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Tuesday, August 31, 2004

  Understanding 'Middle-Class Squeeze'
Economists have found that people with identical incomes can wind up in very different places financially. A few years ago, Stephen F. Venti and David Wise examined the relationship between income and wealth for people nearing retirement age. If everyone had approximately the same savings behavior, then you would expect that most of the variation in wealth would be due to variation in lifetime income. High earners would have accumulated much more wealth than low earners, but within an income group the differences would be small.

What Venti and Wise found instead was that much of the variation was within an income group. You could find high-income people who had managed to accumulate very little wealth, and vice-versa. As Hal Varian noted, "Mr. Venti and Mr. Wise started their analysis by estimating the lifetime income of each household, then sorted the households into 10 equal-sized groups based on their estimate. Their most striking observation was the extreme variation in total asset accumulation within each income group. For example, the wealth held by the top 10 percent of households in the group just below the median was 35 times the wealth held by the bottom 10 percent of that same income group." To understand this observation, imagine two families with virtually identical incomes annual incomes of $40,000. After several decades one family has accumulated $700,000 in savings for retirement and the other winds up with just $20,000 in savings for retirement.

There is a parallel between the problems of middle-class squeeze and obesity. Self-control is required in order to live within one's means financially and in order to maintain a low body weight. .... Small changes in lifestyle can have large cumulative effects. A family that spends 92 percent of its after-tax income will accumulate substantial savings, while a family that spends 98 percent of its disposable income will not. On the surface, their lifestyles might not seem to differ, but eventually they will end up in very different circumstances.

Similarly, someone may consume 99 percent of the calories that her body needs each day, and someone else may consume 102 percent of the necessary calories. While they appear to be eating almost identical amounts, those two people will end up with very different body masses after several years.

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