Poorer Than Their Par­ents? A New Per­spec­tive on In­come In­equal­ity

A New Per­spec­tive on In­come In­equal­ity

Rotman Management Magazine - - CONTENTS - By R. Dobbs, A. Madgavkar et al.

Flat-or-fal­lling in­comes in ad­vanced economies have im­pli­ca­tions for to­day’s cit­i­zens — and fu­ture gen­er­a­tions.

Flat-or-fall­ing in­comes in ad­vanced economies have im­pli­ca­tions for fu­ture gen­er­a­tions.

in ad­vanced economies since World MOST PEO­PLE GROW­ING UP War II have as­sumed that they and their chil­dren will be bet­ter off than their par­ents and grand­par­ents — and for most, that as­sump­tion has been cor­rect. Over the past 70 years — ex­cept for a brief hia­tus in the 1970s — buoy­ant eco­nomic growth has meant that all house­holds, es­pe­cially those of the Baby Boomer gen­er­a­tion, ex­pe­ri­enced ris­ing in­comes, both be­fore and af­ter pay­ing taxes and re­ceiv­ing gov­ern­ment trans­fers such as un­em­ploy­ment or so­cial se­cu­rity ben­e­fits.

This pos­i­tive in­come trend has come to an abrupt halt in re­cent years: Our re­search shows that in 2014, be­tween 65 and 70 per cent of house­holds in 25 ad­vanced economies were in in­come seg­ments whose real mar­ket in­comes — from wages and cap­i­tal — were flat or be­low where they had been in 2005. This does not mean that in­di­vid­ual house­holds’ wages nec­es­sar­ily went down, but that house­holds earned the same as or less than sim­i­lar house­holds had earned in 2005, on av­er­age.

In the 12 pre­ced­ing years, be­tween 1993 and 2005, this ‘flat or fall­ing’ phe­nom­e­non was rare, with less than two per cent of house­holds not ad­vanc­ing. In ab­so­lute num­bers, while fewer than ten mil­lion peo­ple were af­fected in the 1993–2005 pe­riod, that fig­ure ex­ploded to be­tween 540 and 580 mil­lion peo­ple in 2005–14. Taxes and trans­fers to helped soften the blow, but dis­pos­able in­comes were nonethe­less flat or down in 20 to 25 per cent of in­come seg­ments, on av­er­age.

The se­vere re­ces­sion that fol­lowed the 2008 fi­nan­cial cri­sis and the slow-growth re­cov­ery since are a fun­da­men­tal cause of this phe­nom­e­non, but we found that deep-rooted de­mo­graphic and labour-mar­ket fac­tors have also played a role — and will likely con­tinue to do so, even if eco­nomic growth ac­cel­er­ates. These fac­tors in­clude shrink­ing house­holds, a smaller share of GDP go­ing to wages, and in­creased au­to­ma­tion in the work­place. Even in the 2005 to 2014 pe­riod, mar­ket in­comes in most of the coun­tries we stud­ied would have risen slightly had it not been for such changes.

In this ar­ti­cle, we will sum­ma­rize the fac­tors un­der­ly­ing the ‘flat or fall­ing phe­nom­e­non’ and out­line some op­tions for deal­ing with what is po­ten­tially a cor­ro­sive so­cial and eco­nomic de­vel­op­ment.

The Flat-or-fall­ing Phe­nom­e­non

There are sev­eral ways to think about in­come in­equal­ity and its im­pli­ca­tions. The most com­mon ap­proach in re­cent years has been to look at the ris­ing gap be­tween the wealth­i­est seg­ments

of the pop­u­la­tion and those in the mid­dle or lower end of the scale. This, for ex­am­ple, has been the fo­cus of French econ­o­mist Thomas Piketty, whose best-selling book about the con­cen­tra­tion of wealth go­ing to top earn­ers sparked broad pub­lic dis­cus­sion. An­other fre­quently used ap­proach is to fo­cus on the poor — those with in­suf­fi­cient in­come to pro­vide for their ba­sic needs, of­ten cal­cu­lated as a per­cent­age of the me­dian in­come.

Our re­search looks at a third as­pect, which has not been as widely stud­ied: The rapid growth in the pro­por­tion of in­come seg­ments in ad­vanced economies whose earnings both be­fore and af­ter taxes and trans­fers have been flat or fall­ing. This goes be­yond the de­gree of in­equal­ity mea­sured in the stan­dard Gini in­dex by pro­vid­ing a de­tailed view of the tra­jec­tory of all in­come seg­ments, which can be lost in a con­sol­i­dated in­dex. We fo­cus on in­come rather than on wealth or con­sump­tion, and we also look at the evo­lu­tion of in­comes over time, rather than at a fixed point.

We used three ap­proaches to an­a­lyze this flat or fall­ing phe­nom­e­non. The first looked at changes by in­come seg­ments, or house­holds di­vided into deciles (tenths), quin­tiles (fifths), and even per­centiles (one-hun­dredths), de­pend­ing on where they rank in the na­tional in­come dis­tri­bu­tion. We ex­am­ined in­come seg­ments in six ad­vanced economies — France, Italy, the Nether­lands, Swe­den, the United King­dom and the United States — to de­ter­mine how they have fared over the past two decades. We then scaled up the find­ings to in­clude 19 other ad­vanced economies — in­clud­ing Canada — with sim­i­lar growth rates and in­come dis­tri­bu­tion pat­terns, for a to­tal of 25 coun­tries with a com­bined pop­u­la­tion of about 800 mil­lion that ac­count for just over 50 per cent of global GDP.

Our sec­ond ap­proach was an analysis of a de­tailed data set for 350,000 peo­ple in the three coun­tries, with mi­cro­data avail­able — France, Italy and the U.S. For these coun­tries, we ex­am­ined in­come by age bracket and ed­u­ca­tional at­tain­ment. Fi­nally, we sought to un­der­stand per­cep­tions through con­duct­ing de­tailed sur­veys of more than 6,000 peo­ple in France, the UK and the U.S. that tested how peo­ple felt about the evo­lu­tion of their in­come.

Our first key find­ing: Since 2005, house­hold in­comes across ad­vanced economies have stag­nated or fallen for most in­come seg­ments. This is based on an analysis of in­come seg­ment data from na­tional agen­cies in the six coun­tries we looked at in de­tail, a to­tal of 487,000 house­holds. On av­er­age, 65 to 70 per cent of the pop­u­la­tion were in in­come deciles (10-per cent slices of the pop­u­la­tion) whose real mar­ket in­comes in 2014 fell com­pared with 2005. In our six fo­cus coun­tries alone, more than 400 mil- lion peo­ple were in in­come seg­ments with flat or fall­ing mar­ket in­comes. When scaled up to the 25 coun­tries in our sam­ple, this trans­lates into 540 to 580 mil­lion peo­ple.

By com­par­i­son, in the 12 pre­vi­ous years, be­tween 1993 and 2005, less than two per cent of the pop­u­la­tion — fewer than 10 mil­lion peo­ple — were in in­come seg­ments whose av­er­age mar­ket in­comes were flat or down. The im­pact was smaller when mea­sured in dis­pos­able in­come; but even af­ter ac­count­ing for higher net trans­fers to house­holds be­cause of the re­ces­sion, dis­pos­able in­comes, on av­er­age, were flat or down in 20 to 25 per cent of in­come seg­ments.

The dis­tri­bu­tion of flat or fall­ing in­comes var­ied across the six economies we stud­ied in depth. At one ex­treme was Italy, which ex­pe­ri­enced a se­vere eco­nomic con­trac­tion in the re­ces­sion af­ter the 2008 fi­nan­cial cri­sis and has had a very weak re­cov­ery since. There, real mar­ket in­comes were flat or fall­ing for vir­tu­ally the en­tire pop­u­la­tion. At the other ex­treme was Swe­den, where only 20 per cent of the pop­u­la­tion had flat or fall­ing in­comes. In each of the four other fo­cus coun­tries — France, the Nether­lands, the UK and the U.S. — the pro­por­tion of seg­ments whose mar­ket in­comes did not ad­vance was in the 60-to-80 per cent range.

The vari­a­tion was even greater at the level of dis­pos­able in­come: The share of in­come seg­ments whose dis­pos­able in­come did not ad­vance be­tween 2005 and 2014 ranged from 100 per cent in Italy to 10 per cent in France and less than two per cent in Swe­den and the U.S. These vari­a­tions re­flect widely vary­ing na­tional eco­nomic, fis­cal and mone­tary pol­icy re­sponses to the re­ces­sion.

The trend of flat-or-fall­ing in­comes was con­firmed by our sec­ond analysis of age- and ed­u­ca­tion-based pop­u­la­tion seg­ments. Our data on 350,000 in­di­vid­u­als from France, Italy and the U.S. tracked in­comes of de­mo­graphic seg­ments based on three age brack­ets (younger than 30, 30–45, and older than 45) and three lev­els of ed­u­ca­tional at­tain­ment — low, medium and high, based on whether a per­son received less than a high school diploma, a high school diploma, or a bachelor’s de­gree or above.

This sec­ond set of data con­firmed our re­sults from the first analysis by in­come seg­ments: We found that in­come from wages fell for all pop­u­la­tion seg­ments be­tween 2002 and 2012, re­gard­less of age or level of ed­u­ca­tion. In all three coun­tries, less-ed­u­cated work­ers, and es­pe­cially younger ones, have been most af­fected. More­over, the re­ces­sion and weak re­cov­ery have led to per­sis­tently high lev­els of youth un­em­ploy­ment, pre­vent­ing young peo­ple across ad­vanced economies from launch­ing

ca­reers. These are the peo­ple who are lit­er­ally at risk of grow­ing up poorer than their par­ents.

Women were also over-rep­re­sented in lower-in­come deciles. Sin­gle moth­ers were more likely to be in seg­ments that were not ad­vanc­ing, although there was a vari­ance among coun­tries. In the U.S., 20 times as many sin­gle moth­ers were in the low­est-in­come decile as in the high­est. In Italy, there were eight times as many sin­gle moth­ers in the low­est in­come house­holds as in the high­est-in­come house­holds. For France this num­ber was 11 times.

Our mi­cro­data for the U.S. show that sin­gle-mother house­holds not only earn less than the av­er­age house­hold, but their real house­hold in­come also de­clined nearly one per­cent­age point faster than all other house­holds in the decade from 2003 to 2013.

The cit­i­zen sur­veys we con­ducted in 2015 in France, the UK and the U.S. show that per­cep­tions are in line with the find­ings of our analysis of in­come and pop­u­la­tion seg­ments. We sought to gauge whether peo­ple per­ceived a de­cline in their in­come by ask­ing them to re­spond to state­ments about their fi­nan­cial po­si­tion to­day, whether it had im­proved, and how it com­pared with

that of friends and neigh­bours. We also asked what they ex­pected their fi­nan­cial po­si­tion to be in five years’ time, and whether they thought they were worse or bet­ter off than their par­ents at the same age.

While the an­swers var­ied by coun­try, over­all, there was an even split, with 30 to 40 per cent say­ing their in­comes were not ad­vanc­ing, and the same pro­por­tion say­ing their in­comes had ad­vanced. The re­main­ing 20 to 30 per cent were neu­tral and did not feel strongly ei­ther way. The 30 to 40 per cent who felt they were not ad­vanc­ing held more pes­simistic views about their fu­tures and the fu­tures of their chil­dren than those who felt they were ad­vanc­ing. Nearly half of those not ad­vanc­ing ex­pected not to ad­vance in the fu­ture, com­pared with just one quar­ter of those who felt they were ad­vanc­ing. Those who felt they were not ad­vanc­ing fell into one of two camps: The two-thirds who be­lieved that things would im­prove for their chil­dren and the next gen­er­a­tion, and the re­main­ing one-third, who saw slow in­come growth as a per­sis­tent prob­lem that would con­tinue to af­fect their chil­dren.

Over time, de­clin­ing earn­ing power for large swaths of the pop­u­la­tion could limit de­mand growth in economies and in­crease the need for so­cial spend­ing and trans­fer pay­ments, even as tax re­ceipts from work­ers with stag­nat­ing in­comes limit ca­pac­ity to fund such pro­grams. The im­pact could be more than purely eco­nomic, how­ever, if the dis­con­nect be­tween GDP growth and in­come growth per­sists.

Our sur­vey pro­vided an in­di­ca­tion of the po­ten­tially-cor­ro­sive so­cial and eco­nomic con­se­quences of flat-or-fall­ing in­comes. Along with ques­tions about in­come trends, we asked about peo­ple’s views on trade and im­mi­gra­tion. The cit­i­zens who held the most neg­a­tive views on both were the same group who felt their in­comes were not ad­vanc­ing and did not ex­pect the sit­u­a­tion to im­prove for the next gen­er­a­tion. More than half of this group agreed with the state­ment, ‘The in­flux of for­eign goods and ser­vices is lead­ing to do­mes­tic job losses,’ com­pared with 29 per cent of those who were ad­vanc­ing or neu­tral. They were also twice as likely to agree with the state­ment, ‘Le­gal im­mi­grants are ru­in­ing the cul­ture and co­he­sive­ness in our so­ci­ety’.

Those who were not ad­vanc­ing and not hope­ful about the fu­ture were also more likely than those who were ad­vanc­ing to sup­port na­tion­al­ist po­lit­i­cal par­ties such as France’s Na­tional Front or, in the UK, to sup­port the move to leave the Euro­pean Union.

What Can Be Done to Ad­vance In­comes?

For gov­ern­ment pol­i­cy­mak­ers and busi­ness lead­ers alike, in­tro­duc­ing changes that rekin­dle in­come ad­vance­ment is not straight­for­ward and may re­quire some dif­fi­cult trade-offs. Poli­cies to raise pro­duc­tiv­ity may not help re­duce in­come in­equal­ity, for ex­am­ple, while ef­forts to achieve a more equal in­come dis­tri­bu­tion may at times in­hibit moves to in­crease pro­duc­tiv­ity growth. Fol­low­ing are four pol­icy op­tions aimed at stim­u­lat­ing dis­cus­sion.

1. CRE­ATE MEA­SURE­MENT TOOLS TO GAUGE THE EX­TENT AND EVO­LU­TION OF FLAT OR FALL­ING IN­COMES In­ter­na­tional or­ga­ni­za­tions in­clud­ing the OECD and the In­ter­na­tional Labour Or­ga­ni­za­tion (ILO) are start­ing to look at more ef­fec­tive ways to mea­sure in­come in­equal­ity, along­side other stan­dard eco­nomic in­di­ca­tors such as un­em­ploy­ment or GDP growth. In­come ad­vance­ment could be­come a pol­icy goal in its own right, a fun­da­men­tal in­di­ca­tor of the health of the econ­omy and so­ci­ety, com­pa­ra­ble to poverty re­duc­tion or sus­tain­ing over­all em­ploy­ment.

To ad­dress the is­sue of flat-or-fall­ing in­comes ef­fec­tively, pol­i­cy­mak­ers will need to adopt spe­cific met­rics to track the phe­nom­e­non across the en­tire in­come spec­trum. For now, such data are not sys­tem­at­i­cally gath­ered in most coun­tries, and where statis­tics are avail­able, they tend to be based on sur­vey data. Mea­sur­ing flat-or-fall­ing in­comes is an im­por­tant start­ing point to pro­vide a fact base, and the met­rics could be im­proved, in­clud­ing through use of more re­li­able sources such as tax data.

Track­ing this data could be part of the for­mal man­date of in­ter­na­tional or­ga­ni­za­tions in­clud­ing the OECD or the World Bank so that it can be ag­gre­gated and com­pared across coun­tries. As dif­fer­ent poli­cies are de­ployed around the world, they could be struc­tured in a way that would en­able their out­comes to be mea­sured. Track­ing and eval­u­at­ing flat or fall­ing in­comes would al­low for the de­vel­op­ment of a set of best prac­tices that could be de­ployed across coun­tries.

2. RE­VIVE GROWTH AND EN­ABLE A THRIV­ING BUSI­NESS EN­VI­RON­MENT THAT CRE­ATES JOBS As we have seen, the eco­nomic down­turn was a fun­da­men­tal cause of the lack of in­come ad­vance­ment for a large ma­jor­ity of in­come seg­ments since 2005. The corol­lary is that re­vival of stronger eco­nomic growth will be a key to rais­ing in­comes, even

in the face of de­mo­graphic shifts and labour-mar­ket changes that work against them. Con­versely, if the cur­rent low-growth world be­comes ‘the new nor­mal’, flat-or-fall­ing in­comes could be­come en­trenched.

The para­mount im­por­tance of boost­ing growth through im­proved pro­duc­tiv­ity is a theme we have re­searched ex­ten­sively. About three-quar­ters of the po­ten­tial for pro­duc­tiv­ity im­prove­ments comes from the adop­tion of ex­ist­ing best prac­tices and ‘catch-up’ pro­duc­tiv­ity im­prove­ments, while the re­main­ing onequar­ter comes from tech­no­log­i­cal, op­er­a­tional and busi­ness in­no­va­tions that push the fron­tier of the world’s GDP po­ten­tial. Gov­ern­ments have many op­por­tu­ni­ties to help boost pro­duc­tiv­ity, in­clud­ing through mea­sures that would re­duce waste and im­prove re­source and en­ergy ef­fi­ciency, in­crease com­pe­ti­tion and dereg­u­la­tion, or tar­get in­fras­truc­ture and other in­vest­ment that cre­ates new jobs in the short run and shores up eco­nomic growth over the longer term.

3. DE­VELOP MEA­SURES AIMED AT HOUSE­HOLDS MOST AT RISK Be­yond such gen­eral reme­dies, the phe­nom­e­non of flat-or-fall­ing in­comes could be ad­dressed through mea­sures specifically aimed at low and mid­dle-in­come house­holds or the pop­u­la­tion seg­ments we iden­tify as be­ing most at risk, in­clud­ing young peo­ple with low ed­u­ca­tional at­tain­ment, women and older work­ers.

Up­grad­ing skills and eas­ing the tran­si­tion from ed­u­ca­tion to em­ploy­ment is one ap­proach. At the se­condary school level, pub­lic school sys­tems can col­lab­o­rate with lo­cal busi­nesses to craft vo­ca­tional train­ing and ap­pren­tice­ship pro­grams, par­tic­u­larly in fast-grow­ing ser­vice in­dus­tries such as health­care. Gov­ern­ments and busi­nesses could work with uni­ver­si­ties and other post-se­condary in­sti­tu­tions to ex­pand ac­cess to qual­ity ed­u­ca­tion and en­sure that the learn­ing pro­vided is rel­e­vant to the work­place of to­mor­row. And in­cen­tives could be of­fered for stu­dents to pur­sue fields of study such as sci­ence, tech­nol­ogy, engi­neer­ing and math, which lead to more lu­cra­tive jobs.

To raise labour par­tic­i­pa­tion among women and older work­ers, pol­i­cy­mak­ers could pro­vide greater ac­cess to child care, or help women en­ter or re-en­ter the labour force by re­mov­ing tax rules that pe­nal­ize two-in­come house­holds. Tech­nol­ogy could also pro­vide some so­lu­tions. Dig­i­tal plat­forms such as Linkedin or Mon­ster, which link em­ploy­ers with work­ers, pro­vide a new way of over­com­ing a skills mis­match, while com­pa­nies such as Taskrab­bit pro­vide op­por­tu­ni­ties to be­come en­gaged in in­de­pen­dent work.

We es­ti­mate that such on­line plat­forms could in­crease global GDP by two per cent be­tween now and 2025. En­forc­ing an­tidis­crim­i­na­tion laws would also help raise in­comes for women and mi­nor­ity seg­ments, while pen­sion re­forms can re­duce the pro­por­tion of work­ers who leave the labour force early.

4. USE TAX AND WEL­FARE POLI­CIES TO SE­CURE DIS­POS­ABLE IN­COME GROWTH

Many ad­vanced economies used trans­fer and tax poli­cies to bat­tle the ef­fects of the re­ces­sion and its af­ter­math. Fis­cal stresses and mount­ing gov­ern­ment debt can make rais­ing taxes and trans­fers eco­nom­i­cally chal­leng­ing to­day and in the fu­ture. But rather than im­ple­ment­ing broad-based re­dis­tribu­tive pro­grams, pol­i­cy­mak­ers can use tools tar­geted at in­come deciles with fla­tor-fall­ing in­comes that are not as costly.

For ex­am­ple, even where na­tional in­come taxes are low, sales and value-added taxes, pay­roll taxes and prop­erty taxes can fall heav­ily on low and mid­dle-in­come house­holds. These taxes could be ad­justed to raise dis­pos­able in­comes for these house­holds. Pol­i­cy­mak­ers can also con­sider the im­pact of their spend­ing de­ci­sions on dis­pos­able in­comes of seg­ments whose in­comes are not ad­vanc­ing. A pub­lic tran­sit sys­tem, for ex­am­ple, is likely to pro­vide more value for a lower in­come house­hold than a new high­way.

Where there is po­lit­i­cal con­sen­sus, di­rect pay­ments such as a guar­an­teed ba­sic in­come scheme could be used to main­tain dis­pos­able in­comes. Also, where ap­pro­pri­ate, labour rules could help lift in­comes for seg­ments that have not been ad­vanc­ing. This might in­clude ad­just­ing min­i­mum wages or extending em­ploy­ment ben­e­fits to part-time and tem­po­rary work­ers, which some coun­tries have al­ready done.

The Role for Busi­ness Lead­ers

Flat-or-fall­ing in­comes — and the un­der­ly­ing causes for them — raise ques­tions about how busi­nesses can thrive over the long term in ad­vanced economies. The de­clin­ing pur­chas­ing power of the broad mid­dle classes in con­sump­tion-driven economies is the most ob­vi­ous prob­lem. An­other arises from one of the most im­por­tant causes of in­come stag­na­tion: Es­ca­lat­ing de­mand (and cost) for high-skill labour and fall­ing de­mand for other types of work­ers. This is cre­at­ing a po­ten­tially-se­ri­ous short­age of high­skill tal­ent across ad­vanced economies and a glut of less-skilled work­ers.

Busi­ness lead­ers have a le­git­i­mate role to play in shap­ing the dis­cus­sion on flat-or-fall­ing in­comes and help­ing to cre­ate so­lu­tions. CEOS can be ad­vo­cates for the in­vest­ment and growth nec­es­sary to cre­ate em­ploy­ment. They may rec­og­nize that pay­ing bet­ter wages and in­tro­duc­ing profit-shar­ing and non-cash ben­e­fits can raise em­ployee dis­pos­able in­comes and at the same time, raise pro­duc­tiv­ity and loy­alty. Com­pa­nies can also ben­e­fit by tak­ing steps to keep women and older work­ers in the work­force.

Fi­nally, com­pa­nies can in­vest in a bet­ter labour pool — and in­crease the earn­ing po­ten­tial of work­ers — by col­lab­o­rat­ing with the pub­lic sec­tor on job-rel­e­vant ed­u­ca­tion. More broadly, com­pa­nies can act as cat­a­lysts in their com­mu­ni­ties to en­act pol­icy changes.

Richard Dobbs is a Di­rec­tor of the Mckin­sey Global In­sti­tute (MGI) and a Se­nior Part­ner, based in Mckin­sey & Com­pany’s Lon­don of­fice. Anu Madgavkar is a Part­ner with MGI, based in Mckin­sey’s Mum­bai Of­fice. James

Manyika is a Di­rec­tor of the MGI and Se­nior Part­ner in Mckin­sey’s San Fran­cisco of­fice.

Jonathan Woet­zel is a Di­rec­tor of the MGI and a Se­nior Part­ner in Mckin­sey’s Shang­hai of­fice. Jacques Bughin is a Di­rec­tor of MGI and a Se­nior Part­ner in Mckin­sey’s Brus­sels of­fice. Eric Labaye is Chair­man of the MGI and a Se­nior Part­ner based in Mckin­sey’s Paris of­fice. Lies­beth Huis­man is a for­mer En­gage­ment Man­ager at Mckin­sey’s Am­s­ter­dam of­fice. Pranav Kashyap is an En­gage­ment Man­ager at Mckin­sey’s Sil­i­con Val­ley of­fice. The com­plete re­port on which this sum­mary is based can be down­loaded on­line.

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