Understanding Living Standards

Commentary, Poverty, Frontier Centre

Feeling the blues as you scan the bills from the Christmas blowout? Cheer up. It turns out that you’re probably a lot better off than you think.

That timely news comes to us from the Employment Policy Foundation, an American think tank dedicated to the study of labour markets and how they work. Statistical research recently publicized by the foundation demonstrates that living standards have been rising a lot faster than statistics show.

The revised data refute conventional wisdom about the declining middle class. You’ve heard the mantra often enough: The rich get richer. But ordinary working folks, squeezed by taxes and rising prices, watch helplessly as their disposable incomes shrink. Not so, as it turns out.

Old yardsticks used to measure earnings had reported a decline in average incomes of 13% between 1973 and 1995. The new numbers show just the opposite depending on the statistical measure used. They show that incomes actually increased between 13% and 36% over those years.

Some caveats. The figures come from U.S. statistics, but number-crunchers here use similar assumptions, so Canadian measurements will be similarly off the mark. Second, the numbers ignore the taxes that have relentlessly hammered down Canadian living standards relative to our southern neighbours. On a pre-tax basis the comparison should hold.

Anyway, how could the living standard measurements have been so wrong?

In turns out that the Consumer Price Index, which describes the inflation rate, is unreliable. Two problems distort the CPI. First, the "basket of goods" priced to produce the index no longer describes what shoppers actually purchase. Changes in lifestyles and value patterns have made the weightings inaccurate. Second, many price increases reflect higher quality and more value added. Car prices, for instance, may be a lot higher than they used to be, but they’re not the same cars. They are loaded with all sorts of gadgets and improvements that increase the price.

On January 1, 1999, the U.S. Bureau of Labor Statistics, the agency responsible for calculating the CPI, finally heeded these warnings. It adopted changes to the formula to minimize distortions based on the range and quality of goods included in the basket.

Over a decade or two, even small errors in the inflation rate compound to make significant differences in the measurement of people’s material well-being. By 2020, adoption of the new CPI will show that real growth has been 10 percent higher than would have been estimated using the previous CPI methodology.

But the revised formula will not be retroactive. Correcting errors in past official reporting would open up a hornet’s nest. Every payment indexed to inflation would turn out to have been too generous. Just imagine how senior citizens and unionized workers would respond were they asked to refund past cost-of-living overpayments on old-age pensions or wages.

But the Bureau did use the new CPI model to look back as far as 1990, just to see how far out recent numbers have been. The experiment showed lower inflation, as predicted. It also revealed that official growth estimates in real earnings and income since 1990 are roughly 3% "too low." By 1997, real earnings had actually risen modestly from their pre-1990s recession level, and real per capita consumption was almost 14% higher than in 1990.

Although the new CPI formula will deliver more accurate data, it’s still out of whack by 0.5%, according to Stanford University economist Michael Boskin, chairman of a commission that recommended the changes. Unfortunately, the Bureau has been unwilling to correct the CPI to account fully for quality change so Americans will continue to look poorer than they are.

Ditto for us.