Hollow Argument

Are middle-income earners missing out as those at the top get richer? Not lately.

Listener: March 10, 2007.

Keywords: Distributional Economics;

There is a theory that people on middle incomes are not doing as well as those at the top. Either their jobs are disappearing, their pay is being depressed, or both. Meanwhile, those at the top are getting huge pay increases (most evident in the extraordinary remuneration of top executives at US companies).

Economists differ over why this might happen. Some argue that the information and communications technology revolution undermines many middle-income jobs. Meanwhile, managing has become more difficult and the executives are rewarded commensurately.

Other economists argue that the hollowing out is due to globalisation. The jobs of people on middle incomes are more easily “offshored”, while international demand for their bosses and very skilled professionals pushes up their pay.

There is an ambiguity in what we mean by “middle income”. That group need not be “middle class”. (If there is no significant upper class, then the middle class can hardly be in the middle.) Indeed, the group is primarily people in manufacturing and those services that are internationally tradeable. Many in the middle would be (skilled) “working class”, others “lower middle class”.

The expression “hollowing out” is not easy to explain, either. It is best thought of as “emptying out”. Although the bulk of workers remain in the middle, the pay of some is drifting towards the bottom.

The theory is a little unsure about what is happening among those at the bottom, who frequently provide personal services which cannot be easily mechanised or carried out overseas. Their income is also greatly influenced by the unemployment level and the system of income support.

The “hollowing out” theory was developed in the US to explain its income trends. Does it apply to New Zealand?

Unfortunately, we don’t have as much data as the Americans. But the just-released first round of results from the 2006 Census fills some of the gaps. We need to interpret them with care, so some definitions first.

Those over 15 were asked to report their “gross income” – earnings plus investment income and benefits. Thus the data is for adult individuals.

Children do not come into the calculations at all. Nor does the data refer to households (comparisons are affected by people increasingly living in smaller ones). Taxes are not deducted nor government-supplied personal services added, so this data tells us little about trends in disposable income, spending power, or the material standard of living. The data tells us only about what is happening in the market to pay, investment income and benefits. Because of changes in the 1980s we cannot safely compare the data before 1991.

The biggest caveat, though, is that people report their incomes and we don’t know how accurately they do so.

In 1991 the top 10% of adults (about 250,000 people) told census enumerators that they received 31.9% of all gross income. Five years later that share had risen to 35.8% and it rose again to 37.2% in 2001. That is a big shift. If the top’s share is going up, the share of the rest has been going down. That is consistent with the argument that there was a hollowing out in the 1990s.

However, between 2001 and 2006 the trend reversed. The top decile’s share fell from 37.2% to 35.9%, back to roughly where it was 10 years earlier but still well above the 1991 level. There were offsetting gains for those lower down. Top incomes rose an average of 7.2% after allowing for inflation over the five years, but others’ incomes rose 10.9% in the five years.

Does that mean the hollowing out has ended? Perhaps some other economic force has been overpowering it. Possibly it was the strong jobs growth. Since that cannot go on – we are running out of potential workers – the hollowing out trend may recommence.

On the other hand, the government could argue that its policies of lifting skills in the labour force, and industry development, are lifting the market incomes of those lower in the distribution. It will take time to get sufficient evidence to decide whether this is correct. Even so, whether or not the government’s policies have worked, the hollowing out trend of the 1990s reversed in the early 2000s.

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