As young people take to the streets in countries across Europe, it is important to bluntly name the crisis that afflicts rich Western societies: hopelessness. Every nation has its own unique problems, and particular issues such as immigration or inflation can spark a broader protest, but it is becoming clear that growing numbers of people feel society is not organized to serve their interests.
What does an average worker want? To serve in their profession with dignity and earn a salary that allows for independent life decisions. Through their hard-earned money, they hope to afford the possibility of ascending the property ladder, paying for their children’s education, and having reasonable access to healthcare. This is the crux of what we in Europe call a social market economy. And this is what people expect when they do their part, which is to study, work, and pay taxes.
As young people take to the streets in countries across Europe, it is important to bluntly name the crisis that afflicts rich Western societies: hopelessness. Every nation has its own unique problems, and particular issues such as immigration or inflation can spark a broader protest, but it is becoming clear that growing numbers of people feel society is not organized to serve their interests.
What does an average worker want? To serve in their profession with dignity and earn a salary that allows for independent life decisions. Through their hard-earned money, they hope to afford the possibility of ascending the property ladder, paying for their children’s education, and having reasonable access to healthcare. This is the crux of what we in Europe call a social market economy. And this is what people expect when they do their part, which is to study, work, and pay taxes.
This social contract has been eroding in the developed West. The last several decades of growth in industrial productivity are reversing and the influence of trade unions declining. To understand this, we need to look back to the 1960s and ’70s, as post-World War II societies saw the proportion of total economic output paid to workers in the form of salaries and benefits grow. That share of labor to GDP, as it is known, peaked in countries that are part of the Organization for Economic Cooperation and Development (OECD) in the 1970s at around 70 percent. For most of these countries, the share of labor to GDP dropped in the 2000s to between 50 and 60 percent. Put simply, ordinary citizens in rich societies are getting a smaller portion of the total economic pie. And young people who grew up watching their parents flourish under the old social contract are now developing a sense of intergenerational hopelessness.
A key feature of this problem is the fact that rising wealth in society tends to accumulate mostly in residential real estate. Housing remains the only asset class that provides daily value while accumulating wealth as prices rise. But as younger generations find the housing ladder increasingly out of reach, their salaries minus rent provide them with what can only be described as mediocre prospects. They become more dependent on social security systems as asset prices continue to gobble up most of the rise in real wealth.
This challenge has found two widespread solutions in the rich world. Middle-class members of society tend to gravitate toward arbitrage opportunities in countries where average incomes are lower than their own, boosting their spending power. Common examples include how British publics buy real estate on the Iberian Peninsula or take cheap flights to vacation in Asia. The other solution has been for governments to provide widespread social support to prop up living standards for people who have started to fall out of the middle class.
Initially, this state support was necessary only for the underskilled. This allowed minimum wages to remain below the actual cost of labor. Businesses started to rely on this competitive advantage. The more they convinced governments to keep minimum salaries low—or not fixed at all—the more they could push the cost of labor onto social budgets. Gradually, state support would become necessary for more skilled laborers as well.
This system was never sustainable. Since tax bases are relatively wide in rich Western democracies, the revenues of governments depend on the middle class—salaried professionals. But more than that, gathering taxes and spreading them through burgeoning welfare states is costly, unfair, and erodes the self-esteem of people who work full time and still cannot make ends meet. They cannot buy homes and are forced to live in government-subsidized housing. They cannot put their children through the schools and universities they want. All of this makes social support schemes more necessary, and they in turn allow enterprises to pay workers less. People living on social support become the cattle of a workforce, with fewer and fewer choices available to them. In addition, they realize that not being educated and not being able to demand the full cost of their labor means their children go to subpar schools and don’t get the necessary education levels to create their own destinies.
All of this results in a downward spiral. Wage growth is suppressed, and as tax revenues ultimately depend on the wages of the middle class, lower government revenues lead to lower salaries for many educated professionals on the public payroll. Teachers, nurses, and police officers are increasingly finding themselves qualifying for social support, particularly in wealthier areas where they can no longer afford to live and work without government assistance.
The results are plain to see. In the 1970s, a single-salary household in Western societies could afford a decent life. Today, two average salaries rarely mean the same quality of life enjoyed by the previous generation. In macroeconomic terms, if labor compensation accounted for about 70 percent of GDP in OECD countries in the 1980s, with social spending at around 16 percent and a deficit of around 2 percent, today the pie has been rearranged to accommodate less money for workers, much higher social spending, and almost double the deficit. Governments feel powerless to break the cycle. This results in a form of intergenerational hopelessness for more and more people in developed societies. People work full time yet cannot hope to make ends meet. They feel the system doesn’t work. And they don’t see a way out. This breeds the resentment and anger that we now see bursting out in various protests.
Is there a solution? I think there is. To start with, governments and businesses need to recognize that the status quo is unsustainable. Radical changes are necessary. Reforms need to ensure that people earn salaries that cover the full cost of labor in their particular region. Salary rises mean businesses must be allowed to pay less taxes. Governments can then gradually reduce the amount of social support they dole out. Such a system would at least mean ordinary citizens feel more in control of their finances and fates. It would allow for an honest conversation about costs and trade-offs rather than the convenient fiction that the old ways can continue without a course correction.
Is any of this easy to achieve? No, especially considering the permanent competition among countries for investment and business development based on low wages. But this traditional hold is weakening. More and more people work independently and not necessarily in the country they live, raising their bargaining power and lowering that of businesses. Smarter policies around setting localized values to labor are necessary, although countries will need bodies such as the European Union and the OECD to take the lead in publishing methodology and science to help determine adjustments. A big question here is the role of artificial intelligence, which could hurt job growth but also boost productivity and raise salaries if societies pay attention to how it is rolled out.
Part of the puzzle will be figuring out a wholesale rethinking of taxation. Independent workers enjoy corporate tax models that salaried individuals do not. Governments must recognize these inequities and address them. All income—salaries, dividends, and rents—should be taxed similarly to create a fairer system for the modern economy.
The risk of inaction is clear from the headlines in the news. Intergenerational hopelessness brings revolutions. Even if people see that the proposals of populists or extremists are not going to work, they want to break the old system because it has failed them and their children. They have little to lose. But destroying the system will make it impossible to create widespread progress or face communal challenges such as climate change. That is the real downward spiral we must all avoid.
