Stalling Incomes - A Post-Great Recession Phenomenon

A recent report by McKinsey Global Institute looks what has happened to household market and disposable incomes since the Great Recession and compares the current situation to what happened in the past.  This is particularly pertinent given the recent rather dramatic growth in global wealth disparity.   In this two part posting, I will first look at the phenomenon of flat or falling incomes and follow it up with part two which will examine why incomes stopped rising and how this will impact the next generation of workers.

McKinsey's research focuses on an interesting and little discussed aspect of income inequality; the proportion of households that have seen their real market incomes flatten or fall below where they were ten years earlier.  McKinsey focusses on the segments of income distribution (deciles or quintiles) and examines how households in each of these segments compare with similar households in the same segment in a previous period, in the case of this study, comparing the period between 1993 and 2005 to the period between 2005 and 2014.  For example, the authors examined whether a person who entered the workforce as a member of the second decile of income distribution would be worse off or better than a person who entered the workforce as a member of the same decile in a previous time period.

A lack of real growth in household incomes is not unprecedented; it occurred during the Great Depression and during the stagflation period of the 1970s.  What is different is the proportion of households that have seen their incomes stall; the authors estimate that two-thirds of all income groups in the 25 nations in the study have seen their economic well being stall over the past decade, representing between 540 and 580 million people.

Households in advanced economies fall into one of three categories:

1.) Not getting by - household income is below the poverty line.

2.) Not catching up - household income is not rising as rapidly as people in the next-richest population decile.

3.) Flat or falling - household income is either flat or falling.

Here is a graphic showing the percentage of households in each category:

In their initial analysis, the authors focussed on income segments in six economies; France, Italy, the Netherlands, Sweden, the United Kingdom and the United States.  They found the following regarding real market and disposable income:

1.) both incomes and GDP rose from the end of World War II to the mid-1970s for the majority of the population.

2.) this pattern broke down during the period of stagflation in the period from the mid-1970s to early 1980s.

3.) both incomes and GDP rebounded during the late 1980s and continued until 2005.  Per capita GDP rose by two to four percent per year and real median household income rose in tandem.

4.) in 2014, the situation changed dramatically.  Market incomes of 65 to 70 percent of income segments in advanced economies were flat or falling compared to their level in 2005 (i.e. pretax household incomes based on income decile averages did not advance between 2005 and 2014. 

The authors found that in the six aforementioned focus countries, more than 400 million households were in income segments that experienced either flat or falling market incomes compared to only 2 percent of households that experienced the same income stagnation in the period from 1993 to 2005.  When measured using disposable income (income after taxes paid and transfers received), between 20 and 25 percent of households were in income segments that did not advance between 2005 and 2014 compared to less than 2 percent in the period between 1993 and 2005.

Here is a graphic that shows a country-by-country breakdown of the percentage of households experiencing flat or falling market and disposable incomes between 2005 and 2014:

As you can see, Italy comes off the worst with market incomes falling in 97 percent of income segments and disposable income falling in 100 percent of income segments.  The drop in disposable income was largely a result of increasing taxes and benefit reductions related to austerity measures that the government imposed to control its mushrooming debt and deficit problems.  In the United States, 81 percent of income groups saw a flattening or decrease in market income but only the top 1 percent of the population had either  flat or falling disposable income.  This was largely due to government intervention during and after the 2008 financial crisis.  

Here is a graphic comparing the total growth in market and disposable income for each income quintile on a country-by-country basis, comparing the period from 1993 to 2005 (black line) and 2005 to 2014 (blue/grey bar):

You can quickly see how strongly income growth levels plummeted between 2005 and 2014 when compared to growth levels between 1993 and 2005, particularly market income growth for middle income groups; in the United States, the Netherlands, Italy and the United Kingdom, middle income groups saw their market incomes drop by between 4 to 10 percent.  In only one case, the second income quintile in Sweden, did market income growth over the period from 2005 to 2014 exceed its growth level over the period from 1993 to 2005.  When looking at disposable income growth, none of the jurisdictions and income quintiles saw growth in the period from 2005 to 2014 exceed growth in the previous period. 

To close this posting, let's look at a graph from FRED which shows what has happened to average real hourly compensation in the United States since 2000:

Over the period from Q1 2000 to Q1 2016, real wages have grown by 21.86 percent, resulting in a compounded annual growth rate of 0.99 percent.  Looking at the period from Q3 2006 to Q2 2014, real hourly wages were basically flat over a nearly eight year long period.

As we all suspected when looking at our personal finances, wage growth has stagnated, particularly when compared to the level of wage growth in the past.  In the second part of this two part posting, I will examine why incomes in developing economies have stopped growing, a factor that will have a significant impact on the next generation of workers.