A leading economist has a plan to heal our fractured societies

We live in increasingly divided societies, in which the social contracts that bind us are fraying. One driver is globalisation, which has intensified competitive pressures. Another is technology, which has increased the returns to highly skilled labour, and exacerbated inequality.

Technology has also transformed our awareness of what else is happening around the world. It has changed the way we communicate and organize, often in ways that divide. As a result, social sustainability - society’s internal cohesion and ability to hold together over time - is in jeopardy.

How do we overcome these divisions? Part of the answer lies in rethinking the systems that bind society together and that look after those adversely affected by structural changes. Societies have always had mechanisms for looking after the young and the old, for spreading income over the life cycle, and for looking after those who have fallen on hard times, with some combination of support from family, community organisations, the market and the state.

These systems are under new and intense pressures. Ageing means the cost of looking after the old has risen, both in terms of pensions and new medical technologies that prolong life. In more specialised economies, unaffordable housing combined with the need for higher levels of education and training mean adolescence is prolonged. Young people depend on family support for even longer. Technology and automation are destroying and creating jobs faster than some workers can adapt.

In most countries, fiscal space to address these issues has diminished as debt levels have risen, and as many tax systems have become less progressive. At the same time, growing inequality within societies and across generations has created tensions that spill over into political discontent and a rise in populism.

To make our societies more sustainable, we need to rethink “the welfare state” (or "social safety net"). We need to restore progressivity in our tax systems. Arguably, we have done a poor job of managing the social consequences of globalisation and technological change in recent decades. We now have a chance to put in place a better social contract – but this requires serious research and public debate to create something suited to the demands of the 21st century. This is precisely what we are undertaking at the London School of Economics (LSE), under the banner of “Beveridge 2.0”.

1. Link retirement age to life expectancy. This would be an obvious way to expand the working age population and reduce the strain on government budgets caused by rising demand for social spending. Countries like the Netherlands have increased their retirement age to 67 in 2023, then linked it mechanically to life expectancy from 2024 onward. Doing this would avoid the inevitable political row when it becomes necessary to raise retirement ages. For developing countries with more favourable demographics, linking retirement ages to life expectancy as soon as possible would mean minimal political fallout and more time to adjust expectations.

2. Help workers adjust to automation with active labour market policies. Estimates vary, but artificial intelligence and automation will probably affect about half of jobs within the next two decades. It is striking that all jobs, including many of the professions, have aspects that are routine, repetitive and ripe for machine learning. The key question is whether the new, emerging jobs are ones in which humans have a comparative advantage over machines, or if they will require human skills as a complement. The only certainty is that most workers will have to adjust. Their ability to work and contribute to society will depend on that adjustment being successful.

Given the inevitable rapid economic transitions that globalization and technology bring, perhaps we should adapt our labour market institutions? “Flexicurity”, a model associated with the Netherlands and Denmark, is based on three principles:

(1) highly flexible labour market contracts that allow employers to adjust quickly

(2) generous social security for workers that provide support during economic transitions

(3) active labour market policies including comprehensive lifelong learning to help workers find new jobs

Under such a system, labour unions have to accept employment security rather than job security. Employers have to accept that the price of flexibility is higher taxes to pay for generous unemployment insurance, social assistance and active labour market policies. This also has to be accompanied by a well-developed system of adult education, affordable child care and serious public funding to support transitioning workers.

Danish active labour market policies cost 1.7% of GDP – many multiples of what is spent in most countries - but this has generated one of the lowest unemployment rates and most consistently happy societies, based on international surveys. Building such labour market institutions requires strong traditions of collective bargaining and cooperation but, given we know profound changes in labour markets are coming, there is no reason countries could not move towards this model in an evolutionary fashion.

Percentage of work activities with the potential for automation, by industry

3. Make part-time work easier. More part-time work could start to change the nature of jobs to reflect the fact that routine aspects are likely to be done by machines. In many countries, part-time work has grown in importance, but policies have not kept up. One positive counterexample is the Netherlands, which prohibits discrimination against part-time workers and adjusts social security and other entitlements pro rata to hours. As a result, 76.6% of women and 26.8% of men in the Netherlands work part-time, compared to about 20% on average across the EU.

4. Make lifelong learning real. Many countries talk about encouraging lifelong learning but very few have been successful. Removing age limits for access to student loans, as countries like the UK and US have done, is a positive step. Making public finance available for the accumulation of human capital over a career is another option. For example, Singapore is experimenting with providing every citizen over 25 with a voucher every year worth S$500 (US$376) which they can accumulate and use for training from hundreds of approved providers.

5. Invest in early education and preventative health interventions. Politicians often speak of the state providing “a hand up not a hand out” or what the Canadians call “going from a safety net to a trampoline.” Many of the most effective policies are around early education and preventative health interventions, which ultimately reduce welfare spending in the long run. The challenge is making sure the policies are cost effective and that politicians allocate resources to programmes that will pay off decades after they are elected.

6. Restore progressivity in tax systems. There is clear evidence of a declining trend in tax progressivity in OECD countries, particularly in the 1980s and 1990s. Tax reforms have raised exemption thresholds and lowered top personal income tax rates, placing a greater tax burden on the middle class.

Similarly, corporate tax rates have fallen on average across the OECD (from 32% on average in 2000 to 25% in 2015) while taxes on consumption have risen (the average standard rate of VAT increased from 18% in 2000 to 19.2% in 2015). This has had negative effects on social cohesion and social mobility.

In more unequal countries, the ability of children to do better than their parents tends to be much reduced. Restoring progressivity in tax systems and enabling greater social mobility will do much to heal divisions in society.

Figure 1: Great Gatsby curve: income inequality and social mobility

Figure 1 shows the relationship between inequality and social mobility as measured by intergenerational income elasticity (defined as the per cent change in earnings of a child’s generation associated with the percent change in the parent’s generation).

7. Move public debate from “them and us” to “us.” Many welfare states were designed on the principle that most people get back close to what they put in. Nick Barr of LSE argues that the welfare state is three quarters piggy bank - mutual insurance over the life cycle - and only one quarter Robin Hood - transferring resources from the rich to the poor. John Hills, also of LSE, has shown this clearly for the UK, where most people take out more when they are young (in the form of education) and old (pensions and health care) and put more in when they are of working age (through taxation). This results in a balance over a lifetime (see figure 2).

Figure 2: In the UK, we get out roughly what we put into the welfare state

Nonetheless, political conversations around the welfare state have become more about “them and us.” The political right argues there is a hard-working majority who pay and a lazy minority who scrounge off the state. The left uses the language of the 1% who rig the system and minimise transfers to the needy. “Welfare” – which is about helping people fare well in their lives – has somehow become a word with deeply negative connotations. Moreover, the implicit intergenerational contract breaks down if there are big differences in the size of generations and in their economic circumstances. We need a sensible public debate that acknowledges the importance of mutual insurance, intergenerational justice and our mutual interdependencies. We need a discussion about “us”.

The issues around making welfare states sustainable are obviously interconnected.

Equitable investments in health and education reduce the need for redistribution later in life. Facilitating part time work and its taxation extends work lives and may have positive benefits for well-being. Education and behavioral changes can increase life expectancy at a lower cost to health budgets than medical interventions.

Setting out this agenda so broadly is not just mad ambition. It may actually help us find new solutions.

What solutions are being tried in your country? Leave your comments and questions here for the panellists in Dr. Shafik’s Davos session on ‘Saving Economic Globalization from Itself’ on Tuesday, January 23 at 16:00.