FRBSF Economic Letter
99-26; September 3, 1999
 Economic
Letter Index
Who Has Benefited from California's Recovery?
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.
Tracking the benefits of economic growth
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.
Winners and losers in the 1990s
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.
Permanent or transitory 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.
Can the business cycle explain the disparity?
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.
Factors tempering the outlook for California
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).
Conclusions
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
Economist
Heather N. Royer
Research Associate
Reference
Reed, D. 1999. "California's Rising Income Inequality: Causes and Concerns."
Public Policy Institute of California.
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
to:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
|
