How Millionaires Are Making Middle-Class Americans Work Harder Than Ever

Last Updated Apr 4, 2011 1:15 PM EDT

Last month, the feds said that in the fourth quarter of 2010 the U.S. economy grew 3.1 percent, up from 2.8 percent as initially thought. Feeling any richer?

If you're like most people, you probably find it hard to say. That's because even per capita measures of GDP are a poor measure of how someone is faring economically. It doesn't tell you how any additional income resulting from faster growth is distributed among the rich, poor and all points in between. Nor does GDP tell you if gains come from higher consumer spending on, say, handguns, as financially strapped towns and cities cut back on policing.

Enter Cornell University economist Robert Frank, who has a far more useful way of gauging economic well-being. He calls it the "toil index." It measures the number of hours someone must work each month to be able to rent a house in a community where the schools are of at least average quality (In short, what most of us, at a minimum, would want.) And here's what you find when you look at that number:
Unlike per capita GDP, which, apart from brief recessions, grew at a strong and steady rate from the end of World War II until the recent downturn, the toil index has been much more volatile. Its movements suggest that recent increases in income inequality have imposed substantial economic costs on middle-income families.
Like a heavier workload. In 1950, the average employee had to put in 42.5 hours per month on the job to afford a median-price house in a decent school district, Frank notes in a recent paper (click on adjoining chart to expand). Over the next two decades, that figure fell slightly to 41.5 hours. Between 1970 and 2000, however, it soared to 67 hours. Per capita GDP during this time was also rising steadily, an indication of growing national wealth. But -- and here's the rub -- not evenly.

To the richest go the spoils
Income following WWII rose rapidly for all U.S. households. But after 1970 it soared for the very rich, while growing far more slowly for almost everyone else. Frank notes that "almost all significant income gains" in recent decades have gone to the wealthiest 20 percent of Americans. Even that figure is deceptive, since income grew even faster at the very top of that group. Consider this:
  • Between 1976 and 2000, the share of total income earned by the top 1 percent of U.S. households rose from roughly 9 percent to more than 23 percent
  • Between 1970 and 2000, income for the top 1 percent rose more than 300 percent, while increasing less than 15 percent for median households
  • Between 1979 until 2008, the top 1 percent got 36 percent for all gains in household income
  • Average CEO pay rose from roughly 40 times an average worker's pay in 1980 to 263 times in 2009
  • Shortly before the financial crisis, the top fifth of income earners owned 85 percent of private wealth, while the bottom 80 percent owned 15 percent
  • The top 1 percent have more than 38 percent of all privately held stock, 61 percent of financial securities and 62 percent of business equity
  • Average annual income for the top 0.1 percent -- the richest one in a thousand households -- rose from just over $1 million in 1974 to more than $7 million today
In other words, the U.S. economy is increasingly -- and drastically -- less equal than it used to be. As political scientists Jacob Hacker and Paul Pierson write in their recent book, Winner-Take-All Politics: How Washington Made the Rich Richer and Turned Its Back on the Middle Class, the gap between "haves" and "have-nots" in America is widening as never before:
These mind-boggling differences have no precedent in the 40 years of shared prosperity that marked the U.S. economy before the late 1970s. Nor do they have any real parallel elsewhere in the advanced industrial world. A generation ago, the United States was a recognizable, if somewhat more unequal, member of the cluster of affluent democracies known as mixed economies, where fast growth was widely shared. No more.
Why U.S. homes are getting bigger
It's no secret that most people in the U.S. are working harder for a shrinking piece of the pie. But Frank's toil index offers an important insight: The rising concentration of wealth at the top indirectly changes the spending decisions of everyone else lower down on the economic ladder.

That's because our financial well-being is judged not only by how much we consume, but also by how that consumption compares to how our friends and neighbors are living. In a neighborhood where used cars are the norm, for instance, your new Toyota might make it feel as if you're ahead of the game. But the calculation changes when everyone on the block is used to buying a new Mercedes every year.

To assess our socioeconomic position, in other words, we need a frame of reference. This doesn't refer to people trying to keep up with the Joneses out of some childish need to flaunt their success. The issue is how hyper-concentration of wealth in America causes us to alter our economic demands. And the high -- perhaps incalculable -- costs of economic inequality.

Frank's main example is housing. When the super-rich build a bigger mansion (and they can afford to since, as discussed, they've been getting richer), that changes the frame of reference for the slightly less affluent. So they, too, build a bigger home. That shifts the economic picture for those on the next lower rung, and all the way down the income ladder.

That dynamic, which he calls an "expenditure cascade," helps explain why U.S. homes have significantly increased in size over the last four decades -- from an average of 1,570 square feet in 1970 to some 2,300 square feet in 2007. That growth isn't a result of climbing family income, because that changed far less over that time. Rather, what changed was families' frame of reference -- their socioeconomic context for deciding how expensive a house they need to live in a neighborhood with good schools. Frank describes their dilemma:
Families that failed to rent or buy a house near the median of the local price range would have to send their children to below-average schools. The only alternative to seeing their children fall behind is to keep pace with what others are spending.
What inequality costs
Housing isn't the only area where we see this pattern, Frank notes. Rising consumption at the top also cascades into spending on everything from clothes and gifts to weddings and birthdays. Take job interviews. When one applicant buys a pricey new outfit, other candidates also have to spend more or risk not making it to the next interview round. And yet when all the applicants fork out for new duds, no one's chances of getting hired are improved.

Some of this increased spending is useful, of course, since it raises the amount of money entering the economy. But above a certain level, consumption offers diminishing returns. It becomes wasteful. How? By draining money that could go toward more socially productive uses, such as building a high-speed rail system or improving public education.

And by forcing people to toil longer simply to afford to live where their kids can get a good education. Those who can't are out of luck. Put another way, the ultimate cost of rising inequality in America is, quite literally, our future.

Thumbnail from Doenertier82 via Wikimedia Commons; graph from "Supplementing Per-Capita GDP as Measure of Well-Being," by Robert Frank
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  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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