Tuesday, June 09, 2015

Rise of the Machines: Fall of the Middle Class or Rise of the Poor?

There's a simple concept in capitalism that any improvement in efficiency as a result of technology results in a net improvement in welfare for consumers. Initially, those improvements mean higher profits for manufacturers. However, market forces quickly push the benefit to consumers in the form of lower prices and improved quality. This concept has been proven time and time again. A great example is the famous Ford Model T. When introduced in the mid 1920's, it sold for $850, making it affordable for the majority of Americans. (Adjusted for inflation, that's about $12,042 in 2015 dollars). However, improvements in the assembly line and tooling process drove the price down to $250 ($3,541 in 2015). More than fifteen million Model T's were produced.

A common argument people engaged in protectionism make is that regulations should protect jobs. Therefore, new products or processes that reduce demand for labor need to be regulated. From 1925 to 1930, as Ford introduced new production methods, not one single worker was let go as a result. In fact, more were hired to support expanded production. A more affordable Model T meant more demand. Additional profitability also meant higher wages for works. 100,000 of those Model T's were sold to Ford employees at retail prices.

Granted, there are cases where technology eliminates jobs. The Ford Model T decimated the horse whip industry. Carriage makers turned to making automobile bodies. Nobody needed to whip their horses any more, so these coach builders no longer needed leather straps, leather whips or other leather accoutrements. Had the shrillest voices of the day prevailed, there would be regulations requiring cars to be sold with horse whips. (I kid you not.)

Rich people tend to be the worst, particularly when their conscience catches up with their avarice. Robber Barons of the Guilded Age quickly switched over to being philanthropists, spending vast swaths of their fortunes (much to their heirs dismay) on social improvement schemes ranging from libraries to endowments for the arts. Unfortunately, lessons aren't always learned. For every Henry Ford or George Westinghouse, there were 10 industrialists who exploited markets - often with help from State and National lawmakers - to amass huge amounts of wealth without giving more than a passing thought to other stakeholders in those markets. Then comes the day when, from the couched luxury of their corinthian leather office chairs behind rainforest mahogany desks in opulantly decorated corporate suites, they criticize the inequal distribution of wealth between the elite rich and the swelling multitudes of poor.

My new favorite self-loathing elitist is South African multi-billionaire Johann Rupert, who warned that the rise of the machines will result in social unrest as robots and AI replace low skilled laborers. He also laments the destruction of the middle class, which further increases the divide between rich and poor. His argument is that social unrest will follow, as resentment from the poor will be countered with fear and suspicion from the rich.

There are several arguments with Rupert's mode of thinking. First, is that the middle class has always been fluid. It is not growing and shrinking per se, but what is happening is that the level of mobility  between the middle, upper and lower classes is changing. Certainly, the financial crisis and great recession has forced much of the middle class into the lower classes. But it has also made more rich people, as those whose assets were not dependent on financial markets were able to quickly recover. In 2007, just before the onset of the financial crisis, 9.2 million US households were classified as millionaires. That fell to 6.7 in 2008, but by 2013 had recovered to 9.6 million households. If you're wondering what happened to the 2.5 million that stopped being millionaires? They slid into the middle class. Unfortunately, the middle class shed some 4.1 million households to the ranks of the lower class.

I don't want you, the reader, to get hung up on these levels, mind you. They're relative. The  middle class is defined as those households whose incomes fall between 0.5 and 1.5 times the average household income. A millionaire, on the other hand, is defined as someone who has at least one-million-dollars in assets. It's actually pretty common for someone with a million dollars in net assets to also be living off an income of less than the median household income. The difference is that more of their income is disposable because they own their assets, while most of the middle class is financing their assets. In many cases, the wealthy are living off their assets - collecting royalties, annuities, dividends and other payouts. These people also enjoy a lower tax rate than wage earners (10% vs ~30%).

But how do we define the poor? That gets much easier. The poor generally have little or no capital assets (eg a home or car), and their income is not sufficient to support the acquisition of these assets while leaving enough disposable income to support their needs. A poor person either rents an apartment or home, or has to live in a shared living situation with friends or relatives. A poor person either relies on public transportation, owns a used car, or is financing a vehicle. They are unable to provide for basic needs while also saving money for future needs (retirement, emergency savings). Note that I'm talking "ability" here. We have some of the richest "poor" people on earth in America, buying name brand clothes and expensive jewelry while driving high end luxury vehicles. Also, I'm not defining the poor in terms of income. A poor person in New York earns a prevailing wage of around $12.35/hour, while someone in a rural southern area will be pegged to the minimum wage of $7.25. The New Yorker will be $6,000 above one-half the median income, and thereby considered middle class. The rural worker will be $6,000 below that same mark, and therefore considered poor. However, the rural worker will face lower costs of living, such as rents and food prices, and would therefore enjoy the same standard of living as the urbanite New Yorker. (This, incidentally, is a big driver of migration from the North East. Yes, wages are lower in the South, but cost of living is even lower, so overall living standards tend to be better.)

Taken this definition, let's look at what constitutes rich. You should be considered rich if you have non-wage income (eg income from assets, investments, etc) sufficient to provide for your basic needs and support a savings rate of 10% of income. We've traditionally associated the rich with people who don't have to "work for a living", and that's the definition I'd like to stay with.

That leaves us with the "middle class". I define the middle class as being between the rich and poor, which seems somewhat obvious. But given the definitions of rich and poor above, the middle class would be those people with a mixture of asset-based income and wage based income which is sufficient to support their basic needs, a 10% savings rate, but also to allow for 10% of their income to be "disposable". By disposable, I mean they money can be spent on either non-essential items (landscaping for their yard), or to satisfy their basic needs with better commodities (designer label clothes, luxury cars, organic food, boutique coffees, etc).

At this point, if you've followed me, it's because you've granted me a lot of latitude. I've come from talking about how technology, while making some workers obsolete, ultimately benefits everyone (including the poor). And my argument should come full circle, because here is my point: if the people at the bottom rung of the income ladder cannot increase their income, then cheaper goods will bring them closer to realizing the middle class dream. If technology reduces the price of making a t-shirt from $10.33 to $3.47, then a poor person can either buy 3 times as many t-shirts for the same price, or they can buy a far nicer t-shirt at the same price. Consider that many of the things today considered necessities - internet, cable, phone service, electricity - were considered luxuries by our grandparents. Technology and change has always benefitted the poorest people even more than the richest because it has better allowed them to afford goods and grow closer to the middle class lifestyle.

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