The new social contract in the 21st century..

By Matt Dallisson, 12/02/2020

Life has changed substantially for individuals in advanced economies in the first two decades of the 21st century as a result of trends including disruptions in technology, globalization, the economic crisis of 2008 and its recovery, and shifting market and institutional dynamics. In many ways, changes for individuals have been for the better, including new opportunities and overall economic growth—and the prospect of more to come as the century progresses, through developments in science, technology and innovation, and productivity growth. Yet, the relatively positive perspective on the state of the economy, based on GDP and job growth indicators, needs to be complemented with a fuller assessment of the economic outcomes for individuals as workers, consumers, and savers.

In a report, The social contract in the 21st century: Outcomes so far for workers, consumers, and savers in advanced economies, the McKinsey Global Institute takes an in-depth look at these changes in 22 advanced economies in Asia, Europe, and North America, covering 57 percent of global GDP. Among the findings: while opportunities for work have expanded and employment rates have risen to record levels in many countries, work polarization and income stagnation are real and widespread. The cost of many discretionary goods and services has fallen sharply, but basic necessities such as housing, healthcare, and education are absorbing an ever-larger proportion of incomes. Coupled with wage stagnation effects, this is eroding the welfare of the bottom three quintiles of the population by income level (roughly 500 million people in 22 countries). Public pensions are being scaled back—and roughly the same three quintiles of the population do not or cannot save enough to make up the difference.

These shifts point to an evolution in the “social contract”: the arrangements and expectations, often implicit, that govern the exchanges between individuals and institutions. Broadly, individuals have had to assume greater responsibility for their economic outcomes. While many have benefited from this evolution, for a significant number of individuals the changes are spurring uncertainty, pessimism, and a general loss of trust in institutions.

Employment has risen but labor markets are polarized and wages have stagnated

Despite the 2008 financial crisis, the first two decades of the 21st century have seen work opportunities expand and employment participation rise to record levels in most countries. The share of the working-age population in employment has risen strongly in our 22 sample countries to a high of 71 percent. In 2018, 45 million more working-age people were employed than in 2000 (Exhibit 1).

While opportunities for work have expanded and employment rates have risen to record levels in many countries, work polarization and income stagnation are real and widespread.

Alternative work arrangements have gained in prominence, typically in the form of self-employment, temporary work, part-time work, workplace fissuring, or zero-hour contracts. Such arrangements have enabled greater labor market participation: part-time paid work was the primary driver of the increase in overall employment between 2000 and 2018. Its share rose in 18 out of 21 countries, by an average of 4.1 percentage points, equivalent to 29 million jobs, while that of full-time employment declined by 1.4 percentage points.

Labor markets opportunities expanded particularly strongly for women. Of the 45 million additional workers since 2000, 31 million are women. Female employment increased by 6.3 percentage points between 2000 and 2018. The growth in female employment in this period is seen almost everywhere except Norway and the United States, where it has declined by 1.3 and 2.2 percentage points, respectively. Some 14 million additional male workers were employed during this period, although their share of the working-age population fell by 0.4 percentage points on average.

New work opportunities have benefited high-skill, high-wage workers and low-skill, low-wage workers, relative to the middle that has been squeezed. Between 2000 and 2018, the number of people in middle-skill, middle-wage occupations dropped by seven million in 16 European countries and the United States, although this trend has been slowing in the United States.

Wage stagnation has been a persistent challenge for many workers (Exhibit 2). Between 2000 and 2018, average wages grew just 0.7 percent per year across 22 countries. Although wage growth was positive in 20 out of 22 countries, the growth rate was less than one percent over 18 years, and less than half the average annual GDP growth of 1.6 percent during the same period.

Median equivalized net income grew even more slowly than wages, by just 0.4 percent between 2000 and 2018 annually, indicating unequal wage growth across income groups. Relative poverty rates even after taxes and transfers rose between 2000 and 2016; the share of the working-age population earning less than 50 percent of household median income increased from 11 percent to 13 percent over that period, equivalent to 14 million additional people across the 22 countries.

Work is changing in part because of global trends such as technological innovation and globalization. (Going forward, climate change may also have an effect on work and other economic aspects of the social contract.) Across the United States and 15 European countries, between 20 and 30 percent of the working-age population, or more than 160 million people, now engage in independent work, with a growing proportion leveraging digital platforms to do so. About 70 percent say they do so out of choice. Technological innovation has also created new types of work that did not previously exist, from drivers on ride-sharing apps and big data translators to professional video gamers and social media influencers.

Accompanying these disruptive trends is a shift in institutional arrangements that made labor markets more flexible and increased the responsibility of individual workers for their own employment and wage outcomes. For example, employment protection that governs the dismissal of regular workers and hiring of temporary workers has been shown by OECD research to have decreased over the past two decades. Wage negotiation mechanisms have also been changing: the share of workers governed by collective agreements declined in 15 out of 22 countries, from 44 percent to 38 percent on average, with the most significant declines in countries including Germany, Greece, and the United Kingdom.


For consumers, discretionary goods and services are cheaper, but housing and other basics are more expensive

While the cost of discretionary goods and services has been falling, the cost of basics—especially housing, which accounts for 24 percent of household consumption—has risen much faster than general consumer prices and is absorbing a substantial part of households’ income (Exhibit 3).

Prices for clothing, communication, furnishing, and recreation are falling relative to general consumer prices in all regions. Holding all else constant, the average person can work six fewer weeks a year and still consume the same amount of these categories as in 2000.

Technology has helped unlock new consumption in discretionary categories, some of it taking the form of “free” services for consumers, such as social media, communication, and information services. The combination of falling prices and improving quality has led to an increase in consumer surplus, the wedge between what consumers are willing to pay and what they actually pay for goods and services.

Globalization has increased competition in traded goods such as clothing and electronic goods, leading to significant price improvements. China, Vietnam, and other emerging economies have become key lower-cost manufacturing centers, and this has both driven down prices and increased offerings to consumers.

Institutional moves to deregulate markets for some discretionary goods and the reduction of trade barriers to allow for greater competition have played a role in improving economic outcomes for consumers. Between 2000 and 2013, the OECD index for product-market regulation fell across all sectors tracked—telecommunications, transportation, and utilities—and by 33 percent on average for 22 advanced economies. Overall, price declines were steepest in markets that are most exposed to technology, globalization, and deregulation such as communications.

Unlike many discretionary goods, the cost of housing, healthcare, and education have risen faster than general consumer prices across countries in our sample, meaning that a higher share of income would need to be spent for the same consumption level. Holding all else constant, consumers across ten countries in our sample on average would have to work an additional four weeks a year to consume the same amount of housing, healthcare, and education that they did two decades ago.

Housing is the primary cause of this loss in purchasing power in most countries. Housing costs have increased significantly in almost all 20 countries for which data is available, accounting for 39 percent of the change on average across 15 European countries and the United States between 2002 and 2018.

Holding all else constant, consumers across ten countries in our sample on average would have to work an additional four weeks a year to consume the same amount of housing, healthcare, and education that they did two decades ago.

Healthcare prices increased sharply in the United States, where it explained 17 percent of the change in consumer prices; in Europe, healthcare constituted just three percent of the change. Education costs have jumped in all countries except Japan, and almost doubled in the United Kingdom partly due to cuts in university fee subsidies that started in 2010; however, education accounts for just two percent of total consumption spending on average in 22 countries.

The increase in housing, healthcare, and education spending for consumers absorbed income gains to varying degrees in ten of our 22 countries between 2000 and 2017. In countries where incomes increased, the largest erosion of 107 percent of incremental income was in the United Kingdom, meaning that the gains in income have been entirely absorbed by increased spending on basic goods and services. In France, these price increases absorbed 87 percent of income gains. In countries where incomes did not increase—in Italy, Japan, and Spain—the rising spend on basics further eroded incomes by 6 to 29 percent.


Individual and institutional savings have declined at a time when they matter even more

Increasing longevity and the decline in birth rates are making saving for retirement both a greater imperative and a greater challenge. While access and variety of saving and investment options have expanded, many households are not saving at all, and median wealth growth has been falling.

As people live longer, the number of expected years spent in retirement across our 22 sample countries has increased from 16 in 1980 to 20 in 2018. These gains and expansions in productive working life are a hallmark of progress in the 21st century, yet they also pose a considerable challenge for both institutional and individual savers. Institutional pensions, whether public sector or employer provided, will need to deal with higher pension pay-outs and lower receipts, even after accounting for longer working age. Individual savers will need to save more for themselves for their longer lives and compensate for the shortfall in institutional saving.

Real median net wealth has not recovered in 13 countries since the financial crisis; it declined from $104,371 to $80,659 on average in our 22 sample countries between 2007 and 2018.

In response, about half of OECD countries have raised the statutory retirement age and some, including Denmark, Finland, Italy, and the Netherlands and Sweden, now explicitly link the retirement age to life expectancy. By 2060 the normal retirement age will approach 66, which represents an increase of 1.5 years for men and 2.1 years for women. Life expectancy has been increasing at a faster rate.

Governments and private sector institutions concerned about fiscal sustainability have taken action over the past two decades to shift a larger responsibility to individuals for their own retirement savings. The net pension replacement rate that an average worker can expect to receive from her or his mandatory pension has decreased by 11 percentage points for the average person in our 22-country sample (Exhibit 4). Net replacement rates, which measure how effectively a pension system provides a retirement income to replace average earnings, now range from 92 percent in Italy to just 28 percent in the United Kingdom.

Many pension schemes have changed from defined-benefit plans, for which institutions guarantee a minimum return and thus bear the market risk, to defined-contribution ones, for which individuals bear the market risk.

To compensate for the extended period in retirement and decreasing institutional savings in most countries, household private savings would need to increase. However, with widespread stagnation in wage and income growth in many economies and aggregate declines in some, the household saving rate has fallen in one-half of our sample countries by almost 6 percentage points since 2000. Moreover, surveys show that more than half of individuals did not save for old-age last year, and a quarter did not save any money at all.

Real median net wealth has not recovered in 13 countries since the financial crisis; it declined from $104,371 to $80,659 on average in our 22 sample countries between 2007 and 2018 and has only just started to rise again. Inflation-adjusted growth in mean net wealth has also been sluggish since the crisis: annual growth has been close to zero for most of the post-crisis period.

The proportion of individuals with zero or negative net worth has risen significantly in recent decades. In the United States, for example, the share of households with zero or negative net worth rose to 23 percent in 2017 from 16 percent in 2001.


Institutions have shifted responsibility for outcomes to individuals

Along with disruptive global trends and slow GDP growth, a shifting social contract is affecting these outcomes, through the changing roles of public and private sector institutions, and interventions that shape individual or institutional responsibility for economic outcomes. Our research suggests that in 19 out of 22 countries, institutions are intervening less in the marketplace, while governments in 18 out of 22 countries have somewhat stepped up their spending (Exhibit 5).

Some of the biggest changes in the extent of market intervention are a decline in employment protection for workers on temporary contracts, a substantial reduction in product-market regulations, and a sharp fall in the net replacement rate for mandatory pensions. In terms of public sector spending, the biggest change came from pensions, for which public spending across the 22 countries rose by 1.9 percentage points on average. This in turn was almost entirely a function of demographic change, as people live longer. Healthcare spending also rose by 1.1 percentage points, and about 30 percent is explained by aging.


These findings are broadly consistent across countries, regardless of their institutional setup. We identified three groups: (1) countries where market intervention is high and public spending is also high, such as Austria, Belgium, France, and Scandinavian countries; (2) countries where intervention is high and public spending middling, such as Germany and the Netherlands; and (3) countries where market intervention is lower and public spending is also relatively low. This latter set includes Japan, South Korea, Switzerland, and the United Kingdom and United States.


Outcomes for workers, consumers, and savers vary by socioeconomic groups

Bringing together the evolution of economic outcomes across the three arenas and the changing institutional role, we find considerable variation among social and economic groups.


Adapting the social contract for the 21st century

To achieve better and more inclusive outcomes for individuals in the next decades of the century, we identify 10 key challenges which affect large numbers of individuals and which are likely to persist unless addressed, given current trends:

Some institutions—public, private, and social—and individuals are starting to adapt and take action. In the private sector, one sign of a broader reappraisal was given by the Business Roundtable, a group of CEOs of major US companies. In August 2019, it announced that its members are redefining the purpose of a corporation, to care and deliver value for employees, customers, suppliers and communities, as they do with shareholders. The social sector and other forms of institutions, including philanthropic foundations and faith-based charities, are also playing a larger role in addressing some of the key challenges. Families are helping their younger members with education and housing. In the United Kingdom, parents supporting their children are ranked the 10th largest mortgage lender.

Finally, individuals themselves are changing their behavior in light of these changes to the social contract. Many workers are opting for independent work as their primary source of income or to supplement their existing income. Automation requires new and different workforce skills, and individuals today have many more possibilities to prepare themselves and improve their skills, or learn new ones, than they used to. For example, courses on online platforms are increasingly accessible; others are engaging in lifelong learning to stay ahead.

Most of these efforts seem early, localized, and relatively small in scale and scope, compared to the extent of the challenges. Moreover, many have yet to fully take into account the effect of factors, including climate change, likely to impact work and other economic aspects of the social contract. Therefore, concerted action is needed on two fronts: first to make sure that the gains of the 21st century so far are sustained and scaled, and the potential for even more opportunities and economic prosperity is fully realized. Second, to make sure that the outcomes for individuals in the next 20 or more years of the 21st century are better and more inclusive than in the first 20 and increase broad and inclusive prosperity.


This content was originally published here.