Hollowing Out

• Author: Ali Alichi

Hollowing Out Finance & Development, December 2016, Vol. 53, No. 4

Ali Alichi

The U.S. middle class is shrinking as households climb into higher, or slip into lower, income brackets

The U.S. middle class—households with 50 to 150 percent of the national median pretax real income—has been shrinking. Middle-income households declined by 11 percentage points (from 58 to 47 percent) of the total U.S. household population between 1970 and 2014. In other words, the U.S. income distribution has been polarizing, or hollowing out, as middle-income households became richer or poorer (see Chart 1).

From 1970 to 2000, this polarization was mainly good news because more households moved into upper-income ranks (with real, or after-inflation, incomes higher than 150 percent of the median) than slipped down to real incomes less than 50 percent of the median. Since 2000, however, the story has reversed. More middle-income households have fallen into lower-income than have risen into higher-income brackets.

Falling into a lower-income bracket takes a toll on households, especially at a time when average real incomes have been broadly stagnating. This hollowing out has damaged the economy in recent years by hampering consumption—the main engine of U.S. growth. Lower consumption in the world’s largest economy also hurts its trading partners, as well as many other countries indirectly tied to the U.S. economy through global production and financial chains.

Middle-class trendsA strong economy needs strong consumption and investment to function well. Low-income households have limited ability to consume and save little. High-income households save a lot but, relative to their incomes, consume too little. Middle-income households provide a reliable balance for consumption and saving in a society. In the United States, the middle class not only accounts for most of the economy’s consumption, it also provides most of its human capital and owns most of its physical capital, such as houses and cars. So a shrinking middle class hurts the economy.

The 11 percentage point shift in the middle-class share of total U.S. households since 1970 represents, in part, economic progress; roughly half of these households advanced up through the income distribution, while the other half moved down over that span. But the long-term trend masks a deterioration since the turn of the century. While the majority of middle-income households that left the middle ranks moved up between...