The real middle-class squeeze

Given the obsession with economic inequality, you might think it’s the main force squeezing the middle class. It isn’t. We have this not from some right-wing think tank but from President Barack Obama’s top economists. The bigger culprit, they show, is the slow growth of productivity — that messy process by which the economy improves efficiency and living standards. Greater inequality is a distant second in assaulting middle-class incomes.

So concludes the annual report of the White House Council of Economic Advisers. The CEA, as it’s known, performed a fascinating “what if” exercise. Assume that the most favourable post-World War II trends had continued, it said. Specifically: Productivity maintained its rapid growth of the 1950s and 1960s; inequality stayed at lower levels; and labour-force participation didn’t drop.

What happens then to middle-class incomes?

Answer: They double. The income of the median household goes from roughly $50,000 to $100,000 after inflation. The biggest increase, about $30,000, would stem from faster productivity growth. Less economic inequality would account for $9,000 and higher labour force participation — more workers — for $3,000. (Yes, that’s only $42,000; the rest reflects the favourable interaction of the three trends.)

Just why this didn’t happen is a central economic story of our time. The CEA doesn’t offer a comprehensive theory. It merely divides the post-war era into three sub-periods based on the economy’s changed performance. For example, the years from 1948 to 1973 are labelled “The Age of Shared Growth,” because the economy grew rapidly and gains were widely distributed.

I’d tweak the CEA’s approach slightly. Here’s how I’d characterise the different phases of the post-war economy.

The Postwar Boom, 1945-64: It was unexpected. Memories of the 1930s endured. A 1946 Gallup poll found that 60 per cent of Americans feared a depression within a decade. But underlying conditions favoured expansion. There was a huge pent-up demand for consumer goods as a result of weak spending in the Depression and the war; also, a backlog of new technologies to be exploited (television, synthetic fibres, air conditioning, jet travel); and low household debt. Suburbanisation was in full swing. As the CEA notes, income gains were widely shared.

The Great Inflation, 1965-1982: We couldn’t let well enough alone. Economists argued that deft policies could keep the economy close to “full employment” (defined as a 4 per cent unemployment rate). The experiment backfired. Inflation — virtually non-existent in 1960 — hit 6 per cent in 1969 and 13 per cent in 1979. This led to four recessions (1969, 1973, 1980 and 1981). Because no one seemed capable of subduing inflation, people lost faith in national leaders. Rising foreign competition deepened pessimism.

The Great Moderation, 1983-2007: A period of brutally tight money, engineered by Federal Reserve chairman Paul Volcker, crushed inflationary psychology and started a 25-year boom. There were only two mild recessions (1990, 2001). As inflation fell, so did interest rates; and as interest rates fell, stocks and home prices rose. People spent or borrowed against newfound wealth. The personal savings rate dropped from 10.6 per cent of disposable income in 1980 to 2.5 per cent in 2005.

The Big Scare, 2008-????: The boom’s confidence turned self-destructive. People overborrowed; lenders overlent. What was scary about the ensuing crisis was that it was supposedly made impossible by modern economics and financial regulation. The fact that it happened anyway made consumers and business managers extra cautious. They are now protecting themselves against both known and unknown risks. We remain in the grip of “the big scare,” though it may be loosening.

What this history teaches is that we have less control over our economic destiny than is often assumed. At every juncture in the chronology, people — including “experts” — did not foresee the next major change. In the early 1960s, they didn’t anticipate high inflation; in the late 1970s, they didn’t expect its demise. In this respect, the surprise 2008-09 financial crisis was typical.

The same ignorance inhibits what we can do for the middle class. Government — a.k.a., politicians — can address some middle-class wants by redistributing income from the rich through tax breaks and subsidies. But this approach has limits and not merely because the rich will resist.

Recall, as the CEA found, that inequality isn’t the main cause of sluggish middle-class incomes. It’s poor productivity. There are always rhetorical solutions: more infrastructure spending; better schools; simpler taxes; more research. Though some policies may be desirable, there’s no guarantee they will improve productivity. Influencing productivity is hard because it depends on so much (management and workers, technology, market behaviour, government policies and more).

We simply don’t know how to orchestrate predictable productivity increases. If it were easy, it would already have been done. Saving the middle class, though popular, is qualified by economic reality. Our ambitions often exceed our powers. — © 2015. The Washington Post.

Saving the middle class, though popular, is qualified by economic reality; our ambitions often exceed our powers

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