We hear it all the time, that since the 1970s, middle class living standards have been flat. The chart above produced by the left leaning Economic Policy Institute is perhaps one of the most famous claims. The thing is though, is that it’s false. What they did to make that chart was to deflate productivity and wages using 2 different measures of inflation. The top one is deflated by the Nonfarm Business Implicit Price Deflator, the one at the bottom by the Consumer Price Index. There are many differences between the two but the one that matters is that the CPI suffers from what’s known as substitution bias.
This is an issue that has been known by economists for many years. It works like this: when relative prices of goods change, we adjust our buying habits to mitigate the impact. If you don’t adjust for that change, you overstate the rate at which the cost of living grows. To give an example, imagine that every week you buy 2 apples and 2 oranges, each of which costs $1. That means your cost of living is $4. But imagine that suddenly the price of oranges goes up to $2. That same basket of goods now costs $6, a 50% inflation rate. But in reality, we adjust, so you can instead buy 3 apples and one orange, which costs $5, a much more modest 25%. But the CPI would register the 50% rate because it doesn’t regularly adjust the basket of goods. The implicit price deflator does adjust for this substitution and as such shows a lower, more accurate level of inflation.
Here’s the same chart as above, but using the same measure of inflation for both.
As you can see, the wage stagnation disappears. Now, while the original chart overestimates the troubles of Americans, the corrected one underestimates for two reasons. While the IPD uses a more accurate formula, the goods it covers are not reflective of the normal purchases of you or me. Also, because this measures average wages, it’s distorted upward by rising inequality.
Thankfully, there’s yet another measure of inflation that doesn’t suffer from substitution bias, measures normal consumer purchases, and has been calculated for a long enough time that it’s helpful for long term trends. It’s called the Personal Consumption Expenditure index (PCE). It’s used by the Congressional Budget Office and by the Federal Reserve.
For the second problem, I could use the Census Bureau’s income data, but there’s problems, namely that it doesn’t include fringe benefits such as healthcare which makes up a large and growing share of employees compensation. But helpfully, the Social Security administration publishes data based on W-2 tax forms which include all forms of compensation.
The SSA’s data on median income was last updated for 2015 and goes back to 1990. The results are as follows:
Nominal Median Income 1990: $14499
Divided by
1990 PCE deflator (2015=1): .616
Equals
Real Median Income 1990: $23535
The median income for 2015 was $29930
That’s a 27% increase in 25 years or around 1% a year. That’s not huge, especially when you consider that average income rose 39% over that time, but that’s also not nothing and proves that we are better off.
This study from the left leaning Urban Institute comes to a similar conclusion, finding a 38% increase in median income between 1979 and 2013. Also like mine, it finds that average income rose quite a bit faster, in this case by 67%.
This study from the Minneapolis Federal Reserve bank also finds substantial median income gains.
There’s more data that would indicate rising affluence.
We now spend more money at restaurants than we do at grocery stores.
Homes are bigger than ever
Despite huge increases in efficiency, we consume far more electricity than we used to
And despite soaring tuition costs, more Americans than ever have gone to college
These are all difficult to reconcile with flat incomes and hopefully will convince the people who read this.
To be clear, I don’t think everything’s hunky dory. While wages have risen, they would be about 20% higher if income inequality was the same as it was in the 70s, which is a lot. Also, the cost of college is soaring, our system of retirement savings is inadequate, and we spend far too much on healthcare for what we get.
But at the same time we need to recognize that we’ve never been better off. Ignoring it leads to needless pessimism and nostalgia. It leads to politicians calling for erecting trade barriers in an attempt to bring back “high wage” manufacturing jobs when in reality protectionism will only mean higher prices and less innovation. It leads to calls to keep out immigrants, who are supposedly driving down wages, which traps people in third world poverty. Most of all, it distracts from the real issue, which is productivity growth that has been pathetic for 40 years, especially since the recession. Productivity is the only way by which our living standards can sustainably rise and our ability to be better off tomorrow depends on raising the growth rate.