“Poorer than their parents”

A report from McKinsey Global Institute (MGI) takes a look at household income levels between 2005 and 2014. As expected the financial crisis of 2008 influenced the expected growth levels. Other factors identified by the authors have a cumulative effect on the increase or decrease of the income levels.

Income inequality is the topic of many papers, and this one shares a lot with Thomas Piketty’s best-selling book, Capital in the twenty-first century. In this research the focus is between 2005 – 2014, and most of the data gathered by the authors has been taken by surveys and interviews.

The report focuses on five countries, Sweden, France, The Netherlands, Italy, United Kingdom and the United States.

Why this is happening

Besides the financial crisis, five more factors are identified by the paper to have the most impact on the income levels:

Demographics factors – households are shrinking as a result of lower fertility rates and the decrease of the number of working-age adults per households, because of aging.

Changing nature of the labor market, in particular the impact of globalisation where companies build extensive supply chains to tap into a global pool of labor, increase in part-time/temp work and the rise of automation.

Capital income factors (less ROI from capital for the middle class) and taxes.

Last but not least, aggregate demand factors – meaning all of the above put together amplify the effect each of them taken separately. The report gives a very detailed look on how each factor influences the changes in income per household.

Solutions

The report also gives plenty of suggestions on how to remedy this situation (page 70+), things like: increasing productivity through reducing waste, deregulation and target infrastructure investment. When it comes to restoring investment, MGI estimates that at least $57 trillion in infrastructure investment—more than the estimated value of the existing infrastructure stock—will be needed by 2030 to support GDP growth.

Other areas involve promoting entrepreneurship and innovation, increasing STEM literacy and education, raising labor participation for women and older workers and adjusting taxes.

However most of the solutions seem to ignore the fact that we are on a cross road of having big changes in the labor pools of advanced economies, with the increasing adoption of new technologies. It feels that it makes the assumption that we need traditional incentive schemes to promote higher wages, for an economy that is anything but traditional at this point.

Even looking 20 years ago (as the report does), you can see that the environmental forces that put negative pressure on wages and stretching the labor market to an inverse bell curve, where the biggest supply of jobs goes to higher-skilled people and lower-skilled people (at least for the short-term).

The report has the same conclusion as many other research papers, that incomes for the middle class are flattening.

The part that is concerning, is that this trend seems to be passing on to the next generation, rather than being absorbed by the previous one.

You can find the full report here, a copy of the report can be downloaded clicking the link right under the header (I missed it the first time around).

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1. First image from the report, page 9. Reference links to: 2014 or latest available data for market income (wages and income from capital); population measured in income deciles.
2. Second image from the report, page 50, focus on United Kingdom and United States