Why the Middle-Class Squeeze Is Getting Worse

Heather Berger (0:00)

Welcome to Thoughts on the Market. I'm Heather Berger for Morgan Stanley's US. Economics Team.

Sarah Wolfe (0:05)

And I'm Sarah Wolfe, Senior Economist and Strategist on Morgan Stanley's Thematic and Macro Investing Team in the Global Investment Office.

Heather Berger (0:12)

Today, the K-shaped economy, the middle class, and how AI could reshape both. It's Friday, September 11th at 10 a.m. in New York.

The K-shaped economy has been a major theme this year. At its core, it describes an economy where households are experiencing very different circumstances. Those with more assets have benefited from rising wealth, while those with less wealth remain more dependent on income and more exposed to increases in essential costs. But that top versus bottom framing can miss an important part of the story. The middle class.

Sarah, you recently wrote about what it takes to make it to the middle class in America. How would you define the middle class today, and how does that differ from the way that households define it themselves?

Sarah Wolfe (0:55)

I think the important thing here is that economists and households define the middle class very differently from each other. And I'll get into why that's the case. So if you're an economist, the middle class is roughly defined as two-thirds to twice the median household income. Which today means if you're making around $55,000 a year to $168,000 a year, depending on where you live in the country, that is roughly the middle class. And that's where about half of Americans sit today.

We've actually seen that number decline. So 61% of Americans in the 1970s were in that middle class definition by economist terms. Now it's about 50%. So we have seen it shrunk. But even though it's shrunk, fewer and fewer households feel like they're in the middle class. And they don't define it by necessarily income or a specific number, but they really define it by milestones, I would say. So do you own a home? Have you been able to build a family? And can you pay for childcare?

Have you saved enough for retired? Do you have an emergency fund? Are you constantly stressed about your bills? That feeling is really what the middle class is about today. And I would say that less than 50 percent of Americans actually feel like they're in the middle class once you start to put that definition around it.

Heather Berger (2:08)

What are the key factors that actually make a household feel financially secure?

Sarah Wolfe (2:13)

I think there's four things that determine household security and stability. The first, of course, is income, stable income. Do you have a job and do you think you're going to continue to have a job? Six months from now, we love the University of Michigan Consumer Sentiment Survey that asks consumers this. Do you have affordable fixed costs like housing, child care, health care, and transportation?

Do you own assets? This is critically important because if we look at where gains have come from, from the last five years, it hasn't really been that much through the labor income channel. It's been through the asset channel like home equity, retirement savings, are you invested in the stock market, et cetera.

And then the last one is this emergency fund and a manageable debt. What is your debt load? Is it fixed rate or is it revolving? The more of these pillars that a household has, the more financially fulfilled and comfortable they are and the more likely they are to feel like they've made it to the middle class, but the reality is that fewer and fewer households are meeting these four boxes that define the middle class by historical terms.

Heather Berger (3:16)

And what has made that security harder to achieve? Which of those costs that you mentioned have moved the furthest out of reach?

Sarah Wolfe (3:22)

I think these numbers are going to maybe surprise our listeners, but in some ways feel very real to them as well. So if we look at how much inflation has risen since the 1970s, shelter, the cost of housing has risen 6.6 times more than the overall inflation basket. Child care costs have risen by 14 times more than the overall inflation basket.

And health care costs have risen 10 times more. And if we dig more into child care, we now like to call it the second mortgage, and we're not being sarcastic or anything. The reality is that to send two children to child care in America costs more than a mortgage in 45 states, and costs more than rent in 49 states. So it's really this reality has gotten a lot more expensive, and these baskets, these individual things like child care, health care, shelter, that define the middle class, have risen more than the overall inflation basket, and certainly have risen more than income growth over this period as well.