Business shutdowns hurt those just above the poverty line

Brett Nelson | May 08, 2020

Sections Economics

Collections COVID-19 Crisis

As widespread business shutdowns seize up the US economy amid the coronavirus pandemic, who’s going to be hit the hardest?

It’s likely to be households making $30,000–$60,000 a year, according to research by University of Notre Dame’s Sarah Kroeger and University of Wisconsin at Oshkosh’s Chad Cotti. This income range goes from just above the poverty line to just below the national median income—a group that Census Bureau data indicate accounts for about a third of American families.

This finding may hold ominous implications as unemployment explodes and the COVID-19 recession threatens to become the deepest since the Great Depression. In the consumer-driven US economy, the issue is whether households can balance their spending and savings as incomes ebb—something that economists call “consumption smoothing.” This is a lot harder for some households than others, Kroeger and Cotti find.

To study consumption smoothing, the researchers mined the Nielsen Datasets at Chicago Booth’s Kilts Center for Marketing. They focused on a Nielsen Consumer Panel collection of data on nondurable spending such as food and clothing by at least 38,000 households for each year between 2004 and 2014, a period that included the Great Recession. Nielsen gave shoppers a scanner to track their purchases, and 80 percent of those surveyed continued to participate in the study year after year.

The researchers then matched the spending data to specific household characteristics—including income, gender, race, age, and education—to see which variables had the biggest impact on consumption-smoothing ability. Kroeger and Cotti were testing the late Milton Friedman’s permanent income hypothesis, which says that people tend to smooth their consumption on the basis of expected lifetime earnings rather than on temporary fluctuations. Linking specific household characteristics to consumption-smoothing trends could help policy makers design targeted programs to encourage forward thinking and boost savings rates, the researchers suggest. 

Lower-income households found it hardest to smooth their outlays, the researchers find.

“The pattern of consumption smoothing has relevant implications for household debt, nutrition and health care of children, homeownership, and many other public policy areas,” they write.

However, the theory doesn’t always hold up in the real world, the researchers find. While the average household turned out to be fairly adept at smoothing consumption in response to income variations and economic uncertainty, many households had trouble sticking to long-term budgets and responded more sharply to short-term windfalls and downturns, according to the research. 

When trouble did hit, households that couldn’t smooth their spending suffered the most. Those with lower-middle-class incomes were especially vulnerable, the researchers find, and households headed by men were more adversely affected by increases in local unemployment risk than those headed by women.Neither education nor race was a statistically significant predictor of consumption smoothing.

Of all the income levels, households that generated between $30,000 and $60,000 a year exhibited the choppiest consumption, according to Kroeger and Cotti. A big reason, they write, is that “these households are likely to be the least protected from income fluctuations with either saved assets or welfare assistance for food, rent or medical care.”

Crunching the data over a full decade also helped the researchers distinguish deliberate spending—the kind driven by long-term income expectations—from reactions to unexpected shocks. The researchers find that at all income levels, at least some households wound up spending what they took in regardless of future expectations. Lower-income households, however, found it hardest to smooth their outlays, the researchers find.

This presents an ongoing worry for policy makers in light of the current economic recession. Compounding the concern, households living near the poverty line may be encouraged to take out payday loans and open steep-interest credit cards that higher-income households tend to avoid.