Tuesday, March 17, 2015

Exclusive Prosperity - The Disappearing Middle Class

Economic historians have long pointed out the importance of the contributions of the middle class to economic development.  This occurs through three mechanisms:

1.) the middle class is the incubator for entrepreneurship and innovation.

2.) middle class values stress the accumulation of savings and human capital.

3.) the consumption power of the middle class leads to diversification and expansion of markets.

If you think of it in terms of the 0.1 percent and the rest of us, one extremely wealthy individual is unlikely to buy 1000 toasters, computers, automobiles and homes whereas, the 999 who are defined as middle class consumers, are most likely to buy 999 of each item between them.  That's the power of middle class consumption in today's economy.

A recent report from the Center for American Progress examines the key role of the middle class in global prosperity.  The Inclusive Prosperity Commission, which includes former U.S. Secretary of the Treasury Lawrence Summers, begins by noting that in the decades following World War II, rapid economic growth brought hundreds of millions of people around the globe to a position where they had economic security through both benefits paid by employers and those provided by government social programs.  Households in the last half of the 20th century widely believed that hard work would result in economic security for their families.  This model of the economy has come under severe stress in recent years with downward pressure on growth in wages, particularly for the middle and lower classes.

In the report, there are a handful of graphics that go a long way to explaining the issues facing the world's, and particularly America's, middle class.  Here is a graphic showing the average growth rate of incomes for the bottom 90 percent of earners over ten year periods from the 1950s to the 2000s, including 2010 to 2012 in light blue, for six advanced economies:

As you can see, average income growth for the bottom 90 percent in the latest partial decade has been either slower or far slower than growth in earlier decades for all nations except Australia.  In the cases of the United States, Japan and the United Kingdom, income growth for the bottom 90 percent has actually been negative over the period from 2010 to 2012.

Here is an interesting graphic that compares the growth in productivity (in brown) to the growth in average income (in blue) for the bottom 90 percent for the same six advanced economies:

In every case but Canada, productivity growth has outstripped income growth, in some cases by a very wide margin.

Now that we know that the bottom 90 percent of earners have suffered from low rates of income growth and since the middle class has been responsible for the lion's share of economic growth since the Second World War, what impact has exclusive prosperity had on economic growth?  Here is a graphic that sums up the relationship very neatly:

In almost every case, the average annual GDP growth rate in the period between 2010 and 2013 has been significantly lower than what it was in the decades going back to the 1950s.

Let's focus on the United States.  Here is a graphic that shows the changes in wages for full-time male workers in the United States from 1963 to 2008 based on educational attainment:

Over the last four and a half decades, only college graduates and those who attended graduate school saw their wages rise.

This graph shows the impact of stalled wage growth:

Since the middle of the 2000s, the labor share of income has been steadily dropping, particularly after the Great Recession.  In fact, labor's share of income in the third quarter of 2014 was just above its lowest level since 1947.

On the other hand, this is what has happened to the real output per hour of American workers:

This is what has happened to corporate profits:

While labor's share of income has plummeted, real output has continued to grow and with it, corporate profits.  This tells us that worker power has declined significantly at the same time as corporate power has grown.  As growth of wages and incomes has slowed and productivity has risen, the beneficiaries of economic growth have been shareholders and top management rather than employees.   This shows us that, as noted in the title of this posting, prosperity has become exclusive.

The report concludes by looking at five key areas that need to be developed to create inclusive prosperity:

1.) returning to a real wage growth environment to raise living standards and provide profit-sharing and share ownership for all employees so that everyone benefits from corporate success.

2.) raise skill levels for workers through education through both on-the-job training and post-secondary trade and non-trade formal education.  While this may reduce profits over the short-term, it  will provide long-term benefits.

3.) support and promote innovation because innovation drives growth in productivity.

4.) align corporate executive incentives with long-term profitability rather than focussing on short-term profits.  The shift to equity-based pay has caused management to maximize profits rather than maximizing the long-term value of the company.  As it stands now, executive stock option plans are designed to enable executives to make considerable personal gains when share prices spike rather than through longer-term corporate growth.

5.) countries must co-ordinate their efforts to  ensure that global economic growth is sustainable.  Part of this should be achieved through restored integrity in corporate taxation.

As the authors of the report note in their preface:

 "History tells us that societies succeed when the fruits of growth are broadly shared.  Indeed, no society has ever succeeded without a large, prosperity middle class that embraced the idea of progress.  Today, the ability of free-market democracies to deliver widely shared increases in prosperity is in question as never before. The primary challenge democracies face is neither military nor philosophical. Rather, for the first time since the Great Depression, many industrial democracies are failing to raise living standards and provide opportunities for social mobility to a large share of their people. Some of those countries that have produced economic growth have done so in a manner that has left most of their citizens no better off. This is an economic problem that threatens to become a problem for the political systems of these nations—and for the idea of democracy itself."

It certainly appears that today's marketplace is not working in favour of either long-term economic prosperity or the interests of the middle class, rather, it is focussing on maximizing very short-term, quarter-by-quarter corporate profits.  Without aligning the interests of middle class employees with the interests of those that dwell in the corner offices on the upper floors of office towers, we can look forward to a future of modest economic growth. 

1 comment:

  1. Another piece of information is the labor participation rate. This is why labor share is going down. Don't want to do something(stay late work off the clock), you’re done, next guy up who will do the job and do it for less. Think because you have a fancy degree and deserve more money for what you bring to the company, nope, wrong the guy from India will come in on an H1B1 visa do your work and the guy who used to sit next to you his work as well for half of what you used to make.