The Social Contract in the 21st Century

The Social Contract in the 21st Century

McKinsey Global Institute February 2020 Report

Subject: Economic outcomes and the relationship between individuals and institutions have shifted for workers, consumers, and savers in advanced economies.

Life has changed substantially for individuals in advanced economies in the 1st 2 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, 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 the report, The social contract in the 21st century: Outcomes so far for workers, consumers, and savers in advanced economies (PDF–2.7MB), the McKinsey Global Institute takes an in-depth look at these changes in 22 advanced economies in Asia, Europe, and North America, covering 57% of global GDP.

The Takeaway

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 3 quintiles of the population by income level (roughly 500-M people in 22 countries). Public pensions are being scaled back, and roughly the same 3 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.

Policy makers, business leaders, and individuals will need to focus on 2 fronts.

The 1st is sustaining and expanding the gains achieved through continued economic and productivity growth; business dynamism; investment in economies, technology and innovation; and continued focus on job growth and opportunity creation.

The 2nd is tackling the challenges individuals face, especially those most affected.

Leaders are beginning to respond to these opportunities and challenges to varying degrees. However, more is needed given the scale of the opportunities and challenges, if the outcomes for the next 20 or more years of the 21st Century are to be better than the 1st 20 and increase broad prosperity.

Across the United States and 15 European countries, between 20 and 30% of the working-age population, or more than 160-M people, now engage in independent work, with a growing proportion leveraging digital platforms to do so. About 70% 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.

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 10 countries in our sample on average would have to work an additional 4 weeks a year to consume the same amount of housing, healthcare, and education that they did 2 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% of the change on average across 15 European countries and the United States between Ys 2002 and 2018.

Healthcare prices increased sharply in the United States, where the report explained 17% of the change in consumer prices, in Europe, healthcare constituted 3% of the change. Education costs have jumped in all countries except Japan, and almost 2X’d in the United Kingdom partly due to cuts in university fee subsidies that started in Y 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 10 of the subject 22 countries between Ys 2000 and 2017.

In countries where incomes increased, the largest erosion of 107% 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% of income gains. In countries where incomes did not increase: Italy, Japan, and Spain the rising spend on basics further eroded incomes by 6 to 29%.

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 Y 1980 to 20 in Y 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 payouts 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.

In response, about 50% 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 Y 2060 the normal retirement age will approach 66, which represents an increase of 1.5 yrs for men and 2.1 yrs 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 2 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% for the average person in our 22-country sample. Net replacement rates, which measure how effectively a pension system provides a retirement income to replace average earnings, now range from 92% in Italy to just 28 % in the UK.

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 1/2 of the sample countries by almost 6 percentage points since Y 2000. Moreover, surveys show that more than 50% of individuals did not save for old-age last year, and 25% did not save any money.

The proportion of individuals with Zero or negative net worth has risen significantly in recent decades. In the United States the share of households with Zero or negative net worth rose to 23% in Y 2017 from 16% in Y 2001.

Bringing together the evolution of economic outcomes across the 3 arenas and the changing institutional role, the report found considerable variation among social and economic groups, as follows:

  • High-skill, high-income individuals have fared well. Economic outcomes for the Top 2 quintiles of the population (by income and wealth levels) have improved since Y 2000. The employment share of approximately 115-M high-skill, high-wage workers in Europe and the United States has risen strongly, by almost 4% since Y 2000, and their compensation has also grown. Savings rates for high-income groups as a share of disposable income and their overall share of total wealth have risen.
  • Middle-skill, middle-income workers have been squeezed out of the labor market. Roughly 120-M middle-skill, middle-wage jobs in Europe and the United States have been “hollowed out,” as jobs in this segment decline, although recent data suggest a slight recovery for mid-wage workers in the United States.
  • Consumption and savings outcomes have been worse for many low-skill, low-income individuals. Some 95-M low-skill, low-wage individuals in Europe and the United States have been especially affected, even though their employment share has risen. The share of total income for the bottom 2 quintiles declined by 1.2% between Ys 2000 and 2017, from 20.4 to 19.2. As consumers, lower income groups have been hard hit, particularly by the housing market. The biggest deterioration has been in their capacity to save: median savings for the lowest wealth quintile as a share of disposable income dropped by 14% on average in Germany, Spain, Sweden and the United Kingdom. The share of total wealth of the bottom 60%, already very low at 7.6%, has fallen to 7.3%.
  • Young people have fared less well than the elderly. The young (15 to 30), who make up around 180-M individuals across the sample countries, have difficulty obtaining well-paid, high-quality jobs and also have a harder time climbing on the housing ladder, with much lower wealth than their peers two decades ago. Compounding the problem is the rising cost of housing; the cost of a minimally acceptable house is 23% of incomes for young people Vs 14% for adults and over 65. By contrast, old-age relative poverty is falling almost everywhere.
  • Women have seen improvements but still lag men. Over 67% of job growth from Ys 2000 thru 2018 is attributable to women, and the number of working women rose from 175 to 206-M. Yet, they are still behind; the share of working women increased from 44 to 46% but has yet to attain parity. The gender pay gap narrowed from $0.80 to 0.85 for each $1.00 a man earns. It ranges from a low of $0.96 in Belgium to a high of $0.65 in SKorea. As savers, women have a median level of net wealth that is just 62% of men’s in 8 European countries, although the gap narrowed in the last 2 decades.
  • Minorities continue to face challenges. In some countries such as the United States, families struggling the most tend to be Black or Hispanic, the wealth of the median White family was 10X higher than the wealth of the median Black family and 7.5X higher than the median Hispanic family in Y 2016. Moreover, automation trends may be widening the racial wealth gap: Black Americans may have a higher rate of job displacement.

To achieve better and more inclusive outcomes for individuals in the next decades of this Century, the report identified 10 Key challenges which affect large numbers of individuals and which are likely to persist unless addressed, given current trends, they are as follows:

  1. Persistent income polarization and wage stagnation. Wage stagnation has mostly affected those in middle-skill, middle-wage occupations, roughly 200-M people in the 22 countries. The Big Q: What can be done to enable a higher share of income going to labor?
  2. Work fragility and transition supports. Employment-related risks are rising and employment protection is on the wane, partly because of the increase in alternative work arrangement. With automation, between 40 and 150-M workers may need to switch job categories in advanced economies. The Big Q: How can flexible, dynamic labor markets be supported, while also reducing fragility for workers?
  3. Challenge of affordable housing. Roughly 165-M in the 22 countries are overburdened by housing costs, which have risen significantly faster than inflation in many markets. The housing challenge also has cascading effects on individuals as workers. The Big Q: What could be done to unlock supply and other constraints?
  4. Rising expense of and growing demand for healthcare and education.Rising healthcare and education costs significantly affect more than 125-M individuals who spend more than 10% of their outlays on healthcare and education, as well as the almost 245-M people who are primarily supported by public budgets. The Big Q: How can technology and the competitive dynamics that benefited discretionary goods and services be harnessed to make healthcare and education more affordable?
  5. The growing savings and retirement problem. The Big Q: In a century of longer life expectancy and aging, how can the capacity and incentives for individuals to save more and more effectively be expanded?
  6. The multiple pressures on low-income individuals. Low-income groups, who make up roughly 335-M in the 22 countries, face difficulties across all 3 arenas of work, consumption, and saving, and their position has grown more precarious than it was in Y 2000. The Big Qs: How can social safety nets and other supports be revamped for the current era and set of challenges? What market-based mechanisms can be established to assist them?
  7. A new era of challenging outcomes for the under-30 generation. Young people between 15 and 30 yrs old have less access to well-paid, stable employment, affordable housing, and decent savings, compared to previous generations. The Big Q: What can be done to support them?
  8. The persistent gender and race gaps. Although more than 205-M working women have made strides in the labor market, they continue to lag behind men in terms of employment, wages, savings, and overall wealth. Similarly, the racial wealth gap in some countries, such as minorities who constitute 90-M people in the United States, is both persistent and growing. The Big Q: How can opportunities presented by the future of work be harnessed to narrow the gap?
  9. The growing challenges of place. Certain regions and local economies, mostly in Southern Europe and in declining industrial areas in the United States have not recovered fully from the global financial crisis. The Big Q: What can be done to better integrate regional labor markets into the growing economy?
  10. The risk of unsustainable government funding. Tax collection and government revenue generation is not keeping pace with government spending, which has risen to support individuals cope with global trends. The Big Q: What can be done to ensure the sustainability of these public budgets?

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.

And finally, individuals 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. Courses on online platforms are increasingly accessible, others are engaging in lifelong learning to stay ahead.

Most of these efforts are early, localized, and relatively small in scale and scope, compared to the extent of the challenges.

So, a concerted action is needed on 2 fronts: 1st 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 and 2nd, 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 1st 20 and increase broad prosperity.

About the Report Authors

James Manyika and Sven Smit are co-chairs of the McKinsey Global Institute, where Anu Madgavkar and Tilman Tacke are partners and Jonathan Woetzel is a director. Abdulla Abdulaal is a consultant in McKinsey’s Dubai office.

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Paul Ebeling

Paul A. Ebeling, a polymath, excels, in diverse fields of knowledge Including Pattern Recognition Analysis in Equities, Commodities and Foreign Exchange, and he it the author of "The Red Roadmaster's Technical Report on the US Major Market Indices, a highly regarded, weekly financial market commentary. He is a philosopher, issuing insights on a wide range of subjects to over a million cohorts. An international audience of opinion makers, business leaders, and global organizations recognize Ebeling as an expert.   

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