Income Inequality: Why So Many Households Are Not Advancing by Richard Dobbs, McKinsey & Company
Incomes from wages and capital were flat or fell for two-thirds of households in 25 advanced economies between 2005 and 2014—an explosive increase from less than 2 percent in the previous decade.
While it’s broadly assumed that children will grow up to be better off than their parents, the reality is that a new generation of young people in advanced economies risks ending up poorer. In this episode of the McKinsey Podcast, McKinsey senior partner Richard Dobbs and McKinsey Global Institute (MGI) partner Anu Madgavkar talk with Peter Gumbel about the increase in the number of households that experienced flat or falling incomes in the past decade—and the implications for future growth and economic advancement.
Peter Gumbel: Hello, I’m Peter Gumbel, senior editor, based in Paris, at the McKinsey Global Institute. Today I’m delighted to be speaking with Richard Dobbs, a McKinsey senior partner in London, and Anu Madgavkar, an MGI partner based in Mumbai. Richard and Anu have been spearheading new research on income inequality for the McKinsey Global Institute, and they’re the coauthors of a new report called Poorer than their parents? Flat or falling incomes in advanced economies. One of its striking conclusions is that two-thirds of households in 25 advanced economies have been affected by this flat-or-falling-income phenomenon. They’re here today to explain what that is, why it’s happening, and what it means. Richard and Anu, thank you for being with me today.
Richard Dobbs: Hello.
Anu Madgavkar: Hi, happy to be here.
Peter Gumbel: Great. Let me start with you, Anu. What exactly do we mean by flat or falling incomes?
Anu Madgavkar: Our research look at groups of households organized by income segments. We’re then able to track what these typical groups have experienced in terms of income growth over the last decade and the period prior to that. When these typical households, in each income segment, see no advancement in terms of their income, we’re able to say that there is a general lack of economic progress.
By this metric, we see a very dramatic increase in the phenomenon of flat or falling incomes. The proportion of households that have been affected by this trend has virtually exploded, from less than 2 percent to as much as 65 percent to 70 percent of the population, in the past decade—from about 2005 to 2014.
Peter Gumbel: That’s a tremendous increase. Have others already looked at this, or is this research quite unique in terms of the bigger debate out there about income inequality?
Anu Madgavkar: There has been a lot of very influential and important work on income inequality. But much of it, including the work by Thomas Piketty and others, has really focused on the very top of the income distribution—perhaps the top 5 percent of households or the richest 1 percent, even.
We don’t focus just on that segment. We look across the income distribution at multiple segments to understand how inequality has manifested itself in terms of income trends and income growth for all segments, and not just the richest.
There is also another body of work around inequality that has looked much more at poverty, talked about inequality as inequality between countries, and documented the fact that addressing poverty has helped shrink inequality between countries. But we, again, bring a new aspect by focusing on inequality within countries and zooming in on the middle-income group of households, the median household, to understand how inequality is affecting this broad mass of households within the advanced economies. We’re able to then dissect this and present a picture of what’s changed and why it’s changed—and in a relatively new way, which makes this work distinctive.
Peter Gumbel: The countries that you’re focusing on—the 25 countries—mainly include the United States and Western Europe. Given that the recession after the 2008 financial crisis hit so hard, how much of the problem you’ve found is related to the aftermath of the financial crisis and the very slow recovery that we’ve had since then?
Anu Madgavkar: We do find that the global crisis and its slow recovery since 2007 and 2008 had an important role to play. If you think about the period from 1993 to 2005, we found that growth in aggregate demand, in GDP and the employment that came with that, would have boosted disposable incomes for the median household by about 18 percentage points over the period.
But if you look at the period from 2005 to 2014, that 18 percent has come down to just about 4 percent. So there was a big shrinkage in disposable income because of the slow recovery in the aftermath of the crisis. The really interesting point is that notwithstanding the crisis and the recession and the slow recovery, you still did have a positive contribution to disposable income because of overall growth.
Then you also had important long-term structural factors which are demographic in nature, as well as the changing pattern of labor markets that have played in favor of some kinds of workers but not in favor of other kinds of workers. These longer-term structural trends have actually taken away even that 4 percent–positive contribution from aggregate demand over this period.
Peter Gumbel: Turning to you, Richard, obviously these numbers are very startling. But there’s also a bigger political context out there. Could you talk us through what you see as the implications? What are the “so whats” of these findings?
Richard Dobbs: The findings suggest we have a problem in three areas. First of all, on an individual basis, everyone wants their children to be progressing and to be better off than they were. It’s a fairly common, around-the-world feeling.
In the world we are painting here, there’s a significant chance that we’re not going to meet that aspiration. For many individuals, this is going to be deeply disappointing. Second, it will result in lower economic growth. The people who are doing less well typically have a higher propensity to spend [a larger proportion of their incomes]. The fact that they are doing less well means that we’re going to be facing lower economic growth.
Third, this is going to result in rising social tensions. As part of our research, we have surveyed 6,000 people, and we’ve understood their attitudes. The chunks of people who both are not advancing and perceive they’re not advancing—and think that’s going to continue—are much less likely to be supportive of many of the things that have helped drive economic growth over the past few years: free trade, technology, migration. This group of people who are not advancing tends to be very negative about all of those factors. As we see this rising group of people who are not advancing, we’re going to see increasing social tensions. That will come home and cause quite a lot of problems if we don’t address it.
It matters at the individual level—all of us wanting to progress, to have our children progress. It matters at a societal level in terms of the level of growth, and it also matters in terms of social instability.
Peter Gumbel: Is this something that governments have focused on? Or are we coming up with something which is new and adding