Friday, November 18, 2011

Middle Class Income Stagnation is a Myth

The conventional wisdom is that the middle class, 'The Bottom 99 Percent”, has seen stagnating or shrinking income. Thought inequality has unquestionably been rising rapidly, the conventional wisdom is wrong, a result of measurement problems.

The debate has focused on the exact magnitude of income inequality, ignoring that even the highest estimates are too small to eat up all economic growth. The central problem is underestimation of total growth.

Wages, household earnings and earnings of tax units appear to grow slowly. Between 1970-2008 real wages grew 15%, median household income 16%, and according to Pickety&Saez taxable income of "The Bottom 99 Percent" by 12%.

This contrasts with another more reliable and complete measure. Between 1970-2008 Real Per Capita GDP increased by 108%, based on National Accounts data calculated by the Bureau of Economic Analysis.

How can per capita income double, but the income of the middle class barely go up? According to the Conventional Wisdom, the answer is simple: The rich must simply have taken the rest. Indeed according to Pickety&Saez between 1970-2008 the share going to the top one percent increased from 9% to 21%. Mystery solved!

Wrong. Rising inequality alone cannot account for the gap between output growth and middle class stagnation.

Let’s return to Pickety&Saez and their oft-reported figures. They find that real average taxable income grows only 29% between 1970-2008, when including the top one percent (and including capital gains). This is just a quarter of per capita GDP growth. The discrepancy is not a major problem for their original task of estimating relative inequality, but it poses a problem for estimating growth.

There are at least three measurement problems:

1. Taxable income is only part of total income. In 2008 taxable income as reported by Pickety&Saez was only 58 percent of GDP, a decline from 1970. We can’t just ignore the rest of national income. There is a similar income-base problem with BLS wage data.

2. Average Household and Taxable Unit sizes have been shrinking since 1970, both growing at around one and a half time the rate of population.

3. Inflation is systematically miss-measured, as the Boskin-comission found. When calculating GDP a different and less biased inflation measure is used than CPI-U-RS.

The Congressional Budget Office made their own estimates, accounting for the first two problems, though not for inflation. They confirms that the share of post-tax income going to the top one percent increased from 8% to 17% (a bit lower than Pickety&Saez, perhaps because of household size adjustment and a broader income base). Since the CBO estimate of income growth of 62 percent in the shorter period covered is very close to GDP numbers, their estimates of real middle class income growth are also higher, at 46 percent.

A careful new study by Bruce Meyer and James Sullivan corrects for the aforementioned problems. Similar adjustments are done by Burkhauser et al. (2011) and Gordon (2009). Like the CBO, all these studies correspond better with GDP data, and produce higher estimates of middle class income growth (results summarized bellow).

My simple method is combining the best income-distribution estimate (from Pickety&Saez) with the best income-growth estimates (from GDP numbers). This method shows that that between 1970-2008 the real per capita income of the "Bottom 99 Percent" grew by 80%, and the income of the "Bottom 90 Percent" grew by 60%.


The "Top one Percent" took 25 percent of total growth, half of Pickety&Saez estimate. This is bad enough, so why exaggerate? Let me stress once more that I use their distribution numbers, just a different and more realistic figure for aggregate income growth. Underestimating total growth ironically also leads to an underestimation of how much richer the top one percent became (5 times rather than 3 times richer).

To argue for middle class stagnation one must argue that GDP growth numbers are wrong, and estimates based on smaller income bases right (a claim I have never seen, though I am hardly an expert). More on the topic by the always excellent James Pethokoukis.


Real Median Income around 1970-2008:

Not adjusted, Census: +16%

Adjusted for measurement problems:
CBO: +35%
Burkhauser: +37%
Meyer&Sullivan: +50%
Gordon: +52%

Real Average Income of "Bottom 99 Percent" 1970-2008:

Not Adjusted, Pickety and Saez: +12%

Adjusted for measurement problems:
CBO: +46%
Combining Pickety&Saez with GDP: +80%

25 comments:

  1. I have not read it, but it seems Tyler Cowen accepts the Conventional Wisdom.

    Of course you can make a case that the middle class stagnated 1973-2008 *compared* to 1945-1973, when their income growth was somewhat faster.

    ReplyDelete
  2. Yeah that is his thesis. The 'stagnation' term is exaggeration. The decline of the 2nd order differential needs an explanation. I highly recommend you read it.
    You can start by watching this debate between Tyler and Eric Brynjolffson
    http://www.livestream.com/techonomy/video?clipId=pla_e0493fff-f62c-4a9c-bf6b-2844f9ad8d58&utm_source=lslibrary&utm_medium=ui-thumb

    ReplyDelete
  3. One thing I don’t like is picking 1973 (the height of a boom, just before recession) as a starting point, that is cheating if we want to talk long term growth. So let’s go with a more neutral 1970. Everything is inflation adjusted.

    GDP/capita growth
    1946-1970:+2.1%
    1970-2008:+1.9%

    Do we really need an explanation for this slight decline? The decline is larger if 1973 is (misleadingly) chosen. The typical explanation of a backlog of innovation from the Depression and WWII can easily account for it, don’t see a puzzle here.

    This is a significant problem for Cowen, since his technological explanation requires per capita GDP to grow slower, which it really didn’t.

    Now let us combine this with Pickety and Saez income share data:

    Income growth of “Bottom 99 Percent”:
    1946-1970: +2.2%
    1970-2008: +1.6%

    During the first period reduced income inequality added about a sixth to the income of the non-rich, and during the second period widening income inequality took away a sizable quarter of their growth.

    To the extent that there is a puzzle, it is why the 80% growth of the income of the “Bottom 99 Percent” and 60% growth of the “Bottom 90 Percent” show up as only 10-20% growth in certain measures, such as Average Wages (Remember: Average Wages appear to be stagnating too, not just median!), Median/Average Household and Taxable Unit income.

    The problems appear to be:
    • CPI Overestimates inflation
    • Household/Taxable Unit size declining
    • Wages/Household Income/Taxable Income only includes a part of total income.

    Correcting for some of all these, the papers I cited above get the income growth of middle class to roughly 50-60 percent, same as my method. For instance the 46% number of the CBO is for 1979-2007. During this sub-period my simple combination of GDP and Pickety&Saez income distribution gives 43%.

    When people point out the three problem to Cowen, his leftist readers start shrieking, with little factual basis. Tyler Cowen is a intellectually fair guy, but in this intellectual climate when parts of the left have gone insane the result of being fair is to accepting bad arguments.

    In sum, combining: slightly lower growth than Golden Age, increasing inequality and at least 3 serious measurement problems the puzzle of stagnation is solved.

    Interestingly, in your link Professor Brynjolffson accepts the myth that rising inequality alone can explain why wages stagnate while GDP grows.

    A liberal bias among academic economists plus a bias from qualitative rather than quantitative thinking explains why this lazy explanation became so popular.

    ReplyDelete
  4. How about following (which should strengthen your argument)?

    - Impact of immigration on median incomes

    - Total compensation with benefits vs. wages

    - Distinguishing between the median households and actual households, which will often experience a high degree of income mobility.

    - Disparity in hours worked. http://www.slate.com/articles/arts/everyday_economics/2007/03/the_theory_of_the_leisure_class.html

    - Demographics (baby boomers at peak productivity, their children at lowest)

    - Distributional effects of supply shift of new labor supply from China, etc., which should be evident in other countries with large trading ties.

    ReplyDelete
  5. Good point about starting at 1973. However, then you must also go till 2009 or 2010 as ending at 2008 is also at the peak of the boom.

    ReplyDelete
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  7. There is no Saez&Pickety inequality data after 2008.

    Also 2008 is not the peak of the boom (2007 is), it is a recession year where per capita GDP declined compared to the prior year.

    ReplyDelete
  8. Good information. Thank you for this!

    I do have a question, though. One argument I have often heard in defense of the contention that the middle-class has been stagnating is that the average middle-class family now finds it necessary for both parents to work in order to maintain a comfortable lifestyle, whereas (they argue) "back in the day" a comfortable lifestyle could be maintained on one income alone. Do you have any insights into this? Sometimes I wonder if these people are simply looking back to a golden era that never existed, but I'm not old enough to know from experience.

    If what they are saying is correct- if it really is the case that only a few decades ago a normal middle-class lifestyle could be supported with one working parent- then there would seem to be a tension between your information and theirs. I mean, how could the middle-class be progressing in real terms, while at the same time middle-class families are having to work more hours just to live like they did a few decades ago?

    Thanks!

    ReplyDelete
  9. On average, Americans actually work slightly less now than 1970. Women work more, but men work less. Hours worked have increased for high-income, not low income Americans.

    Careful, state of the art research shows that Americans have more leisure now:

    [1965-2003] “leisure for men increased by roughly six to nine hours per week (driven by a decline in market work hours) and for women by roughly four to eight hours per week (driven by a decline in home production work hours).”

    http://ideas.repec.org/a/tpr/qjecon/v122y2007i3p969-1006.html

    ReplyDelete
  10. Lots of great info, sir, I appreciate the concise and rigorous analysis. I'm a philosophy student so, alas, I don't encounter the hard stuff nearly enough. I was wondering if you could suggest some economic texts that will introduce me to the subject, its historical development, etc. And also, out of this information how do you begin to formulate a critique, a holistic analysis of social arrangement? If you know some figures that go in for that type of thing, please, suggest away!
    ...Just wondering, are the numbers you rattled off consistent with African-American communities economic progression?

    ReplyDelete
  11. African Americans have had slightly faster income growth than average, though the rate of convergence was apparently fastest 1940-1960, and slowed since.

    I suggest starting with an introductory textbook, and reading the parts you care about.

    It’s easier to give examples of readable work in economic history:

    http://www.amazon.com/Concise-Economic-History-World-Paleolithic/dp/0195127056

    http://www.amazon.com/Wealth-Poverty-Nations-Some-Rich/dp/0393318885

    http://www.amazon.com/Ordinary-Business-Life-Economics-Twenty-First/dp/0691096260

    ReplyDelete
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  13. I get so tired of seeing people saying that Boskin found that the CPI overstated inflatio0n and then conveniently ignoring the fact that the CPI was changed to correct the errors he found.

    I've learned that the people who do this are generally
    not worth paying any attention to.

    ReplyDelete
  14. I get so tired of hearing that
    Boskin said the CPI overstates
    inflation and conveniently ignoring
    that the CPI was changed to
    correct the problems he identified.

    ReplyDelete
  15. Speaking as one of those shrieking leftist readers (not that I religiously read Cowen) your argument suffers from one gaping hole: it simply assumes away all questions of equity in a majoritarian democratic society. That is while in sentence two you readily concede "inequality has unquestionably been rising rapidly" you discount this factor to zero in arguing that "stagnant does not mean zero". Okay fine, the numbers run where they do I guess, but what is your defense against "relatively stagnant"?

    The traditional defense of libertarian laissez-faire types in the face of democratic political systems that operate (at least in their proponents' minds) on principles of equity expressed in the pragmatic dogma of "greatest good for greatest number" is some version of "rising tide lifts all boats" that argues that the right criteria is absolute and not relative gain in income/living standard. But the hidden assumption is that people in steerage are in fact riding higher than they would be in a less laissez-faire environment, that the measurement is not just one of absolute growth from a given baseline with any positive number being okay, but that the level is better than it otherwise would have been.

    And that is where traditional liberal economics (in the old sense) falls short, relative outcomes for individual quintiles are just waved away in the face of Ricardian arguments that operate at the level of national accounts. Well the argument made by those who even on your analysis have gained the bulk of the absolute and relative gains to the 85% (99% is hyperbole) that "well heck you are better off than the typical Malian villager" isn't quite satisfying. Not when in theory democratic majorities can, and in 'Old Europe' have introduced social and economic systems based on relative pie slices and absolute outcomes for those who still get smaller slices of the pie than those at the top(I mean there are still billionaires in Socialist Hellhole Sweden) but get relatively larger, and often often absolutely larger, slices of overall gains from productivity than their American counterparts.

    Now there is an exit from this problem for libertarians of a certain mind-think, you simply take the tack of Bryan Caplan of GMU in 'Myth of the Rational Voter'. If you don't agree that the proper measure of success is national wealth writ large and that the relative and absolute larger slices taken by those who control distribution of gains from productivity are just the 'price' of that growth in wealth, then the powers that be should just remove your rights to vote. Problem solved!!!!

    Well yeah, just as Alexander the Great 'solved' the problem of the Gordian Knot. If you just redefine 'Democracy' to 'Kleptocracy' and valorize the latter then all those pesky 'greatest good' arguments discount to zero. The problem is that the kleptos are at least ostensibly still operating in a democratic marketplace. In light of that overly narrow focus on the actual meaning of 'stagnation' misses the point. That is your whole piece starts out from the position: "Yes inequality is growing both absolutely and relatively. So fucking what? Look over there! 'It's Halley's Comet!!!'

    Back up and explain why democratic majorities should NOT demand 'greatest good' outcomes. In other words restore equity to the equation and maybe this liberal will stop 'shrieking' and start 'discussing'.

    ReplyDelete
  16. Tino:

    To be clear on what I think you're saying:

    1. P&S don't include income not shown on tax returns, income which *is* reflected in GDP. Viz: Their 2010 "income control" (the denominator in P&S's "share of the income" calculation) is only $8 trillion, in a $14 trillion economy.

    2. Total income as expressed in GDP per capita, has grown much faster than taxable income per [unit].

    3. While this does not disprove the change in relative shares (you even imply that inequality has increased faster by this standard than by P&S's), it shows that the *absolute* real income of middle-class [units] has grown much faster than suggested by the taxable-income-based P&S measure. (This assumes that that "uncounted" income is distributed in the same proportions as taxable income is distributed in P&S, right?)

    4. The much lower inflation asserted by the GDP deflator (relative to CPI) suggests that absolute real buying power of the middle class has grown faster than suggested by P&S. (The correlation of CPI with the MIT billion-price index leads me to question this line of argument, and equally to question the higher-inflation assertions at shadowstats. I don't think you're invoking the "rich people had higher inflation" argument, right?)

    5. Household units have shrunk, so this further increases growth in income *per person.* (re: "Taxable Unit sizes have been shrinking since 1970, both growing at around one and a half time the rate of population," I assume you mean "shrinking" not growing?)

    5. So the bottom 90 or 99% have actually seen strong absolute real income growth, far stronger than is suggested by analyzing taxable income.

    If the growth was 80% as your calcs assert, MC incomes grew by 2% a year -- about equal to the 1.94% growth in real GDP per capita. If growth was 44% (an average of the other researchers you cite), MC income growth was 1.3% -- suggesting the inequality growth that you suggest elsewhere.

    I'd be very interested to see this approach applied to the true middle income range, say the 30-70%ers.

    @BruceWebb:

    As a fellow screaming leftie, I utterly despise the "greatest good for the greatest number" usage, because it's stupid and meaningless. Which do you want? The greatest good or the greatest number? There can be (but there is not necessarily) a tradeoff.

    Better to say "maximize aggregate utility," and point out that there is a declining marginal utility to monetary income and wealth. So any presumed negative incentive effects on growth resulting from income redistribution must be offset against quite massive utility boosts from that redistribution.

    Also important to point out that those assertions of incentive-based damage to growth are based purely on the substitution effect (if you're paid less you'll work less) -- in almost every case they completely ignore, even deny the existence of, the income effect (if you're make more you'll work less). Nor do they consider the "springboard" effects of redistribution, giving tens of millions of Americans a stable platform from which they have the security to take chances, innovate, start new businesses, and move up the income spectrum.

    ReplyDelete
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