Economic Stress and the Middle Class, Part I

May 2014
Ivan Obolensky

In the United States it has been observed that in order to enjoy the benefits of the Middle Class a family must receive an income in the top 20% of the population (minimally over $105,000)¹. The next few articles will examine how this might be true, what factors have contributed to this result, and what if anything can be done about it.

Firstly, is the datum correct? Does it really require an income that high to afford the goods and services that many of our parents’ generation and their parents’ generation enjoyed routinely?

The ‘middle class’ is defined as that social group between the upper and working class. It includes professionals and business workers and their families.

Here is a list of attributes from various sources that I think summarizes the Middle Class in the United States during the 1960s and 1970s when it was at its strongest.

The typical Middle Class family lived in a home that was affordable and was close to 50% or more paid for. For those close to retirement, it was fully paid for.

One of the elements that marked Middle Class neighborhoods in the past was home ownership where the majority owner was not a bank or lending institution. Generational hand-down of fully owned property was normal.

Income and expense ratios that allowed 10% of income to be saved.

The middle class of the 1960s and 1970s always had savings.

Two cars were parked in the garage with probably a third for the kids parked in the driveway.

A 1967 Corvette Stingray cost around $5,000. A 1970 BMW 2002 imported from Germany, as listed in Car and Driver, showed a list price of around $3,000. Most families had two cars which were made in the United States.

Retirement savings existed in substantial amounts.

This would mean having either a pension plan that was fully funded and would provide for at least 50% of current wages for life with the balance coming from retirement savings or even Social Security. Many corporate workers had large stock holdings of their company stock.

Accessible medical care was available if needed, and could be paid for easily.

There was never a question of not being able to afford medical care.

The ability to pay off credit cards every month, except for vacations which might require double payments with the debt retired in six months, was the norm.

Having an American Express Card was unusual. Having a credit card other than a gas card was also unusual. People wrote checks. People paid in cash.

Job security existed.

Many of the Middle Class of this period worked for Fortune 500 companies as part of Middle Management. Job security was assumed until the late 1970s. Insecurity started with the precipitous rise of the dollar due to inflation from earlier government spending. Government outlays ballooned as a result of the Vietnam War, NASA, the Great Society program, and the War on Poverty. To combat inflation, the Federal Reserve policy became one of increasing short term interest rates which made the US a haven for foreign money. The dollar climbed so high that the US manufacturing sector found it impossible to survive due to the high relative cost compared to almost any other country but particularly Europe and Asia. Cost reductions became the order of the day with middle management being the main target as Union jobs were protected.

Education was a necessity for children with college funds available for those that qualified including advanced degrees. It was expected one would go to college. Engineering and medicine were typical programs.

It was assumed you would go to college and not necessarily on a scholarship unless you were extremely bright and driven.

Heirlooms and physical assets such as art, silver, and old cars, existed and were available to be passed on to the next generation.

Families had houses and the houses were filled with things from previous generations that had been handed down. In a sense they were an extra reserve fund as many items had value.

Necessary funds to put children through sports programs, camps, and other educational programs were there.

Everyone paid taxes.

Today less than a third of the US population files taxes for the Federal Government, which automatically makes those in the Middle Class in the top 33% of the population today.²

The above is probably incomplete but what is most important as an impression was that as a group there existed in it a sense of financial permanence and stability. This is a qualitative attribute but going forward it is useful in the sense that it does not specify an exact amount of income earned annually as a criterion for membership. The income level required can float up or down depending on circumstances.

Part of the pressure that the Middle Class in the US has experienced has to do with income levels. The amount needed is different today than previously. Many today feel financial stress. One reason for this is the following:

Although incomes today have increased markedly since the ’60s and ’70s, real wages on average peaked in 1972 and have remained flat ever since.

“Real wages” take into account inflation and therefore express the buying power of money paid for the work completed.

A hypothetical example might be receiving ten dollars an hour in 1970 and being able to buy four cheeseburgers and four cups of coffee including tip. In 1980 one might have received twenty dollars an hour, a one hundred percent increase in hourly rate, but been able to buy only three hamburgers and three cups of coffee with the tip being extra. One’s income may have doubled but the buying power of the money received decreased at a faster rate. In reality one’s earnings went down. This characteristic is reflected in Real Wages because that measure takes into account the actual buying power of the money received.

To repeat so that it is clear: Real wages in the United States on average have remained flat having peaked in 1972.

This information is contained in the appendix to the 2013 Economic Report to the President titled Table B-47: Hours and earnings in private nonagricultural industries, 1966-2011.³

This is a stunning fact, but is it true? It may be, but there is more to it than that.

I am sure you can find exceptions, which is exactly what a certain economics professor did. William Baumol is the discoverer of what is known as the Baumol Effect, or Baumol’s Cost Disease.

William Baumol was born in 1922 and was a professor at Princeton. He wrote extensively about labor markets and entrepreneurship. He was a candidate for the Nobel Prize in 2003 and is affiliated with NYU’s Stern Institute.⁴

To get a grasp of what the Baumol Effect is, one has to understand productivity and productivity increases.

Productivity has several definitions. One commonly reported by the media and used here is the ratio of GDP (Gross Domestic Product) to hours worked per unit of time. The bureau of Labor Statistics reports this measure four times per year. As more output is produced per time unit per individual worker, productivity is increased.⁵

Baumol looked at the relationship of this productivity and costs.

There are jobs where productivity can be increased fairly easily such as in a factory using automation on a production line. As more robotic computer-controlled devices are added, fewer humans are needed, but for every paid hour of a wage-earner overseeing the production line, more goods are made so productivity is increased. With increased productivity comes increased Gross Domestic Product (GDP), the overall measure of economic production in a country. Increases in productivity and its downstream effects (corporate earnings, for instance) justify increased wages to employees.

Not all occupations are like this. Some jobs are more labor intensive than others and productivity increases are difficult to make if not impossible.

Teaching is one. It still takes just as long to read and correct an essay today as it took fifty years ago. Education has attempted to increase productivity by relying more and more on multiple choice tests. College examinations are one Scantron* multiple choice form after another.

Baumol and William Bowen, also of Princeton, examined the salaries of those in the performing arts during the 1960s.

This area of the economy, along with teaching and nursing, has far lower rates of productivity increase than occupations in manufacturing.

They showed that it takes the same number of musicians and hours to train for and perform a live violin concerto in 1870 as it does today. Productivity has not increased yet real wages for musicians have.

Their conclusion was that low-productivity-gain-jobs compete with jobs with potential high-productivity gains in the workplace. They discovered the counter-intuitive result that although high potential-productivity-gain jobs naturally pay increasing salaries over time, those in labor-intensive-low-productivity-growth occupations experience higher rates of income increase.

The reason for this is that fields that have labor-intensive-low-productivity-growth jobs have to offer higher salaries than those in high potential-productivity-gain sectors to simply retain people because otherwise they would pack up and get a job in a field where continuous productivity increases would guarantee a rising salary.

Baumol predicted, therefore, that the costs of goods would fall over time but the costs of healthcare and education would rise and require a larger and larger share of national income and GDP to sustain them. His “cost disease” has proven true in that college tuition has outstripped even medical costs in their rate of increase by almost a factor of two. Medical costs have also risen since the late 1970s. They have gone up over 500% while normal costs of goods and housing has increased 300% over the same period.

To compound the issue, this phenomenon appears to be structural in nature.⁶

Structural means it is intrinsic to the system itself and that attempts to legislate it away or attenuate it using mandated external fixes are likely not to work over time.

With real wages flat and education and medical costs taking a larger and larger slice of GDP as well as family incomes, less is available for other needs. This creates economic stress and difficult choices.

Although Baumol’s Cost Disease explains some of the difficulty that the US Middle Class as well as the US Government is experiencing, the picture is still not complete.

We will explore this further next time.

*Scantron is the name of a company that prints multiple choice forms. I did some college courses a couple of years ago. All exams used Scantron forms with choices A-E that one had to fill in using a Number 2 pencil. Tests were marked by running the completed forms through a Scantron machine which prints out the score of each student which the professor retained for their records. Essays were minimal.

1. Table HINC-06. Income Distribution to $250,000 or More for Households: 2011. Retrieved on May 12, 2014 from http://www.census.gov/hhes/www/cpstables/032012/hhinc/toc.htm.

2. Smith, C. H., (2014, May 05), The Destabilizing Truth: Only the Wealthy Can Afford a Middle Class Lifestyle, of two minds.com Charles Hugh Smith. Retrieved on May 12, 2014 from http://charleshughsmith.blogspot.com/2014/05/the-destabilizing-truth-only-wealthy.html.

3. Thomas, K. (2012, March 12), Basics: Real Wages Remain Below Their Peak for 39^th Straight Year. Middle Class Political Economist. Retrieved on May 12, 2014 from http://www.middleclasspoliticaleconomist.com/2012/03/basics-real-wages-remain-below-their.html.

4. Baumol, W. J. Retrieved on May 12, 2014 from http://www.stern.nyu.edu/faculty/bio/william-baumol.

5. Productivity. Retrieved on May 12, 2014 from http://dictionary.reference.com/browse/productivity.

6. N.A. (2012, September 29), An Incurable Disease? A new book explains how health care can become both more expensive and more affordable, The Economist. Retreived May 12, 2014 from http://www.economist.com/node/21563714.

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Categories: Articles, Articles (General) Tags: Ivan Obolensky