Will the “shrinking middle class” reduce loan demand?

In a discussion of potential emerging strategic risks facing credit unions, a client recently asked whether the shrinking middle class might reduce systemic loan demand in the long run. The popular notion associated with a shrinking middle class is that “the rich get richer, and the poor get poorer.” The concern was that the rich don’t need loans and the poor can’t afford them, so a shrinking middle class might portend reduced future loan demand.

As with most popular notions, the facts in this case paint a somewhat different picture. It’s true that the middle class is shrinking. A Pew Research Center study found that the middle class shrank from 61% of households in 1970 to just 51% in 2013 (note that that time period spans numerous political environments and economic cycles, both boom and bust).

However, if the middle shrinks, it’s only bad for society at large if it’s because those who used to be in the middle have now seen their fortunes fall to a greater extent than those that have seen their fortunes rise. In other words:

Did the middle class shrink because the lower class grew, or because the upper class did?

The same Pew study found that, over that same span of time, the share of upper-income households rose from 14% to 20%, while that of lower-income households shrank from 29% to 25%.

This is the whole point of the American Dream, that those at the lower end of the income scale move up into the middle class, and those folks in turn move into the upper class.

However, this data doesn’t answer the question of whether the trend will ultimately affect loan demand. It merely tells us that there are fewer households in the lower and middle income cohorts and more households in the upper income cohort; it says nothing about how “poor” or “rich” the lower and upper income cohorts are, and whether that might impact their demand for credit.

From 1984 (when the data was first recorded) through 2016 (the most recent available data), real median household income in the U.S. has risen by 19.7%, or about .61% per year. Note that the pace has accelerated sharply since 2012 as a result of the recovery, similar to patterns experienced during previous economic recoveries. While the overall annual rate of increase appears meager, bear in mind that these numbers are adjusted for inflation. Before inflation, the average annual increase is more than 5%.

That doesn’t necessarily answer the question regarding loan demand, but the moderate pace of increase does suggest that most households aren’t going to be able to buy their cars and houses with cash. However, if we dig deeper, we find that average hourly earnings of production and non-supervisory workers – a group that generally comprises the lower to lower-middle ends of the income spectrum – has risen steadily since the data was first recorded in 1964. (The most recent hourly rate equates to an annual income of about $47,000, which is below the median household income figure; note that “income” includes more than wages, but at the lower end of the spectrum, income from other sources is limited.)

As for those whose fortunes have seen them creep into the upper-income cohort, the data don’t suggest that there’s been a significant increase in those becoming rich. Indeed, the top 1% income share in the U.S., excluding capital gains, was pretty much the same in 2011 as it was in about 2000, and likely hasn’t changed much since.

While future trends will dictate whether loan demand is impacted by the shifting income distribution in the U.S., there is no data to suggest it will be. Other emerging risks, such as autonomous cars and ride-sharing, likely pose a greater threat, but even then only in the long run, and the effects of those phenomena will differ greatly by geography, with the Midwest lagging significantly behind the urban centers of the Coasts. What we do know is that the opportunity for upward mobility in our economy appears to be working as it should, with more households moving out of the lower-income class, and more middle-income households moving into the upper-income cohort.