The Perils of Our Lopsided Income Growth

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Federal Reserve recently released its every-three-year report on consumer finance. I'm here with Bob Johnson--he is our director of economic analysis--to walk through this report.

Bob, thanks for joining me.

Bob Johnson: Great to be here today.

Glaser: So, can you give us a little bit of background on what the Fed's doing here, and why this report is important?

Johnson: Every three years, the Fed goes through and surveys a bunch of individuals and looks at what their incomes are and what they're spending their money on and break it into all sorts of deciles. And then it's used by the Bureau of Economic Analysis to set the weights in the GDP report and how they're going to guess at the GDP report on a fairly limited set of data.

And so it's a really critical report because it helps re-benchmark that report. In addition, it's just a fascinating report--to watch how spending is going on food over time or how cell phones have gone from zero to some relatively high percentage. Those are all things that are embedded in the report. And it also does a nice job of sorting out by incomes and by net worth and by debt how people are overall doing.

Glaser: Let's look at that snapshot of how people are doing. Looking at incomes, what did growth look like over the last three years?

Johnson: Overall, average growth in incomes was about 4%. That's an annual growth rate. That's not a bad number over that three-year period. And that compares to about a 2.1% GDP growth rate over time. So, on the surface, it looks pretty good.

Glaser: So, if incomes were maybe getting a little bit better, how about net worth?

Johnson: Net worth was relatively flat. Depending on if you use a mean or a median, it was between a 0% or a 2% decline; so really not much change in net worth. And that was kind of a situation where housing, during most of that period if you think about it, actually went down in value during that time and stocks went up.

So, you have a situation where one offsets the other, and it really didn't look like we had much of a change in net worth. But underneath the covers, there were some pretty dramatic things happening.

Glaser: Household deleveraging has been a buzzword for a while. What happened over the last three years?

Johnson: And that's a fascinating and unbelievable story. Again, this is by household; it doesn't add up the way that some of the other statistics do. But overall, it showed that by household the debt declined by about 20%--at least partially because the number of mortgages outstanding went down as homeownership rates went down. So, that was probably the key contributor to that. But there were probably a few other things, too. The credit card debt was down overall, and that was partially offset by student loans being up.

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Glaser: You mentioned, on the surface, that income growth looked pretty good. Was that evenly distributed? Did people--high earners and low earners--kind of all equally gain during this last three years?

Johnson: Unfortunately, no. One of the key ways of looking at that is asking, what is the mean--which is overweighted by people who make a $1 billion. Or look at median that says it's half below and half above that number. And unfortunately, the median number was much worse. It was down something like 5% over that three-year period. Clearly, not a good situation there. And if you look at the data: The wealthiest 10% had income gains of 10% while the bottom 40% actually saw declines in their incomes.

Glaser: So, a pretty big disparity there. How about on the net-worth side?

Johnson: On net worth, again, the changes there weren't all that different. The mean and the median, as I mentioned, were 0% and negative 2%. So, you got a little bit of a closer situation there. But keep in mind that there's a huge gap between what the wealthy have and what individuals have.

If you look at the data, the top 3% have something like over 50% of the assets out there. So, that's just a huge percentage and that keeps growing. That was up from the 2010 survey. Another way to look at it: The bottom 90% owned 25% of all assets while the top 10% owned 75% of all assets. So, there certainly is a disparity building in the numbers.

Glaser: How much of that do you think is being driven by lower homeownership rates? Does that have any impact here?

Johnson: Certainly, lower homeownership rates have an impact. And that's certainly one of the low lights of the report. We've gone down from homeownership being 69% a couple of surveys ago to 67% in the 2010 report to 65% on this one and acting like it wants to move lower than that.

And housing participation has always been a great thing to have because it lets the middle and low-end income benefit from the rising asset prices. And if they're just renters, they don't get that benefit. And so, unfortunately, the trend toward lower homeownership may also drive continuing income and net-worth disparities.

Glaser: So, other than very high income individuals, who else seemed to have done better over the last three years?

Johnson: Certainly, as I mentioned, the homeowners and non-Hispanic whites had nice income growth. People with college degrees had nice income growth. But if you didn't fall into one of the major categories, you probably didn't do as well and probably even saw your inflation-adjusted wealth and income go down.

Glaser: So, from an economic standpoint then, is this inequality problematic for growth?

Johnson: It is. And part of it gets into social things and policies, too. I don't want to get too far down there, but certainly when you get disparities that tends to discourage people from participating in the economy and [and causes them to drop] out, if you will.

So, once you get those big disparities, it's like playing a game of Monopoly: "Why should I keep playing when someone owns Boardwalk and Park Place? I'm just going to lose anyway." So, people drop out of the game. That's what we're a little fearful will happen when the disparities are too big.

So, that's certainly something I worry about. As a forecaster, I worry a little bit. And somebody trying to control economic policy--like the Fed or somebody--it really becomes problematic, too, because high earners don't tend to spend a very big percentage of the income that they get. And what they do they can do on kind of a whim. If things are particularly good--we're getting good news out of Europe and the news on the warfront is looking better--they can spend more and they can turn it on and off on a dime.

On the other hand, lower-income people spend all of their [income]--maybe even a little bit more at the low decile. And so, if they had more of the income, we'd be able to see more of it in the economy and it would be easier to predict. All we would have to know is their income and then we would have a pretty good idea of what was going to get spent. That's not true in the upper brackets.

Glaser: Bob, I certainly appreciate your take on this report today.

Johnson: Well, thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.