Income inequality affecting the masses, expected to continue

25 July 2016 6 min. read

Income inequality in the West continues to increase, hitting the young with low skills the hardest. In the UK, 60% of the population has seen a stagnation or decrease in their disposable income. In the US, those below 30 with low levels of education were 15% worse off in 2012 than in 2002. Continued low growth and the possible acceleration of automation and digitalisation are likely to exuberate the situation, with the income of up to 80% of the workforce stagnant or declining to 2025.

Income inequality has become an issue for a range of stakeholders, forming a political flashpoint, as well as fuelling discontent. The level of changes in income is less clear, however, while the reasons for the decreases are also not well understood. In a new report, McKinsey & Company’s MGI explores recent changes in real income and disposable income for six key western countries: Italy, the Netherlands, Sweden, France, the US and the UK, and considers a number of scenarios for the coming decade.

The report, titled ‘Poorer than their Parents? Flat or Falling Incomes in Advanced Economies’, looks at changes in income inequality rather than wealth inequality, the latter is, according to the firm, accelerating faster than changes in income inequality. Through the research, which also considers future scenarios for changes in income distribution, the firm hopes to highlight the issues so that policy measures can be considered.

Income and disposable income changes

The research shows that in almost all countries looked at, a significant portion of the population has seen their income stagnate or fall. In terms of real market income, the weighted average stands at between 65-70%, while disposable income has fallen by 20-25%. Regionally, however, there are considerable differences. In Sweden, for instance, real income has declined or stagnated for only 20% of the population, while disposable income has stagnated or declined for <2%. In France, while real market income is stagnant or declining for 63% of the population, disposable income has been dropped or declined for a mere 10%.

The Netherlands, the UK and Italy have been hit the hardest since 2005, according to the analysis. Real market income in the UK is down or stagnant for 70% of the population, while disposable income is down or stagnant for 60% of the population. In the Netherlands the figures come in at 70% and 70% respectively, while in Italy, almost everyone has seen their income stagnant or decline while everyone has seen their disposable income stagnant or decline.

Affected by changes

The effect of the stagnating or declining income are relatively stark. The number of households in 25 western countries living below the poverty line has increased slightly, up from 13% in 2005 to 15% in 2014 of the relative populations. The research also found that the gap between income segments across those countries is increasing, with fewer and fewer able to catch up to the next income segment – nearly two-thirds of all income groups, or between 540 million and 580 million people have not advance economically over a decade.

Younger and less educated most affected

The study further highlights that it is the young and uneducated that have seen the steepest declines, although even the better educated as well as older groups have seen their incomes fall. In France, for instance, lower educated people under 30 have seen their real incomes fall by -10% between 2002 and 2012, the mid-education level has seen a -10% decline while the highly educated have seen a -2% drop. In the US young people have been even harder hit, with those below 30 with low levels of education seeing a decline of -15% between 2002 and 2012, the mid-level seeing a decline of -14% and the highly educated young adults seeing a -6% decline.

Change in employment and status

The decline in income is not the only way in which lower skilled employees have been hit in recent years. In many of the major economies, low skill employment rates have dropped significantly since 1994. In Sweden, for instance, employment rates for the low skilled dropped from around 60% in the 2000s to around 48% today, while at the same time, the number of people on temporary employment contracts for the group has jumped significantly. The Netherlands too has seen a large portion of its employee base find themselves on temporary contracts. The research highlights an across the board increase in temporary contracts for the low skilled; temporary employment contracts were also up for the middle skill group. For those with high levels of skill, temporary contracts have crept up since 1994, although not as significantly as for the other two segments.

Future scenarios

Besides the stagnation and income decline seen so far, the research in addition looked into possible future scenarios. In the low economic growth scenario, employment gains will be low. Major factors influencing income, besides GDP and employment, are changes in demographics – primarily ageing and smaller households – and changes to the labour market, such as acceleration of automation and increases in temporary or freelance contracts. The result is a continued wage stagnation or decline, with between 70-80% of the population affected. To stabilise the situation, considerable income transfers will need to take place between groups.

In the second scenario, in which there is robust growth and the labour market picks up, the level of inequality will decelerate, with only 10-20% of the population seeing their market incomes fall. The third scenario sees automation and digitalisation come to rapidly affect middle and low skill jobs, thereby reducing their opportunities for employment. The effects, given the pace of development, may not allow for the creation of additional employment opportunities for these groups, which would negatively affect their income – with, as a result, 30-40% of the population facing flat or falling incomes, requiring a transfer of between 5-10% to provide stability.