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Unlocking the “S” in capitalism

Nicole Papassavvas & Marie Rupp, February 2022

Achieving Sustainability Unlocking the “S” in capitalism allianzgi.com February 2022 Social issues have typically been overshadowed by other aspects of the sustainability story such as climate. That’s changing. The Covid-19 pandemic has shone a light on inequalities in access to basic essentials and life opportunities – and the solution calls for a new brand of capitalism. The “S” in ESG – the environmental, social and governance factors that are a core Key takeaways part of sustainable investing – has long – The Covid-19 pandemic shone a light been overshadowed by other aspects of the on the weaknesses of the modern sustainability story. Yet today, social issues just-in-time economy and was a stark are increasingly coming into focus. reminder that many communities One reason is the Covid-19 pandemic, which has experience inequalities in accessing Nicole Papassavvas exposed serious problems that can arise when both life and livelihood essentials Senior Sustainability countries or communities lack the resources and – Recent events have led to a renewed Analyst opportunities that others take for granted. In focus on the “S” in ESG – the social the worst situations, these communities may be issues that can hold back the growth marginalised from society entirely, experiencing and resilience of economies, and may what is known as “social exclusion”. There’s also be exacerbated by climate change growing recognition that social issues are firmly and digitalisation interconnected with the “E” in ESG – namely the – The concept of “inclusive capitalism” environment and climate change – and that all is gaining steam as part of a more these themes should be addressed together. inclusive approach to economic growth, At Allianz Global Investors, we understand the and it should be addressed alongside importance of social issues to today’s world. our other sustainability pillars at Marie Rupp In fact, it’s a core reason why the concept of AllianzGI – climate change and Senior Sustainability “inclusive capitalism” is one of the three thematic planetary boundaries – with which it is Analyst closely interdependent pillars of our sustainability focus – alongside – By addressing inclusive capitalism climate change and planetary boundaries such via their investments, investors can as biodiversity. Inclusive capitalism is integral accelerate the journey to a more to our goal of working with our clients to drive equal world while capitalising on an inclusive, fairer and more sustainable world. significant growth opportunities as We think it opens up new markets and growth new approaches and infrastructure opportunities as companies innovate to resolve come online inequalities and address the needs of under- served communities. Value. Shared.

Unlocking the “S” in capitalism Why inequality is a growing concern Defining inequality Addressing inequalities is at the heart of the focus on Covid hits schooling social issues – but what does inequality really mean? – Income and wealth inequality are one of the main The closing of classrooms during the pandemic areas that need attention, but we believe financial has pushed 101 million children globally below considerations are not the only way to measure inequality. the minimum reading proficiency threshold; seven million are in Western Europe and North Around the world there are also big disparities in access America.2 And according to the World Bank, to basic needs – the “life essentials” that include food, children affected by learning losses stand to water and clean air (see Exhibit 1). lose USD 10 trillion in future lifetime earnings – – People also lack “livelihood essentials” such as education equivalent to 8% of global GDP.3 and infrastructure. These are necessary for people to participate in economic, social and civic processes and lead productive and creative lives. In fact, UNESCO has found that “socially excluded” people who lack these into reverse. The rate of extreme poverty rose from 8.4% in livelihood essentials “find themselves confined to the 3 2019 to 9.5% in 2020 – the first global increase since 1998. 1 fringes of society”. These inequalities manifest themselves in various ways. In Covid-19: exposing inequalities a survey by our Grassroots Research® team, 27% of French The Covid-19 pandemic has accelerated the problems of educators cited major issues with online learning during exclusion and inequality, with implications beyond health the pandemic, especially for low-income students and and wellbeing. It’s more obvious than ever that many basic those in rural areas who do not have an adequate internet needs, such as food and healthcare, are not guaranteed for 4 connection or hardware. And since robust technology is many of our communities. Many people also lack access to increasingly critical to earning a living – particularly with the kind of education and financial services that would help the growth in home working – the “digital divide” between them build better lives. These shortcomings help explain those who have adequate digital infrastructure and those why during this crisis, progress in fighting poverty has gone who do not is a significant new driver of inequalities. Exhibit 1: life and livelihood essentials explained Food Health Water Life essentials Clean air (core to existence) Energy Safety Home Basic citizen services/information Education (basic and life-long learning) Decent work opportunities Livelihood essentials Wellbeing (core to human development Infrastructure (transportation and communication) in our modern world) Financial services Digital tools and technology 1. UN definition; Beyond Transition: Towards Inclusive Societies (unesco.org). 2. The Sustainable Development Goals (SDGs), 2021 | United Nations 3. WEF Briefing Paper: Shaping an Equitable, Inclusive and Sustainable Recovery 4. Source: UN The Sustainable Development Goals (SDGs), 2021 | United Nations – The extreme poverty rate is the share of world population that is living on less than $1.90 per day 5. Grassroots Research® Market Monitor, Issue 3, 2020 2

Unlocking the “S” in capitalism Another major driver is climate change. Local environmental resources are crucial for a high proportion of the poorest populations, and these resources are affected by global warming. Bridging the digital divide For instance, under the medium scenario for population Some 2.9 billion people remain offline globally – development, the Intergovernmental Panel on Climate equal to around 37% of the world population – Change estimates that at 1.5°C warming 178 million people – with 96% of them living in developing countries. including a high proportion of women, children and the Those who remain unconnected face multiple elderly – will be affected by water stress, drought intensity barriers, including a lack of access: some and habitat degradation by 2050. At 2°C warming this 390 million people are not even covered by a figure rises to 220 million people.6 7 mobile broadband signal. Inequality is a problem for everyone The Covid-19 pandemic is the most obvious recent example of a global crisis that has brought global inequality into stark relief. But think about the recent Shifting the economic model towards financial crises and increasingly regular extreme weather inclusive capitalism events. Inequalities undermine our capacity as a society It is time for society and economy to move to an inclusive to mitigate and overcome the impact of major crises like and fair world these, and as such they are a concern for everyone: A persistent, decades-long rise in gross domestic product – Covid-19 showed how the economy relies on global and (GDP) in many countries has increased overall living tight supply chains and exposed the lack of resilience standards and lifted many people out of poverty. This in the “just in time” model. Broken and delayed supply is proof of the power of capitalism. However, measuring chains affect everyone. GDP has its limitations. It cannot shed light on unequal – Consider the repercussion of a dock workers’ strike on income distribution. Nor does GDP give any insight into the global supply of goods. Or the effect on the price we other types of societal inequality – including less access to would have to pay if the “fair” cost of these goods was healthcare, education or infrastructure. applied that includes the social and environmental costs. According to the Allianz Global Wealth report, the richest – Sustained inequalities often result in heightened political 10% of the world’s population together owned more than or even geopolitical risks. This environment is typically 84% of total net financial assets in 2020, and the middle class 8 negative for economic growth, since it raises costs and is shrinking. And figures from the OECD show that median limits the availability of capital. In many regions of the incomes grew more slowly than top incomes since the mid- world, this has led to large-scale refugee crises. 1980s – and the Covid-19 pandemic made this trend worse. Exhibit 2: median incomes grow more slowly than top incomes Real disposable income growth by income position, average for 17 OECD countries, 1985 2016 (1985 = 100%) 170% Top 10% Median Bottom 20-40% Bottom 10% 160% 150% 140% 130% 120% 110% 100% 1985 1990 1995 2000 2005 2010 2015 Note: Unweighted average for 17 countries for which long-term data are available: Canada, Germany, Denmark, Finland, France, United Kingdom, Greece, Israel, Italy, Japan, Luxembourg, Mexico, Netherlands, Norway, New Zealand, Sweden and United States. Incomes are disposable incomes, corrected for household size. Source: Chapter 2, OECD calculations from OECD Income Distribution Database. Data as at April, 2019. StatLink Data 6. Summary for Policymakers – Special Report on Climate Change and Land (ipcc.ch) 7. Measuring digital development – Facts and figures 2021 (itu.int) 8. Allianz Global Wealth Report 2021 3

Unlocking the “S” in capitalism This is where the concept of inclusive capitalism is gaining steam as part of a more inclusive approach to economic growth. Consider the World Economic Forum’s (WEF) recently Social insecurity launched Inclusive Growth Framework. In its 2020 Davos manifesto, the WEF upgraded the purpose of a company Before the pandemic, informal employment to encompass all its stakeholders – employees, customers, represented 60% of global employment. This suppliers, local communities and society at large – in shared means that 2 billion people worldwide worked 9 and sustained value creation. in jobs characterised by lack of basic protection, 10 Furthermore, over 190 countries have adopted the UN including social protection coverage. Sustainable Development Goals (SDGs) to support a better and more sustainable future for all. By highlighting priorities such as “zero poverty”, “decent work and economic growth” and “quality education”, the 17 SDGs provide a roadmap for companies to address these issues in the way they run acknowledging “the need to ensure that no one is left behind 11 their organisations and through their products and services. in the transition to net zero economies”. And this is a two- With its focus on reflecting the needs of women, youth and way interdependence, as human capital has to be “unlocked” local and marginalised communities in climate-related to secure the skills necessary for climate transition. planning, SDG 13: Climate Action is particularly germane Clearly, the SDGs can provide a much-needed roadmap to to this discussion of inclusive capitalism. SDG 13 highlights address some of the world’s most pressing issues related how the journeys towards both an inclusive world and a to sustainability. Early results are promising: of the 8,550 1.5 degree-aligned world are tightly interwoven. Consider companies in the MSCI All Country World Index, nearly how moving to a low-carbon economy can have social 40% have aligned with multiple SDGs (see Exhibit 3). Of repercussions, for instance if jobs are jeopardised by the those companies, SDG 5: Gender Equality was among the shift away from fossil fuels. This is the impetus behind the top ranked in terms of alignment. But other companies still calls for a “just transition”. At COP26 in November 2021, have work to do: 7% of firms were assessed as “misaligned”, 12 more than 30 nations signed the Just Transition Declaration noticeably on SDG 7: Affordable and Clean Energy. Exhibit 3: companies are grappling with sustainability Level of corporate alignment with SDGs 8,550 Companies .% Most aligned – No strongly misaligned assessments on an SDGs – At least 3 SDGs identified as strongly aligned .% – Higher overall number of aligined SDGs than misaligned .% Aligned – No strongly misaligned assessments on an SDGs – Higher overall number of aligined SDGs than misaligned Neutral or mixed Misaligned – At least one SDG is assessed as strongly misaligned .% – Higher overall number of misaligined SDGs than aligned .% Misaligned – Three or more SDGs assessed as strongly misaligned – Higher overall number of misaligined SDGs than aligned This chart displays distribution of companies’ assessment by SDG for a set of 8,550 companies, as at 11 August, 2020 Source: MSCI ESG Research LLC. Data as at August 2020. 9. WEF Briefing Paper: Shaping an Equitable, Inclusive and Sustainable Recovery 10. The Sustainable Development Goals (SDGs), 2021 | United Nations 11. Supporting the Conditions for a Just Transition Internationally - UN Climate Change Conference (COP26) at the SEC – Glasgow 2021 (ukcop26.org) 12. Assessing Company Alignment with UN SDGs - MSCI 4

Unlocking the “S” in capitalism Closing the gap with climate Our framework for inclusive capitalism While these steps are encouraging, there is still less attention at Allianz Global Investors paid to building a more inclusive world than addressing Thanks to their experience with the climate transition, many climate change and the environment. The UN’s High-level investors increasingly recognise they have the power to Political Forum on Sustainable Development – in effect, make a positive impact through where and how they invest the SDG equivalent of the climate COP – had only its 13th their capital. This applies equally to the transition to a more iteration this year and received scant media coverage. inclusive world. What could explain this gap? We see both a lack of Indeed, as a firm with strong ESG credentials, Allianz Global urgency and a sense that inequalities are happening Investors has been active for several years in integrating in more remote countries. In addition, there are intrinsic people-related sustainability factors in investment challenges in managing social factors. Whereas the fight 13 against climate change has a clear and measurable focus – processes. As part of our ESG risk assessment, we seek to ie, achieving net-zero emissions to stop warming – there identify where investee companies may need to enhance is no single unifying quantitative goal for creating a fair and inclusive world. There is also the question of how to measure sustainable development. It encompasses multiple topics – from education, ways of working and retirement New skills needed to health and financial considerations. Moreover, there are significant cultural and legal differences across countries The shift away from fossil fuels is estimated by the and regions. International Energy Agency to displace around But while the S has been a poor cousin to the E and G of ESG, 5 million jobs. But about 30 million new workers it is still gaining prominence. Social issues are particularly are needed by 2030 to meet increased demand important to millennials and Generation Z investors. And for clean energy and low-emissions technologies; 14 even though inequalities have increasingly come into focus over half are highly skilled positions. in the US, this awareness is now being exported to other parts of the world. 13. We have also published research on the topic of economic inequality, including this paper: Allianz Global Investors | Enabling access to markets can help reduce inequality (allianzgi.com) 14. Net Zero by 2050 - A Roadmap for the Global Energy Sector (windows.net) 5

Unlocking the “S” in capitalism their approach to labour relations or consider more holistically their impact on local communities. But we know there is more that we – and the industry – Vaccine inequality can do. By making inclusive capitalism our third sustainability For every 100 people, around 68 vaccines research theme, we are granting proper resources and were administered in Europe and Northern efforts to identify emerging issues, driving awareness and America, compared with fewer than two in creating change. With the interdependencies of social, 16 climate change and environment, we will be able to address sub-Saharan Africa. this topic alongside our other two thematic pillars: climate change and planetary boundaries. Our analysis in framing and structuring inclusive Urgent next steps capitalism led us to distinguish life essentials and The world must take its lessons from the pandemic that livelihood essentials. We also believe that inequalities revealed the need for a shift of our economic and societal and exclusions deserve the same level of attention, as model. Global leaders are setting the tone by addressing exclusions are generally the consequence of inequalities social topics. The planned introduction in 2022 by the that have been stretched beyond their tipping point, EU of a Social Taxonomy, the social dimension of US including by the pandemic. This focus will likely lead President Joe Biden’s infrastructure plan, and China’s focus to product innovation, including new impact-focused on “common prosperity” are strong signs that the tide is investment strategies. It will also inform proxy-voting turning. We see this as the right moment to take an active decisions and define themed engagement projects, stance on inclusive capitalism alongside climate change which is a proven tool for increasing awareness among and the environment. These interwoven priorities, while corporations. Concerted actions via joint initiatives, representing the biggest challenges facing our planet, including the UN Principles for Responsible Investing, unlock new opportunities for investors to support the 15 transition to a more inclusive and sustainable world. will continue to be another lever to drive change. Exhibit 4: AllianzGI framework for inclusive capitalism Inclusion F airness , f Life Livelihood e a v i i r s Essentials Essentials u a s l n e ri e c d d n u o n B Education ry i s Food a t u e n n a s Health Decent work Pl A at Energy Infrastructure bani Clean air Financial el Water services dlrow apitalism e C B Inclusiv l u a s i n n o e i s t r e s v i i t a D y s e N s People G ties Life Essentials lob Diversity uni e a m g l n m a o h C C e t a m i l apitalism C Inequalities e C Livelihood Essentials Inclusiv Exclusion 15. For example, we contributed to the UN PRI paper on Covid-19 recovery: Sustainable and inclusive: Covid-19 recovery and reform | Engagement guide | PRI (unpri.org)| PRI (unpri.org) 16. The Sustainable Development Goals (SDGs), 2021 | United Nations 6

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