This is disappointing, but seemingly not surprising. After all, income inequality increased sharply during these years. The share of income going to the top 1% of households jumped from 8% in 1979 to 17% in 2007. With a larger and larger portion of economic growth going to those at the top, a divorce between growth of the economy and growth of middle-class incomes is exactly what we would expect to see.

But according to some (here, here, here, here), this picture may significantly overstate the degree of decoupling.

One objection is that the price deflator typically used to adjust GDP per capita for inflation differs from the deflator used for median family income. I’ve addressed that here by using the same deflator for both.

A second concern has to do with GDP per capita as an indicator of economic advance. Since the 1970s a larger portion of GDP has gone to replace old capital equipment and therefore can’t go to household income. Also, the number of persons has increased less rapidly than the number of households, so a per capita (per person) measure of GDP could mislead.

A third worry is that the income measure used to calculate median family income is too thin. If a growing portion of GDP has gone to employer benefits, that would help middle-class households, but it wouldn’t show up in these income data.

To address these second and third concerns, we can turn to a more encompassing measure of household income. The data are from the Congressional Budget Office (CBO). The measure includes all sources of cash income. It adds in-kind income (employer-paid health insurance premiums, food stamps, Medicare and Medicaid benefits), employee contributions to 401(k) retirement plans, and employer-paid payroll taxes. Tax payments are subtracted.

We can use average household income in these data as a substitute for GDP per capita. The CBO data set doesn’t tell us the median income, but it provides something quite similar: the average income of households in the middle quintile of the distribution (from the 40th percentile to the 60th). The following chart adds these two series. The story is virtually identical.

Decoupling is real and sizable.

This isn’t good. In a growing economy, the benefits of growth should accrue not just to those in the upper half (or in the upper 5% or 1% or 0.1%), but to everyone. The income gains needn’t be spread perfectly equally, but those in the bottom half ought to get more than a crumble.

Yet is the story conveyed by this graph misleading? The income data are from the Current Population Survey. Each year a representative sample of American adults is asked what their income was in the previous year. But each year the sample consists of a new group; the survey doesn’t track the same people as they move through the life course. If we interpret the above chart as showing what happens to typical American households over the life course, we’ll conclude that they see very little increase in income as they age. That’s not correct. In any given year, some of the people with below-median income are young. Their wages and income are low because they are in the early stage of the work career and/or because they’re single. Over time many of them will in fact experience a significant income rise. They’ll get pay increases; or they’ll partner with someone who also has earnings; or both. The chart above misses this income growth over the life course (absolute intragenerational income mobility).

The following chart offers one way to see this. The lower line shows median income among families with a “head” age 25 to 34. (As in the first chart, I use families instead of households in order to be able to go back farther in time; data for households aren’t available prior to 1967.) The top line shows median income among the same cohort of families twenty years later, when their heads are age 45 to 54.

To clarify, consider the year 1979. The lower line tells us that in 1979 the median income of families with a 25-to-34-year-old head was about $54,000 (in 2010 dollars). The data point for 1979 in the top line tells us the median income of that same group of families twenty years later, in 1999. They’re now 45 to 54 years old, which is the peak earning stage for most people. The median income in this group is now about $85,000.

In each year the gap between the two lines is roughly $30,000. This tells us that the incomes of middle-class Americans tend to increase substantially as they move from the early years of the work career to the peak years.

Should this reduce our concern about the over-time pattern shown in the first chart above? No, it shouldn’t. Look again at the second chart. Between the mid-1940s and the mid-1970s, the median income of families in early adulthood (the lower line) rose steadily. Median income for these young families was around $25,000 in the mid-1940s. By the mid-1970s it had doubled to $50,000. Americans during this period experienced income gains over the life course, but they also tended to have higher incomes than their predecessors, both in their early work years and in their peak years. That’s because the economy was growing at a healthy clip and the economic growth was trickling down to Americans in the middle. (Though I don’t show it here, the same was true below the median.) After the mid-1970s, this steady gain disappeared. From the mid-1970s to 2007 the median income of families with a 25-to-34-year-old head was essentially flat. Each cohort continued to achieve income gains during the life course. (Actually, we don’t yet know about those who started out in the 1990s and 2000s, as they’re just now beginning to reach age 45 to 54. The question marks in the second chart show what their incomes will be if the historical trajectory holds true.) But the improvement across cohorts that had characterized the period from World War II through the 1970s — each cohort starting higher and ending higher than earlier ones — disappeared.

So yes, for many Americans income rises during the life course. And yes, this is hidden by charts such as the first one here. But that shouldn’t lessen concern about the decoupling between economic growth and household income growth that has occurred over the past generation. We should want healthy income growth not just within cohorts (over the life course) but also across them.

A few other worthwhile recent reads on these topics:

Jared Bernstein’s blog

CBO, Trends in the distribution of household income

Center on Budget and Policy Priorities, A guide to statistics on historical trends in income inequality

OECD, Divided we stand: why inequality keeps rising

Scott Winship, Mobility impaired

Miles Corak, The decline of the American dream

Reihan Salam, Understanding America’s income mobility problem

Mike Brewer and Liam Wren-Lewis, Why did Britain’s households get richer?

James Plunkett, The potential for female employment to raise living standards in low to middle income Britain

Between 1979 and 2007, inflation-adjusted hourly wages for Americans at the median and below were essentially flat. Household incomes in the lower half increased, but not very much. Both wages and incomes for many ordinary Americans trailed far behind growth of the economy. At the same time, the earnings and incomes of those at the top exploded (see here, here, here, here).

One story sometimes told about the 1980s, 1990s, and pre-crash 2000s links these two developments to offer an optimistic verdict on the evolution of living standards for America’s lower half. The story goes something like this: A winner-take-all economy reduces income growth for low-to-middle Americans. But it nevertheless produces a substantial rise in living standards for them. It does so by increasing financial incentives for inventiveness and hard work, which yields leaps in consumption that aren’t reflected in the price data used to measure changes in the cost of living.

To put it more precisely, the story has four parts:

1. Returns to success soared in fields such as entertainment, athletics, finance, and high tech, as well as for CEOs. These markets became “winner-take-all,” and the amounts reaped by the winners mushroomed.

2. For those with a shot at being the best in their field, this increased the financial incentive to work harder or longer or to be more creative.

3. This rise in financial incentives produced a rise in excellence — new products and services and enhanced quality.

4. These improvements haven’t been satisfactorily captured in the price index by which we assess changes in the cost of living. Watching Michael Jordan or LeBron James play basketball is a qualitatively superior experience relative to what came before in a way that isn’t reflected in the price of a ticket or of a cable TV subscription. Similarly, the Macintosh, iPod, iTunes, iPhone, and iPad are so different from and superior to anything that preceded them that what they add to living standards isn’t likely to be adequately measured.

I think there’s a good bit of truth to parts 1, 2, and 4 of this story. But I’m skeptical about part 3.

This brings me to Steve Jobs. Apple and its delightful, user-friendly, (eventually) affordable gadgets play a key role in this story. The question is: Would Jobs and his teams of engineers, designers, and others at Apple have worked as hard as they did to create these new products and bring them to market in the absence of massive winner-take-all financial incentives?

In the things-have-improved-more-than-the-income-data-make-it-seem story, the answer is no. The financial incentive is the critical spur to inventiveness and hard work.

But I don’t find anything in Isaacson’s account of Jobs that supports this view. Jobs himself seems to have been driven mainly by a passion for the products, for winning the competitive battle, and perhaps for status among peers. The satisfaction of achieving excellence and of beating one’s opponents appears to have been far more important than monetary compensation. Excellence and victory were their own reward, rather than a means to the end of financial riches. In this respect Jobs was little different from scores of inventors and entrepreneurs over the ages, or for that matter from Bill Russell, Larry Bird, and Michael Jordan.

The rise of winner-take-all compensation occurred simultaneously with surges in innovation and productivity in certain fields, but that doesn’t mean it was the cause of those surges.

The report was released today in conjunction with this event in London.

How much does economic growth benefit the poor? When and why does growth fail to trickle down?

How can social policy help? Is more social spending better for the poor?

Can a country have a sizeable low-wage sector yet few poor households?

Are universal programs better than targeted ones?

What role can public services play in antipoverty efforts?

What is the best tax mix?

Does improvement in the living standards of the least well-off require a sacrifice of other desirable outcomes?

James Plunkett, Growth without gain? The faltering living standards of people on low-to-middle incomes

Matthew Whittaker and Lee Savage, Missing out: why ordinary workers are experiencing growth without gain

Wenchao Jin, Robert Joyce, David Phillips, and Luke Sibieta, Poverty and inequality in the UK: 2011

To keep up with U.K. developments, I typically look to:

Centre for Analysis of Social Exclusion

Centre for Economic Performance

Institute for Fiscal Studies

Institute for Public Policy Research

Joseph Rowntree Foundation

Policy Network

Resolution Foundation

Mine is titled “Low-wage jobs and no wage growth: Is there a way out?”

Innovation —> economic growth —> median income growth

In this model there are three potential sources of the reduction in median income growth:

1. Innovation has slowed.

2. The degree to which innovation boosts economic growth has declined.

3. The degree to which economic growth boosts median income growth has declined.

Cowen argues for hypothesis #1. He cites an estimate by Jonathan Huebner, a Pentagon physicist, that the rate of global innovation per capita peaked in the late 1800s, remained high to the mid-1950s, and then steadily declined. And he suggests that whereas “The period from 1880 to 1940 brought numerous major technological advances into our lives…. Today … apart from the seemingly magical internet, life in broad material terms isn’t so different from what it was in 1953.” The high rate of innovation through the mid-1950s enabled rapid economic growth for a few additional decades. But beginning in the 1970s economic growth slowed, and along with it median income growth.

The book is well worth reading. (At four dollars it’s also a good deal — less than a large latte, a Sunday New York Times, or a newsstand copy of The Atlantic.) But I’m skeptical on two counts.

First, I’m not convinced that innovation has in fact slowed significantly. Cowen discusses the internet but not computers more generally. Computers are the engine of the postindustrial economy; they are the modern counterpart to steel, railroads, and the assembly line. Advances in computer hardware and software, their widespread dissemination, and their application to myriad tasks — automation and coordination of supply chains in manufacturing, record keeping and scheduling in services, and much much more — surely represent a massive improvement.

Second, the data point to hypothesis #3. A key difference between the WW2-1973 period and the decades since then is that median income growth has become decoupled from economic growth. (Mark Thoma makes this point too.) The rate of economic growth has been lower in the recent era, but it’s nevertheless been decent. Yet median income growth has been very slow. This contrasts sharply with the prior period.

Here’s one way to see this (others here):

Between 1947 and 1973, GDP per family increased at a rate of 2.6% per year and median family income grew at 2.7% per year. From 1973 to 2007, GDP per family increased at 1.7% per year, but median family income grew at just 0.7% per year.

And note the absolute numbers: GDP per family rose by $52,000 during 1947-73 and then by $82,000 during 1973-2007. Median family income increased by $26,000 during 1947-73 but then by just $13,000 in 1973-2007.

Median family income was $64,000 in 2007. Had it kept pace with GDP per family since the mid-1970s, it instead would have been around $90,000.

I’m all for helping to accelerate the rate of innovation. But the big change in recent decades lies in the degree to which economic growth lifts middle-class incomes. If we want to understand slow income growth, that should be our focus.

I share Robert Pollin’s view that the U.S. should strive for full employment — by which I mean, following his lead, an unemployment rate below 4%.

Can we do it? Pollin points to two historical precedents as grounds for optimism. The first is Sweden from 1960 to 1989. Sweden succeeded in keeping unemployment below 4% throughout those three decades by coupling employment-oriented monetary and fiscal policy with wage restraint. But Sweden’s central bank at that time was subordinate to the government. Ours, the Federal Reserve, is independent. Since the late 1970s, independent central banks such as the Fed almost always have prioritized low inflation, rendering low unemployment difficult to achieve. If the Fed isn’t on board, even a workable plan for full employment supported by the American public and our elected officials probably won’t be enough.

What about Pollin’s second precedent, the United States in the late 1990s? During those years the Fed, under Alan Greenspan, did keep interest rates low enough for the unemployment rate to drop below 4%. But Greenspan held rates low despite opposition from other Fed board members, who were concerned about potential inflationary consequences — particularly given the internet-driven stock market bubble. Greenspan took this stance in part because his belief in the self-correcting nature of markets led him to worry less than others about the bubble. In light of the painful consequences of the 2000s real estate bubble, I doubt we’ll see the Fed take that approach again for some time.

Do we need below-4% unemployment? Here a cross-national perspective might shed some light. The following charts show indicators of Pollin’s desired outcomes — a healthy economy, decent pay, low poverty, good working conditions, absence of discrimination — in twenty rich democratic nations. Each outcome is plotted against the number of years from 1979 to 2007 in which each country had sub-4% unemployment.

These charts tell us that while full employment may contribute to good outcomes, it isn’t a necessary condition. In each case, some countries have done well despite seldom or never reaching sub–4% unemployment during the measurement period. In some instances this is a function of strong unions or “production regimes” (think German manufacturing) that are unlikely to be relevant in the American context. In others, though, successful outcomes have owed much to government action.

This is good news because Americans have more influence on the policy choices of the government than on those of the Fed. Whether or not we get back to full employment, we can reach important economic and social goals.

Yet I fear this conclusion is too optimistic. I’m confident that the United States could achieve satisfactory economic growth, a reasonably high employment rate, decent wages, poverty reduction, good working conditions, and less discrimination without full employment. I’m less certain that we can manage sustained wage growth for those in the bottom half of the distribution.

The post–World War II experiences of the rich democracies suggest three routes to rising working- and middle-class wages. One is an environment in which firms face only moderate competition in product markets and limited pressure from shareholders, allowing them to pass on a significant share of growth to their employees. This characterized the period from the late 1940s through the mid 1970s, but it’s now long gone. The second is strong unions. I see little hope of that in America’s future. The third is full employment.

Is there any alternative? One possibility might be to use the Earned Income Tax Credit to subsidize wages. We could extend it higher in the income distribution (currently it phases out at about $45,000), reduce its connection to children (currently it’s minuscule for households with no kids), and index it to average wages (it’s now indexed to inflation). I would prefer the full employment path that Pollin envisions, in which wage growth comes from firms rather than taxpayers. But we ought to have a backup plan.

What impact does the rise in the share taken by those at the top have on the incomes of those in the middle? On one view it’s bad: if the additional millions going to the “winners” had instead been spread among those in the middle, the latter would have been better off. Others suggest the impact is good: winner-take-all markets help make the pie bigger than it otherwise would have been, and a larger pie means a larger slice for the middle class in absolute terms, even if that slice has shrunk relative to the slice of those at the top.*

Pay in major league baseball is a good test case. Since the 1970s professional baseball has had the two defining characteristics of a winner-take-all market: owners’ and/or consumers’ judgment that top stars are much more valuable than the next best, and stars’ ability to exit if offered better pay elsewhere. Salaries for baseball’s top players have skyrocketed. Also helpful: unlike in pro football and basketball, baseball teams’ total pay is not limited by a salary cap.

Here are the two contending hypotheses:

1. Winner-take-all is bad for middle-pay players. Stars’ big paychecks come largely at the expense of their teams’ mid-level players.

2. Winner-take-all is good for middle-pay players. Teams that pay big money for top stars enjoy greater revenue growth via higher game attendance, richer TV deals, better jersey and hat sales, and so on. The stars collect a growing share of these teams’ total payroll, but this is more than offset by the degree to which they help boost the payroll. As a result, salaries for the middle players on these teams increase more than on other teams.

Baseball-almanac.com has data on the salaries of all major league players since the mid-1980s. I’ll examine change from 1989 to 2007, as both are business-cycle-peak years. (I exclude the four teams created after 1989. The Cincinnati Reds also are left out, due to missing 1989 salary data.)

Does paying big money for top stars enlarge the pie? On the horizontal axis of the following chart is change in the share of each team’s total pay that goes to its top three players. Consistent with what we would expect in a winner-take-all market, for most teams that share rose. For example, in 1989 the best-paid trio of players on the San Francisco Giants got 22% of the team’s total pay. In 2007 the Giants’ top three got 40% of the total pay, an increase of 18 percentage points. On the chart’s vertical axis is 1989-to-2007 change in each team’s total pay, in millions of inflation-adjusted dollars. The hypothesized positive association isn’t there. Teams that increased the portion of their pie going to their top three players haven’t gotten a faster-growing pie in return.

That points us toward hypothesis 1, which says a rising share of a team’s pay going to its top stars is bad for those in the middle. As the next chart shows, that’s indeed how things have played out. The chart plots the change in pay for each team’s middle five players from 1989 to 2007 by the change in the top three players’ share of the team’s total pay. Middle-player salaries have tended to grow less rapidly on teams in which the top three’s share has risen more.

The following set of charts elaborates a bit. It shows changes in top players’ pay and changes in middle players’ pay for four teams. The first two teams, the San Francisco Giants and Toronto Blue Jays, are on the right side of the second chart above. Pay for their top three players exploded. It rose for their middle players too, but much more modestly. The next two teams, the Baltimore Orioles and Milwaukee Brewers, are on the left side of the second chart above. Pay for their top three players rose sharply, but less than for their counterparts on the Giants and Blue Jays. Their middle players, by contrast, did better.

But that’s not the full story. To the two hypotheses listed above we should add a third:

3. Winner-take-all is bad for middle-pay players, but its harm is outweighed by other developments.

The “other” development that has mattered most is the growth in team payrolls. Total pay for the median team soared from $23 million in 1989 to $89 million in 2007. This has been the key determinant of salary growth for middle-pay major league players. On average, the pay of the middle five players rose by $300,000 less on a team with a ten-percentage-point increase in the top three players’ pay share than on a comparable team with no change in the top three’s share.** But salaries for the middle five players nevertheless increased on almost all teams, in many instances handsomely so. Across all teams, the average increase for the middle five between 1989 and 2007 was $1 million, nearly a 200% rise. Even among the six teams on which the top three players’ share of pay rose the most — those to the right in the second chart: Houston, Pittsburgh, San Francisco, Toronto, Oakland, and the L.A. Angels — the average increase for the middle five players was $540,000.

What accounts for the sharp jump in team payrolls? One element is enhanced revenues due to expanded demand for tickets, TV rights, and team paraphernalia. Another is a shift in the balance of power away from owners in favor of players. These developments have enabled some teams — the New York Yankees are the paramount example, as you can see in the second chart above — to concentrate a growing share of pay on their top three ballplayers and simultaneously provide a large rise in pay for their “middle-class” players.

Implications for the broader economy probably are limited. One, though, is that even if winner-take-all hurts middle-class incomes, if we had very rapid economic growth it might not matter much. Alas, figuring out how to get that isn’t so easy. A good substitute might be moderately strong growth coupled with strong unions (as in the 1950s and 1960s) or low unemployment (as in the late 1990s). But I’m not too optimistic about that either.

__________

* Some recent analysis and commentary: Andrews-Jencks-Leigh, Cowen, Drum, Kenworthy, Klein, Thoma, Yglesias.

** This is based on a regression of change in middle-five players’ pay on change in top-three players’ share of team pay, change in total team pay, and 1989 level of middle-five players’ pay.