The coming collapse of the Irish middle class

In the her excellent lecture on “The coming collapse of the American Middle Class”, Harvard professor Elizabeth Warren investigates the stagnation in real median wages in the United States since 1970, and highlights the massive amount of extra-risk assumed by families in moving from one to two income households (The Two Income Trap).

It’s probably worth noting at this point that Warren employs a more expansive notion of middle class than many (although not all) in Ireland. Large swathes of the population designated working class in the various class analyses produced by Conor McCabe, and probably the bulk of the social classes defined by the CSO (certainly Professional workers, Managerial and technical, Non-manual, Skilled manual, and probably many in the Semi-skilled category too), would also fit her definition and hence suffer the same problems highlighted.

Like Matt Ridley, Warren notes that the affordability of many essentials has improved markedly. Households buy more sophisticated foods and eat out more often but spending on food as a proportion of income has fallen significantly since 1970. Or to put it another way, it takes significantly less hours of work to purchase a better meal than in 1970. Ditto for clothing, household appliances and electronic goods and even for the (first) household car.

However since 1970, American women have increasingly entered the workforce and Americans have migrated to suburban housing. With two workers per household, far from the office, not only is a second car essential, but households must spend on other new expenses such as childcare, and third-level education. In 1970 Warren points out that to become middle class Americans needed 12 years of education (that is to graduate from second level), where as today most American feel a third level qualification is an essential prerequisite for entry into the middle class. In the United States these costs have been allowed to spiral out of control, with the United Kingdom appearing to follow suit, there but for the grace of God go us?

In addition any potential savings (from improved food, clothing & appliance affordability) are, after deductions for new & increased costs elsewhere, completely eaten up by more expensive housing. Housing in this context is something of a double edged sword. While rising house prices eat up any gains in real wages, they also increase households’ asset wealth. Home owners can in later life trade downwards and use any capital gain on their properties as a pension. They could also remortgage to help fund a new business if they so wished. With real house prices falling since 2005 younger workers will find housing more affordable (increasing the purchasing power of the their wages), while existing home owners find themselves locked in to large mortgages with a large deteriotation in their expected asset wealth.

With the death of the Celtic Tiger, David McWilliams argues this is the fate facing the Irish middle class. Large debts, decreasing asset values, shrinking real wages (whether via increased taxes or levies, pay cuts or below inflation pay rises).

Whatever the overall reason, the trend of a middle class that is either running to stand still or actually falling backwards is of crucial significance here, because the Irish middle class is about to take a giant leap backwards.

This group is now getting hammered by the collapse of property prices – which, ironically, has to continue if we are to get competitive and become a proper trading nation once again.

This is the central dilemma for all of us: we need to ‘lock in’ cheap property as a competitive advantage for the country, but that means trapping the property-owning middle class in a brace, where their debts remain static but the value of their assets falls.

This means, in its simplest form, that middle class Ireland is broke for the foreseeable future.

And he paints a bleak picture of that future. Bear in mind while reading of emigration that 57% of our school leavers now go onto third level.

In the 1980s, the middle class responded by emigrating. Atypical emigrant in the late 1980s was three times more likely to have a university degree than one who stayed at home.

This trend will probably repeat itself, and the fiscal situation will deteriorate as unemployment rises and tax revenue falls. Ireland is on course for a failed fiscal adjustment – all the indicators are pointing to it.

The state will then try to get its hands on cash from wherever it can.

This is why a tax on savings is likely to be introduced, as are all sorts of other charges and stealth taxes.

All the while, the position of the middle class – which seemed to be so strong a few years back, when the property scam blinded people – will become more and more edgy.

This is exactly what Warren documented in her book.

So what are the alternatives? Whether we like it or not, with the balance sheet shattered, some form of debt restructuring for Ireland’s private sector is a given.

Time will tell how this will work out.

Also, given an anticipated last-gasp, smash-and-grab exercise from the state, the middle classes will take some of their cash out of the country and the Irish banks.

This is what happened in Latin America for decades when capital flight was endemic.

The real damage done by these changes is not in the stagnation of real wages alone (in part driven by spending, however essential, on new goods and services), but by the increase in the levels of risk a family must bear. Dismantling, however piecemeal, the welfare state steadily increases the risk of bankruptcy. And Irish bankruptcy laws are incredibly severe.

With two incomes required to pay mortgage, should a parent lose their job (or perhaps even a child get sick) debt default approaches with every jobless week. The probability of one of two working parents losing a job, through whatever cause, is much greater than that of single worker becoming unemployed, and depending on the reason for the job loss, there is no backup worker at home that can re-enter the workplace. E.g. Should a husband lose a job through illness, his wife will be unable to take on extra work to compensate.

The increased risk borne by families in every sphere – from pensions (the shift from defined benefit to defined contribution), to job loss and health should mean that appropriate policy responses are taken to reduce risk elsewhere. The recent phenonem of giving mortgages on the basis of a multiple of joint income is absolute madness. But with bank solvency dependent on house prices remaining high, can we really hope for an end to this any time soon?

Warren argues that the 3-tier American class system (Rich, middle-class, poor) is being replaced with something approaching a two-tier system, a comfortable upper class (that includes any members of the old-middle class that are lucky enough to avoid personal disasters throughout their working life) and the poor – which will include any members of the former middle class struck by job loss, illness and other problems.

In a recent interview in the Washington Post Warren gave a concise overview of the problem

Well, I believe that the middle class is under terrific assault. And I don’t want to play this as a capitalism issue.

When we compare middle-class families today with their parents a generation ago, we have basically flat earnings-a fully employed male today earns on average about $800 less, adjusted for inflation- than a fully employed male earned a generation ago. The only way that houses could increase or families could increase their household income was to put a second earner into the workforce, and, of course that’s now flattened out because there aren’t any more people to put into the workforce. So you’ve got, effectively, flat income in this time period, with rising core expenses; housing; health insurance; child care; transportation, now that it takes two cars to get everywhere, two jobs to support; and taxes, because you’ve got two people in the workforce and we have a somewhat progressive taxation system. So that families are spending a lot more on what you describe as the basic nut.

The third leg to the triangle, and that is families, to deal with this, stopped saving and started going into debt.

And the debt side of where families both spend more money and are made much more vulnerable on mortgages, on credit cards, on check overdraft fees, all this side of it, the credit side of it really means that we have a middle class that a generation ago we would have described as solid, secure, dependable. If you could just get into the middle class, you could pretty much count on a fairly comfortable life and all the way through to a comfortable retirement.

That’s been hollowed out. Sure, there are people who are going to make it through just fine, but the vulnerability of families in the middle class has just, it has gone up enormously.

The mispricing of risk played a large part in the creation of the Great Recession, is it time for a rethink about the amount of risk we are piling onto families today? We’ve bailed out the banks, but haven’t even begun to discuss issues like this.