Home > Uncategorized > The fall of the US middle class

The fall of the US middle class

from Steve Pressman

As the rich received a bigger piece of the pie, everyone else got relatively less. We can see this in the falling share of income going to the middle-three income quintiles (Figure 1).

One standard economic argument for great inequality is that it generates incentives to make money and contributes to economic growth, which increases average living standards. Even if this is true, not everyone benefits from growth. Saez and Piketty (2013) estimate that since the late 1970s nearly 60% of all gains from growth have gone to the top 1%, roughly those making $500,000 or more in 2016.1 Consequently, a typical US household has seen little improvement in their absolute standard of living for several decades. We can see this in figures on real median household income, which increased only slightly over the past quarter century – growing from $54,432 in 1988 to $56,516 in 2015.

We focus here on another distributional measure – the size of the middle class. A thriving middle class is important for a number of reasons. First, there are political factors. Rothstein & Uslaner (2005, p. 52) argue that inequality reduces social capital or the trust needed to sustain democracy. Second, Robert Malthus (2008[1803], p. 594) noted: “Our best grounded expectations of an increase in the happiness of the mass of human society are founded in the prospect of an increase in the relative proportions of the middle parts.” For Malthus, the additional income that moves one from poverty into the middle class is what makes life worthwhile. Finally, a large middle class improves economic performance. Alfred Marshall (1920, pp. 529-32, 566-9) noted that higher earnings may improve the habits of working people, thereby improving productivity and everyone’s standard of living. From a Keynesian perspective, a large middle class increases consumption, effective demand and economic growth because middle-class households tend to spend larger fractions of their income than wealthy households. . . . .

 

Figure 2 plots the percentage of middle-class households in the US between 1974 and 2013 using our methodology and the Luxembourg Income Study (LIS),4 an international database  of income and socio-demographic information. LIS data for the US came from annual Census Bureau household surveys.

Undoubtedly the US middle class has shrunk since the 1980s, when it comprised 59% of all households. The only exception was the economic boom of the late 1990s when the size of the US middle class held steady. Figure 2 also shows what happens when our computations do not allow median household income to fall. The main adjustments occur after the Great Recession. In 2010, median household income for a family of four was $4,800 below the inflation-adjusted figure for 2007. Taking this into account reduces the size of the middle class by 1.2 percentage points. In 2013 median household income for a family of four was more than $5,100 below the inflation-adjusted figure for 2007. Using the higher real median income from 2007 reduces the size of the US middle class to just 50% in 2013.

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  1. Blissex
    August 13, 2017 at 4:13 pm

    The optimism of this article is heart-warming, and the confusion between the “middle-income class” (the working class that is) and the “middle class” is common.
    But consider also these two graphs that I happened to build on FRB SL FRED; the first line is working age USA population, the second line is light vehicle unit sales, the third is residential housing starts, all 1976-2016:

    https://fred.stlouisfed.org/graph/fredgraph.png?g=eIvs

    The striking feature is that in a period of adult population growth and increasing suburbunization light vehicle sales and residential housing starts, quintessial middle-income class expenditures, have been flat or gently declining overall, with a bit of an uptick in the debt bubble years 1996-2006. In this graph I have added the “real” GDP-index for the same period:

    https://fred.stlouisfed.org/graph/fredgraph.png?g=eIwX

    Obviously the “real” GDP index has been growing rather faster than the working age population, and light vehicle unit sales and residential housing starts have not. How is that possible? Have the great USA middle-income class decided since 1976 that keeping up with the Joneses was useless and making do with older cars and fading houses was better?

    «Consequently, a typical US household has seen little improvement in their absolute standard of living for several decades. We can see this in figures on real median household income, which increased only slightly over the past quarter century – growing from $54,432 in 1988 to $56,516 in 2015.»

    Well, the figures for light vehicle unit sales and residential housing starts seem to suggest that the real standard of living of working class middle-income ($50,000) families has actually slowly declined over time. If that indeed is the case, the mystery is how the “real” GDP-index has been growing much faster.
    I suspect that the expansion in the share of the “real” GDP-index of finance from 2% to 8% is part of the explanation, but that presents a further mystery: on average a working-class family earning around $50,000 a year is paying today $4,000 of their income in finance fees, directly or indirectly. How is that possible? What kind of services are those $4,000 a year buying?

    • August 14, 2017 at 5:47 am

      Are you saying the average working-class family is being taken advantage of by those who provide them “financial services?” If you are, I agree.

      • Blissex
        August 14, 2017 at 4:46 pm

        «average working-class family is being taken advantage of by those who provide them “financial services?”»

        That seems likely to me, but the mystery remains of how this happens. A 50k/y family with 30k/y and a 20k/y earners rarely has 4k spare to pay finance sector fees. Even assuming that the fees are 30% of the value of the financial services sold, that gives 12k/y of finance investment/purchases by that family. Sure there are huge fees on employer provided health care, on mortages, on insurance, but that much?

        The bigger mystery however as per the topic of the article is how is it possible that the “real” GDP-index grows 200% over 40 years while population grows 50% yet light vehicle sales and housing starts on average go sideways or tendentially fall.

        A large part of the increase in the “real” GDP-index is services, and in particular financial services, but while that is obvious on the GD*I* side, it is a lot less easy to see it happening on the GD*P* side:

        * On the GDI side the income of the financial sector has grown 2.5 times in percent as part “real” GDI that has grown 3 times, so in absolute terms the finance sector GDI has ballooned by 7.5 times in 40 years.
        *Where is the production (that is sales of services) that matches that increased income? Does the average family really pay directly or indirectly $4k/y in financial sector fees or is it just a colossal accounting “inconsistency” between GDI (a number) and GDP (an index)?

      • August 15, 2017 at 4:01 pm

        Interesting. What I’m seeing is more consumer goods being bought on the never-never, and house mortgages going up over that period from 10 year to 30 year typical; also satiated mass markets and bankruptcies increasing need for credit in mass production, storage and marketing, and banks able to increase charges for as yet unproven new entrants. Such chains of percentage markups accumulate geometrically.

      • August 16, 2017 at 9:54 am

        Blissex and Dave, Robert Kennedy said this as part of a speech just two months before his assassination in 1968. “Too much and too long, we seem to have surrendered community excellence and community values in the mere accumulation of material things. Our gross national product…if we should judge the United States of America by that – counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for those who break them. It counts the destruction of our redwoods and the loss of our natural wonder in chaotic sprawl. It counts napalm and the cost of a nuclear warhead, and armored cars for police who fight riots in our streets. It counts Whitman’s rifle and Speck’s knife, and the television programs which glorify violence in order to sell toys to our children.

        Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile. And it tells us everything about America except why we are proud that we are Americans.”

        Kennedy was only repeating (albeit more eloquently) what the creator of GNP had already pointed out. But the issue is this: how did we screw things up so badly? Banking and finance share a large part of that blame, in my view. Banks and similar institutions have only one product to sell, so to speak – debt. So, they worked hard to create our current world where GDP and debt define all of us and everything. Financial fees are merely one among many ways to do this job. I see no reason banks and financial institutions should not pursue this road to the end. So, each of us may always pay fees to banks to live in a home. Our children may pay for college their entire lives. And their parents may pay for child birth till the end of their lives. And while illness may no longer bankrupt an individual or family, the debt for that illness extends indefinitely from one generation to the next. No business or manufacturer will ever be “out of debt.” And governments will pay finance fees perpetually.

    • Blissex
      September 6, 2017 at 3:18 am

      I’ll try belatedly to explain the problem with the difference between GDI and GDP for the USA case which is particularly blatant, as large “hedonic improvements” are applied to the “real” GDP index, for example:

      http://www.bloomberg.com/view/articles/2016-10-19/no-u-s-manufacturing-isn-t-really-booming
      «Without adjusting for deflation, value added in computer and electronics manufacturing is up 45 percent since 1997. With the adjustments, it’s up 699 percent! What’s happening here is that the Bureau of Economic Analysis has been trying to account for vast improvements in the processing capacity and thus quality of computers, semiconductors and other electronics equipment.»

      Therefore obviously while “hedonically improved” “real” GD*P* for that sector has grown 699%, its “real” GD*I* has not grown by 45%, not by 699%.
      This should mean that “real” (including after hedonic adjustment) GDP growth should be reported to be significantly larger than “real” GDI growth, yet according to the BEA they match.

      How is that possible? Well, not clear, but the simplest assumption is that in other sectors, for the same amount, the reverse has happened: “real” GDP has grown only 45% but “real” GDI has grown 699%. That is the “hedonic” deflation in computer and electronics manufacturing compensates for very real and galloping inflation in other sectors, like finance.

      If that is how “real” GDP and “real” GDI are made to match, my suspicion is that the BEA is trying hard to mask the huge decrease in dollar productivity/increase in inflation in some sectors by “optimistically” estimating large “hedonic improvements” in other sectors.

      My impression is that “hedonic improvements”, whether that’s the intent or not, result in over-estimating the growth rate of GDP in general, and in particular in under-estimating the rate of income inflation in several sectors.

      • Blissex
        September 6, 2017 at 3:20 am

        «its “real” GD*I* has not grown by 45%, not by 699%.»

        I meant: its “real” GD*I* has only grown by 45%, not by 699%.

      • September 7, 2017 at 12:14 pm

        Blissex, what I’m trying to say, like Robert Kennedy is that methods like GDP and GDI really provide little information about what’s important in terms of the long-term stability, durability, and wellbeing of a society, particularly a democratic one. For example, the Dutch calculate GDP. But in terms of legislation and public policy they really look much more to essentials such as voter turnout, kids having fun in school (e.g., time to meet with friends, games, puzzles), public debate on important topics (over half of TV programming is public debate and discourse), volunteerism, integration of peoples and values, etc. Money and economics are certainly part of the lives of Hollanders, but a relatively small part, and one that’s always kept in perspective in terms of other, more important elements.

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