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Jared Bernstein: What the heck happened to the middle class?


The Pew Research Center released a report this week on the middle class, called "The Lost Decade of the Middle Class: Fewer, Poorer, Gloomier."

OK, that’s a really depressing title. But they’ve got the data to back it up (details/summary here). A few nuggets:

• Median, or middle-class, income (inflation-adjusted) was lower at the end of this decade than at the beginning. And if you look at the more comprehensive measure of net worth—assets minus debts—it’s worse. Median net worth fell 40%, or about $60,000, from 2007 to 2010, as the housing bubble popped and trillions in home equity evaporated.

• But—and this is crucial to understand—that’s not just due to the Great Recession. The business cycle expansion of the 2000s, i.e., the growth period before the recession, was the first on record during which median household income stayed flat, according to Census data.

• 85% of middle-class poll respondents said it’s harder to maintain a middle-class standard of living compared to a decade ago.

• In a result I found particularly gloomy, just 43% of middle-class respondents said their kids' living standards will exceed their own, down from 51% just a few years ago in 2008.

This is pretty alarming stuff. What’s going on here?

A full-bore analysis of the causes is beyond our scope here. And frankly, the full story just isn't well-understood yet by anyone. But we’ve got some pretty good ideas of the prime suspects:

The Growth of Inequality: This one has to be high up in the mix. Yes, overall economic growth has been slower over the period when middle-class wages and incomes have been stagnating, but growth has been positive—real GDP is up. And productivity growth actually accelerated over the last few decades. Back when I studied econ, it was generally asserted that as productivity rose, so did living standards. And there’s logic to that—if an economy can produce more goods and services per hour, its citizens should be better off. 

But that’s only true on average. If, due to other factors, the distribution of that growth eludes the middle class and the poor, then society may grow richer on average, but for the middle class, growth is nothing more than a spectator sport. And the evidence suggests that in recent decades, that's exactly what's happened.

Of course, that begs the question: How did we end up with all this inequality?

Financial Mis-allocation and the Shampoo Economy: Economists have stressed factors like globalization and technological change favoring more skilled workers, and those have played a role (especially the former). But there’s something else that’s less well understood, in part because it’s newer than the other issues, or at least it hasn’t been the subject of as much scrutiny in this regard: the shift in economic activity and resources to the financial sector. 

First, the returns in this sector are implicated in the inequality story. If you look at the occupations of the top 0.1%, it ain’t school teachers. It’s financial industry executives, managers, and traders.

Second, those earnings don’t trickle down, because they’re not supporting productive investments with the potential to generate wealth down the line. These are not your grandfather’s financial markets, allocating capital to its most productive activity. They’re flash algorithms, exploiting nanosecond price differentials, they’re synthetic derivatives whose values are twice removed from a price movement in some other obscure financial instrument. 

And it’s not just that capital is misallocated to these opaque uses. It’s that because they’re so poorly understood—even the heads of the big investment houses, in honest moments, admit that—and so inherently volatile, our business cycles end up looking like shampoo instructions: bubble, bust, repeat.

The Absence of Full Employment: As I stress here, when middle-class incomes have tracked productivity growth, the job market has been far more welcoming than has been the case in recent years. During the 2000s, employment growth has extremely slow—even before it tanked in the Great Recession.

Again, middle-class households depend on their paychecks, not their stock portfolios, to make ends meet, and especially in an economy like ours with very low union density, the only way middle- and low-income workers can count on the bargaining power they need to claim their fair share of productivity growth is if employers need them. So when labor supply consistently exceeds labor demand—the definition of a slack job market—a lot of working people are going to fail behind. 


What to do about all this? More progressive taxation, along with a tax on financial transactions can help with inequality and mis-allocation. Serious financial reform with teeth can help with the shampoo cycle. For full employment, you need a Federal Reserve committed to that goal as much as price stability, along with aggressive fiscal policy and direct measures of job creation when the market’s not delivering the goods. 

Granted, those policy measures aren’t exactly in the mix right now. But if we want to make sure the middle class fares better over the next decade, they need to be.


Jared Bernstein served from 2009 to 2011 as chief economist to Vice President Joe Biden, and as a member of President Obama's economic team. He is currently a Senior Fellow at the Center on Budget and Policy Priorities, and an MSNBC contributor.