The Incredible Shrinking Middle Class by Michael Moffitt

Headline: Shrinking Middle Class A Threat to Stability
Dateline: April 11, 2019, The Wall Street Journal, p. A6

This article opened, “The middle class is shrinking and its economic power diminishing in the U.S. and other rich countries, a development that threatens political stability and economic growth according to a report by the Organization for Economic Cooperation and Development. (OECD)”

The article continues, never questioning or explaining this assertion of doom, “At the peak of its powers in 1985, the aggregate income of the middle class was four times that of the richest group. Three decades later it had fallen to less than three times.” The alarm of panic was sounded in the article by the quoting the dreadful 30-year shrinkage of the middle class all the way from 64% to 61% of our population.

It seems strange that, on the sports page where statistics are always prominent, we never read such statistical mumbo jumbo. We see frequent celebrations of new performance records but never comparisons between the best and the average. There are no statistics about the middle class of athletes because nobody cares. There is seldom whining about how sports are being ruined by the over-achieving of those few who outperform all others. People don’t complain that new marathon records don’t help them walk their dog any faster. Is there any field of human endeavor or any place on earth where everyone is above average or where eighty percent of the entrants can remotely hope to compete with the best one percent? Do we ever teach our children to strive for their personal average?

We frequently hear this assertion that financial over-performance of the few is at the expense of the middle class and will result in our doom. Who is this “middle class?” How badly are they suffering? How fast are they falling behind and why? Is the trend reversible? Has it discouraged mobility? What can or should be done about it. None of these seem to be the most frequently asked questions, which makes them all the more interesting.

Wikipedia says you can find definitions of the middle class that vary from the middle 20% of incomes to the middle 60%. Note that by either of these definitions the middle class can become richer or poorer, but it can never grow or shrink. Our WSJ article (above) cites an OECD definition of middle class as households with incomes between 75% and 200% of median household income. ¹ In the United States this translates to $23,400 to $64,000 for a single person or from $41,500 to $166,000 per household. Using this definition and Bureau of Labor Statistics data we find that two above average high school dropouts in a household, both working, make a combined income more than $53,000 annually putting them squarely in the middle class. We also learn that an above average single fresh computer science or engineering graduate is too rich to be in the middle class. Personally, I find this information more confusing than illuminating.

In 1933 unemployment reached 24.75% not including many others working part time or at reduced wages. Manufacturing activity shrank by 25% from its 1928 peak. The farm population surged to 24.9% for the first time on record as people moved back to the land in large numbers. Farm prices plummeted. Peak wheat prices in 1925 at $2.14 per bushel fell to less than $.50 in 1932. Farm output was decimated by widespread drought. The value of stocks in the market fell by 83%. Over half of our population was desperately poor. The middle class evaporated. Government was helpless. Only World War II, increased financial liquidity and debt pulled the economy and the middle class back. The resulting debt was paid off with post war growth and cheaper dollars after post war inflation.

The lesson here is that recessions great or small can be extended by government misdirection and will cause shrinkage of the middle class. More important, the middle class can shrink to great depths and come back quickly by a vigorous people and a free economy. If we think about it, we know several things about how this all works.

First, in any economic downturn, the most vulnerable get hurt first. The least powerful and least productive are the first to lose their jobs. The least profitable businesses are the first to go broke. More people slip out of any given level of prosperity due to being less well off than climb into it due to increased income. Inevitably, income disparity decreases and “middle class incomes” shrink

Second, in periods of economic recovery or growth this process reverses itself. The people that have nothing gain at the fastest rate. As employment expands, the unemployed find jobs, part-time workers work more hours, starting wages are the first to rise and marginal businesses build a cushion of profits. More people climb into any given level of prosperity due to being better off than slip out of it due to reduced income. Inevitably, population in every income category except the very least well off grows.

Third, rising levels of education create a rising middle class and greater income inequality. If this were not true, there would be no economic incentive to seek higher education. Today, about 35% of our work force has no formal education beyond high school vs. 45% twenty-five years ago. Meanwhile, today 40% of our work force has bachelor’s degrees or higher vs. 28% twenty-five years ago. It should not be a surprise that the 40% with the least have only grown their real incomes by about 0.5% annually over that twenty-five year period. The world has become more competitive but this group as a whole has not added qualifications to learn higher-level skills. Nor should it be a surprise that with higher levels of education, income level in the middle of the top 40% has grown at a 1.0% annual rate, two times the growth rate of the bottom 40%.

Fourth, rapid innovation makes the most successful innovators more wealthy and makes it more difficult for the least competitive to catch up. In a free society, every great period of innovation produces great fortunes. Think railroads, Rockefeller, Carnegie, Mellon, Morgan and Vanderbilt in the nineteenth century. Think Ford, Coca-Cola, Eastman Kodak, Xerox, Watson (IBM), semiconductors, Gates (Microsoft), Jobs (Apple, Pixar), Fred Smith (Federal Express) and Walton (Wal-Mart) in the twentieth. We begin the twentieth century with Page and Brin (Google), Hastings and Randolph (Netflix), Bezos, and Zuckerberg and many more in the wings. These great fortunes increase the number of people with great wealth. Millions of other lives become better and richer with economic growth resulting from their innovations. Unsuccessful innovators lose, but those losses are dwarfed by benefits of innovation and the rising economic tide it creates. People at the bottom of the economic ladder often do not have the skills or resources to keep pace, but they still enjoy benefits from innovation (think cellphones and computers), and at least the opportunity to breakout to a higher level of prosperity.

Fifth, freedom is far more powerful than just the freedom to innovate. Free markets are the essence of democratic society. In an economy regulated by free markets every buying decision by every citizen is a vote by the buyer to give resources to the seller in exchange for a product or service the buyer deems worthy of the price. If a seller does not provide value in the eyes of buyers, the seller goes broke. If the seller produces the best products or services at the lowest cost, the seller gets richer and his business grows. Sometimes it becomes important for government to overrule the free market, but each time it does, an economic price is paid. In the eyes of the people who ultimately pay all the bills, the market sets the most equitable price and government’s decision to alter the allocation of resources in the economy makes the economy less just and less productive. Even with good reasons for government to regulate the free market we should always remember that in the extreme, government allocation of economic resources is incompatible with economic growth and individual freedom. There has never been and there can never be an innovative and growing economy that is not primarily regulated by free consumers who assess the value of all things as they pay all the bills.

Finally, subsidies do not get counted in most income statistics and as a result are not recognized in many discussions of income distribution and disparity. Nevertheless subsidies are important and they do count. In the last fifty years the United States has built a web of subsidies to increase income for our least fortunate. Many of these, including Medicare and Social Security, go to all citizens or are counted in income statistics. The income transfers from richer to poorer citizens not accounted for in income statistics now approach one trillion dollars per year. ² Roughly this means that the average household within the top 40% of incomes gives the average household within the lowest 40% an annual income transfer of over nineteen thousand dollars tax free. Including these subsidies nearly every family within the lowest 20% of incomes has more than doubled their real income in the last fifty years. Including subsidies, the poorest 20% of us has more than kept pace with the income growth of all income groups except those in the top five percent of incomes. To discover the total scale of generosity in our great country, add to this one trillion dollars all the non-cash benefits provided to the less fortunate by great and small foundations and the $400 billion donated to private charities each year by individual citizens.

If our goal is to increase the economic welfare of the middle class, we need to recognize how they became the richest middle class in the history of the planet and to do more of it: to stimulate economic growth, to promote education for those who value and appreciate it, to preserve and promote natural and democratic regulation of the economy by the free market, and especially to promote incentives and freedom to innovate. We need to celebrate the rock stars and entertainment stars and science stars and athletic stars and business stars. These are the people who raise the bar for all of us and upon whose shoulders future generations will stand. We need to emphasize to our political stars that the citizens produce all the wealth and government’s only legitimate role is to protect their freedom to do so. Real political stars understand they serve the people, forsake demagoguery and embrace equal protection and opportunity under the law. They also embrace the natural law that equality of everything for everyone is a utopian nightmare and the antithesis of equality of opportunity for all.

Some argue that this discussion ignores the frustration of those who do not participate in or are left behind by economic growth. To these people we should ask. “Is it just that each of us is free to try?” “How can success have meaning or purpose if failure is not a possibility?” “How do we help those who fail without eroding their responsibility and incentive to be creative and productive?” “How do we strike the balance between freedom for those who are productive and security or comfort for those who are not?”

Most important of all, we all need to recognize and reject demagogues: those who promise ease and promote blame, those who divide us according to race or sex or age or religion or, income; those who would suppress debate and demand simple solutions for complex problems; and those who preach doom if they are not heeded. In their place we must seek leaders who challenge every citizen to strive for our personal best in every aspect of our lives. We should believe in our history where a free and responsible citizenry has demonstrated the path to the most innovative, productive, generous and mobile society on the face of Earth.

Finally, looking at census statistics, simple arithmetic tells us five things for certain about the “middle class”: A middle class defined symmetrically around median income can never grow or shrink as a percent of the population. The income of our middle class continues to grow. The income of most below the middle class has grown faster than the middle class only because of increasing federally mandated income transfers. Those above median income up to the top five percent of incomes are growing incomes more rapidly due to higher levels of education and innovation. Those in the top five percent are growing their incomes and increasing their taxes and their generosity even more rapidly, driven by education, innovation, accessibility to international markets and investment income.

How could it be otherwise? Why should it be otherwise?

Michael Moffitt
Michael Moffitt Column

¹ In elementary statistics we learn that any subset defined as a positive function of the median of a distribution will inevitably shrink as a function of any growth in the standard deviation of the population. Further, this shrinkage will be amplified if the subset is asymmetric and the standard deviation grows asymmetrically in the same direction. In simple English this means that the OECD decision to define middle class as asymmetric around the median household income guarantees that the middle class will shrink if the population becomes more prosperous.

² The bulk of these funds are distributed via Medicare and Children’s Health Insurance Program ($583 billion), Social Security Disability Insurance ($143 billion), Earned Income Tax Credit ($72 billion), Food Stamps ($70 billion) and Federal rental assistance ($44 billion)

Granddad’s Dictionary: Reflections on Life in America
by Michael Moffitt
ISBN: 978-1-4908-2916-6 (sc)
978-1-4908-2917-3 (hc)
WestBow Press
Published April 7, 2014
170 pages
Softcover: $12
Hardcover: $23

Author: Michael Moffitt

Michael Moffitt is the author of Granddad’s Dictionary: Reflections on Life in America. He is an inventor, entrepreneur, philosopher and economist. He earned a bachelor’s degree from Northwestern University and an M.B.A. from the University of Chicago.

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