The Shrinking of the Middle Class

Income inequality is on the rise, according to the research of UZH economists David Dorn and Nir Jaimovich. Technological advances and globalization are the main factors behind this development – but Switzerland doesn’t really fit the mold.

Text: : Thomas Gull
English translation: Philip Isler

Job markets  in the US and Western Europe have seen substantial changes over the past 30 years. First, many of the traditional industrial jobs disappeared. Production shifted to China or other developing countries where costs are lower, and more and more workers were replaced by robots capable of carrying out human tasks equally well or better, and at lower costs. This shift was particularly dramatic in the US, where the number of traditional jobs in industry decreased by one-third between 2000 and 2010 – over the space of just 10 years. Technological advances have not only made factory workers obsolete, but are increasingly affecting middle-class jobs with repetitive tasks such as secretarial work or administrative support. Intelligent computer programs can now be trained to not only carry out manual labor, but also perform cognitive tasks if these are clearly defined and repetitive.

Fewer jobs, lower wages

In scientific terms, this type of work is referred to as routine occupation, in contrast to non-routine work. This kind of work can be cognitive or manual. One of the main distinctions is that it involves tasks that require a degree of flexibility in terms of both mental and physical activity. This is something the machines aren’t so good at (yet), which is why it is much more difficult to replace humans with intelligent systems here.
Competition from the world of machines has led to a fall in the number of middle-class jobs that generate middle-class wages. “There are not only fewer such jobs,” says UZH professor of economics Nir Jaimovich, “but the wages paid for this kind of work have also dropped.” The economist spent several years in the US researching and analyzing this development. The loss of middle-class jobs and status coincides with a second trend, which points in the opposite direction: Workers who perform complex cognitive tasks tend to earn higher salaries. At the same time, new employment opportunities are being created in this line of work. “This area is benefiting from the technological advances, since new technology isn’t replacing them but making workers more productive,” the economist explains.

These opposing trends have resulted in an ever-increasing income gap among workers, some of whom are being forced to abandon relatively high-paying routine jobs for other, less well-paid work. Or they’re being pushed out of the job market altogether. In the US, the share of workers with routine occupations has dropped by one-fifth since 1980. Unfortunately, the loss of this kind of employment often results in a loss of social status, and many people drop out of the middle class – one-third of former workers in middle-class jobs now earn less than they used to, and two-thirds are still out of a job.

Job polarization

Economists refer to this development as job polarization. Studies have shown that the gap between high-income and low-income jobs continues to grow, while the middle class connecting the two poles is shrinking.
Nir Jaimovich’s focus has mainly been on the situation on the other side of the Atlantic. But in Europe too, and especially in Germany, the income gap and job polarization have also been increasing, says David Dorn, professor of globalization and labor markets at UZH. Both Dorn and Jaimovich are members of the University Research Priority Program (URPP) Equality of Opportunity, which explores these types of issues. “Switzerland has managed to go against the trend to some extent,” says David Dorn. While some middle-class occupations have also disappeared in Switzerland, the income gap hasn’t seen any significant increase.

There are several reasons for this, according to Dorn. For example, Switzerland has not had a low-wage industry for some time now; Swiss workers are better educated than elsewhere, which makes it easier for them to change their line of work. And Switzerland still has a highly successful exporting industry in areas where innovation and quality outweigh the prices, such as the pharmaceuticals, luxury goods, high-precision machines or, somewhat surprisingly, coffee industries, where thanks to the innovative coffee capsule system, Switzerland is the world’s second largest exporter. This uniquely Swiss path can also be observed when it comes to wages, says economist Dorn. While in the US, the wages of the poorest 10% have declined since 1980, in Switzerland they have grown in line with middle-class and higher incomes. In both countries, the salaries of the top one percent saw the greatest increase, but in the US this rise happened twice as fast than in Switzerland.
Wenn wir nach Europa schauen, stellt sich die Frage, weshalb sich die Dinge in Deutschland anders entwickelt haben als in der Schweiz. Dorn macht dafür den Lohndruck aus Osteuropa und die Schwächung der Gewerkschaften verantwortlich, während in der Schweiz die Arbeitnehmenden und das Kleingewerbe möglicherweise einen gewissen «Konkurrenzschutz» geniessen, weil die Schweizer Löhne auch an aus dem Ausland entsendete Arbeiter bezahlt werden müssen, die in der Schweiz arbeiten.

Looking to Europe, why then did events unfold differently in Germany than in Switzerland? David Dorn mentions the downward pressure on wages from Eastern Europe and the weakened unions as reasons. In Switzerland meanwhile, workers and small businesses perhaps benefit from a certain protection from competition, since staff sent to work in Switzerland from abroad also have to be paid Swiss-level wages.

Superstars more profitable

David Dorn has analyzed another development that is contributing to the growing income inequality. The economist researched the rise of very large “superstar” companies such as Google, Amazon and Walmart in the US. In Europe, superstar firms include the large pharmaceutical companies and banks, car manufacturers such as Volkswagen and Stellantis, created in a merger of automakers such as Peugeot, Citroën, Chrysler and Fiat, and discount supermarket chain Aldi. Examples of Swiss companies that fall into this category are Roche, Novartis and Nestlé.
These superstars have strong or even dominant positions in their respective industries thanks to their technological prowess and innovation. “This gives them many advantages,” David Dorn says, “and they’re generally more profitable.” Thanks to their superior productivity, these firms can sell their products at lower prices, while also keeping their profit margins higher.

Metaphorically speaking, large companies with efficient operations have a thicker layer of cream on top of their milk, which the owners can skim for profit. These profits usually go into the pockets of the firms’ owners and investors, with hardly any passed on to the workers. “This tilts income distribution towards the side of capital,” says the economist. The development can be easily traced by comparing the workers' share in the companies’ value added. In the European Union, the workers’ share of the cake was around 75% in the 1970s, but dropped to 65% in 2010. In the US, the share dropped from just over 65% to below 60%. In Switzerland, it is hovering between 65% and 70%, but unlike in the EU and US, there has been no steady downturn in the share of the labor force in companies’ revenue. “The rise of superstar firms is contributing to the growing income inequality, because capital income is concentrated on a smaller section of the population than labor income,” concludes David Dorn.

Both trends – the rise of superstar firms and technological advances coupled with globalization – are driving inequality. Can’t this process be stopped? Nir Jaimovich has evaluated several strategies that could help prevent workers from dropping out of the middle class, including retraining workers, increasing unemployment insurance, introducing universal basic income and lowering taxes on manual labor. His research suggests that retraining workers is the most efficient path. “Retraining programs improve workers’ chances of finding a new job, and they increase the output of the entire economy,” Jaimovich explains. But they do come with high costs. And by inserting new workers in an industry, they also increase competition among its workers.

Looking into the future, Jaimovich isn’t all that optimistic. “Job polarization is probably likely to increase,” he suspects. When it comes to the effect of automation on employment, Jaimovich sees two possible developments: “Either all jobs that can be automated will simply vanish. Or automation will enable us to specialize in areas where we have the edge over machines, leaving the mundane, routine work to our robot replacements.”

Abusing the monopoly

Superstar firms also raise the question of whether and how the state should intervene. David Dorn believes government should take action in particular when companies abuse their dominant position: “Large firms that exploit their monopoly to generate disproportionate gains or to push competitors out of the market aren’t a good thing.” The economist thinks that in such cases, policy-makers should step in and limit a firm’s market activities.

His second suggestion points in the same direction as the study conducted by fellow economist Jaimovich: When a worker loses their job, they should get retraining to open up new perspectives. And finally, the unequal spread of income should also be countered through taxes and government transfer programs. David Dorn has one reservation, though: “Successful firms contribute to our wealth. So we have to make sure that any intervention doesn’t restrict our economic development, and that there are still enough incentives for people to become entrepreneurs.”


University Research Priority Program

Equality of Opportunity

The rise in economic and social inequality has become a great challenge in societies that strive for democratic and meritocratic ideals. The University Research Priority Program (URPP) Equality of Opportunity researches economic and social changes that result in inequality in the society and evaluates strategies to improve equality of opportunity.
The URPP connects researchers from three faculties who represent the six academic disciplines of economics, law, political science, history, sociology and philosophy. Researchers leverage their combined academic expertise to conduct research in three interdisciplinary research modules: The module Economic Change analyzes how changes in the structure of the economy, such as automation, change the types and the distribution of wealth and income in society.  The module Social Change asks how social norms contribute to a changing perception of inequality, and how norms and perceptions translate into political demands.  The third module, Public Policy, studies how governments can foster greater equality of opportunity.