TCS Daily


Understanding 'Middle-Class Squeeze'

By Arnold Kling - August 27, 2004 12:00 AM

"The 445,000 second homes sold in 2003 represent a 7 percent increase from 2001 and a 33 percent increase from 1995, the Realtors group said.

According to the study, the typical second-home owner is 61, has owned property for nine years and earns a household income of $76,900."
-- Newsday, August 6, 2004

On our family's annual beach vacation this year, I could not get away from thinking about economic issues, such as the well-documented boom in second homes. It led me to ponder the phenomena of "middle-class squeeze," obesity, and the question of where personal responsibility ends and government obligation begins.

More Middle-Class Squeeze

I think of Bethany, Delaware, as a middle-class family resort. My best guess would be that the typical vacationer is in the 80th percentile of the income distribution, meaning someone who is in the top 20 percent. If John Kerry were sincere in targeting the top 2 percent of incomes for tax increases, then most visitors to Bethany would have little to fear. It is certainly several notches below the vacation spot that a ketchup heiress would select.

According to left-wing politicians and the media, the latest economic crisis is "middle-class squeeze," which is the pressure on family budgets caused by government's failure to spend more on education, health care and other middle-class needs. At Bethany, however, we saw a different type of middle-class squeeze. We had to squeeze our way onto the beach, amidst the crowd of umbrellas and chairs. We had to squeeze our way into restaurants, with lines of people waiting outside. We had to squeeze our way through traffic jams any time we got into our car.

But by far the biggest indicator that middle-class squeeze is not quite what is portrayed in the media was the volume of construction and the prices of homes. Since our first vacation there almost twenty years ago, thousands of housing units have been built in Bethany, with much of the building taking place within the past five years. This expansion in supply has done nothing to hold down prices, however. We passed a development, located across a four-lane highway from the ocean, offering "luxury townhomes from the $700,000's." It seemed incredible to us that you could sell a townhome in a second-rate location in a middle-class resort for that much money. Each time we passed another new home site, I would mutter "looks like more middle-class squeeze going up."

The Single Mom

A friend of ours, who I will call Marie, joins us every year when we vacation in Bethany. A while back, Marie told us that she was having trouble making ends meet. We agreed to "lend" her some money (we do not expect to get it back).

Marie was not ostentatious. She did not drive a fancy car or wear designer dresses. She engaged in much quieter forms of extravagance. Buying a cup of coffee every morning instead of making it at home. Subscribing to premium cable channels, even though almost all the movies that her family watched at home were rentals. Spending more on a cell-phone plan for three people than we spend for five. The total picture consisted of items that, individually, do not amount to much, but collectively are more than what can be afforded on a middle-class income.

One evening, when we called Marie to discuss the possible loan, no one was home. It turned out that she had taken her two children to see Indigo Girls in concert. I thought, "We're giving her money, and that is how she spends it?"

What going to the concert illustrates is what I call cause-effect disconnect. Marie simply did not see the connection between her behavior and her financial situation. Ever since she and her husband separated a few years ago, Marie had been telling herself -- and all of her friends -- that her financial problems are due to her ex-husband's stinginess. She believed that more alimony would be the solution. Most of Marie's friends have fallen for her "single mom" shtick.

I am sure that there are divorced women out there who are not receiving money that they need and are supposed to get. However, that was not Marie's problem. Her total income was more than that of a typical Bethany beach vacationer. Her income seemed inadequate only because she was in the 99th percentile for spending, meaning that probably only one percent of families in America spends more than hers each year.

As my wife and I began to grasp Marie's situation, we realized that more important than giving her money was getting her to understand cause and effect. We told Marie to focus less on her dissatisfaction with her divorce settlement and instead to pay attention to her own behavior. We tried to get her to appreciate that rock concerts and other small extravagances played a causal role in her financial straits.

No Typical Middle Class Family

Economists have found that people with identical incomes can wind up in very different places financially. A few years ago, Stephen F. Venti and David Wise examined the relationship between income and wealth for people nearing retirement age. If everyone had approximately the same savings behavior, then you would expect that most of the variation in wealth would be due to variation in lifetime income. High earners would have accumulated much more wealth than low earners, but within an income group the differences would be small.

What Venti and Wise found instead was that much of the variation was within an income group. You could find high-income people who had managed to accumulate very little wealth, and vice-versa. As Hal Varian noted, "Mr. Venti and Mr. Wise started their analysis by estimating the lifetime income of each household, then sorted the households into 10 equal-sized groups based on their estimate. Their most striking observation was the extreme variation in total asset accumulation within each income group. For example, the wealth held by the top 10 percent of households in the group just below the median was 35 times the wealth held by the bottom 10 percent of that same income group." To understand this observation, imagine two families with virtually identical incomes annual incomes of $40,000. After several decades one family has accumulated $700,000 in savings for retirement and the other winds up with just $20,000 in savings for retirement.

Another way to look at the data is that there is no such thing as a "typical middle-class family," because lifestyles vary more within income classes than across them. People with middle-class incomes are all over the map when it comes to spending vs. saving. At one extreme are people like Marie, who spend all of their income and more. At the other extreme is what Thomas Stanley and William Danko call The Millionaire Next Door, a coupon-clipping, used-car driving saver who manages to accumulate a seven-figure nest egg on a five-figure salary. The in-between includes people who can afford to buy second homes in Bethany and, on the other hand, people who report that they are suffering from middle-class "squeeze."

Obesity and Squeeze

There is a parallel between the problems of middle-class squeeze and obesity. Self-control is required in order to live within one's means financially and in order to maintain a low body weight.

Another parallel is that you do not have to consume ostentatiously in order to become obese. As Alex Tabarrok put it, "Obesity rates in the United States have increased dramatically in the past two decades -- so much so that manufacturers of everything from clothes to coffins are now super-sizing. But did you know that the entire increase can be explained by three Oreo cookies a day? The trouble is that calories accumulate so holding caloric expenditures constant even a small permanent increase in calories consumed can lead to serious weight gain over long periods of time."

Small changes in lifestyle can have large cumulative effects. A family that spends 92 percent of its after-tax income will accumulate substantial savings, while a family that spends 98 percent of its disposable income will not. On the surface, their lifestyles might not seem to differ, but eventually they will end up in very different circumstances.

Similarly, someone may consume 99 percent of the calories that her body needs each day, and someone else may consume 102 percent of the necessary calories. While they appear to be eating almost identical amounts, those two people will end up with very different body masses after several years.

What the Wise-Venti analysis of saving suggests is that wealth is determined less by earnings capacity and more by lifestyle choice. Thus, even if you believe that earnings capacity is given by luck or fixed by educational background, people within the middle class still have considerable leeway in determining their long-term financial status. The spenders will wind up with little wealth, and the savers will wind up with a lot.

For obesity, studies of identical twins demonstrate that there are genetic differences in our ability to burn calories. Nonetheless, for most people, the range of feasible lifestyle choices includes calorie consumption a little below or a little above that needed to maintain body weight, with the former leading to weight loss and the latter leading to weight gain. In other words, genetics notwithstanding, our choices do matter.

Cause, Effect and Government

I am no psychologist, but my amateur opinion is that in order to lose weight or save money you have to understand the cause-and-effect relationship between the choices you make and the outcomes that result. You are unlikely to change your lifestyle if you deny personal responsibility.

If Marie continues to believe that her weak financial position is because of her status as a single mom, then she will not make the decisions necessary to control her family budget. Only when she can face the connection between the daily extravagances in her spending and her need to ask friends for money will she be able to get her finances in order.

If you believe that your obesity is caused by corporate America or some other external force, then you probably will be less motivated to control your weight. Only if you are conscious of the connection between the small excess of calorie intake and weight gain are you likely to make the lifestyle changes needed to shed excess pounds.

Under these circumstances, politicians who take on middle-class squeeze or obesity as public policy issues may be causing harm. Sending out a message that government is the solution may serve to weaken the cause-effect connections that people need to make in order to solve what are fundamentally personal problems. The damage caused by exacerbating the cause-effect disconnect that weakens personal willpower may far exceed the benefits of whatever actual remedy the government is able to deliver.


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