Good Deals 13 preview: How social investment can exacerbate inequality

 

At the upcoming Good Deals social investment conference, to be held in London this week, I will be chairing a panel on social investment readiness. The panel will focus on the mechanics and future of investment readiness, largely from a due diligence perspective, to aid understanding of what is required of the different parties involved.

 

But to provide some broader context, I want to outline one wider socio-economic point that prospective social investors and investees should consider: the extent to which social investment may help or hinder the cause of economic equality in society.

 

Private financial investment is often perceived to de facto exacerbate economic inequality, as it is typically the preserve of the wealthy. The basic idea is that the disadvantaged spend everything they earn on basic necessities, whereas people who are financially well-off can save, invest, and thereby increase their wealth. As a consequence, even if the quality of life for the disadvantaged improves, the rich will become richer faster than the poor and economic inequality will increase.  

 

According to the Equality Trust, relative economic inequality is bad for everyone — both rich and poor. It outlines research showing that people in more equal societies are less likely to be victims of violence, are more likely to have better education, mental health and longer lives, regardless of their wealth. Research from the International Monetary Fund even shows that equality is good for sustaining economic growth.

 

In response to this and similar points, many people advocate political and social programmes, such as general taxation and private donor activity, that redistribute wealth and support from the well-off to the impoverished.

 

So where does social investment fit in? Do profit-taking social investors exacerbate or alleviate economic inequality? I’ll touch on just two considerations needed to answer this: the source of the financial return and the social change effected.

 

We need to thank charitable trusts and foundations and high net worth individuals as the primary funders of social investment to date. And in the absence of substantial participation from private institutional investment houses and pension funds, they will continue to be central. However, as trusts and foundations don’t typically distribute profit, let’s use high net worth individuals as a test case.

 

Consider a high net worth individual who makes a £1m social investment at 1% return into a social enterprise that delivers mental health services in deprived communities through government ‘payment in arrears’ contracts. This transaction results in £10k flowing from taxpayers via the government contract and the social enterprise to the investor. And if the HNWI earns more than the average taxpayer, this is a net cash flow to the rich. The social investment apparently exacerbates economic inequality in the short term, albeit not at the same rate as other financial investments may.

 

However, this analysis doesn’t take into account the long-term impact of the government-funded social enterprise. Improving the mental health of deprived individuals may help them improve their future income potential, and thereby reduce economic inequality in the long-term. Obviously, it is the government contract that funds this potential reduction, but the individual can take some credit for facilitating the transaction to the extent that the social enterprise could not obtain finance as cheaply elsewhere.

 

Put simply, on the one hand, an individual's social investment has guaranteed an increase in economic inequality in the short term, but on the other, it has facilitated a potential decrease in inequality in the long term.

 

This equation has some major uncertainties, including the extent and likelihood of a long-term reduction in inequality, and the exact level of ‘credit’ accruing to the social investor for facilitating the transaction between the government/payor and the social enterprise. In other words, whether social investment will over time reduce economic inequality will depend on the specifics of each investment deal.

 

It therefore behoves both social investors and investees to carefully consider the specifics of each potential social investment deal to ensure that they will alleviate rather than exacerbate economic inequality.