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Next Victim of Turmoil: Your Salary

It is possible, for the first time in weeks, to imagine that the credit crisis may be about to ease. But one of the big lessons of the last year has been not to underestimate the severity of the economy’s problems. Those problems are not just about housing or Wall Street.

What, then, will the next stage of the downturn be about? It is likely to revolve around the worst slump in worker pay since — you knew this was coming — the Great Depression. This slump won’t be anywhere near as bad as the one during the Depression, but it also won’t be like anything the country has experienced in a long time.

Income for the median household — the one in the dead middle of the income distribution — will probably be lower in 2010 than it was, amazingly enough, a full decade earlier. That hasn’t happened since the 1930s. Already, median pay today is slightly lower than it was in 2000, and by 2010, could end up more than 5 percent lower than its old peak.

If you look back at poll results over the last few decades, you will see that nothing predicts the public mood quite like income growth.

When incomes are growing at a good clip, as they were in the mid-1980s and late ’90s, Americans are upbeat. When incomes stagnate, as they did in the early ’80s, early ’90s and in the last several years, people get worried about the state of the country. In the latest New York Times/CBS News poll, 89 percent of respondents said that the country had “pretty seriously gotten off on the wrong track,” a record high.

So it’s reasonable to expect that the great pay slump of the early 21st century is going to have a big effect on the next several years. Falling pay will weigh on living standards, consumer spending and economic growth and will help set the political atmosphere that awaits the next president.

The events of the last several weeks have removed any serious doubt that the economy is in a recession. In a recession, businesses cut back on their workers’ hours, hand out raises that don’t keep pace with inflation and often skip paying bonuses. These cuts in hours and pay are the main way that a downturn affects families, because only a small share of workers actually lose their jobs.

As the chart here makes clear, every recent recession has brought an effective pay cut of somewhere between 3 and 7 percent for the typical family. The drop typically happens over a period of about three years, lasting longer than the recession officially does, as pay fails to keep up with inflation.

The recent turmoil — the freezing up of credit markets, the fall in stock markets, the acceleration of layoffs — has made it unlikely that the coming recession will be a particularly mild one.

“The biggest hit will be in 2009,” Nariman Behravesh, the chief economist of Global Insight, a research and forecasting firm, told me, “and it probably won’t be until 2011 until we see any kind of pay gains.”

What will make this recession different, no matter how deep or shallow it is, is that it’s following an expansion in which most families received little or no raise. The median household made $50,200 last year, slightly less than the $50,600 that the equivalent household earned in 2000, according to the Census Bureau. That’s the first time on record that income failed to set a new record in an economic expansion.

Why has it happened? There is no single cause.

Medical costs have risen rapidly, which means that health insurance premiums take up a bigger chunk of workers’ paychecks than they used to. Some of this money goes to good use; it pays for treatments that weren’t available even a few years ago. But some of it, the part that disappears into the inefficient American health care system, is clearly wasted.

And in the last couple of years, the value of the typical worker’s benefits package has stopped growing. Since 2005, benefits packages have become slightly smaller, notes Jared Bernstein of the Economic Policy Institute. So health benefits can’t come close to explaining the recent pay stagnation.

The bigger factors are probably some combination of the following: new technologies, global trade, slowing gains in educational attainment, the rise of single-parent families, the continued decline in unionization and the sharp increase in inequality, which has concentrated income gains at the top of the ladder. Your political views will probably determine the relative weights that you assign to those causes. Economic research hasn’t yet definitively answered the question.

Whatever the cause, though, the effects of the pay slump are going to be significant. Households have already begun to cut back their spending, and they will do so even more next year. Mr. Behravesh predicts that inflation-adjusted consumer spending in 2009 will be somewhere between flat and down 1 percent. If he’s right, it would be the first year that consumer spending didn’t grow since 1980, which just happens to be the last time that the country suffered through a deep recession.

The pay slump will also make it harder for people to pay off their loans. Last week, Bank of America reported that its losses on consumer credit had tripled over the last year.

In all, banks around the world have acknowledged $600 billion in losses as part of the financial crisis. The latest International Monetary Fund analysis suggests they still have another $800 billion in losses ahead of them — and a good chunk of them will occur in this country.

It’s always possible, of course, that some bit of good and unexpected economic news is just around the corner. The situation also seemed pretty dire in the mid-1990s, until the Internet boom came along and incomes then started rising at their fastest pace since the 1960s.

But you would have to be a pretty zealous optimist to forecast a repeat of that story. For two decades, consumer spending has been an enormous driver of economic growth, thanks in good measure to a long bull market, a housing bubble and a boom in consumer debt.

The bull market, the housing bubble and the debt boom have all ended — and now paychecks are shrinking, too.

At some point, the next big economic engine will indeed arrive. It always does. This time, however, it’s going to have some stiff head winds to overcome.

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