Is the middle class getting poorer?

In recent times, rising income inequality — specially the growing gap between the top 1 per cent and the remaining 99 per cent — has been attracting a lot of attention. At the same time, it is creating a deep sense of resentment against the existing economic order (which is often identified with globalisation) in many parts of the world.

But this is not the only way income distribution is changing. Another important change is taking place in the form of rising ‘polarisation’ or ‘hollowing out’ of the middle. In simple terms, it means that the so-called ‘middle class’ is shrinking and more and more middle-income people are becoming richer or poorer.

In the US, the income share of middle-income households — defined as those falling within 50 per cent and 150 per cent of the median (median is the ‘average’ above and below which just 50 per cent of the population belongs) pre-tax real income — has fallen from about 47 per cent of total US income in 1970 to about 35 per cent in 2014. In other words, people are moving towards the extremes (‘tails’) in the scale of income distribution.

Together with rising polarisation, the nature of polarisation has also been changing in recent times, as compared with the past pattern. In the US, during 1970-2000, more middle-income households moved into the higher-income group than into the lower-income range. But since 2000, the pattern has reversed as a larger number of ‘middle class’ households are slipping into the lower income category rather than rising into the higher income brackets. This is happening when the median income itself has remained stagnant, instead of rising. This change is not unique to the US. A similar pattern has been observed in many other developed as well as emerging economies.

One can easily understand why the people being poorer would be unhappy. But why should polarisation (or shinking share of middle income groups in the total pie) — rather than conventional inequality — be a matter of major concern from the macroeconomic point of view? There could be several reasons.

The so-called middle class is considered an important pillar of social and economic stability which has historically played a major role in transforming societies into more enlightened ones. Also, since the poor cannot afford to save or spend adequately on education and skill development while the rich keep a large part of their savings and investment in places (including global tax-havens) where the post-tax returns are highest, the growth rate of a country’s economy depends crucially on the investible resources and human capital generated by the solid middle class. Hence, the dwindling of their share in the national pie may have an important effect on the size and the growth of the pie itself, especially in the developing economies which need a high growth rate of GDP for rapidly raising the living standards of their people.

For an advanced economy like the US which depends mainly on consumption expenditure for its sustenance, people earning less would mean less expenditure, which drags the economy further downwards. People turning poor may try to maintain their consumption expenditure for some time by running into debt which, however, cannot be sustained for long. Further, the debt burden itself continues to depress expenditure. All these make it more difficult for countries such as the US to come out of the slow growth trap. Slower growth of consumption in the US also affects its trading partners adversely.

Why is this happening? Some point to technological changes which are automating/replacing jobs traditionally performed by middle skill people such as factory workers, secretaries, brick-and-mortar retailers. Still others blame the weakening of trade unions due to competition from lower wage countries and the threat/effect of capital and jobs going offshore to such locations. The migration of people (from, say, China, India, Russia and CIS into the US, Canada and Western Europe) with skill categories that compete mainly with middle-income jobs may also contribute to this development. The so-called Great Recession beginning from around 2008 has further aggravated the situation as more people are being forced to settle for part-time jobs and many dual-income households have to depend on single incomes. The relative roles of these diverse forces in explaining this process of polarisation would, of course, vary for different countries and are matters for further research.

Nonetheless, the issue is important, especially when one notes that the rise in polarisation, as measured by a polarisation index (change in share of middle income groups in total income), has been far more than the rise in inequality as measured by the Gini coefficient — the most commonly used index for measuring inequality. In fact, Gini has remained virtually the same for economies like the US over the entire period from 1970 to 2014. Yet, inequality attracts much more attention than the rapidly rising polarisation which may have far more significant macroeconomic and social consequences.

Finally, what can be done to arrest polarisation?

If technological change is the main culprit, nothing much can be done except trying to offset the outcome by suitable tax-transfer policies. But, if falling progressivity of the tax structure is a political reality, then the chances of reversing this tendency by fiscal policy are low. If globalisation working through rising imports, offshoring of activities and immigration from lower wage countries is regarded as the villain, a reversal of globalisation would appear to be the answer.

Irrespective of whether that is the right diagnosis of the problem, politically it is the easiest policy option. Blaming foreigners instead of an inadequate domestic redistribution policy, shifts the blame onto people who do not have votes and absolves politicians.

That seems to be happening in many countries as evidenced by Brexit and the rise of politicians such as Donald Trump (who, if anything, would like to favour the rich even more than the earlier administrations through his proposed tax-subsidy policies) as well as the growing popularity of anti-globalisation political parties from both the extreme right and the left in many parts of continental Europe.

The writer was a professor of economics at IIM-Calcutta

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