Undercover Economist

April 18, 2014 6:41 pm

Have living standards really stopped rising?

‘People drift in and out of all income groups as a result of luck or the life-cycle of a career’
Illustration by Ed Nacional of a man climbing up a ladder made of bills©Ed Nacional

Income inequality is soaring in the US and the UK. The income earned by all but a few has been stagnating for a generation. So I claimed in my column of March 22. But was I right?

Several readers contacted me to suggest alternative interpretations of what look like grim data. Their objections are worth considering: they teach us both about the way numbers can lead us astray, and about the way our economy is evolving.

The first claim is that what looks like stagnation isn’t, because real gains have been mislabelled as mere inflation. The everyday technology of today was the stuff of science fiction in the 1970s when this apparent stagnation began. Perhaps inflation measures haven’t kept up.

There is truth in this argument, although we will never know how much truth unless somebody figures out how many Sinclair ZX81s an iPad is worth. But we should be cautious. In the US, 40 per cent of the consumer price index (CPI) tracks the cost of housing and related costs such as domestic heating; another 30 per cent tracks the cost of food and drink.

If two-thirds of my income goes on basics such as food and shelter, and my income is barely keeping pace with the price of such basics, there is a limit to how ecstatic I am likely to feel about the fact that iPhones exist.

There is a more technical version of the “inflation is lower than we think” argument. Customers can switch between different goods to avoid some price increases: from apples to oranges, from Cox’s Orange Pippin to Granny Smith, from apples at Whole Foods to apples at Tesco. Inflation measures may miss some of that. Or perhaps measured inflation has failed to take full account of quality improvements such as safer, more comfortable, more efficient and more durable cars.

In the US, the Boskin Commission was convened to evaluate such questions and concluded, late in 1996, that the CPI was indeed overstating true inflation by about 1.1 per cent. That’s a shockingly large figure: large enough to matter and large enough to raise questions about whether it can be true. Official statistics have changed as a result, so even if plausible, then the overstatement should be smaller now.

Can it really be that most American families have enjoyed rising incomes which have simply been missed because of errors in measuring inflation? I am not qualified to judge, and the commission became a political football because many government benefits are indexed using variants of CPI.

All this raises the question of whether prices are rising faster for the rich, exaggerating the measured rise in inequality. This is not true in the long run, and recently the opposite has been true: the poor have faced higher inflation than the rich.

Let’s move away from inflation. There are other ways in which things may be cheerier than we think. Russ Roberts, author of econ-novels such as The Invisible Heart, invites us to think harder about flatlining median household income. The “household” has changed over time, getting smaller in the US. So, says Roberts, what looks like stagnation may simply be singledom. If two-person households today make less than four-person households in 1980, that is hardly a problem.

This is a fair point but the effect doesn’t seem large enough to help us much. US household sizes have not shrunk much over the past generation (from 2.63 in 1990 to 2.59 in 2010). Looking not at households but at individuals, real median income for men in the US was higher in 1990 than in 2012. And it was higher in 1978 than in 1990. That is hardly reassuring, even though women have enjoyed strong gains in median income.

A third claim has been made by my colleague Merryn Somerset Webb, among others. It’s that talking about the income share of “the 1 per cent” over time is simply an error, because there is no “1 per cent” over time. People drift in and out of all income groups as a result of luck (being sacked; earning a bonus) or the life-cycle of a career from trainee through the senior ranks to eventual retirement.

. . .

Merryn has a point, but not a killer argument. I strongly suspect (but cannot prove) that no more than 3 per cent of people spend at least a decade enjoying membership of the “top 1 per cent” – in the UK, the bar is £164,000 a year. The majority of people never reach those heights.

Most of these objections should lead us to conclude that growth is not quite as slow as we fear, and increasing inequality not quite as stark as it first seems. None of them is powerful enough to put my mind at rest.

Yet there is genuine encouragement for optimists from the developing world. While inequality in many countries is increasing, it’s gently falling globally, because the likes of China, India and Indonesia are growing much faster than rich countries. And the situation is better than that. As last year’s UN Human Development Report argued, inequality in health and education is being reduced much faster than inequality in income. For once, that is good news that matters.

Twitter: @TimHarford; Tim Harford’s latest book is ‘The Undercover Economist Strikes Back’

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