Beyond growth: Incorporating
sustainability factors into
We need to move beyond narrow, purely economic measures of national success. Our model integrates environmental, social and governance factors with growth analysis to better measure sustainable development.
A new indicator of national progress
Much of what passes for macroeconomic analysis is very narrow in its scope. Economic outlooks tend to focus on short-term growth dynamics in a small number of large economies like the US, Eurozone, China and Japan. These are also heavily tilted towards what is happening in the developed world.
Much of what passes for macroeconomic analysis is very narrow in its scope.
This leaves a lot of questions unanswered. Is growth strong compared with what one would expect? How are small countries that are flying under the radar performing? Is growth environmentally sustainable and inclusive? And is the quality of political institutions being undermined?
The most successful societies blend strong economies with healthy environments, inclusive social policies, representative political institutions and fair legal frameworks. To recognise this, we have built a new indicator of national progress for 135 countries. This combines a measure of economic strength with environmental, social and governance (ESG) factors aligned to the UN Sustainable Development Goals.
Our work is a testament to the benefits of more open economies and societies. This is a message that risks being lost amidst the wave of political populism sweeping through the developed and, in some highprofile cases, developing world.
We have identified 46 countries that have performed better than one would have expected over the past five years in both economic and sustainable development terms. The vast majority of these ‘Social Capitalist’ countries are developing economies in Africa and Eastern Europe. These can be viewed as hunting grounds that will generate both global economic and sustainable development leadership over the next 20 years.
Much of what passes for macroeconomic analysis is very narrow in its scope.
Chart 1: Social Capitalism across the world
Strong gains in living standards concentrated in developing countries
When we shift our attention from large developed economies that have struggled in recent years, we find that strong growth in living standards has been the norm, not the exception. Indeed, the vast majority of developing countries converged on US and broader developed country living standards over the past decade.
This is a distinct improvement since the ‘80s and ‘90s. And, in many cases, this has been accompanied by impressive progress on sustainable development objectives. This reveals that the supposed trade-off between strong economies and strong societies is a false one.
It also highlights the benefits of globalisation at a time when support is dangerously low. Without globalisation, much of the poverty reduction in developing countries over the past 20 years would not have been possible. This is a good news story that deserves to be celebrated. Moreover, stronger absolute and relative growth creates the resources and helps build the political coalitions necessary to support the ESG goals that will make future growth more sustainable.
That said, there is still work to be done. For developing countries to sustain this strong growth performance over the next decade and beyond, further domestic economic and institutional reforms will be necessary, especially since the tailwind from globalisation is currently fading.
Although two of the most prominent developing economies – India and China – do not make the ‘Social Capitalist’ grade, both have been persistently economically dynamic. Moreover, recent developments suggest that their governments are placing more weight on broader measures of progress. If China is to become a ‘Social Capitalist’ it will need to improve the transparency and representativeness of its political and governance institutions. In India, the focus should be on environmental indicators and social equality.
Weak growth a threat to sustainability goals in developed economies
Conversely, the majority of developed economies – particularly in the Eurozone – have scored well on sustainability factors but failed to generate robust economic growth. The danger is that this persistently weak economic growth will amplify existing populist pressures and eventually undermine support for broader sustainability goals.
If developed countries’ commitment to open economies and societies weakens further, it will inevitably weigh on their own growth prospects. It would also damage the prospects for further catch-up growth in developing countries.
At a time of enormous productivity, demographic, social and environmental challenges, this would prove especially counterproductive. The task is therefore to identify country-specific political and policy solutions that can reconcile each of these objectives.
Exceptions to the pattern of weak economic performance and strong ESG credentials among the developed economies include Portugal, Ireland and Sweden, which have performed well across both dimensions.
Meanwhile, Japan stands out – contrary to general wisdom – as an economy that has been more economically dynamic than most, with the country’s shrinking population masking relatively healthy productivity performance. Abenomics has not been the failure it is sometime made out to be.
Chart 2: Top 20 ESG Index countriesSource: Research Institute, Aberdeen Standard Investments, (as of January 2019)
Environmental outcomes a weak point in ESG scores
Although most countries’ ESG scores have been on a rising trend over time, there is a lot of room for improvement. Most major countries are not doing enough to reduce greenhouse gas emissions and limit the damage from climate change, nor improve air quality.
The Paris Agreement is a starting point for addressing the enormous challenge of preventing further damaging increases in global temperatures. However, much more needs to be done, both at a national level and in terms of international coordination.
It is encouraging that Finland, France and the Netherlands have seen improvements in their air quality since 2011. By contrast, Norway, Denmark, Switzerland, Australia, Spain and Portugal have worsened during the period.
And while income and other inequalities between developed and developing countries have been shrinking, disparities within countries are high and have risen over recent decades. Social group equality and participation in civil society organisations were either the least improved or the worst indicators across our whole sample of major markets.
Against a backdrop of populist politics shaped in part by the discontents of globalisation, this degradation of equality and representation is striking and concerning. Addressing these factors will be important for gaining broad-based buy-in for growth-enhancing reforms. This is a challenge that policymakers are struggling to meet.
Dynamic economies throw off more investment opportunities
Our research can be used for a wide range of investing purposes. Strategic investors – whether in listed equities or private markets – who do not wish to take ESG factors into account, can draw on the growth dynamism component of the ‘Social Capitalist’ index to identify the countries where long-term returns may be highest.
Four countries serve as useful examples here. Between 2007 and 2017, per capita GDP as a ratio to that of the US increased from 37 to 48% in Poland, 15 to 25% in China, 14 to 21% in Indonesia and 7 to 12% in India. If their average per capita growth rates were to be sustained over the next decade, those ratios would reach 67%, 44%, 31% and 20% respectively. That would, in turn, imply rapid growth in corporate earnings, both in aggregate and for many individual companies.
This analysis is only a starting point. Investors would need to assess whether the factors that contributed to earlier rapid growth were likely to persist. And even if they were, valuations at the aggregate and individual stock level would be critical for determining the opportunity set, especially on shorter time horizons.
‘Social Capitalist’ economies may generate more sustainable returns
When growth dynamism is combined with ESG performance, the results may be even more powerful. The best way to think about our ESG index – in raw or development-adjusted form – is that it tells us something important about a country’s health and the long-term sustainability of its development model.
A country enjoying rapid growth at the expense of environmental outcomes may face more pressing resource constraints. It may also be more vulnerable to climate change. Similarly, countries in which rapid growth coincides with deterioration in social outcomes may find it more difficult to sustain the political and policy consensus necessary to maintain that growth into the future. Meanwhile, countries with weak political institutions may be more vulnerable to violent and economically damaging regime changes.
In that sense, our ESG analysis can act as a screen for investors who need to identify risks as well as opportunities. Our Emerging Market Debt team incorporates this principle into its funds. The team uses its own ESG scoring to better determine whether sovereign credit spreads compensate investors for countries’ underlying vulnerabilities. Moreover, by focusing on where ESG factors are changing the most, the team is in a better position to determine whether the market is efficiently pricing future risk-adjusted returns.
A vehicle for expressing ethical preferences
Of course, not all investors are motivated by the outlook for pure, risk-adjusted returns. Some may simply want to ensure that their money is invested in a way that is consistent with their own ethical principles. The ESG component of our index is ideal for this purpose. For example, it is possible to build an Exchange Traded Fund (ETF) that uses either our raw aggregate ESG scores or aggregate development-adjusted ESG scores to determine whether, and by how much, to deviate from the benchmark. Our ESG index can also be easily broken into its sub components for those investors only wanting to focus on environmental, social or political factors.
Our model of growth and ESG dynamism sheds lights on which countries are making the most progress on joint economic and sustainability criteria. Many of these countries – particularly in Africa and Eastern Europe – fly underneath the radar in traditional macroeconomic analysis.
In the future, we intend to extend our work in a number of ways. We will identify best-practice ESG-related policies and institutions that can be feasibly imitated elsewhere. This will begin later this year with the environment. We will explore the extent to which our ESG index and its components contain ‘causal’ information about countries’ long-term growth prospects, as well as how growth dynamics influence ESG choices. This will include a more thorough investigation of the link between growth dynamics, ESG factors and asset returns. We are also working with product specialists to determine if we can develop new funds that draw on our research.