The Magazine

Better Off

The mismeasurement of wealth and poverty in America.

May 4, 2009, Vol. 14, No. 31 • By JOEL SCHWARTZ
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Prices, Poverty, and Inequality

Why Americans Are Better Off Than You Think

by Christian Broda and David E. Weinstein

AEI, 63 pp., $15

Economic analysis offers an approach to social problems that is at once vitally important and sharply limited. That generalization applies well to this brief monograph by two economists, Christian Broda of the University of Chicago and David E. Weinstein of Columbia.

Broda and Weinstein seek to refute the widespread contention that "the poor are, at best, no better off economically than they were in the early 1980s." To be sure, that contention is supported by seemingly authoritative statistics:

The Congressional Budget Office (CBO) estimates that between 1979 and 2005 the real hourly wages of workers at the 10th percentile of the wage distribution rose by only 0.2 percent. Moreover, official nationwide poverty rates have remained essentially unchanged from the 1970s, at around 12 percent of all households.

But these statistics are flawed, Broda and Weinstein argue, because they derive from an index--the consumer price index for urban consumers (CPI-U), produced by the Bureau of Labor Statistics (BLS)--that, over time, has dramatically overstated increases in the cost of living--in particular, the cost of living of poor Americans. (The CPI-U,
introduced in 1978, is the BLS's main measurement of the cost of living, covering 87 percent of the total population.)

Broda and Weinstein list several problems with the CPI-U. First, it is marked by what is known as "substitution bias." That is, it doesn't sufficiently account for consumers' propensity to switch from goods that have become relatively more expensive to goods that are cheaper. If the price of, say, Fuji apples has gone up, rational consumers switch to, say Jonathan apples. Alternatively, if the price of all apples has gone up, rational consumers might then switch to bananas.

Second, the CPI-U
doesn't sufficiently account for the introduction of new goods into the marketplace, or the improvement in quality characterizing goods that already exist. The personal computer provides an obvious example of a new good that was introduced into the marketplace, which then improved markedly, even as its price fell significantly over time. Remarkably, Broda and Weinstein observe that--of the Universal Product Codes (UPCs) that existed in 2003, identifying items for sale--almost 80 percent did not yet exist in 1994. Similarly, 72 percent of the UPCs that had existed in 1994 disappeared by 2003.

Third, the CPI-U overstates the plight of the poor in that it doesn't consider the fact that rich households pay around 5 percent more than poor households for identical goods. Not surprisingly, the same item will cost more at Lord & Taylor than at Wal-Mart. (Rich people who patronize the former rather than the latter are not necessarily snobs, nor are they acting irrationally: The personal attention that they receive at Lord and Taylor's may well justify the added cost of buying there instead of at Wal-Mart.)

Considering all of these factors, Broda and Weinstein conclude that "the true cost of living for Americans has increased by around one percentage point per year less than what is implied by the CPI-U." If we take into account the need to compound that one percentage point for each year, the CPI-U dramatically overstates increases in the cost of living, which is to say that Americans' seemingly stagnant incomes go much further today than one would think. As Everett Dirksen might have put it, a percentage point here, a percentage point there, and sooner or later you're talking about a serious augmentation of purchasing power--and a serious diminution of poverty.

If Broda and Weinstein's reasoning seems familiar, that is because it builds on the 1996 Boskin Commission report, which concluded (for many of the same reasons) that the CPI-U was then overestimating the change in the cost of living by 1.1 percentage points a year. Since the BLS altered its calculation of the CPI-U in response to many of the commission's conclusions, it would have been helpful if Broda and Weinstein had said something about the seeming insufficiency of the post-1996 alterations instituted by the BLS. (They allude to the report at one point but do not discuss the BLS response to it.) Significantly, though, a 2006 article in the Monthly Labor Review (a BLS publication) speaks of "a wide belief that an upward bias [in the CPI-U] still exists," citing a 2003 study that estimates the upward bias at 0.9 percent. So Broda and Weinstein are by no means off the mark or out of the mainstream in arguing that the CPI-U continues to overstate inflation by about a percentage point a year.