to deal with their monopolistic power
- Corporates are embracing the need to account for their impact on wider society
- Investors must penetrate a wide variety of metrics and presentation standards and understand the risk of greenwashing
The COVID-19 pandemic has made many investors realise that companies now begging governments for taxpayer support also have duties and responsibilities to society as a whole – far beyond a narrow focus on maximising profits to shareholders. This is not only because taxpayers end up being the ultimate risk-taker for them, but also because the full external impacts of their activities are not costed and charged to them – companies can and do benefit from private profits at the expense of public losses.
While corporates are currently judged purely on their financial capital results – and most will readily point to their success in adding value to human capital through employment – the threats that society faces point to a need for investors to examine the impacts of investee companies on environmental capital and perhaps just as critically, on social capital – the framework that underlies economies and societies.
Man-made climate change has been generally accepted, at least in Europe, as an area that companies need to respond to. As Bertrand Rocher, portfolio manager at Mirova points out, understanding the risks involved in directing capital flows to activities that contribute to making the planet less conducive to human life is not a question of morality, it is about rationality.
But what about the impact of corporates on social issues? As Rocher says, the function of financial markets is not to gauge the degree of social justice. Rather, once they have crossed certain thresholds, social inequalities can only become an important parameter for markets, “as a risk accumulation factor first, but also because unequal societies are ultimately not favourable to economic development per se”.
As the economist Dambisa Moyo put it in an article in the Toronto Globe and Mail recently: “The veracity and very survival of democracy depends on a strong, prosperous middle class – one that is able to hold government accountable.”
From the nineteenth century onwards, liberal democracies have been characterised by a vast and growing middle class. But while inequalities may have been greater a century ago than today, their levels were falling. “This phenomenon has ended and this is an issue we are not prepared collectively to want to face,” as Rocher puts it.
“Unequal societies are ultimately not favourable to economic development per se” - Bertrand Rocher
A standard narrative is that globalisation and automation are hollowing out the middle classes, leading to populist political leaders like Trump and political movements like Brexit and America First. Shamik Dhar, chief economist at BNY Mellon Investment Management, sees a grain of truth in that but argues that the situation is more complex. “Economies are incredibly flexible machines, creating jobs and tasks that we can never dream of,” as he puts it.
Certainly, technological changes like the internet have meaningfully improved productivity, and such periods of rapidly changing productivity are risky for established employment patterns as old industries disappear and new ones arise. “We are okay with that because we can’t stop technical progress, but the combination of new technology plus globalisation is having a devasting impact on the middle classes of the Western countries” says Rocher. While this might be temporary, it could persist for years or even a century, he thinks.
How best to cushion a transition in the nature of what is valuable and hence better-paid in today’s society? In his book ‘Head, Hand, Heart: The Struggle for Dignity and Status in the 21st Century’, David Goodhart addresses some of the consequences. Intellectual jobs, the traditional bastion of the middle classes, have been elevated to the peak of society at the expense of those who use their hands in artisanal jobs, or their hearts in jobs such as low-paid care work.
Relative wage increases have been pronounced. As Goodhart says: “Since 1975 the hourly pay of bus and coach drivers has risen by just 22% (in 2017 prices), compared with a 111% rise for advertisin g and public relations managers.” In the corporate world, this trend has hit the roof with the ratio of US CEO compensation to average workers in the US reaching 271 in 2016, according to a report from the Economic Policy Institute, way beyond the 20-to-1 ratio in 1965 and the 59-to-1 ratio in 1989. “CEOs are getting more because of their power to set pay, not because they are more productive or have special talent or have more education,” the report adds.
What we appear to be seeing is a stark and persisting revaluation of rewards within society, driven not by demand – or by value to society, as would be the norm and acceptable within free-market democracies – but by power. In this period of transition, some companies have benefited to an exorbitant extent and the issue is whether the power they exercise to create those profits needs to be curtailed.
Not traditional monopolies
There are historical precedents – the creation of railroads and then the oil industry in the US in the late nineteenth century led to anti-trust legislation and the breaking up of large monopolies by the administration of President Theodore Roosevelt. Some have argued that we face a similar situation with the FANGS – Facebook, Amazon, Netflix, and Alphabet (Google).
Dhar, however, argues again that the situation is different and requires a more considered solution. “Broadly speaking to a first approximation, the software giants are selling all their goods at zero marginal cost, so it’s hard to argue that they are traditional monopolists.” They can be however, monopsonists (single buyers in a market of many sellers) when it comes to harvesting data. That, argues Dhar, means that traditional antitrust legislation isn’t necessarily the right way to go. But how consumers are protected against their power is an increasing issue. It also ties in with how the companies should be taxed, given their huge profits, even though pricing is at marginal costs.
“Since 1975 the hourly pay of bus and coach drivers has risen by just 22% (in 2017 prices), compared with a 111% rise for advertising and public relations managers” - David Goodhart
While the FANGs and similar companies dominate the global equity markets and their employees can benefit accordingly, they do not dominate the employment markets. In 1990, the ‘big three’ Detroit automakers (Chrysler, Ford and General Motors) and had revenues of $250bn between them and 1.2 million employees.
For those left behind, what should be the solution? There may be a case for new ideas like universal basic income (UBI). But Dhar says: “If you ask me ‘will there be a UBI in any country within the next five years?’, the answer would be no. But if the question is ‘will there be one within the next 20 years?’, the answer is almost certainly yes, somewhere.”
That might be anathema to the US conservative hardliners, but they may be even more disinclined to accept Dhar’s further suggestions that instead of taxing ‘goods’, government should be taxing ‘bads’ such as sugar, tobacco or alcohol, whose consumption cause long-term health impacts and costs to society as a whole.
Transference of jobs to emerging markets based on comparative wage advantages is inevitable and perhaps desirable – the creation of larger middle classes in those countries creates new markets. What is not desirable, however, is transference of industries based on poorer safety standards for workers and other unacceptable practices.
Rocher says: “We need to increase production of batteries for light vehicles, for example, but we need to make sure that children do not work in cobalt mines.” It is collectively counterproductive to grant capital to agents that damage the social environment knowingly or unknowingly, Rocher continues, because they contribute to destroying a framework which enhances economic development.
This whole transition of thinking and corporate behaviour is clearly creating opportunities as well as threats for investors way beyond the immediate disruption caused by COVID-19. “Today’s firm essentially has no choice but to balance maxim-ising profits with broader social goals,” says a 2019 report from PGIM entitled The Future Means Business. The hardest question for an investor trying to select companies with a purpose, it adds, is how to penetrate the layers of obfuscation and ‘greenwashing’.
It may also be worth bearing in mind that as the developed world’s populations age, investment in industries creating better paid ‘heart-related’ or socially focused jobs increase in value to society in comparison with professional jobs whose work is increasingly becoming automated. Goodhart sees a decent chance that “one legacy of the crisis will be to acknowledge a wider range of human aptitudes in our allocation of reward and prestige – which will help us to achieve a better balance between head, heart and hand”.
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