As 2020 gets underway, employment in both Europe and the United States is at a record high and still rising.
Industry Opinions

Advanced Economies’ Missing Link

As 2020 gets underway, employment in both Europe and the United States is at a record high and still rising.

The job losses from the 2008 financial crisis and subsequent recession have been all but reversed. But you wouldn’t know it from the public mood in many developed countries. With so much good economic news, why is public sentiment so gloomy?

New research by the McKinsey Global Institute takes a deeper look at the advanced economies to determine how individuals’ experiences as workers, consumers, and savers have changed over the past 20 years.

There is much to cheer about, including new opportunities for employment and lower prices for some goods and services.

Yet there are also at least three critical issues that are adversely affecting hundreds of millions of people across 22 OECD countries, which may help to explain the mismatch between aggregate economic data and individual experience.

First, consider the good news. Job opportunities have expanded substantially in the first two decades of the twenty-first century, with employment rates across the 22 OECD countries climbing above 70%, on average.

Some 45 million more people are employed today than were in 2000, and 31 million of them are women. Part-time employment, especially voluntary part-time employment offering more flexible work, expanded for both men and women.

Moreover, consumers have benefited from the falling cost of discretionary goods and services, from communications to clothing and furnishings.

Globalization has increased competition and brought down prices substantially, such that, holding all else equal, a person can work six fewer weeks per year, on average in ten countries, and still enjoy the same level of consumption that he or she did in 2000.

Individual mean wealth has recovered as well, after taking a dive in the aftermath of the 2008 crisis. And thanks to digital banking, Robo-advisers, and other fintech innovations, savers have access to more opportunities and products, including many that used to be reserved for the wealthy.

Yet the full picture is far less rosy. Labour markets have become more polarized between high- and low-skilled work, and wages have stagnated for many workers.

While the academic literature has focused a great deal on the decline in middle-skill, middle-wage jobs, our research suggests that it is lower-income individuals who have been hit hardest.

Employment growth for this cohort has indeed accelerated, but wage stagnation has been compounded by rising living costs – especially housing – and changes in pension plans that leave households more exposed to economic fluctuations.

With the exceptions of Japan and South Korea, housing costs have soared over the past two decades in the 18 countries we examined.

Housing is the biggest-ticket item in household budgets, accounting for about one-quarter of household spending, on average (more than double the average share of spending on food). Moreover, the increase in housing costs accounts for 37% of overall inflation since 2000.

Taken together with the costs of higher education and health care, which are especially significant in the US, household spending on these categories has absorbed a significant share – to the tune of 87% in France and over 100% in the United Kingdom – of the income gains of the average household in these countries.

In ten countries, holding all else equal, a consumer would have to work four extra weeks per year, on average, to consume the same amount of housing, health care, and education as he or she did in 2000.

Pensions are another mood dampener. As we live longer, we will need to save for more years in retirement.

Yet, across the 22 countries we examined, mandatory pensions are funded for an average of only ten of the 20 years of expected retirement. The net replacement rate that public pensions and former employers pay toward mandatory pensions has fallen sharply in the past two decades.

There have also been important structural changes: defined-benefit pension plans have switched to defined-contribution schemes, thereby shifting the market risk to individual savers and placing the onus on individual savings at a time when household savings are already down.

As of 2017, just over half of individuals above the age of 15 were not saving for old age, and about one-quarter had no savings whatsoever.

These developments are partly the result of broader trends in automation, globalization, and demographics. In advanced economies such as Germany, Italy, and Japan, the working-age population is in decline.

But there have also been significant changes in the social contract that binds individuals and institutions. Individuals and households increasingly have had to assume greater responsibility for their own economic outcomes, because other institutions have, for various reasons, withdrawn.

Technological progress will make the next few decades of the twenty-first century exciting ones. We will need to ensure that the gains made in the first two decades are sustained and scaled up so that we can realize the full potential for even more opportunities and economic prosperity.

But we must also ensure that outcomes for individuals in the next generation are better and more inclusive than they were in the last.

Sven Smit is a senior partner at McKinsey & Company and a co-chair of the McKinsey Global Institute. Anu Madgavkar is a partner at the McKinsey Global Institute.

Copyright: Project Syndicate, 2020.