FT article on household income

My piece on trends in household income in the advanced economies was published today in the annual world economy survey in the Financial Times.

Beyond the truism that financial crises and recessions are painful, the advanced economies have had widely divergent experiences in recent years.

This is clear even at the level of economic growth. At one end of the scale, Australia has avoided recession altogether, while at the other, Greece has suffered a contraction every year since 2007.

These two are outliers, but it should be clear many variables shape the way countries experience a downturn. These include unemployment levels, the provision of a social safety net and the performance of financial assets. All have a bearing on income.

Although wages are the largest source of income for most households they are far from the full story. Transfers from government (such as social security) and employers (such as in employee health insurance) can be an important part of the picture. So can investment income, including dividends and capital gains.

For the poorest, government transfers can play a big role in ameliorating the effects of recession. By contrast, the richest benefit disproportionately from investment returns. It is no surprise that the incomes of the wealthiest Americans are closely correlated to stock market performance.

Despite its size, the US is in its own way an outlier, as the squeeze on household income started well before the financial crisis.

Median income hit a record high in 1999, according to data from the Current Population Survey (CPS). Despite a dip followed by recovery, the level in 2007 was still slightly below the peak in real terms. Between 2007 and 2012, it fell by 8.3 per cent, according to the CPS data.

Wages had been more or less stagnant for the two decades before the peak, but other factors counteracted this. Increased female participation in the workforce meant household incomes could rise even if wages were static, and transfers played a significant role.

Despite the longevity of the income squeeze, the recent downturn has particular characteristics. “This recession is very different from the last because it is employment-driven,” says Richard Burkhauser, a professor of policy analysis at Cornell University.

“It is the first time that the employment of both men and women has fallen. This is the key factor in falling household incomes rather than the dip in wages,” he adds.

This time, government transfers also cushioned the impact of the squeeze on median incomes. “They have had a much more palliative effect than in the 1980s recession,” he says.

In the UK, the squeeze on household incomes predates the financial crisis but does not go as far back as in the US. From 2002-07, household incomes only grew by about 0.5 per cent a year – much lower than the long-term average of about 2 per cent.

However, a study by the Resolution Foundation, a think-tank, found that average disposable incomes fell in every region but London.

Median incomes for the UK as a whole did not start to fall until 2010. When they did, wages were hit first, so those at the top and middle of income distribution felt the greatest effect. More recently, those on lower incomes have started to feel the impact of benefits cuts.

Germany’s experience differs from others in important respects. For a start, the persistence of a gap between the west and the east of the country, more than two decades after unification, is striking.

According to a German Socio-Economic Panel Study, a survey of households, real disposable household incomes for western Germany were at about the same level in 2005 as in the early 1990s. In contrast, median incomes in eastern Germany rose in the 1990s before dipping in the subsequent half decade.

Its experience since the financial crisis also differs from the US and UK, with median income rising slightly. Much of this can be accounted for by lower unemployment. “This is the most important aspect,” says Markus Grabka, a researcher associate at DIW Berlin, a think-tank. “The German labour market is a very surprising story.”

In the UK, the IFS, a think-tank, has done a simulation on trends in household income until 2015-16. It concluded that much of the pain is still to come. Many changes to taxes and benefits have yet to take effect.

Those at the top and middle have experienced falls and are not likely to enjoy a strong recovery. In contrast, the bottom end looks set to suffer further.

As for the US, Lane Kenworthy, a professor of sociology at the University of Arizona, is downbeat: “If we don’t get back to the rising employment we had in the 1980s and 1990s, median household income will stay flat for the long run.”