The Shrinking Middle Class – What’s The Real Reason?

The so-called “middle class” in America – generally those making between $35,000 and $100,000 a year (depending on where one lives) – has been shrinking over the last few decades. Opinions abound over why this is happening. President Obama and other liberals claim that so-called “income inequality” – the rich getting richer – is the main force squeezing the middle class.

blog150226It isn’t. The proof comes, not from some right-wing think tank, but from President Obama’s own top economists. The bigger culprit by far, they show, is the slowing growth of worker productivity in recent years. Productivity is defined as worker output per labor hour, and it has fallen significantly since 2007.

What we will see today is that rising income inequality is not the main cause of the shrinking middle-class in America. Falling worker productivity growth is the biggest issue by far.

So concludes the latest annual report of the White House Council of Economic Advisers for 2014. The “CEA” as it’s known, performed a fascinating what if” exercise in the latest report. It assumed that the most favorable post-World War II productivity trends had continued until today. Specifically, the CEA selected the red-hot productivity of the 1950s and 1960s and projected that growth to the end of 2014. So what did they find?

In that make-believe scenario, income inequality stayed at much lower levels than today (and the labor-force participation rate didn’t plunge as it has). Again, this assumes that productivity growth of the 50s and 60s continued all the way to today. Unfortunately, it didn’t. As the chart below illustrates, productivity growth has been significantly lower since the 50s and 60s and fell to the second slowest rate on record in the last seven years.

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The chart above ends at the beginning of 2014. According to a Labor Department report earlier this month, worker productivity actually fell at a 1.8% annual rate in the 4Q of last year and was up just 0.8% for all of 2014. That’s well below the 2.5% average from 1948 to 2014. A similar pattern is found in the manufacturing sector. Productivity growth there has plummeted since the 1990-2000 decade.

blog150226c

The CEA report also looked at what would have happened to middle-class incomes in this hypothetical high productivity scenario. What they found is that middle-class incomes would have doubled! The income of the median household would have gone from over $50,000 (where it is today) to over $100,000 – after inflation. Wow!

The question is, why did productivity growth slow down so much since 2007? The CEA doesn’t offer a comprehensive theory – no real surprise there. Yet this significant slowdown in productivity growth should be the central economic story of our time, but it isn’t. Let’s consider some of the reasons below.

As noted above, the productivity of US workers has grown at an average annual rate of about 2.5% since 1948, but has averaged only about 1.0% since 2011 – less than half the historical rate. First and foremost, the explosion in federal regulation has retarded productivity growth. The National Association of Manufacturers estimates that federal regulations cost the economy a whopping $2 trillion annually.

Likewise, the protection of certain existing companies and industries at the expense of more efficient producers, including startups, has taken a toll. Ditto for ill-targeted federal subsidies (green energy, etc.) that have retarded productivity growth.

For the first time in post-World War II history, more US businesses are shutting down as compared to new startups. Would-be entrepreneurs are less likely to risk their limited capital on new ventures given the daunting regulatory maze and the anti-business bent of the current administration, not to mention the obvious drift toward higher income taxes and capital gains treatment.

I could go on with examples of how increasing government regulation and anti-business policies have hamstrung growth in worker productivity, and have led us to the point where more businesses are closing than are opening for the first time in post-war history.

The real point today is that rising income inequality is not the main driver that is shrinking the middle-class. Rather, the biggest threat to the middle class is the big decline in worker productivity growth since 2007.

And we can thank government over-regulation for most of that. Just remember, it didn’t have to be this way. Even President Obama’s top economists agree. But don’t expect the president to admit that.

** Today, the Federal Communications Commission voted to adopt Obama’s
“net neutrality” rules to regulate the Internet. It remains to be seen how
bad it will be. Fortunately, the decision will be challenged in the courts.

 

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