January 2004
By ROBERT PEGG
A recent book by Elizabeth Warren and Amelia Warren Tyago entitled "The Two Income Trap: Why Middle Class Mothers and Fathers are Going Broke," argue that contrary to popular opinion, many of us are financially worse off today than we were a generation ago. According to the book's central argument, the average two-income middle class family today earns 75 percent more than the typical single-income family did 30 years ago. However, today's family ends up with less money for everyday living and expenses than the previous generation.
The major reasons for this apparent paradox are the rising costs of housing and education. Two incomes are now needed to provide what one income provided 30 years ago: a middle class home in a safe neighborhood with a good public school. Moreover, the author's calculations do not factor in the cost of private school, such as nursery school, and it does not consider the skyrocketing cost of college. Most parents today view a college education as an utmost necessity, unlike the situation 30 years ago.
The interesting paradox is that the rise in two-income families itself has contributed to the rise in home prices because two income families usually outbid families with only one primary earner. Over the past five years, double-digit residential housing price appreciation around cities such as New York, Boston and Washington, D.C. clearly show that housing costs have become far more expensive than ever before. As a result, you now often need two incomes just to be able to buy a home in a middle class neighborhood. The shocker is that the authors conclude that the two-income family appears to be in a more financially precarious position when compared with yesteryear's one income family. The study estimates that today's two-earner family is two-and-a-half times more likely to face a job loss than their counterparts of the early 1970s. If one partner's paycheck is lost or reduced, their backs could be against the wall.
Another reason why we may be worse off is the phenomenon of the wealthy known as "expenditure cascade." This is a phenomenon noted by Robert H. Frank, a professor of economics at Cornell University. He writes, for example, that when top earners build larger mansions, they shift the frame of reference that defines an acceptable house for those slightly below them on the income scale. When those people respond by building and buying bigger houses they in turn shift the frame of reference for those just below them and so on. In investigating this trend, the author notes that the median size of a newly built home in 1970 was 1,500 square feet. By 2000, the median size of a newly built home had increased to 2,300 square feet, even though the median family's income had not changed very much.
Although some of the trends regarding the socio-economic well being of today's middle class families may be true, it is also true that we are better off in some way than our parents were. Health care, for example, has advanced considerably and safety standards are higher. Many forms of communication and transportation are cheaper and more efficient. Travel around the world is not prohibitively expensive. In addition, certain items such as clothing and electronic gadgets cost significantly less when adjusted for inflation.
One problem in keeping up with our parent's generation is that paycheck growth for present day earners has been sluggish. Although the nation's gross domestic product has grown in recent quarters, 2.8 million jobs have been slashed from the nation's payrolls since March 2001. With 13.7 million Americans either unemployed and looking for work or too discouraged to keep trying, wage and salary growth has slowed significantly. In the latter part of the 1990s, when unemployment rates dropped below four percent, wage and salary growth, as measured by the Commerce Department, rose at an average annual rate of seven percent. In 2000, even as the stock market fell, wages and salaries for Americans still increased eight percent. However, that growth dropped to 2.4 percent in 2001 and to 0.9 percent in 2002. These increases were below the annual changes in the consumer price index of 2.8 percent in 2001 and 1.6 percent in 2002.
The bottom line is that unless wages and salary growth increases to a more respectable rate, we may lose additional financial and economic ground when compared with the prior generation. Only time will tell.
About the author: Mr. Pegg is managing director of Tocqueville Asset Management LP, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.