Inequality: A persisting challenge and its implications

Inequality is not a new phenomenon, but in recent years it has reemerged as a social and political flash point in advanced economies and beyond, stoking public dissatisfaction. Perspectives about inequality—what it is, how it is evolving, and how to address it—are polarized. At times, even the data used to support arguments are contested.

In Inequality: A persisting challenge and its implications (PDF–1.5MB), we provide a fact base to inform the discussion, drawing on a wide range of sources and ongoing McKinsey Global Institute (MGI) research. We highlight different dimensions of inequality, such as inequality of wealth, of income, of consumption, and of opportunity, with a particular but not exclusive focus on the G-7 countries—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States—which in many ways are at the epicenter of the challenges around inequality. This article, an abridged version of the discussion paper, is divided into the following sections:

Viewed from a broad perspective, inequality is in decline as developing economies led by China and India have considerably narrowed the gap in wealth and income with richer countries since the 1980s. Higher-income countries’ share of global wealth fell from 80 percent in 2000 to 71 percent in 2014, while the wealth share of middle-income countries such as Indonesia and Mexico rose from 14 percent to 22 percent (Exhibit 1).

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Our prior research shows that emerging economies generally have accounted for about two-thirds of the world’s GDP growth and more than half of new consumption over the past 15 years. The convergence can also be seen within the 36-member Organisation for Economic Co-operation and Development (OECD): the consumption expenditure gap between G-7 and low-spending OECD countries has halved since 2000.

Inequality within many advanced countries is moving in the opposite direction from the global trend of declining inequality between countries. In G-7 economies and across many (but not all) advanced economies, wealth and income inequality in general has been rising since the 1980s.

It is important to provide nuance and context to this blanket statement. Within inequality, there is a hierarchy of sorts: the distribution of wealth among the population is substantially more unequal than the distribution of income, which in turn is more unequal than the distribution of consumption, based on consumption expenditure. For example, in 2014, the wealthiest 1 percent of people in G-7 countries owned about 27 percent of the total wealth. That was double the 13 percent share of total income that went to the top 1 percent of income earners in the same countries that year.

In the OECD, wealth inequality has risen since 2000 on average in two-thirds of the member countries, as measured by the ratio of mean-to-median wealth. Not all countries march in lockstep; inequality as measured by the wealth Gini coefficient grew significantly in countries affected by the financial crisis such as Ireland, Eastern European economies such as Latvia and Slovenia, and some of the most developed economies including Switzerland and the United States. Meanwhile, inequality improved in Belgium, Poland, and Sweden.

In France, the United Kingdom, and the United States, the G-7 countries for which data are most readily available, the share of wealth for the top 1 percent rose rapidly, from 20 percent in 1990 to 27 percent in 2000. The rise subsequently tapered off, with the share of wealth of this top cohort remaining around 27 percent by 2014.

In income terms, too, inequality has become more pronounced. The pretax income share of the top 1 percent in the OECD doubled from 6 percent in 1980 to around 11 percent in 2014. Similarly, income inequality as measured by the Gini coefficient of post-tax disposable income has been mostly rising since the 1980s, albeit at different levels across G-7 countries (Exhibit 2).

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In G-7 countries, equality of opportunity continues to depend heavily on personal attributes or endowments such as gender, age, ethnicity, family background, and place of residence. People in G-7 countries on average attain tertiary education degrees more frequently today than they did ten years ago, although some educational outcomes in literacy and numeracy have been declining. About 50 percent of women had attained tertiary degrees in 2017, compared with 42 percent of men. Women’s average net income nonetheless continues to trail men’s, at 84 cents for every $1 a man earns, although the gap is narrowing.

For people between the ages of 25 and 35, the story is similar: at the same age, their now-older peers earned more than they do, even though the younger generation is considerably better educated.

Inequality is complex and polarizing as an idea and has been the subject of fierce debate throughout history. Since the Enlightenment in 17th-century Europe—and especially today—the discussion has been marked by a lack of consensus about the extent of inequality, how it is measured, and what levels of inequality are optimal or appropriate.

At the heart of the debate are differing viewpoints shaped by culture, history, and ideology, as well as economic and social trade-offs. Is inequality inevitable and even useful, or is it fundamentally bad? To what extent can inequality be offset by greater opportunity and innovation? And are these notions mutually exclusive?

Some economists and social scientists argue that inequalities of wealth, income, and consumption can harm economic growth in the long run by hindering educational opportunities, human capital formation, and intergenerational mobility. Growing inequality is seen by some economists as a signal of excessive monopoly power, rent seeking, or activities with negative externalities and adverse effects on economic performance. Moreover, when incomes go mostly to those at the top, some suggest there is little left to motivate people further down the earnings ladder. One economist in the 1970s, Arthur Okun, made a celebrated analogy between inequality and a “leaky bucket”: If some people are suffering from thirst while others have plenty of water, he argued, then water should be transferred to the thirsty people even if the only way to do so is to use a leaky bucket, resulting in a loss of efficiency (water).

Others argue that these debates would be better served by a focus on economic growth and increasing the absolute size of the economy, rather than how the growth is shared. In this view, inequality is a result and enabler of economic progress, driving investment and the willingness to take risks. Accordingly, certain social transfers aimed at redistributing economic gains are viewed as dampening incentives or distortionary, where the role of the state could be rolled back. Such arguments focus on removing structural barriers and targeting high growth rates, so that individuals across all parts of the wealth, income, and consumption distributions can progress.

Such differing perspectives make for a complex debate. Research suggests that people perceive outcomes arising from choices, effort, and risk as generally fair. Moreover, during periods of sustained growth—and when that growth is shared among the broad base of the population—social attitudes tend to overlook faster growth of income in top quintiles, according to some research. However, inequality can flare up as a point of contention and contestation during periods of slow progress, if the wealthiest or highest earners continue advancing while others are squeezed. This is exacerbated when inequality is associated with treatment, for example by employers or justice systems.

Such debates have heated up since the 2008 financial crisis, as incomes have stagnated in G-7 and other advanced economies. A plethora of new research into causes and solutions has attracted public attention.

MGI’s recent work on economic resilience in Europe demonstrates the existence of very different social contract models across countries, with some more or less egalitarian in the creation and distribution of economic value. The economic situation in individual G-7 countries across a range of indicators—including inequalities of income, wealth, and consumption, as well as more general economic measures—can vary considerably (Exhibit 3).

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When it comes to inequalities of opportunity, the percentage difference in median earnings by gender covers a range from 6 to 25 percent across G-7 economies. Variations in measures of social mobility are less pronounced, with managers being 2.2 times more likely to come from a family of managers in one country versus 1.8 times more likely in another. Further, citizens’ beliefs are not correlated with specific economic outcomes across G-7 countries. This suggests that citizen discontent is influenced by a range of both economic and noneconomic factors.

There is also considerable variation in relative poverty levels before and after taxes due to policy choices. For example, France and Germany move from the highest pretax poverty levels to the lowest following social transfers. On average, transfers brought the Gini coefficient for income inequality in the G-7 in 2016 down from 0.49 pretax to 0.32 thereafter. The reductions were particularly significant in Germany and the United Kingdom and smaller in Japan and the United States (Exhibit 4).

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Economic disruptions and the widening of inequality over the past several decades have affected large segments of the population in G-7 countries. Wages have stagnated for many, male employment has declined, and the economy may have become more fragile, as market incomes increasingly fail to lift people out of poverty. At the same time, the cost of basic goods and services, such as education and healthcare, has risen faster than overall inflation.

Average real wages have grown in five of the G-7 countries since the financial crisis in 2008, but in Italy and the United Kingdom they have fallen. Real net income has declined for 25 percent of individuals in six of the G-7 economies (excluding Japan) since 2005. For 60 percent of the population, disposable income has risen faster for people in the next-richest income decile than it has for them. Households as well as individuals have felt the impact. Our research has shown that market incomes were flat or fell for around 70 percent of households in advanced economies in 2014 compared to similar households in 2005, although government taxes and transfers reduced the impact on disposable income for many.

These effects are related to a decline in middle-wage jobs across advanced economies over the past three decades. In the United States, for example, the share of adults living in middle-income households declined from 61 percent in 1971 to just 50 percent in 2015. While about two-thirds of this shift has been upwards, to upper-middle and higher-income households, one-third of those have shifted down to lower-middle and the lowest income households, creating an hourglass-like effect. Our research on skill shifts and automation suggests competition for high-skill workers will likely increase, while displacement may be concentrated mainly on low-skill workers, continuing a trend that has exacerbated income inequality and reduced middle-wage jobs. It has also consolidated or exacerbated disparities of income and other inequalities within the same cities, such as Washington, DC, and Paris (Exhibits 5 and 6).

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On the employment front, average employment in the G-7 has remained broadly stable since the 1980s and employment of the working-age population has risen. However, the employment rate for women has grown sharply, by 16 percentage points, even as the male employment rate has declined by four points. The male employment rate remains higher than the female rate, at 76 to 65 percent, but the gap has narrowed markedly.

Several indicators point to a growing fragility and precarity in the economy. Relative poverty rates before taxes on average in the G-7 have risen by seven percentage points from 23 percent of the population in 1985 to almost 30 percent in 2016. Transfers and tax reduce that proportion but do not fully compensate; on average, almost one in seven people living in the most advanced economies remains in relative poverty after taxes and transfers.

Education, healthcare, and housing costs have all risen. Since 2002, overall inflation has increased by 36 and 32 percentage points in the United States and in the European Union, respectively, while the nominal price of education has increased by 101 and 77 percentage points. Healthcare costs have also exceeded inflation in both Europe and the United States.

Further increasing financial fragility has been the rise in household indebtedness, which jumped from 87 percent of net disposable income in 1995 to 121 percent in 2008 and 123 percent in 2017.

Such trends in material living standards have contributed to rising discontent. People are not feeling optimistic about the future and their own personal economic situations, and surveys show a waning of public trust in governments and other societal institutions. In one global survey, 60 percent of respondents said they believed their country was “on the wrong track.” Income inequality and wage stagnation are causes of particular dissatisfaction. Almost half of the people polled in 16 advanced economies believe the average person in their country is worse off today than 20 years ago.

The financial crisis of 2008 and the slow recovery from the recession that followed it left many households exposed. Beyond cyclical factors, long-term global trends have also contributed to changing economic outcomes and will likely continue to play out in coming years.

The declining labor share of national income has been driven by structural changes in advanced economies since 1980. Its causes and effects are widely debated in the literature, with some evidence that it contributes to wage stagnation. Our recent research focusing on the capital share of income suggests that boom-bust cycles and rising capital depreciation have played a significant role. The largest declines have been in France, Germany, and especially Spain, where the labor share has dropped by 12 percentage points since the 1980s. The United States has seen a 5 percent decline in the labor share since 1980; three-quarters of that decrease occurred since 2000. Collective wage bargaining—often via unions—has declined in both the G-7 and the OECD, putting employees in a weaker position in negotiating wage increases. Moreover, labor productivity growth is near historic lows in the United States and much of Western Europe.

Digitization and automation are frequently cited as factors in the declining labor share of income, and they pose other profound challenges in the workplace. Scenarios we have developed for the effect of automation and artificial intelligence (AI) adoption on the global workforce suggest that, in most cases, the jobs displaced by automation and others created by new labor demand, including from rising productivity as a result of technical change, could be approximately in balance in many advanced countries. However, significant workforce transitions could occur in the short to medium term. Occupations in some sectors will decline while in others they will rise. Skills requirements for workers will likely change as machines increasingly complement the work of humans, with basic cognitive skills no longer sufficing for many jobs, while demand for technological and social and emotional skills rises. A similar trend is occurring in connection with cities and job locations.

Changing dynamics in the business world also affect workers. Over the past 20 years, 70 percent of GDP and gross surplus gains across G-20 countries have accrued to a handful of economic activities including finance, real estate, tech, pharma, and some business services. This drives strong wealth effects in the form of gains to holders of physical assets (real estate) and intangible assets. While these sectors tend to be light on labor, high-skill workers associated with these activities see gains. Moreover, the search for assets in these sectors fuels geographically concentrated searches for talent, IP, and other intangible assets that reinforce the gains to these locations, contributing to the growth of “superstar” cities that are gateways of finance, tech, and innovation activity, and which are pulling away from peer cities in terms of income growth. The impact also contributes to a bifurcation of growth prospects within superstar cities, which have some of the highest levels of urban inequality among the world’s cities.

Finally, global integration is leading to higher competition in the labor market in advanced economies. Research over the last several decades suggests that this is playing a part in the narrowing wage gap between workers in advanced and developing economies while contributing to increasing domestic income inequality. The growing prosperity of developing economies, at times propelled by dynamic large companies, is also raising the competitive stakes for firms in advanced economies. These emerging-market firms now play a large role on the global stage: while they accounted for only about 25 percent of the total revenue and net income of all large public companies in 2016, they contributed about 40 percent of the revenue growth and net income growth from 2005 to 2016. Nonetheless, globalization is not static: changing value chains, the growth of regional trade, reduced labor-cost arbitrage and other factors may affect this dynamic in the future.

Both old and new measures and interventions may be needed to counter disparities and strengthen inclusive growth. Given the wide range of views and differing economic situation in G-7 countries, no single solution is likely to fit all.

New consensus will need to be found among policy makers, business leaders, civil society organizations, and citizens to enact meaningful change. Any such consensus will need to be built on a national level, given the broad divergences among countries on the issue. Multilateral cooperation may also be needed, especially relating to trade and tax policies. In this final section, we do not make specific recommendations but rather provide a scope of solutions based on an in-depth analysis of more than 350 initiatives being proposed and piloted in G-7 countries.

Economic growth has been the central mechanism to deliver broad-based prosperity. Abundant literature covers aspects of this imperative, including promoting fair and efficient markets, nurturing a well-balanced economy across geographic areas, investing in innovation and infrastructure, leveraging monetary policy, and increasing the ease of doing business to stimulate growth while balancing the regulatory burden for entrepreneurs.

Business leaders, policy makers, and other stakeholders have at their disposal a range of actions to improve economic inclusion. The ideas being proposed and piloted align with two main pathways for action: addressing inequality of opportunities and addressing inequality of outcomes.

Policy makers, academics, business leaders, labor organizations, and others are examining ways to widen economic opportunities and improve outcomes for all. Among other efforts, these could include:

Providing access to quality healthcare and education. Healthcare and education are basic goods that are widely cited as being able to improve economic chances for individuals. Accessible healthcare will likely be increasingly important as individuals live longer, with action needed to address imbalances in health outcomes based on socioeconomic and geographic factors. Effective primary and secondary education will also be indispensable in a transition period to a more automated future. Schools may need to adjust their curricula to focus on skills of the future, including creativity and complex problem solving, alongside a new emphasis on science, technology, engineering, and mathematics (STEM) subjects. Encouraging innovation in education and expanding vocational training and apprenticeships could help ease transitions into work in a more digital world.

Rethinking work and skills. Beyond primary and secondary education, providing workers with lifelong skills at scale is sometimes seen as the challenge of our generation. Research suggests that tomorrow’s workers will need to be adaptable and equipped with both enhanced technical skills and well-developed social, emotional, and higher cognitive skills. A number of large companies in Europe, the United States, and Asia are implementing large-scale “reskilling” programs for their workforces, although they remain the exception; some of these efforts start with an attempt to map the existing skills of workers and then project forward to the skills the firms expect they will need. Efforts being considered also examine issues of fair and adequate compensation, opportunities to increase labor market flexibility for more efficient and fluid work transitions, and effective ways to support those in nonstandard employment.

Addressing biases and discrimination while promoting diversity and inclusion. Targeted action to ensure that all individuals are given a fair chance, regardless of background or personal attributes is among the ideas being tested. Efforts include supporting underrepresented groups, not only through antidiscrimination policies and frameworks but through a diversity and inclusion agenda that can also serve as a source of competitive advantage. Other approaches suggested to widen inclusion include improving citizen or employee representation, potentially on corporate boards or by encouraging forms of labor-management cooperation.

Employing new metrics and incentives to encourage social value creation. Further efforts to encourage and enable capital owners to deploy their capital for social good, for example through outcome-based funds, are widely discussed. Many call for improvements in the measurement of economic and social value created by companies, what investors prioritize, how business is taught at business schools, and how national success is defined, including focusing on metrics of inclusion or well-being beyond GDP.

Solving for how economic gains are shared. Discussions of economic inequality frequently coincide with debates on tax and transfer models. Leading thinkers from within government, the private and social sectors, and academia are proposing ideas for how to alter or introduce new forms of taxation to achieve greater fairness or effectiveness.

Designing social assistance for the modern age. Transfer models in advanced economies are seen by some as ripe for updating for a world of automation and workforce transitions. Ideas being considered include rethinking employment benefits, providing better support to individuals in times of hardship or old age, facilitating greater prosperity among younger generations, and fundamentally rethinking social assistance through cash transfer programs.

Inequality is not a condition that can be eradicated, but its rise can be dulled or reversed and its causes and outcomes addressed. For all the differing views, inequality is a social and political issue that is both unpredictable and potentially volatile. For policy makers, business leaders, and other stakeholders, the current climate of mistrust and waning confidence in institutions creates a new urgency to work together to build social consensus and find effective solutions for a more inclusive future.