Do we need a new social contract?

What is the common thread in recent news stories about established democracies being destabilized by populism and extremism? The lower middle class is reeling and expresses its frustration in the voting booth or in the streets. The establishment appears unprepared for such a rebellion. It has lost its grip on reality and, more often than not, loses the levers of power as well. What is happening and what can be done about it, in the interest of the public?

Two recent reports ponder the need for a new social contract. The World Bank report “Toward a New Social Contract: Taking on distributional tensions in Europe and Central Asia” examines the socio-economic underpinnings of recent unrest, especially the changing nature of inequality, the ineffectiveness of the current redistribution policies, and the sense of exclusion and marginalization perceived by some. It highlights that these issues are as much about horizontal inequalities between groups as about vertical inequalities, and that emerging distributional tensions between groups may be a major factor behind the surge of populism. The second report, “Rethinking Society for the 21^st Century,” from the International Panel on Social Progress (IPSP), is broader in scope as it covers socio-economic, governance, and cultural issues in three volumes. It is also motivated by the observation that while tremendous progress has been achieved since World War II, social trends and environmental threats may undermine all of this. But it takes note of promising institutions and initiatives, and combines optimism about the available opportunities for policies and institutional reforms with great caution about the likely political developments.

The two reports differ in terms of geographic coverage—the first focuses on Europe and Central Asia, while the second is global—but their broad policy messages are similar. Their recommendations for a new social contract are complementary. Both reject the temptation to curb globalized economic activities or technological innovation and argue for an adaptation of the welfare state and other key institutions to the new challenges. The World Bank report proposes broad principles for adapting the welfare state to the new situation and responding to the demands of a genuinely fairer social contract. The IPSP report claims that the compass for future progress is empowering people, through investing in their capacities and developing more participatory governance mechanisms. In a nutshell, in the current rebellious situation where demagogues’ sirens are tempting the electorates, we do not need more technocracy but more democracy.

Inequalities in Europe and Central Asia

In Europe and Central Asia, concentration of incomes at the top has increased and this has certainly contributed to the uneasiness of European populations and distrust in institutions and elites. By focusing on distributional tensions between groups and persistently low social mobility, a clearer view of the deep economic transformations emerges. Three groups seem particularly relevant: workers in different occupations, generations, and regions.

Technological change, together with a significant increase of trade openness, has influenced indus­tries and workers in very different ways. A particularly striking fact is the shrinking share of routine-task-intensive occupations, those normally held by middle-class workers. Workers in this type of occupation do not easily transition to other jobs, so their livelihoods are jeopardized. Loss of long-held occupations for middle-class workers means more than lower earnings; it means loss of security and identity. For example, individuals who have not worked in full-time jobs are much more likely to rank themselves as poor than those with such jobs, even if the actual income of the two groups is the same.

The changes of the labor market have also generated rifts between generations. Younger cohorts include a larger share of workers who are unemployed or in low-quality jobs. For these younger workers, lower earnings and fewer old-age income prospects imply a widening intergenerational divide, which is an important source of distributional tension. And another, more subtle, gap is separating birth cohorts. Younger cohorts are facing higher income inequality at every point of their life cycle compared with older ones—as if they were living in different countries.

Differences in income levels and poverty rates persist or have even increased across regions in many countries of Europe and Central Asia. In the European Union, income inequality between regions of the same country is today 10 percent higher than what it was in 2000, while income inequality between countries is 20 percent lower. This spatial divide cannot be simply remedied by labor mobility because the poorest, having no access to formal insurance mechanisms, rely on local family networks that provide informal protection, and do not easily leave their native regions.

Contours of a new social contract

Given their long and varied experience with social welfare institutions and progressive taxation, countries in Europe and Central Asia should be well equipped to deal with distributional tensions. But these institutions were designed for a very different economic environment. In many countries, the bulk of social protection and pension benefits are available to those with long and stable employment histories. The younger generations do not have these histories.

Rather than prescribing or even iden­tifying a specific set of policies, the World Bank report proposes a set of three principles: (1) move toward equal protection of all workers, no matter their type of employment, while promoting labor markets’ flex­ibility; (2) seek universality in the provision of social assistance, social insurance, and basic quality services; and (3) support progressivity in a broad tax base that complements labor income taxation with the taxation of capital. These three principles, considered jointly, could help level the playing field and redesign a stable social contract and support a future of sustained shared prosperity.

These principles echo the experience of Scandinavian countries. While low trust in institutions is a widespread feature in the world nowadays, Scandinavia is an exception. The IPSP report highlights the success of development strategies based on equality and investment in human capital and safety nets, as exemplified by these countries throughout the 20th Century. The social-democratic welfare state is commonly viewed as based on heavy taxation of income and idiosyncratic acceptance of social programs, two features that would be hard to export to countries that are more diverse. But the picture is actually more complex and more interesting. First, the Nordic countries are no longer culturally uniform and even if they struggle to adjust to this new diversity, their efforts to adapt are worth following closely. Second, the social-democratic formula combines strong market discipline and open trade with a strong ethos of cooperation among social partners, in particular, through the centralized bargaining that enforces wage compression across workers and industries. Wage compression weeds out low productivity processes and effectively subsidizes highly productive firms and industries, promoting efficiency and innovation. The strong safety net is only a small part of the formula, though it is important in empowering individuals and, thanks to universality of access, garnering wide support in the population. It has a strong human capital investment component (education, health), as well as strong gender liberating component (care, parental leave) and is more about pre-distributing than re-distributing. In a nutshell, wage compression, universality, flexicurity, and predistribution are the keywords of this social contract, which is very market-compatible.

Does that suffice as a compass for the coming decades? The IPSP report offers additional insights. First, the social-democratic “grand bargain” between capital and labor requires strong representative organizations which may not be available everywhere and may not fit more decentralized traditions. Also, it may not be ambitious enough for a millennial generation that cannot envision its future in the traditional corporate career format. Reforming the mission and the governance of business companies, especially corporations, is a supplementary and important alley to explore, in order to bring social progress where people spend most of their daytime, i.e., at work. As the current wave of protests often revolves around the theme that people feel ignored by the elites, dispossessed of control over their lives, it is essential to think of the new social contract as developing and weaving participatory mechanisms at all levels and in both in economic organizations and in political institutions. Moreover, corruption is very high in protesters’ recriminations. Efforts at curbing it must involve better control mechanisms for civil society watchdogs in addition to standard judicial and political checks. Empowering people is not just a matter of basic human capital and rights. It has to put people in a position to have a say in important aspects of their lives. As the IPSP report emphasizes, participatory traditions have been developed in many parts of the world and are definitely not a privilege of the most affluent countries.

In contrast to what populists are promising, these proposals, while feasible, are no quick fixes. But inaction is not an option. Easing distributional tensions and fostering social cohesion rather than division can make a big difference, not just for equity but also for long-term prosperity.