Economic growth, inequality and the middle class

Have middle class Americans truly failed to benefit from economic growth?

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Editor’s note: The following piece is an adapted excerpt from a longer report by the author, published by ITIF. Click HERE to read the full paper.

Inequality will no doubt take center stage through 2016. But it’s important to have the right debate about what growth means for the middle class.
In his 1957 book, The Affluent Society, John Kenneth Galbraith argued that for the first time, we had conquered the problem of providing necessities to the entire population. He projected that within 50 years, the need for work would decrease, and that more time would be freed for the pursuit of higher needs. While this projection has certainly yet to come true, his distinction between absolute and relative needs is important to understanding growth today.

Most people think that growth is something very consequential that accomplishes a great deal—e.g., conquering hunger, providing health care, or getting a good education. While it is true that many people at the bottom of the income scale are barely making do, most Americans don’t have problems with the necessities. Economic growth today takes the form of better products, many consumer gadgets, and more recreation.

In conversations with friends, when I cite such things as computers, cell phones, social media, gaming consoles, HDTVs, high-priced coffee and other baubles, the usual response is that these items are the “frills” and not the important part of economic growth. But they are mistaking the problems caused by a high level of inequality with the potential of the economy to produce a cornucopia of consumer goods and services. Because the top 40 percent of the income distribution is responsible for nearly two-thirds of consumer spending, it should not be surprising to see that growth mainly takes the form of more discretionary items for this sector of the population.

This distinction between absolute and relative needs is all the more critical in the context of a growing debate over economic equality and what to do about it – a debate that was most recently sparked by the runaway success of Thomas Piketty’s Capital in the Twenty-First Century. Among the more spectacular claims by Piketty and his colleague Emmanuel Saez is that between 1979 and 2007 (the last year before the onset of the Great Recession), over 91 percent of income gains due to productivity growth since 1979 were captured by the wealthiest 10 percent of the population. This means that just 9 percent of economic growth during this period went to the benefit of the bottom 90 percent of the population.

In a longer paper for ITIF, I make a detailed methodological case for why the Piketty-Saez analysis is flawed.

I also make the case that in terms of the “middle class” standard of living, Americans have benefitted broadly. In fact, all of the growth that occurred within each of the major consumption categories I show below could not have occurred if the bottom 90 percent of the distribution got only 9 percent of the growth.

In particular, here’s what “growth” means inside each major consumer category for both average Americans and for consumption of that category by the richest 25 percent of the population—those who set the standard to which the rest aspire to:

  • Food and Drink.

Despite spending a much smaller share of our budgets on food across the income ladder, we have shifted dramatically to spending nearly half our food dollars to eating out or buying prepared foods rather than preparing food at home (which is a much cheaper alternative). We have access to fresh fruits and vegetables year-round and a wide variety of choices of every type of commodity. And we can and do consume greater quantities of meats, poultry, fish, and seafood.

The main difference in the consumption of wealthy households in this area is their frequenting of high-end, sit-down restaurants where it is common to spend more than $40 a person for a meal and bottle of wine. The newspapers and local magazines in every major metropolitan area have regular columns and annual lists on the best restaurants in town. While there is a space for “cheap eats,” much attention is directed to “foodies” who are willing to spend much more per meal.

A middle-brow commodity that has grown by leaps and bounds since its founding in 1971 is the Starbucks coffee chain, which now has nearly 12,000 stores in America (and another 9,000 around the world). Before the coffee craze took off, most consumers spent between the equivalent of 50 cents and one dollar for a cup of coffee. Now, a cup of Americano goes for nearly $3 and other options can run to close to $6 a serving. The mass consumption of this kind of coffee is a sign of economic growth because otherwise people would be spending their money on bargain coffee.

  • Housing.

We live in bigger homes and apartments with fewer cases of multigenerational crowding and one-bathroom units. Other advances include much better appliances and more amenities (e.g., air conditioning, central heating, better insulation, WiFi) multiple car garages and outdoor patios). In the 2000s there was a dramatic increase in home ownership that has since disappeared because of the crazy lending policies of big financial institutions that had learned how to make complex securities based on home mortgages. While this was a house of cards that was destined to fail in a big way, this doesn’t offset the long-run trend to better housing.

For wealthy consumers, the operative word is “bigger” with the rise of “McMansions”—homes with 5,000 square feet of space or more. In addition, the prevalence of “gourmet kitchens,” huge bathrooms with Jacuzzis and specialty showers, paneling, “window treatments,” and expensive furniture are often included options. Once again, media outlets follow the local housing market with weekly write-ups of display homes in special sections filled with relevant advertising. Surprisingly, high-end appliances companies such as Thermador and Bosch have regular full-page advertising in the national edition of the New York Times.

  • Transportation.

Relative to every other industrialized country, Americans have many more cars per household and drive them many more miles. This is mainly due to our lower population density and suburban enclaves with more single homes scattered further from urban centers. With a paucity of public transportation, many households are forced to have one auto per adult. Pressure is also put on the government to keep gas taxes low and maintain a wide network of large highways and arteries (we have many more four- and six-lane roads in our suburbs than exist in any other countries). The result is an auto culture in which most people jump in the car for the daily tasks and prize the autonomy that this personal mode of transportation provides. The downside of the single car culture is heavy traffic during rush hours and flare-ups of delays at other times as well.

Not only do we drive more than they do in other countries, our cars are much bigger and have gotten bigger over time (e.g., the remarkable prevalence of SUVs and light trucks). As for added amenities, virtually all have automatic transmission and air conditioning, are more fuel efficient, more powerful, and more filled with technologies like navigational tools, entertainment options, and rear view cameras. The “entry luxury” market is quite large with alternatives from around the world—e.g., Acura, Audi, BMW, Infiniti, Lexus, Mercedes, and Volvos to name just a few. And all of these brands advertise widely.

  • Clothing.

People used to have relatively few clothes but now have homes with many closets to accommodate multiple outfits, shoes, and other choices. While it is quite easy to provide adequate protection from the elements at a relatively low cost, variety and style change rapidly, and there is now specialty clothing for activities like running, biking, yoga, etc. Nowhere is this more evident in the “high performance” clothing that keep cold weather and rain out while being relatively light and easy to move in. Since most of the spending in this area is discretionary, branding has become very important, and the cost of items of clothing, shoes, and accessories varies from tens to hundreds to thousands of dollars.

  • Health Care.

While I agree with most analysts that our system is tremendously overpriced (providing us average care at best), we are also living longer and healthier despite bad eating habits, limited exercise, and widespread obesity. Much of this difference is based on advances in treating a variety of chronic diseases and disorders that in the past used to be considered fatal and incurable.

Our medical knowledge is increasing significantly with advances in genetics and other technologies but obviously still has a long way to go. Given that much of economic growth has gone into spending more on health care, this is often missed in income analyses because the vast majority of health care costs are paid for by insurance (with the majority of the premiums paid for by companies) and by the government through Medicare, Medicaid, and government-run health care facilities. Finally, the advantage of the rich in this area is not as dramatically different as it is in other areas—they have better insurance and often have access to better specialty treatment, especially in cases involving substance abuse, depression and mental illness.

  • Education.

There are so many stories about what is wrong with American education that progress is often underappreciated. The Department of Education annually publishes The Digest of Educational Statistics, which tracks all aspects of education and how they have changed over time.

Here are some numbers that document the progress we have made:

  1. In terms of high school completion, the “status dropout rate” was 15 percent in 1980 and 7 percent in 2011; for African-Americans, the gain was from 28 to 7 percent and for Hispanic youth it was from 34 to 14 percent; for young people living in households in the bottom income quartile, the decline was from 28 to 13 percent.
  2. In 1972, 31 percent of high school graduates enrolled in college in the first year following graduation. Today, that number is 68 percent; among students from low-income families, the gains in this metric went from 31 to 54 percent; and while African-Americans and Hispanics trailed white students by a considerable amount in 1972, this gap shrunk to just a couple of percentage points in 2011.
  3. In terms of degrees awarded, in the academic year that ended in 2000, there were 556,000 associates degrees awarded; 1,238,000 bachelor’s degrees, and 582,00 graduate degrees. By 2011, the numbers shot up to 942,000 associates degrees; 1,716,000 bachelor’s degrees, and 893,000 graduate degrees.

Of course, this does not mean that low-income and minority students have opportunities equal to children from wealthier families. Research shows that the wealthy have cascading advantages that are evident by entry into kindergarten— for example, in terms of larger vocabularies, and exposure to more sources of information and culture – than those from low-income households. Children from high-income families are likely to go to better elementary and secondary schools and to be provided with tutors should they need them. By high school completion, they score much better on college entrance exams and are much more likely to enter highly selective colleges. At all grade levels, children from rich families tend to go to private schools where the classes are smaller and academic options greater.

  • Recreation and personal and business services consumed by individuals.

By definition, these are almost all entirely discretionary expenditures. Many people may be surprised to find out that spending on these activities adds up to more than what we spend on health care.

The Bureau of Economic Analysis (BEA) of the Commerce Department estimates that tourism alone is responsible for $800 billion a year, with an approximately equal amount spent on recreational activities without travelling away from home. And the increase in foreign travel by Americans is another indicator of increases in income. Further surprising is that spending on business services is worth another $1 trillion, which includes banking, brokerage, real estate, insurance, and other spending to manage one’s accounts. Nearly half of this spending is not paid for directly but are “imputed”—e.g., those free checking accounts still require people and machines to produce, and the non-payment of interest offsets the cost of services that the BEA estimates was worth over $200 billion in 2013.

Obviously, there are vast differences in the quality and amount of spending in these areas by wealthy households relative to those with less income. For those with substantial discretionary income, the options are legion – the classic trip to Europe; “adventure travel” to deserts, mountains, and undeveloped areas; stays at specialty resorts catering to golfers, gamblers, or families, plus much more. Middle-income people also have many options which revolve around shorter travel distances and destinations in North America or Caribbean islands.

But the real advance in the last several decades is the cheapening of electronic gadgets. Currently, HDTVs with cable reception are in three-quarters of households, while over 80 percent of individuals ages 18 to 64 live in households with a computer and access to the Internet through some device.

Today, 68 percent of households subscribe to cable television service, up from 20 percent in 1980; and another third pay more for streaming services with 21 percent of households subscribing to Netflix. But the most prized electronic possession is the cell phone, which permits instant access to friends and families. Ninety-one percent of households have at least one cell phone, and 65 percent have at least one smart phone.  In particular, the combination of computers, cell phones, and social media are at the center of many people’s daily life, especially those under the age of 30.

In contrast to Piketty’s analysis, data from the Congressional Budget Office over the same years show that the bottom 90 percent received 59 percent of the growth and the people at the median income level grew by 50 percent. These results are much more consistent with the discussion on rising consumption across the board than the paltry 5 percent growth in the bottom 90 percent found in the Piketty approach.

Neverthless, since the bottom 90 percent did not get its proportional share of growth, inequality rose at the same time that middle class standards of living was rising.

These dual phenomena are reflected in polls on middle class attitudes from the Pew Research Center that reveal both the negative attitudes people have about the overall economy and the positive attitudes they have towards their own situation.

Young people, in particular, are optimistic about their future. In 2010, for example, 63 percent of Americans (including 70 percent of Americans ages 18 to 29) agreed that “although there may be bad times every now and then, America will always continue to be prosperous and make economic progress,” And in a Pew poll in 2012, 59 percent said that they lived better than their parents at a similar age, and only 18 percent said things were worse. Yet at the same time, voters surveyed in exit polls after the 2014 election expressed lots of concerns that the economy was going in the wrong direction.

Given these concerns, economic inequality and what to do about it will continue to take center stage at least through 2016.

But it’s important to have the right debate about what growth means and what the middle class needs for its economic security.

Stephen Rose is a labor economist who consults and writes on economic issues in Washington, D.C. Previously, he has worked for Georgetown University, the Department of Labor, and Third Way.

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