FRBSF Economic Letter
2000-25; August 25, 2000
 Economic
Letter Index
Have Californians Kept Up in the 1990s?
Although by most measures the California economy has been outperforming
the U.S. economy for nearly five years, a number of statistics on family
income suggest that Californians are losing ground relative to others
in the U.S. Data on income growth show that while median family income
outside of California grew by more than 8% between 1989 and 1998, median
family income in California declined by 4%. This divergence in outcomes
has not been limited to income growth at the median. In 1998, a greater
number of Californians lived in poverty, a smaller number were in the
middle class, and a majority had family incomes below those of comparable
families living outside of California.
Such statistics have struck a nerve among policymakers, researchers,
and the public, and have prompted many to ask whether the government should
take a more active role in guaranteeing the equality of outcomes among
the population. However, before considering policy prescriptions designed
to reduce income differences between California and the rest of the nation,
it is important to understand why family incomes in California have deviated
from those in other states. This Economic Letter reviews recent
research by Daly and Royer (2000) that examines the extent to which demographic
and business cycle differences account for the divergence of California
from the rest of the U.S. in the 1990s.
Tracking and measuring income
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 can be used to trace changes in the
distribution of real income in California and the rest of the U.S. between
1969 and 1998. Recognizing that income fluctuates with the business cycle,
this analysis focuses on family income in three peak years--1969, 1979,
1989--and 1998, the latest year of data available.
Income in this analysis refers to combined pre-tax, 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 relatively 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. All incomes are valued in 1998 dollars using the Personal Consumption
Expenditure Index (PCE).
Trends in relative family income
Looking at statistics on income growth over time suggests that Californians
have not experienced the same gains in income during the most recent expansion
as have families elsewhere in the nation. However, these statistics reveal
little about the absolute levels of income in these areas or how the standard
of living in California compares to that of families living outside of
California. This type of information is important to understand more fully
how the absolute and relative well-being of families in California compares
to other U.S. families. A simple way to assess the differences in income
levels between California and the rest of the U.S. is portrayed in Figure
1. The figure shows the dollar difference in real adjusted family
income between California and the rest of the U.S. by percentile with
each line representing one of the four business cycle peak years used
in the analysis: 1969, 1979, 1989, and 1998. Where the line is above zero,
families in that percentile in California had higher real incomes than
families in the rest of the U.S.; where the line is below zero, families
in California had lower real incomes than families elsewhere in the nation.
As Figure 1 shows, in each of the years except 1998, families in California
had higher real adjusted incomes than families elsewhere in the United
States at every percentile of the income distribution. The dollar difference
in income levels between California and the rest of the nation was largest
in 1969. As the relative income gains outside of California surpassed
those realized by Californians, the dollar difference between incomes
in the state and elsewhere in the nation decreased. In 1969 a family at
the 50th percentile of the income distribution in California earned about
$2,418 more than the median family living elsewhere in the U.S. In 1989,
the difference still was positive but had fallen to about $1,877. The
change was even greater for families at the bottom of the income distribution.
In 1969, a family at the 10th percentile of the California income distribution
had about $1,400 more than an equivalent family living elsewhere in the
U.S. By 1989, this difference had shrunk considerably; the difference
in family income at the 10th percentile was about $370 in 1989.
However, the most striking result in Figure 1 is the change in California's
experience during the 1990s. In 1998, only families in the top 70th percentile
or above of California's income distribution had real adjusted incomes
greater than their counterparts elsewhere in the U.S. Families occupying
the remaining percentiles of California's income distribution had lower
real incomes than those at equivalent percentiles elsewhere in the nation.
It should be noted that when adjustments are made for the differential
cost of living in California and the rest of the U.S., the magnitudes
of the differences in 1969, 1979, and 1989 are smaller, and the magnitude
of the difference in 1998 is greater (Reed, Haber, and Mameesh 1996 and
Reed 1999).
Factors contributing to California's divergence
from the U.S.
It is natural to ask what caused California to diverge from the rest
of the U.S. in 1998. A number of factors are candidates, including differential
changes in industrial structure, regional economic conditions, and demographic
characteristics. While each of these is important, Daly and Royer focus
on two: differential changes in the population structure and differences
in business cycle timing.
To understand the extent to which changes in the demographic characteristics
of California's population have caused the income distribution in the
state to deviate from that in the rest of the U.S. in the 1990s, Daly
and Royer perform a simple reweighting exercise that imposes the demographic
structure of the rest of the U.S. on California. The results are shown
in Figure 2, which
compares the dollar difference in adjusted family income by percentile
in California and the U.S. in 1998 (as in Figure 1) to the dollar difference
in family income between California and the rest of the U.S. when the
U.S. age, sex, race, and education structure is applied.
Again, the thick solid line shows that under the actual (unadjusted)
distribution of income in California, only families in the top 70th percentile
or above of the California income distribution had real incomes higher
than equivalent families living outside of California. In contrast, under
the demographically adjusted distribution (dotted line), families from
the 45th percentile and above in California have real adjusted family
incomes higher than their counterparts living elsewhere in the U.S. Thus,
adjusting for demographic differences moves the income gains and real
adjusted family income levels in California much closer to those experienced
by families outside of California. This being said, even when these population
characteristics are accounted for, sizeable differences remain in outcomes
between California and the rest of the U.S. during the 1990s.
Daly and Royer look at business cycle effects because California experienced
a much longer and deeper recession in the early 1990s than did the rest
of the U.S. Measured by changes in payroll employment growth, the U.S.
economy outside of California began to recover early in 1992, when job
growth turned positive, and 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. According to these data, California's expansion is about
two years behind the rest of the nation's.
To account for this difference, Daly and Royer compare the income distribution
in California in 1998 to that for the rest of the U.S. in 1996. Putting
the results from the business cycle and demographic adjustment together,
the thin solid line in Figure 2 shows the dollar difference in income
for California and the rest of the U.S. in 1998. Recall that since Daly
and Royer are adjusting for differences in business cycle timing in California,
the comparison is between California incomes in 1998 and incomes in the
rest of the U.S. in 1996. The exercise in Figure 2 is to compare the unadjusted
line (thick solid) to the line with the simple demographic adjustment
(dotted) and to the line with both the business cycle and demographic
adjustment included (thin solid). The results support the hypothesis that
business cycle timing matters. Combined, the business cycle and demographic
adjustments succeed in lifting the real income level of Californians at
nearly every percentile of the income distribution above the income values
of those living outside of California.
Summary
At first glance, the income statistics on California suggest that seven
years of economic expansion have left state residents worse off than those
residing elsewhere in the U.S. Whether one compares income growth or income
levels, families in California appear to have "fallen behind."
An examination of the causes for these disparities suggests that demographic
and cyclical factors play a significant role in determining the differences
between California and the rest of the U.S. Changes in the composition
of California's population relative to the rest of the U.S. account for
between one-third and one-half of the differences in measures of income
distribution between the two areas. Further adjusting for differences
in business cycle timing explains virtually the entire observed difference
between family income in California and the rest of the U.S.
Mary Daly
Senior Economist
References
Daly, M., and H. Royer. 2000. "Cyclical and Demographic Influences
on the Distribution of Income in California." FRBSF Economic Review,
pp. 1-13. http://www.sf.frb.org/econrsrch/econrev/2000/article1.pdf
Reed, D. 1999. "California's Rising Income Inequality: Causes and
Concerns." Public Policy Institute of California. http://www.ppic.org/publications/PPIC116/index.html
Reed, D., M. Haber, and L. Mameesh. 1996. "The Distribution of Income
in California." Public Policy Institute of California. http://www.ppic.org/publications/PPIC000/index.html
All URLs accessed August 15, 2000.
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
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Research Department
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P.O. Box 7702
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