FRBSF Economic Letter
1999-26 | September 3, 1999
The California economy is stronger than it has been in a number of years. Employment growth is solid, unemployment is low, and consumer confidence is rising. California’s revival has prompted many to ask whether the benefits of growth have been spread evenly throughout the population. This Economic Letter reports on changes in the distribution of real family income in California over the past decade, examines who has benefited from the 1990s expansion, and compares these patterns to those for the rest of the U.S. The findings suggest that the differential timing of the 1990s business cycle in California and the rest of the U.S. accounts for much of the observed disparity in real income growth between these two regions. Correcting for this difference in business cycle timing shows that compared to the rest of the U.S., California’s recovery has produced rewards relatively quickly.
Studies of income growth typically rely on data from the March Current Population Survey (CPS). The March CPS is an annual survey of a nationally representative sample of more than 50,000 U.S. households (5,000 households in California) containing detailed questions about household composition and sources of income. These data are used to trace changes in the distribution of real income in California and the rest of the U.S. between 1989, the last business cycle peak, and 1997, the latest year for which data are available.
Income in this analysis refers to combined pretax, post-transfer real resources of all members of a family. To control for the fact that $20,000 a year provides a higher standard of living for a single person than it does for a family with multiple members, all incomes are adjusted by family size. An easy way to make this adjustment is to divide total family income by the number of individuals in the family. However, to account for the possibility that economies of scale exist for larger families (“two can live more cheaply than one”), the analysis assumes that a family of two requires 1.4 times the income of a family of one and that each additional person increases the family’s income needs by 0.25. Although the analysis examines changes in the distribution of family income over time, the results do not reveal how the income of the same families have moved. Since the March CPS data include a different sample of households each year, the analysis focuses on how the income of families at a particular percentile in 1997 compares to the income of families at an equivalent percentile in 1989. All incomes are valued in 1998 dollars using the Personal Consumption Expenditure (PCE) Deflator.
Figure 1 shows the percentage difference in real family-size adjusted incomes by percentile in 1989 and 1997 for California and the rest of the U.S. As the figure indicates, by 1997 sustained economic growth outside of California had lifted almost the entire distribution of real income for the U.S. above 1989 levels. Although those in the upper half of the distribution gained more than those in the lower half, only families in the bottom 7% of this distribution had 1997 incomes lower than equivalent families in 1989.
In California, the story was much different. In 1997, real family income had yet to return to pre-recession levels for about two-thirds of California households. Real income for the median household (50th percentile) in California was about 6% lower in 1997 than it was in 1989. As was true for the United States, income gains in the bottom quarter (25th percentile and below) of the distribution were smaller; on average, real income for the bottom 25 percent of the income distribution was 17% lower in 1997 than in 1989.
Although most policymakers and researchers expect business cycle downturns to have disproportionate effects on those at the bottom of the income distribution, few were prepared for the large difference between the distribution of rewards from growth in California and the rest of the U.S. While such a difference is troubling, it may be too early to tell if it is a permanent phenomenon.
Figure 2 shows the evolution of employment in California and the rest of the U.S. over the last decade. (The series are indexed to 1989=100 for comparison.) As the figure shows, the 1990s recession was both longer and deeper in California. The U.S. economy outside of California began to recover early in 1992, when payroll employment growth turned positive. Less than one year later, total employment for the U.S. excluding California had surpassed its pre-recession peak. In California, payroll employment continued to contract until early in 1994. In addition, the number of jobs lost in California during the prolonged recession made for a slow return to pre-recession levels of employment. Total payroll employment did not surpass its pre-recession peak until January 1996. Not surprisingly, the disproportionate loss of jobs in California compared to the rest of the U.S. introduced substantial disparities in unemployment rates, real median income, and poverty. After following the U.S. unemployment rate closely during the 1980s, California’s unemployment rate surged in 1990, surpassing the rest of the U.S. by almost 2 percentage points at its peak. Although the gap has narrowed, unemployment in California remains more than one percentage point higher than in the U.S.
Figure 3 shows that real family income also was greatly affected. California’s real median income fell by about 15% between 1989 and 1993 (the trough of the recession), compared to a decline of less than 6% in the rest of the United States. The disparity was even larger in the bottom half of the income distribution. The average decline in family real income at the 25th percentile and below was over 25% compared to about 12% for the rest of the U.S. As a result of deteriorating real incomes at the bottom of the income distribution, California’s poverty rate increased by more than 5 percentage points during the recession.
As Figure 2 shows, measured by employment growth, California’s expansion is about two years behind that for the rest of the U.S. Thus, to evaluate how the rewards of economic expansion have been distributed in California relative to the rest of the U.S., it is important to move away from comparisons based on calendar time and look at those based on the number of years spent in economic recovery. The results of such an analysis are portrayed in Figure 4, which compares the percentile of the income distribution at which real family income surpassed its 1989 peak in California and the rest of the U.S. by the number of years of recovery. The first two bars show that in the third year of economic expansion, families above the 74th percentile of the income distribution in California (top 26%) had real incomes greater than equivalent families in 1989; outside of California, two years of growth left the entire distribution of real income below its 1989 level. Measured this way, California’s economic expansion delivered benefits more quickly than did the expansion outside of California.
The third year of recovery produced similar results, with California’s recovery boosting a greater percentage of families above pre-recession levels of income than the U.S. recovery. Although data constraints prevent a comparison of California and the rest of the U.S. beyond three years of expansion, data for the rest of the U.S. for the fourth and fifth years suggest that the benefits of economic growth began to be distributed rapidly as the recovery proceeded. By the fourth year of the U.S. expansion, about 40% of the real family income distribution was above 1989 levels. By the fifth year, 1997, families at nearly all percentiles of the income distribution were better off than their counterparts in 1989. If the same pattern holds for California, the entire distribution of real family income in the state will surpass its pre-recession peak by the end of this decade.
This optimistic outlook for California is tempered by the fact that the distribution of rewards to those in the bottom quarter of the state’s income distribution has not kept pace with the rest of the U.S. Comparing the extent of recovery for the 25th percentile of the income distribution in California and the U.S. shows that by the fourth year of the expansion–the last year for which data are available for both California and the U.S.–families at the 25th percentile of the U.S. income distribution had regained two-thirds of their pre-recession income. In California, families at the 25th percentile had recovered less than one-half of their pre-recession incomes.
A number of factors may explain this difference in the pace of income growth at the bottom of the income distribution in California and the rest of the U.S., such as differences in industrial structure, the proportion of immigrants in the state, and the distribution of schooling. Data from the CPS and the decennial Census show that California has a higher share of low-wage immigrants than other parts of the U.S. In addition, California has larger populations of individuals without a high school education or on public assistance. Finally, much of the job growth in California during the 1990s has been in industries with high skill requirements. Together these factors likely will constrain earnings growth for those in the lower quarter of California’s income distribution (see Reed 1999 for a discussion of these factors).
By most measures, the California economy has recovered fully from its deep recession earlier this decade. Employment levels are high, unemployment is low, and personal income growth is consistently outpacing the U.S. average. Despite these strengths, many Californians feel left behind by the current expansion. However, a comparison of California’s recovery with that for the rest of the U.S. suggests that the expansion in California is generating benefits relatively quickly. Based on the experiences of the rest of the U.S., much of the distribution of real family income in California will surpass its pre-recession peak by the end of this decade. However, a number of factors unrelated to the business cycle may temper income growth in the bottom of the distribution.
Mary C. Daly
Heather N. Royer
Reed, D. 1999. “California’s Rising Income Inequality: Causes and Concerns.” Public Policy Institute of California.
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