A NEW SOCIALCONTRACT
Overcoming fears of technology and globalization means rethinking
the rights and obligations of citizenship
Nemat ShafikWe are living in an age of insecurity.
Increasingly, the values of liberal
democracy, liberal economies, anda rules-based international system
are being repudiated—even though they havedelivered progress for the vast majority of people.
Discontent has been fed by fears over slowing economic progress, especially in advanced economies,
flatlining productivity and social mobility, andconcerns about the future brought on by shifts indemography and technology.
We see this expressed in our politics. Popularanger and distrust of elites, compounded by thefinancial crisis, have led to growing support fornationalist and illiberal politicians. We see it in
the mounting evidence of declining perceptionsof well-being and trust in many countries. Whilethe causes of our discontent vary, they all point to
the need to revitalize our politics, economics, andsocial contract to provide citizens with a greater
sense of security and confidence in the face ofimpending changes.
Why are so many people in some of the more
successful countries in the world so unhappy?
Inequality is a major cause, as is fear about future

4FINANCE & DEVELOPMENT | December 2018

prospects caused by automation and aging. While
the world has become more equal between countries, there have been different effects on income
distribution within countries. The middle classin emerging markets and the richest 1 percent
globally have benefited enormously, while themiddle class in advanced economies has suffered.
And parents in many countries worry about theirchildren’s prospects in the face of the high costsof education and housing, alongside low-quality
jobs with poor benefits.

Protectionist calls
Many blame globalization and technology, but
I would focus more on the failure of our social
contract to manage properly the consequences ofboth. Our social contract—by which I mean therights and obligations of citizenship—has frayed
as a result of hyper-globalization and the austerity
that followed the financial crisis. The advance ofautomation and intensifying global competition
have driven down the wages of less skilled workers. As a result, many call for more protectionismor blame immigrants. But the answer is not todeglobalize and revert to our national silos, but toDecember 2018 | FINANCE & DEVELOPMENT

5rethink our social contract to heal these tensions
and help people adjust.
All this has been compounded by sluggish
growth since the Great Recession. A recent studyof 25 advanced economies by the McKinsey Global
Institute found that 65 to 70 percent of households(or 540 million to 580 million people) experienced
flat or falling incomes before taxes and transfersfrom 2005 to 2014. When growth is slow, people
become less generous and less tolerant.
To be sure, fiscal policy reduced this decline to20 to 25 percent in terms of disposable, or after tax,incomes, according to the 2016 McKinsey study“Poorer Than Their Parents? Flat or Falling Incomesin Advanced Economies.” Safety nets worked particularly well in the United States, turning a 4 percent
drop in market incomes into a 1 percent gain indisposable incomes over time. This 5 percentage
point change was helped by the Obama administration’s stimulus plan, which transferred more than$350 billion to households in the form of tax relief
and assistance to workers affected by the downturn.
In France, the safety net raised median disposable
income by 3 percentage points above median market
income, while in the United Kingdom, transfers fully
offset the decline in market incomes.

Future shock
While these redistributive policies softened theblows dealt to lower-income households by theGreat Recession, they also contributed to a massive accumulation of debt driven by the direct
and indirect costs of the crisis. To reduce it,
many countries later resorted to welfare cuts that
unleashed social grievances, with communities
feeling they were being left behind and individuals
experiencing a loss of dignity and sense of control
over their destiny. In the United Kingdom, forexample, Fetzer (2018) argues that welfare cuts
took the biggest toll in regions that ended up
voting for the populist UK Independence Partyand in favor of Brexit. The combination of globalization, the financial crisis of 2008, and theausterity that followed meant that many people
faced a massive shock with a very thin safety net
to support them.
Fear of future prospects is another source ofdiscontent. This fear is largely rooted in expectations that automation will eliminate many typesof routine and repetitive work while creating moredemand for highly skilled labor. Compounding
6FINANCE & DEVELOPMENT | December 2018the anxiety is the rise of precarious work at low
wages with minimal or no benefits. While somepeople find advantages in these more flexible work
arrangements, others experience serious economic
insecurity. Precarious employment reduces both
physical and mental health as individuals lose asense of agency over their own lives.
Furthermore, there is a risk that automation
will further bifurcate labor markets in favor of thehighly educated. The US Bureau of Labor Statistics
predicts that for every highly paid job in softwaredevelopment, there will be six new low-paid jobs
for personal care and home health aides between
2014 and 2024.
These anxieties have found their expression
in the political arena. In the United States, forexample, Delsman (forthcoming) finds that 21 of
the 22 states where jobs were most vulnerable toautomation voted for Donald Trump in the 2016
presidential election, while all 15 least vulnerable
states backed Hillary Clinton.

Division of responsibilities
The backlash highlights the need for a new social
contract, one that adapts to changed economic
realities and better manages the social implicationsof globalization. The social contract includes thepayment of taxes in exchange for public goods, andthe way that society looks after the old, the young,the infirm, and those who have fallen on hardtimes. Because the social contract is fundamentally
values-driven, solutions will vary across societies.
Even so, every society will have to think of who
benefits from its social safety net, which is the mechanism through which we pool risk and offset, tosome extent, the impact of luck on life chances.
Every society will also have to make choices about
the division of responsibilities between the family,
the voluntary sector, the market, and the state. This isessential since the welfare state is also the mechanism
for ensuring the equal standing of all citizens so thatthey can participate fully in public life.
There are fundamental questions to answer,
which have grown more complex in more heterogeneous and globalized societies. Whom do we feelobligations to take care of and share risks with?
What responsibilities go along with those obligations? How much do obligations extend beyond
families to communities or other regions? Whatabout poor people in other parts of the world?
Are we obliged to leave future generations at least

AGE OF INSECURITY

an equivalent endowment of physical, social, andnatural capital as we were given?
As part of the new social contract, we may needto reinstate the reciprocity and insurance element
in welfare provision. There is a toxic perceptionthat there are “hard-working people” and “welfarescroungers” when in fact, as John Hills at the London
School of Economics (LSE) has shown for the United
Kingdom, the vast majority take out (in the formof education, health care, and pensions) broadly
as much as they put in (in taxation when they areworking) over the course of their lives. The rich pay
more tax but tend to live longer, so they benefit morefrom pensions and health care in old age.

Universal benefits?
Perhaps we need to revisit the political and social
advantages of universal benefits, which are betterfor getting political buy-in and ensuring quality.
The founder of the welfare state in the United
Kingdom, the LSE’s William Beveridge, intended
it to be based on the concept of universal social
insurance. That link was lost as the social safety net increasingly was funded through generaltaxation and some citizens opted out throughprivate provision. Richard Titmuss, the pioneering
British social researcher, noted that “separate discriminatory services for poor people have always
tended to be poor quality services.” Keeping thebetter-off engaged with public services sustains a
sense of mutual obligation and maintains pressure
to uphold standards.
How would a new social contract address inequality? In the medium term, so-called pre-distribution
policies are key—education, social mobility, infrastructure investments in poorer regions, and spreading productivity improvements to the frontier.
Countries with greater social mobility grow fasterbecause they more effectively match people to theright jobs, generating higher productivity. The best
way to raise innovation and productivity may be toprovide opportunity to the “lost Einsteins” who are
disadvantaged by the circumstances of their birth(Van Reenen and others 2018). Greater investment
in equalizing education opportunities and outcomes
would have a high payoff and enhance confidence
in the fairness of the system.
Old and young
We also face huge issues of intergenerational fairness.
Many aging societies now spend more on the oldthan the young. Data from the Organisation for
Economic Co-operation and Development showthat as the age of the median voter rises by a year,
public spending on pensions goes up by 0.5 percent
of GDP (Ebbinghaus and Naumann 2018). Older
people vote and are very effective at protecting theirinterests—the young should do the same. But older
people should care, not just about their own children
and grandchildren (who can be supported throughbequests), but about others’ too, since they will
inhabit the same society. One solution is to giveyoung people entitlements that they can use toimprove skills over the course of their lives. Under
such a social contract between generations, young
people would repay the investment with higher
future taxes that could finance care for the elderly.
Intergenerational fairness and social mobility areissues that will take time to address; in the nearterm, some degree of redistribution is essential. Tax
systems have become less progressive as advanced
economies lowered corporate taxes and top rates on

Countries with greater social
mobility grow faster because they
more effectively match people to
the right jobs.
personal income in the 1980s and 1990s and raisedvalue-added taxes. This is especially problematic given
widening inequality in market incomes. And because
wealth has grown even more unequal than income,we should explore taxing wealth such as inheritance,land, and real estate. Recent IMF research shows that
greater equality boosts growth, so such reforms may
also help revive sluggish economies (Ostry, Berg, andTsangarides 2014).
Another way to address inequality would be to
put a floor under incomes, which would help ensurethat even low-wage earners can enjoy a reasonable
standard of living. I am not a proponent of universal basic income except in poor countries thatlack the capacity to manage a welfare state or where
it would substitute for an even worse policy, suchas energy subsidies. In most middle-income andadvanced economies, universal basic income would
be expensive and inferior to a properly functioning
welfare state. It also risks undermining the widespread view that anyone who can work should, andit does not take adequate account of the importance
December 2018 | FINANCE & DEVELOPMENT

7

We must renegotiate choices we made in the past because
they no longer fit current circumstances.
of meaningful work to well-being. Better solutions
include wage subsidies, earned income tax credits,and higher minimum wages, combined with accessto services such as education and healthcare.

Labor flexibility
The spread of low-quality jobs with few benefits andthe impact of automation are sources of insecurity
that must be addressed. To make a successful transition to digital economies, governments must makeit easier to switch jobs and guarantee workers a fairshare of the benefits from this transition. Potential
solutions include ensuring a level playing field inwage negotiations, profit sharing, and cooperatives.
Otherwise those left behind will keep voting for policies such as restrictions on trade or labor mobility
that thwart modernization of the economy.
Firms should have flexibility to hire and fireworkers as the economy changes but then provide generous unemployment benefits, training,and job placement. “Flexicurity,” as it is called in
Denmark, is just such a system. It relies on firms’willingness to pay higher taxes and to engage withsocial partners on skill needs in exchange for more
flexible employment rules. Unfortunately, spending on worker education and training has beendeclining across most countries, and firms haveless incentive to spend when employee turnoveris high. Investment in training and transitional
support must be raised to facilitate the transition
to the labor markets of the future.
As countries get richer, people work fewer hours,
and automation will accelerate this trend. It will
be important to use productivity gains from automation to eliminate routine and repetitive tasks
and make time for more meaningful work andleisure. Giving part-time and temporary workers(who tend to be lower skilled and lower paid) more
rights to pensions, paid leave, and training has
been a positive reform in countries like Denmark,Germany, and the Netherlands.
Income shift
As technology advances and populations age, working lives will be longer, and people will need toretool several times in their careers. Abolishingmandatory retirement ages and removing age limits
8FINANCE & DEVELOPMENT | December 2018

for student loan eligibility, as the United States
and United Kingdom have done, are a good start.
Linking eligibility for pensions to life expectancy,
as the Netherlands has done, is an even better way
to adjust workers’ expectations.
At a global level, we also must find a way
to redress the massive shift in income fromlabor to capital. A first step would be to remove
policies that tax labor more heavily, although
issues of international tax competition makethis difficult. An international effort to ensurethat capital is taxed where the economic activity
takes place, rather than in offshore havens andvarious “tax efficient” structures, would go along way toward restoring a sense of fairness inthe world economy.
In sum, we need a new social contract to create asense of security in our globalized and fast-changing
economy. The social contract is about how we pool
our resources to provide the public goods we agree
are needed and how we support those affected byadverse shocks. While different societies will makedifferent choices, we have all arrived at a crossroads:
we must renegotiate choices we made in the past
because they no longer fit current circumstances,much less those of the future. A new social contract is essential to restoring a sense of security andsustaining political support for open economies
and societies.
NEMAT SHAFIK is director of the London School of Economics
and Political Science.
References:Delsman, Ben. Forthcoming. “Automation and Populist Vote Share.” Cited in The People
vs. Democracy: Why Our Freedom Is in Danger and How to Save It, Yascha Mounk. 2018.
Cambridge, MA: Harvard University Press, 158.
Ebbinghaus, Bernhard, and Elias Naumann. 2018. “The Popularity of Pension andUnemployment Policies Revisited: The Erosion of Public Support in Britain and Germany.”
In Welfare State Reforms Seen from Below, edited by Bernhard Ebbinghaus and Elias
Naumann, 155–86. Basingstoke, United Kingdom: Palgrave Macmillan.
Fetzer, Thiemo. 2018. “Did Austerity Cause Brexit?”Warwick Economics Research Paper
Series 1170, University of Warwick, United Kingdom.
Ostry, Jonathan, Andrew Berg, and Charalambos G. Tsangarides. 2014. “Redistribution,Inequality, and Growth.” IMF Staff Discussion Note 14/02, International Monetary Fund,Washington, DC.
Van Reenen, John, Alex Bell, Raj Chetty, Xavier Jaravel, and Neviana Petkova. 2018. “Lost
Einsteins: Who Becomes an Inventor in America?” CentrePiece 23 (1): 10–13.