Consumers to Get Rude Awakening From American Dream

The stock market crash may have profound effects not only on stock investors but also on consumers, the vast majority of whom own no stocks. It may well be the long-awaited rude shock that will awaken the middle class to the fact that the American Dream is long over for them and force them to change their spending patterns. The implications for the business and economic environment are dramatic.

The American Dream has always meant ever-rising living standards and even higher incomes for our kids. But for many Americans this is no longer the case, because of the world of surpluses that we are facing for the first time since the 1930s. The flood of foreign exports, not just from Europe and Japan but from South Korea, Taiwan, and other newly industrialized countries, has pushed the yearly U.S. merchandise trade deficit close to $200 billion. U.S. business has reacted to heightened competition by cutting costs: High-paying jobs are being eliminated, benefits pared and production moved from union facilities in the North to the low-cost Sun Belt or even abroad.

U.S. wages for low-skilled jobs in basic industry are not competitive with those in the newly industrialized countries, to which production is increasingly fleeing. Unit labor costs in manufacturing are 10 times higher here than in South Korea and eight times higher than in Taiwan. The fall in the dollar needed to close this gap is not only astronomical but almost impossible: a hotel room in Seoul would then cost more than $1,000 a night!

More Non-Union Workers

Worse still, many unionized industries are not even competitive at home. Such industries as steel and autos pay their workers as much as two-thirds more than what non-unionized Americans with similar skills are willing to work for. No wonder employment is shifting to non-union workers: In the non-farm work force, the share of unionized workers fell from 30% in 1955 to 16% in 1986.

In every major sector, weekly wages for non-supervisory workers peaked in 1973 or 1979 and have declined since then.

In some sectors, such as retailing, they have fallen sharply in the 1980s, largely due to heavy reliance by employers on part-time workers.

Indeed, part-timers can be scheduled to work only when needed, and additional cost savings can be gained since employers pay them fewer fringe benefits. Between 1973 and 1986 the number of involuntary part-time workers rose from 2.3 million to 5.3 million.

An employment shift is also under way from the high- to the low-paying industries, as a consequence of job losses to imports in many high-paying basic industries. Non-supervisory jobs in manufacturing fell from 28.4% of the total in 1973 to 19.3% in 1986, while retail employment rose from 21.4% to 23.7%, and service jobs from 22.2% to 30%. Yet manufacturing jobs pay half again as much as service jobs, and more than twice as much as retailing.

These developments, all closely related to fierce cost-cutting by U.S. business, caused real income per household to fall considerably in this decade.

Concentrating on wages and salaries alone--the income mainstay for the overwhelming majority of ordinary consumers--we see sharp declines in purchasing power. On balance, real wages and salaries per household dropped 8.7% from 1973 to 1986. And, after increasing earlier in this recovery, they dipped once again in the first half of this year. The share of households with $20,000 to $60,000 pretax incomes in 1985 dollars, the core of the middle class, slid from 53% of the total in 1973 to 49% in 1985.

As cost control accelerates, the share of this middle-income group will probably fall even more, to 38% by 1995. As those families’ purchasing power is reduced, households with incomes below $20,000 in 1985 dollars are expected to rise to 50% of the total in 1995, compared to 39% in 1973.

Those on top, conversely, will continue to grow in number and income. Postwar babies are entering their top earning ages, and well-paid jobs for highly trained professionals are expanding in areas where the United States can compete internationally. The average income for households with pretax incomes over $60,000 in 1985 dollars rose from $124,000 in 1973 to $131,000 in 1985 and is likely to reach $149,000 by 1995. Their share of total income will rise from 30% in 1973 to 50% in 1995.

Shrinking Families

Even though the decline in living standards for many began as long ago as the mid-1970s, most middle-income families have been slow to accept the fact that they can no longer live higher on the hog than their parents, or retire rich.

For a time, they have been able to delude themselves: First, in the 1970s, older women joined the work force, but that didn’t prevent further erosions of household purchasing power. Then, those women postponed having children and had fewer of them: The average family size shrank from 3.42 in 1975 to 3.23 in 1985. That didn’t work either. And now, people are borrowing to finance life styles that they can’t afford but hate to give up.

Yet this borrowing can’t go on forever. Sooner or later, people must face up to reality, which for them is the end of the American Dream. They may do so now, with the stock market crash making them worry about a rerun of the Great Depression and revealing to them how financially overexposed they are.

The consequences will be enormous. First, the realization that the American Dream is over for them will lead to frustration, which might easily be vented through protectionism. “Cut those slave-labor-produced goods off at the border,” they’ll reason, “and then we can return to the life styles we knew and loved.”

Of course, protectionism doesn’t work. Major actions to limit U.S. imports would trigger retaliation abroad, and everyone’s trade and economic activity would suffer.

Second, income and spending shifts will cause changes in the markets for goods and services, as well as savings and investment flows.

Retailers serving top earners will continue to gain, as will those selling to low-income groups, but middle-market retailers will be squeezed along with their customers. Financial and other services favored by upper-income people will be big winners.

Third, the concentrating of income at the top will greatly increase savings and hence the funds for investment. In this country there is a clear division of labor between saving and spending: families with over $75,000 in pretax income save 38% of their after-tax dollars, but those with less than $10,000 in income spend $1.97 for every one of their after-tax dollars!

The income shift in favor of the upper-income households, coupled with demographic factors such as the natural aging of the U.S. population, should raise the saving rate from 5.1% in 1985 to more than 10% in 1995, a level that has been rare in the postwar era.

Finally, if as we expect, consumers pull in their spending horns as a result of the shock of the stock market crash and admit that the American Dream is over for many of them, a recession will develop quickly.

Consumers account for two-thirds of GNP, so spending restraint will drag down the whole economy. And the recession, which will probably start early in the new year, could be long and deep if it spawns severe protectionist legislation here and abroad, and financial crises that the Federal Reserve and other monetary authorities cannot contain.

The stock market crash will probably force many families to realize that the American Dream of ever increasing purchasing power is over for them. This will be a rude awakening to them, to those from whom they buy, and to those who will feel the effects of their frustrations.