Unemployment, Wage Stagnation, and the Balance-Sheet Recession
i should describe the human race
as a strange species of bipeds
who cannot run fast enough
to collect the money
which they owe themselves
—Don Marquis, "quote and only man is vile quote"
Over at Rortybomb, Mike Konczal has an interview with the University of Chicago's Amir Sufi on his work connecting Americans' debt with our still-high levels of unemployment; he calls Sufi's work, along with that of Atif Mian of Berkeley, "the most interesting and important empirical work on what is going on with this Great Recession."
The second thing is that the deleveraging effect is real. The Survey of Consumer Finances shows that up until the 90th percentile of the distribution, as of 2007, made up around 65 percent of people’s net worth. If you see a massive decline in the value of your home, it is kind of mechanical that if you are thinking about savings and retirement you’ll think, “I was planning on having enough equity in my home when I retire that I could just borrow against it for the rest of my life. Now I don’t, so I have to adjust my consumption path immediately.”
Konczal interviewed Sufi on the occasion of two new papers: "What Explains High Unemployment?: The Aggregate Demand Channel" (PDF) and "Household Balance Sheets, Consumption, and the Economic Slump" (PDF), both co-authored with Mian, the latter also with Kamalesh Rao of MasterCard Advisors. Here's a brief piece from the authors describing their research:
Our research suggests that 65 percent of the job losses from 2007 to 2009 came from the drop in household spending induced by the collapse in home prices and its effect on a highly levered household sector.
The declines in consumption are far too large to be explained by the drop in house prices alone. It was the combination of collapsing home values and high debt levels that proved disastrous. High-debt areas have been plagued with delinquencies, deleveraging, and the inability to refinance into lower rates -- all characteristics of overleveraged households.
Sounds obvious, right? Making the connection to job losses requires another step:
If weak household balance sheets are responsible for a large share of job cuts, we expected losses in non-tradable industries to be much larger in U.S. counties with weak household balance sheets. That is exactly what we found. In counties in the top 10 percent of the 2006 household-debt distribution, employment in non-tradable industries declined 5.1 percent from 2007 to 2009. In the counties in the bottom 10 percent, the losses were only 0.3 percent.
"Non-tradeable" just means the sale of stuff you can't export, like haircuts and restaurant dinners. Sufi and Mian found, in "What Explains High Unemployment?," that "counties with high household leverage before the recession experienced much sharper declines in employment during the recession." Since tradeable stuff gets passed around the country, the unemployment effects even out less dramatically elsewhere:
Our theory predicted that the decline in employment in tradable industries would be uniform across the country. In other words, when Californians reduce their spending on goods produced throughout the country, employment in tradable industries nationwide will decline. This, too, is exactly what we found.
In short, areas with severe housing crises like Las Vegas and Chicago see higher unemployment in local, nontradeable industries, but exert a pull on unemployment throughout the United States. And there's a spillover effect from unemployment onto those who remain employed:
In the absence of absolute wage rigidity, we should expect at least some downward response of wages to the large decline in employment in high leverage counties.... We find that debt to income ratios as of 2006 have a negative effect on total wage growth from 2007 to 2009. The coefficient in column 2 implies that a one standard deviation increase in the 2006 debt to income ratio leads to 1% lower wage growth, which is about 1/5 a standard deviation.
And that wage effect is worse on the working poor than the wealthy:
Columns 6 and 7 examine the correlation between debt to income and wage growth at the 10th and 90th percentile of the wage distribution. We find suggestive evidence that wages decline by more in the lower part of the wage distribution.
Obviously, this reflects broader trends over a longer period of time, as noted by Gary Becker and Richard Posner last year:
Between 1997 and 2008, median U.S. household income fell by 4 percent after adjustment for inflation. It presumably did not rise in 2009, and may not in 2010 either. A median is not an average; average income rose because the incomes of high earners rose, and so the effect was to increase the inequality of the income distribution.
And Becker and Posner bring us right back around to household debt, which increased at a time when the things we often think of as greedy acquisitions of the financially irresponsible have become ever cheaper during an era of increasing standard of living (emphasis mine):
In considering the effect of wage stagnation and growing income inequality, it is important to distinguish between money income and standard of living. As long as the quality of goods and services increases (largely because of technological innovation in a broad sense that includes new business methods as well as scientific and engineering progress) faster than their cost, the standard of living will rise even if incomes do not. The quality of health care continues increasing rapidly, and part at least of the rapid rise in health insurance premiums is payment for that increased quality. The quality-adjusted cost of consumer electronics has plummeted in the same period.
But even if the standard of living has increased for most people whose incomes have not risen, or have even fallen, this would not alleviate the growing political problems that wage stagnation and the resulting increase in economic quality are likely to create, if they haven’t done so already. People take for granted most improvements in goods and services, and do not consider the improvements to be full compensation for a flat or declining income. Then too liquidity constraints may exclude people from access to many of the improvements; this is a problem for many people who cannot afford health insurance.
Economic anxiety arising from wage stagnation was masked until the fall of 2008 by the Federal Reserve’s low interest rate policies; people could borrow cheaply to maintain and even increase their consumption. Now they realize they are overindebted and cannot continue to support consumption by borrowing.
I think Becker and Posner muddy the waters a bit by conflating health care and electronic goods. For example, when I went to buy an HDTV a couple years ago, I could choose from anything from a small, cheapo off-brand for a couple hundred bucks, to a 1080p living-room consuming beast over a thousand dollars. And I could do what I ultimately did: buy a used tube HDTV for fifty bucks. Meanwhile, my experiences in comparison-dental-shopping were awful: they took months, while my teeth continued to deteriorate. Some of the problem was asymmetrical information: I can give you a quick rundown on what features to look for in TVs, but not in dental implants. Most of us simply don't have the knowledge to shop between health-care providers—which would provide negative pressure on costs—nor the time or ability to consider a range of options. I'm vaguely aware of the differences between plasma and LCD, or can at least get that information quickly. When I go to the dentist, I basically have to do what he or she tells me to pay for. (The same goes for higher education, the other massive contribution to household debt among the middle class.)
Nonetheless, it's still a very good point. The vicious cycle goes something like this: wage stagnation -> increased debt to compensate for wage stagnation -> declining consumption due to debt/wage stagnation/unemployment -> more wage stagnation/unemployment -> more debt. As Konczal demonstrated last year, working off the Economic Statistic of the Decade, borrowing took off as wage growth flatlined. And Konczal takes the comparison of median household income income with wages even further:
I’m happy many more women are in the workforce. But if the real driver of household wage growth is simply that households are working more hours, then that isn’t exactly wage growth. “I want to make more money so I doubled my shifts” isn’t really the same statement as “they are paying me more money.” Winship points out male wages have increased around 8% over a 35 year period, for an annual growth rate of 0.23%. Something eventually had to give: maxed out at capacity, both in the number of hours in a day and the line of credit approved – if this was a firm, would you want to invest?
This leads to the "two-income trap" made famous by Elizabeth Warren and Amelia Tyagi:
So we looked at the data for two-income families today earning an average income. What we found was that, while those families certainly make more money than a one-income family did a generation ago, by the time they pay for the basics -- an average home, a health insurance policy, a second car to get Mom to work, child care, and taxes -- that family actually has less money left over at the end of the month to show for it.
And the two-income trap is a factor in the insane housing prices we saw during the past decade:
[A] big part of the two-income trap is that families have basically bid up the cost of living. Housing is a big example. A generation ago, an average family could buy an average home on one income. Today you can't do that in three-quarters of American cities.
One thing that I haven't seen any research on, but can't help but think it's a factor nonetheless, is household deleveraging due to the dominant political ideologies of the past couple decades. My grandparents grew up with the social-safety-net programs that emerged from the New Deal, and grew old in the last era of private pensions. My parents were not so lucky, but they're old enough to be in the safety-net safety zone, of an age that politicians do not dare to challenge on their Medicare and Social Security.
Meanwhile, I just turned 30 and practically every presidential election of my lifetime has brought some new approach to sinking the net. I became an adult during the Ownership Society of the Bush years, and while I think following the travails of my 401(k) is interesting, I have to monitor it regularly to make sure I'm not losing money from inflation, much less so that it up and vanishes because Tim Geithner makes the wrong facial expression and the markets tank while I'm busy making the money that goes into it.
My point is that for young adults, our long-term financial future looks perilous. It might not be; the government might well continue Social Security and Medicare far into the future. But I don't have a great deal of confidence that it will, which makes me careful with my money, which is noble and all, but it also means I buy less stuff, which isn't good for the way the U.S. economy is constructed. I can't imagine I'm alone in this, which would mean that those of us who are middle-class and financially stable in the short term but paranoid about the long term are contributing to the mechanism that Sufi and Mian outline.
It's a mess, as Don Marquis continued, in the voice of archy the cockroach.
as far as government is concerned
men after thousands of years of practice
are not as well organized socially
as the average ant hill or beehive