Inflation is damaging real investment returns. It is also accentuating inequalities in society. Rising energy and food costs fall disproportionately on lower income groups. Middle income levels are also feeling the squeeze and will do further as interest rates rise. This comes on top of the social issues exposed by the pandemic. Investors, having elevated concerns about climate change in their investment strategies, need to do the same with social concerns. We have to contribute to a “just transition” because not doing so risks a damaging political backlash to change.
There is no doubt that the cost of living is rising. The UK press reported last week that retail prices for petrol hit an all-time high. The inflation report for January pegged the annual increase in UK consumer prices at 5.5% with retail price inflation at 7.8% - it’s highest since 1990. If COVID was the number one conversation subject amongst the general public in 2020, it is inflation today. The fear is of more to come. Regulated energy price caps will be lifted from April pushing up domestic heating bills massively while most workers will pay additional National Insurance (tax) contributions. Those with floating rate mortgages or consumer debt will likely face higher interest costs as well. It’s a combination of things that have got people talking about the hit to consumer confidence and the risks of a recession in the foreseeable future. Higher interest rates and energy costs are rarely a positive combination for economic growth.
As always in economics there are levels and rates of change. In the UK, like in other economies, inflation has been low in recent years such that the price level has been relatively stable. Meanwhile, aggregate wages have been increasing. Between 2014 and the end of 2021, whole economy wages rose by just over 25% while the consumer price index rose by 16% - with 6% of that coming in the last year. It is true that the last year has seen an acceleration in prices relative to wage growth that has hit real household incomes. But we are a long way from the 1970s when I was growing up and inflation was persistently ahead of wage growth – oh, and there were real shortages of fuel and rising unemployment as well. At the whole economy level, things are not that bad and households, in aggregate, have enjoyed real wage gains in recent years.
How robust will spending be?
Consumer spending grew by 7.9% in the UK last year and the consensus forecast is for 3.4% growth in 2022. This is not consistent with a recession. It remains to be seen whether these forecasts are too optimistic. There has not really been a clean run of consumer spending data in recent months because of the impact of the Omicron variant and the surge in COVID case rates from November to February. The Bank of England is clearly concerned that spending will get hit because it suggested at the last Inflation Report that inflation and thus interest rates would come down again during its forecast period. The concerns can be applied across the global economy especially if energy and goods prices remain elevated.
Inflation falls disproportionately on lower income groups and the rise in fuel and food prices, cuts in some welfare benefits and increased National Insurance contributions will hit real incomes very hard. This comes on top of some of the negative social impacts caused by the pandemic, again falling hardest on lower income groups. The pandemic has exposed inequalities in access to health and social care, education and good quality housing. While unemployment is falling, during the pandemic the jobs most impacted by lockdowns were in sectors like retail and hospitality, so again impacting on the lowest paid workers in society. For many, the ability to work from home or choose to relocate because of the flexibility offered by new ways of working were not realistic options.
Not only have disruptions to the economy, to public services and jobs fallen disproportionately on low income groups, they have not benefited from the positive wealth effects. Ownership of financial and real assets is skewed towards wealthier sections of society. Government support did provide a buffer for those most impacted by the pandemic, but this was temporary and nothing like the longer-term support that accumulated wealth can provide. While not wanting to be too melodramatic about the whole thing, even today you can get reports of widespread use of food-banks alongside references to record bonuses in parts of the financial sector. Inequality seems to have worsened during the pandemic.
Focus on Social
With this in mind the “S” in ESG needs to be given more prominence. Investors have done a lot to align portfolios with net-zero targets to combat climate change, but more attention now needs to be given to today’s social problems and to ensure that the future transition to a low carbon economy is a just one. It is complex but investors increasingly need to judge the extent to which companies are focused on their own human capital and on the broader impact they have on society. So taking into account diversity and inclusion, gender pay gaps, the quality of benefit packages, how workers grievances are handled, training and welfare support amongst many other factors are becoming as important as understanding the carbon footprint. There is a local and global aspect to this. We need to be very mindful of how complex global supply chains impact on workers’ rights and communities as well as how people in the factory down the road are treated.
Inequality breeds anger and this can be directed in a political way. Many commentators would argue that unequal recovery from the global financial crisis laid the seeds for the populism that we saw develop in the last decade. The same could come in the wake of the recovery from COVID and the risk is that dark forces try to hijack efforts to make the future more sustainable and equal. There is talk in the UK of groups lobbying for a referendum to be held on the government’s net zero plans. The backlash against COVID vaccines and restrictions may also appeal to those who feel that they are being left behind after the disruptions of the last two years.
Investors have a role to play in ensuring that they are very vigilant in investing in companies that look after their workforces, that provide training and development and equal opportunities. Governments also have to be more focused on things that are pretty obvious. Look at the current situation. People are being asked to pay more for fuel from sources that are supposed to be on the way out and pay to upgrade their fuel efficiency. At the same time the companies that provide domestic energy are making record profits. I am not saying raise taxes on energy companies, but governments need to be mindful of the optics. The green revolution needs hearts and minds and if ordinary people think it’s going to cost them even more, the political objections to progress will grow.
I have always believed that the green revolution can have a massively positive social aspect to it, delivering lower energy costs, more decentralised economic activity and new skills and jobs. As investors we are putting money to work in transition companies and new technologies, so let’s make sure we also keep a keen eye on what it means for current and future employees and the communities they live in.