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My challenge to Tyler

Posted By Russ Roberts On September 20, 2011 @ 1:44 pm In Data,Standard of Living,Uncategorized | Comments Disabled

There is a new theory from Noah Smith [1], for the alleged stagnation of America’s standard of living, the Great Relocation [1] (HT: Tyler [2]).

The idea, in a nutshell, is that economic activity is relocating from rich Europe, America, and Asia to developing Asia faster than technological progress can replenish it.

This makes no more sense to me than Tyler’s Great Stagnation story–but I will save that for another time. For this post, I want to focus on Tyler’s reaction [2] to Smith’s story. His first point is this one:

1. Median income begins to stagnate in 1973, before this trend is significantly underway.

You hear this claim about median income all the time (and you are going to hear a lot more between now and November 2012) and I do not understand it. What is it supposed to mean? Does it mean that the person who was the median or family in 1973 continued onward at a constant standard of living without any gains despite enormous gains in per capita income? This is the way the story is usually told–the rich (as if they were a fixed group of individuals, an exclusive club) somehow managed to gain all of the gains of the intervening 38 years for themselves. This is clearly not true. If you look at any data that follows the same people over time, you will see that their lives improve as they get older and that they are typically better off than their parents. Better off in absolute terms, not relative ones. Some people move up relative to others. Some move down. But the entire distribution moves up.

Or does it mean that the typical family or individual in America today has the same standard of living as people back in 1973? Is the median a surrogate for the middle class? This is a different claim from the first one. The problem with this claim is the types of people in the middle in 1973 are different from the types of people now. There was a major demographic change in the 1970′s. The divorce rate exploded. Suddenly (and it was pretty suddenly) new households were created as couples divorced. The rate of household creation grew faster than population.

The effect of this increase in the divorce rate was to change who was at the median. A lot of below-median families were created in the 1970′s headed by recently divorced single women who suddenly found themselves wanting to be in workforce. They had not prepared for this. Their skills were different. Adding those families pulls the measured median down. That fall in the median does not mean that the family that was at the median was now worse off. It’s like the median height falling at the party when the Celtics leave. Nobody in the room gets any shorter. Similarly, in the individual data, people who weren’t working (their wages were zero but non-workers earning zero aren’t included in the measured median) were working unexpectedly. They were typically people with below-average wages. The measured median fell.

This of course created a lot of economic hardship. The surge in divorce rates made a lot of people poor. But you don’t want to conclude that the American economic system is broken because of an increase in the divorce rate. Most people, and I think this includes Tyler, don’t view the stagnation of wages or incomes as the result of a social change but as the result of a change in how the system treats someone today relative to yesterday. When you keep repeating that median income is stagnant, you usually mean that people are stuck or are not getting ahead.

The same phenomenon occurs when there is an increase in immigration by low-skilled workers. That reduces the median wage. That statistical change doesn’t make anyone worse off in and of itself.

I will also mention, as I have before, that the standard measures of median income understate growth because they overstate inflation and understate compensation–they leave out many forms of compensation that have grown more important since 1973.

Here has what has truly changed in the fabric of the American workforce since 1973. Before 1973 you could graduate from high school or not even finish high school and live pretty well. You could work in a factory or do a number of things that paid well in the relative sense–you could be somewhere near the middle.

That isn’t true any more. Not finishing high school is very bad for your probable place in the income distribution. And such a person may actually have a lower standard of living in absolute terms relative to 1973. Factory jobs are disappearing. Yes, some are part of the Great Relocation. But many or maybe even most are part of the great increases in productivity that have occurred since 1973. America manufactures more stuff since then with fewer people. There is no evidence there of a great stagnation but rather the opposite.

The difficult financial life of a high school dropout and even many high school graduates who do not go on to a college is a symptom not a cause of economic change. It is the symptom of a more productive economy based on knowledge and information. It’s an unpleasant symptom but the underlying cause is a good thing. The way to deal with the symptom is to improve the education system.

So my challenge to Tyler is to tell me what he thinks the stagnation in median income signifies. Has there been a change in the returns to education or creativity? Or is it mostly a statistical artifact? Whichever answer he gives, I would like to see him reconcile it with the panel data–the surveys of economic information that follow the same people over time. Others are of course welcome to chime in as well. If Tyler responds I will link to either his post or his email if he wishes.

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URLs in this post:

[1] a new theory from Noah Smith: http://noahpinionblog.blogspot.com/2011/09/great-stagnationor-great-relocation.html

[2] Tyler: http://marginalrevolution.com/marginalrevolution/2011/09/the-great-relocation-or-the-great-stagnation.html

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