The Middle-Class Is Hollowing Out, and That’s Okay

Common wisdom holds that today the middle-class is being “hollowed out.” Income alarmists claim that this yet another worrisome symptom of inequality, rising automation, or whatever your preferred economic boogeyman is in America and across the developed world. Every couple of years, new data is trumpeted as confirming this pessimistic gospel. Unfortunately, this truth is only op-ed deep.

Case in point: news stories and columns recently reporting the findings of a report produced by the Organisation of Economic Co-Operation and Development (OECD). According to BBC, the latest data shows, “declining chances of rising prosperity and growing fears of job insecurity.”

The report itself contains a crucial caveat: “over the past 30 years, middle-income households have experienced dismal income growth or even stagnation in some countries.” That’s right, the key word is “some” because trends have been wildly different in different developed countries. But these differences are being papered over to promote a gloomy narrative, apparently to encourage greater government redistribution and regulation. But in fact, the countries seeing greater income mobility have kept their governments largely restrained.

Titled “Under Pressure: The Squeezed Middle Class,” the OECD’s report is an impressive collection of charts and figures that explore the purported decline in the middle-class across dozens of countries. The report notes that, “fewer people are in the middle-income class than three decades ago. The OECD-average share of people in middle-income households fell from 64% to 61% between the mid-1980s and the mid-2010s.” The discussion is accompanied by the following chart, which looks at the movement in all classes across countries over the past thirty years.

Percentage point changes in the shares of population in middle-income class, mid-1980s to mid-2010s

The countries on the left-end of the chart have seen large declines in the share of households in the middle class, but that one statistic is not the end-all-be-all. It matters, of course, what happened to those middle-class households that left the middle. In Sweden, Finland, Luxembourg, Spain, and Norway, as the middle-class shrank, the growth of the lower class exceeded the growth of the upper class. But in Germany, Canada, the United States, Australia, and the Netherlands, the opposite was true. The shrinking of the middle-class coincided with the growth of the upper-class. This effect seemed to be particularly large in the US, a country often lambasted as having greater income inequality than anywhere else in the developed world.

This data gives readers a better understanding of how “inequality” and relative wealth shares have changed, but the reader may still be unclear as to why these trends matter.

The report authors suggest that a large middle-class is the key to shared prosperity for all, arguing that, “there is a significant positive relationship between the level of household median income in purchasing power parities and the size of the middle-income class.”

While the OECD researchers don’t speculate as to why that may be the case, left economists such as Columbia University economist Joseph Stiglitz argue that inequality can weaken demand throughout the economy and lead to over-investment in economic bubbles. Stiglitz has reasoned that the wealthy save far more than they spend, leading to less purchasing activity throughout the economy and more reckless investment endeavors.  But, when the data presented above is broken down further, the relationship between median income (a good measure for society-wide prosperity) and the size of the middle class dissipates.

If we limit the analysis to countries where median household income is at least $20,000 (using the same data source the OECD uses), there doesn’t seem to be any correlation between the size of the middle class and median income. In other words, beyond a certain point, wealthier countries don’t have larger middle classes.

Source: OECD data collected from LIS Cross-National Data Center, NSFIE, and EU-SILC

But why does OECD data show a strong, positive relationship between poorer countries’ wealth and the size of the middle class? It helps that two of the poorest countries on the OECD’s chart (India and South Africa) have recent histories of rigid systems of stratification.

Institutions such as apartheid in South Africa and the caste system in India kept even skilled citizens poor based on their lineage (who their parents are), which wastes the talents of perfectly capable individuals. These countries still feel the residual effects of these oppressive systems and are still poor and unequal as a result. Countries such as Brazil and Mexico certainly have their fair share of problems, but the lack of recent government-enforced stratification in these countries leave them both more equal and richer than India and South Africa.

After taking these countries’ histories into account, there doesn’t seem to be much of a connection between income inequality and societal wealth. Societies can indeed become more prosperous on the whole, even as their middle classes hollow out. Instead of obsessing and fretting over increased “stratification,” policymakers should focus on how to remove barriers to innovation and entrepreneurship. Countries across the OECD should be focused on making more millionaires, not more middle-class citizens.