Why the American Middle Class Is Dying

A skills gap is combining with more international competition for services to shrink the middle class and stall wage growth.

The skills gap is widening, the middle class is shrinking, and wages are stagnant. America has underinvested in areas of competitiveness over the past several decades while overinvesting in short-term fixes that mask the underlying issues. Ostensibly a response to labor-market shocks brought on by recessions, the low interest rates of the early 2000’s and the current QE program are, on a deeper level, attempts to compensate for titanic shifts in the labor market.

The US long ago lost much of its low-end manufacturing overseas. Manufacturing peaked at 22 percent of payrolls in 1977 and is slightly under 9 percent today. A recent uptick would seem to be a positive, and well reported, piece of news for the US economy. But the new manufacturing is not labor intensive, and creates few jobs relative to what left. Many of the returning or newly created manufacturing jobs require the ability to operate and program complex machinery. The dismal US education system underprepares students for these realities. Americans have skills, but the skills and talents do not seem to match what employers are looking for.

Far more troubling, however, is the loss of employment in occupations once considered safe from offshoring and technological advances. It is not just manufacturing that can be outsourced and mechanized anymore. The ceaseless march of technology and increasing speed of internet connectivity are creating an entirely new competitive landscape—this time for service jobs. The new global class of cheap-but-educated labor is alien to anything the US worker has ever experienced. Today, a routine or repetitive knowledge job can be moved to the developing world or replaced altogether with computing power.

The result is that well-paying service jobs are leaving the US—or are simply never being created here. Instead, new customer-service centers are built in India, and robots are the first to be hired. Any job a robot can do or that a computer program can automate is under siege.

Alan Blinder estimates 22 to 29 percent of US jobs are potentially offshorable. Not all will move, but all are contestable. A contestable job will not necessarily be outsourced, but now exposed to international competition. This limits wage pressures businesses feel. If a job is contestable on an international scale, a worker is competing with cheap talent around the world—not just in the next cubicle. This limits a workers ability to negotiate wages: negotiate too much, and the robot or foreign call center begins to look a lot better to management. As breakthroughs in IT cause the number of globally contestable jobs to increase, the global flattening of wages across tradable services industries is likely to continue.

According to the Census Bureau, median household income peaked in 1999 and has steadily declined with only a slight reprieve before the housing bubble burst. Adjusted for inflation, the 2012 US median income was below the 1989 level. The step-up in competition for middle-class jobs from developing nations is, essentially, a step-down (or at best sideways) for US middle-class, middle-wage jobs.

With few good jobs left, and fewer being created, middle-income wages have stagnated. According to Goldman Sachs, there were relatively few lost jobs on the high and low end of the wage spectrum during the recession, and these jobs bounced back quickly. The middle suffered much greater losses, and their recovery has been slower.

It is a middle class rout, and perhaps only the middle class itself appreciates what is happening. A 2012 Pew Research Center report aptly subtitled “Fewer, Poorer, Gloomier” showed an American middle class that is less optimistic—26 percent thought the next generation’s standard of living would be worse. Between 1971 and 2011, Pew estimated proportion of middle class households declined from 61 to 51 percent, and their share of total income decline from 62 percent in 1970 to 45 percent in 2010.

The shrinking of the middle class and stagnant wage growth are disinflationary forces. With wages flat, the middle class cannot increase consumption and pay more for housing. Much of this is apparent already as the US economy struggles to grow demand.

Highly skilled services and manufacturing tend are areas where the US currently maintains a comparative advantage. Typically high-wage occupations benefit from tradability. Creative, education-intensive industries are not being offshored or replaced with technology—at least not yet. At the moment, these are the jobs the US has an advantage in producing and exporting. Technological improvements tend to enhance these jobs, not replace them. But there are no guarantees. The new reality demands being brilliant or different; mundane will not cut it.

The US needs to protect its comparative advantage in services. Losing this, now or in the future, could be catastrophic. A consistent decline in educational outcomes indicates the US may not be setting itself up well for future competition. Mediocre PISA test scores are one thing, but the note that US students did poorly at creative problem solving is a red flag.

This is the middle skills gap; skilled services that guaranteed middle class status a generation ago are no longer produced in the US. And the US continues to prepare a workforce for an economy that no longer exists. Currently, the US has a comparative advantage in high-end services, which produces a trade surplus and job growth. But the US is currently blind to a titanic shift in its competitive advantages in the coming decades. The US must shift its focus toward developing employees with the skills to bypass the middle skill gap. Highly skilled tradable sectors should be nurtured and encouraged. Ignoring them will consign the middle class to a continued skills gap and economic stagnation.

Samuel Rines is an economist with Chilton Capital Management in Houston, TX.

Image: Flickr/David Neubert. CC BY 2.0.