For example, a middling performer on the income Gini coefficient can be one of the best performers on the CII (example highlighted in the green box). This is because the country’s average performance in income inequality is more than offset by strongly positive showings in wealth distribution and access to opportunities, particularly in the areas of intergenerational mobility and gender pay gaps.
Conversely, a country that scores well on the income Gini coefficient can be average on the CII (example highlighted in the red box). This country’s performance in opportunities is average and the difference is largely due to the severe wealth inequality offsetting its relatively more equal income distribution. Factors driving the wealth inequality include negligible wealth taxes and favourable homeownership tax policies (e.g. tax rebates on mortgage interest payments and tax deductions for maintenance, refurbishments and household services) that enable homeowners to accumulate wealth faster.
In the subsequent section, we argue that investors must worry about economic inequality because of its impact on the macroeconomic environment, politics, policies, and markets. Many studies have established the relationship between economic inequality and macroeconomic variables such as growth and inflation, while the implications of economic inequality on the political environment, policy landscape and drivers of market returns are not as well researched. We employed our CII to examine how economic inequality affected political stability, the rise of populism, country risk premiums and equity market returns. We summarise our findings below.
Impact of inequality on growth and inflation
A wide range of past research concluded that inequality hurts economic growth especially in middle- and high-income countries and exacerbates inflation.
Inequality reduces GDP growth by impeding labour productivity and consumption growth. Rising economic inequality could result in poorer human capital quality due to limited access to credit, education and healthcare. Labour productivity is also potentially lower if significant parts of the population face challenges with employment, or are unable to acquire the new skills needed for and share in the benefits of technological innovation. Consumption is undermined by prolonged weak or stagnant income growth for lower income groups, especially because these groups also typically have a higher propensity to consume out of income.
According to studies by the IMF and OECD, a 1 percentage point (ppt) deterioration (increase) in the income Gini ratio was associated with 0.07 to 0.12 ppt reduction in annual GDP growth. Using our CII, a 1 ppt increase in broad inequality shrinks a national economy’s GDP by 0.12 ppt.
Inequality worsens inflation as a result of arguably less equitable policies. Societies with higher inequality tend to see higher income groups preferring inflation to taxation when it comes to financing government spending, given the more progressive nature of income and wealth-related taxes. There is also a preference for monetary easing to support asset prices when economic conditions turn unfavourable, which leads to higher inflation in the longer term.
Other studies found that an increase in the Gini coefficient of 1 ppt was associated with 0.4 to 1.3 ppt increase in inflation. Our CII saw a similar relationship, with a 1 ppt increase in broad inequality corresponding with a 0.8 ppt increase in inflation.
Impact of inequality on political stability and populism
Our research showed that economic inequality has a negative impact on political stability and is one of the key drivers of populism. We saw this in the deterioration of political stability and rise in populism across both Emerging Markets (EM) and Developed Markets (DM) in recent years.
As shown in Exhibit 2, based on an aggregate index of six indicators of political instability, there is a robust positive relationship between inequality and political instability across EMs and DMs.
Exhibit 2: Inequality and Political Instability