This week’s post comes from Dougald Middleton, Partner in UKI Transaction Advisory Services at EY.
The middle class is shrinking in the UK and in almost every developed economy. The structural drivers that rebalanced employment towards managerial and professional roles are weakening – along with economic growth rates – and this turnaround in fortunes is driving profound economic and political change.
This blog sets out to identify the key characteristics of this change and what it means for the government and corporate sectors.
A squash and a squeeze
The idea of the ‘squeezed middle’ isn’t new. But in the last year there is mounting evidence that this squeeze is having a long-lasting and momentous impact on developed economies. Last month’s major OECD report on the ‘Squeezed middle class’ showed that across its 36 developed countries, the proportion of people living in households in their middle-income group fell from 64% in 1981 to 61% today. In the last 30 years the proportion of the US considered middle-class fell 5 points to 51%, one of the lowest in the OECD. In the UK, a below average 58% of the population are now categorised as middle-class.
These may seem to be relatively small changes. But it is important to remember that it is the reversal of a very long-term trend of growth in what was traditionally the most stable segment of our economy and society.
The primary drivers for this decline can be broadly split into two categories. The first is a squeeze on disposable income. Over the past 30 years, middle-income households have experienced stagnating wage growth as they lose out to higher earners. Median middle-class incomes increased by third less than the average income of the richest 10%, according to the OECD. Meanwhile, housing, childcare and healthcare costs have risen.
Housing costs as a share of middle-income budgets increased OECD wide from one quarter to one third between 1995 and 2015. House prices have grown twice as fast as inflation and one and a half times faster than household median incomes.
The middle class is also being hollowed out by a decline in the number of middle-income jobs and reduction in job-security. Automation and technology is often cited as the prime threat to middle-class jobs, with one-in-six middle-income workers in jobs at high risk of automation. But there is a complex interplay of other factors also in play. Public-sector employment, which archetypally provides a significant number of middle-class jobs, has fallen sharply in many economies. The UK has 1.1 million fewer public sector jobs than 2009. Economic uncertainty and changing business models have also increased the level of temporary and contract work. In the last 13 years, self-employment has grown fastest in the UK in the ‘administration and support’, and the ‘professional, scientific and technical services sectors’.
This is a complex trend that defies one universal theory, as we’d expect given its given its incidence in economies as diverse as the US, the UK and Sweden. One potential driver for wage stagnation – falling productivity – has a cornucopia of explanations, including low interest rates and default rates that have arguably stymied the most productive use of capital. But would greater investment speed up automation? Would this have led to a greater or fewer number of middle-income jobs and wage growth? And what about new the generations of workers?
The generation gap
We can’t talk about class without discussing age, with growing evidence of the difficulty of breaking into the ‘middle class’. In the UK, official figures show that 31% of graduates are overeducated for the job they are doing. Meanwhile, UK house prices have increased by at least 60% more than median incomes in the last two decades.
Across the OECD, 68% of the baby boomer generation belong to the middle class, compared to 60% of millennials. The potential for generational pressures doesn’t end there. Middle-class working-age households pay 17% more in taxes than they receive in benefits. Meanwhile, elderly middle-class households are net beneficiaries, receiving 60% more in benefits than they pay in taxes.
The headline measure of inequality in the UK hasn’t changed markedly since the end of the 1980s, but the headline hides a significant generational gap. Real average incomes after housing costs have risen for pensioners and high earners, but stalled for working age low to middle-income families.
Losing the middle ground
There is an argument to say that we should be worrying about the poorest in society before the middle classes. But we’d argue that the pressures we see here are all part of the same continuum. Any diminishment of middle class opportunities and earnings has a knock-on impact, particularly into lower-income employment where competition for work increases – as highlighted by the figures on graduate employment above. And any group feels that under attack is likely to look for alternative answers. The rise in populism isn’t being driven entirely by the squeezed middle; but sheer size of this group in most developed democracies makes them a significant political force and their desertion of the centre ground is having a transformative impact.
The impact of populism on business comes in two main strains. The breakdown of consensus around the middle ground means that populist parties, even those not in power, are disrupting domestic politics to the point of breaking down traditional party lines. As a result, there is less predictability for business. Government and therefore policies are more fluid. Secondly, the populist policy agenda itself is broadly, so far as we can generalise, more oriented towards anti-globalisation. Trade barriers are rising as are international tensions. In some areas, populists are pushing for de-regulation, which may help some businesses; but companies are also seeing tighter restrictions on deals and penalties for moving operations overseas.
Thus, the breakdown of the centre ground needn’t create an inherently anti-businesses environment. But it is already throwing new challenges and it undoubtedly makes the political and policy backdrop less predictable, making it harder for business to make long-term plans.
Losing the mid-market
The other related strand affecting many businesses is the impact of declining middle-class spending, especially on mid-market consumer sectors. Two of the most striking figures in the OECD report are:
- One in five middle-income households spend more than they earn
- One third of middle-income households in the UK report having difficulty making ends meet.
Unless consumer businesses have a strong unique selling point (USP), they will struggle to attract the spending of strapped-for-cash middle income earners, whilst also not appealing to either low or high-income consumers.
In 2015, Campbell Soup CEO Denise Morrison identified “a shrinking middle class in developed markets” as one of four “seismic” shifts affecting her company.
It’s a trend that we’ve seen in play for some time in UK retail. The role-call of retailers going into administration since the financial crisis, is primarily a list of those that offered neither low prices or a unique/premium product or experience. In food retailing, mid-market supermarkets are rapidly losing ground to discounters. The mid-market has also suffered in the restaurant sector. This is an industry with other pressing issues – rising costs, oversaturation, high levels of debt – but it’s notable that the mid-market casual dining portion of the sector has suffered the most. The UK didn’t fall out of love with eating out, but again it focused on dining experiences with a strong USP.
“In 2011 Aldi and Lidl had 6% market share, and by the end of 2018 this will have more than doubled to 14%. A market share of 20% no longer seems impossible, which incidentally is still below the European average of 22%. Put another way, £15 billion sales per annum are being lost by supermarkets each year, which is equivalent to a retailer the size of Morrisons.”
Mike Watkins, head of retailer and business insight at Nielsen UK:
The next area to watch is housing. The UK market has shown considerable resilience, with volumes dipping, but pricing rising or stable in most regions outside of London. Nevertheless, there are question marks over what happens when the government’s ‘Help to Buy’ scheme ends in 2023. More than four in every five ‘Help to Buy’ scheme users are first-time buyers, whose purchases hit their highest level for 12 years at the start of 2019. If this prop is removed how many first-time buyers will step onto the ladder if middle-incomes are squeezed and jobs are less secure?
Beyond these areas of consumer spending, there is already pressure growing on healthcare and education. For universities, domestic uptake isn’t the only issue, but many business plans are predicated on expanding numbers of UK entrants.
Businesses’ roles and opportunities
Many of the forces pressuring the middle class have deep structural roots. We cannot hope to reverse or stop this trend of decline in traditional middle-class employment, but we can try to outrun it in the UK by creating new jobs and opportunities. New technologies and changes in customer priorities will create the potential for new careers, but we need growth and stability to put in place the necessary structural changes and investment to release this potential.
There is a role for government to play, for example in redirecting investment into areas that increase productivity and address regional imbalances; increasing investment in further education and life-long training; and re-thinking taxation and distribution to reflect changing economic, technological and social changes. But there is also a big role for business in driving many initiatives, either in partnership with government or through its own programmes. To replace the number and type of jobs currently being lost – and to restore above-trend growth – will require a fresh consensus between business and the government.
This could include initiatives for business to put spare cash into investment and training and to help regionally and structurally rebalance the economy. Further initiatives could encourage business to put further investment into the green economy, including low-carbon infrastructure – such as electric vehicle charging points, renewables and more sustainable homes. There is an opportunity to create global growth hubs in sectors where the UK has a competitive opportunity and advantage, such as life sciences.
A shift in values?
Some of the anti-globalisation pressures on companies to described above coincide with initiatives that companies were already starting to embrace, such as near-sourcing as part of a focus on low-carbon and the green agenda. In judging the health of an economy, we’re also seeing a slow, but steady shift away from a narrow focus on GDP growth to something more holistic in response to a need to think beyond the bare numbers.
Indeed, as we’ll explore in greater detail in further blogs, businesses are spending more time thinking about how their social purpose intersects with profit and the long-term value of their business – a topic that EY is exploring in the Embankment Project. More on how this intersects with transactions to follow.
Edited by Kirsten Tompkins