Middle-class stagnation?

| Wednesday, Nov. 23, 2011

Are Wall Street's "Occupiers" correct to allege that the richest 1 percent of Americans pay for their luxuries by stealing from the bottom 99 percent?

One can question the intellectual credentials of the Occupiers. They're overly fond of juvenile platitudes. But don't blame them too terribly much for believing that American prosperity has been hijacked by a handful of plutocrats.

Not only has Uncle Sam recently revved up his corporate-welfare handouts, the mainstream media have spewed forth for many years now countless stories of middle-class stagnation.

This stagnation narrative says most Americans have treaded water economically since the mid-1970s, with only the richest experiencing sustained improvement in their material well-being.

For example, Robert Reich, former Labor secretary, lamented in 2008 in The Financial Times that "Almost all the benefits of economic growth since (the 1970s) have gone to a small number of people at the very top."

One bit of evidence often used to support this gloomy claim is the fact that median household income in America, when adjusted for inflation using the Consumer Price Index (CPI), was only 18 percent higher in 2006 than it was in 1976. That's a pathetically poor growth rate.

But let's look more carefully at the data.

First, the average number of people living in an American household fell between 1976 and 2006 from 2.86 to 2.56. The result is that a given amount of income in a typical household is today shared by fewer people. Each person now gets a bigger slice of the household's pie.

So the 18 percent rise in real median household income from 1976 through 2006 turns into a 32 percent increase in real median household income per person.

Still not great growth, but it's noticeably less gloomy than the 18 percent figure -- and it's economically more accurate.

Second, inflation is likely overstated . Because the dollar's purchasing power fell during these years, 2006 dollars aren't comparable to 1976 dollars. To make them comparable requires some inflation adjuster.

The best-known adjuster is the CPI, but it's not the only -- or necessarily the most reliable -- adjuster. There's also, for example, the Gross Domestic Product (GDP) Deflator and the Personal Consumption Expenditure (PCE) Deflator. Using a different inflation adjuster gives a somewhat different picture of what has happened over the years to prices and incomes.

For example, adjusting median household income for inflation by using the PCE Deflator shows that the real income of the median household rose from 1976 through 2006 by 26 percent. Using the GDP Deflator produces an even greater rise in real income -- 31 percent.

So which is it• Eighteen percent• Twenty-six percent• Thirty-one percent• Perhaps none of the above (given that yet other inflation adjusters will yield different figures)?

Frustratingly, there's no unambiguously correct answer. Adjusting for inflation is as much art as it is science.

My own sense is that most inflation adjusters do a poor job accounting for improved product quality, thus causing inflation to be overestimated. That is, many price increases are caused less by a falling value of the dollar and more by rising product quality.

So, if we use the "Boskin Deflator" -- which does the best job of adjusting for inflation by accounting for higher product quality -- we find that real median household income rose from 1976 through 2006 by 43 percent. And real median household income per person rose by 60 percent -- far better than the 18 percent figure typically used to tell the stagnation story.

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