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.

Thus, correcting for consumers' ability to substitute, and for the introduction of new and better products, Broda and Weinstein maintain that, far from being stagnant, "real wages at the 10th percentile have increased by fully 30 percent since 1979," which means that "the well-being of the poor is substantially greater today than it was 25 years ago." They estimate that, properly calculated, the poverty rate can be said to have "fallen by 60 percent since 1970."

How persuasive is their argument? On one level, it seems compelling. Given all of the material improvements in American life in the last four decades, on a common sense basis it is hard to believe that poverty today is just as serious as it was in the early 1970s. Consider a statement by Nicholas Eberstadt, himself the author of another recent study of poverty: "A wealth of evidence shows that those who are counted as poor today have dramatically higher living standards than their counterparts in the 1960s." Specifically, poor Americans now spend only one-sixth of their money on food, as opposed to a third in the 1960s--even as obesity has replaced hunger as the main nutritional problem of the poor. Only six percent of America's poor now inhabit what are defined as "crowded" dwellings, versus 25 percent in 1970. And children in poor families today are more likely to have an annual medical checkup than were nonpoor children only 20 years ago.

By depicting poverty as a condition that appears not to have changed (and, in fact, to have worsened slightly) since 1970, the official poverty rate blinds us to real and obvious improvements in the material conditions of the poor. Broda and Weinstein are to be commended for calling to our attention an important piece of evidence that helps account for these improvements.

At the same time, their presentation of poverty is limited in various respects. Let me mention three. First, on a purely economic matter, I have already noted the contention that poor people pay less for the same goods than do rich people. There is, however, a counterargument. It can plausibly be claimed that the poor often pay more than the rich. Poor people, or at least some poor people, lack the funds to buy in bulk, have to pay interest on big-ticket items that they can buy only on the installment plan, or lacking transportation, purchase goods from local stores that charge more than
others (perhaps because of shoplifting).

I am willing to believe that the poor who buy at Wal-Mart more than compensate, on balance, for the poor who pay more for the reasons that I have just stated. Still, it would have been nice if Broda and Weinstein had developed their argument by responding to this obvious objection.

The other two limitations point to considerations that economists are less likely to address than other social scientists, an occupational blind spot that was usefully analyzed in Steven Rhoads's excellent The Economist's View of the World. Thus Broda and Weinstein assume that the poor are rational economic actors, who "can switch their consumption [from more expensive goods] to those categories of goods whose relative price has fallen." They certainly can, but how many do? No doubt many poor people carefully husband their resources by spending prudently; but it is surely also the case that at least some poor people are poor--or, to be more precise, exacerbate their poverty--because they consume irrationally, spending money on goods that they don't need and spending less than they should on goods that they do need.

Furthermore, the same mental or emotional problems that make someone an irrational consumer would also tend to make him an undesirable employee, lessening if not eliminating his earned income. That consideration is not, however, addressed by Broda and Weinstein. Still more fundamentally, they present (not surprisingly) an exclusively economic picture of poverty which looks only at the material consumption of the poor. "The poor have access to new and better goods," a fact, as they rightly note, that isn't captured by "the observed stability of the official poverty rate."

That argument is both true and important. Still, it is not the entire truth. Man does not live by bread alone, so when we think about poverty in America today, we should be concerned about things other than the material consumption of the poor. To quote again from Eberstadt, who is very much aware of the material improvements in the lives of the poor, the United States can be described as "a country inhabited by large numbers of prosperous paupers" since "crime, dependency, and family breakdown were far more acute" in the early 1990s "than they had been during the Great Depression, when general income levels, and general levels of schooling, were so much lower."

(I grant that crime and dependency--though emphatically not family breakdown--are less severe now than they were when Eberstadt advanced this argument more than a decade ago.)

In short, Eberstadt contended that what is most worrisome about American poverty is its connection to "predictably injurious patterns of individual and parental behavior," which "may account for a great fraction of the domestic problems we confront." Unfortunately, that problematic behavior is not addressed in any way by Broda and Weinstein, whose study of poverty is illuminating but far from comprehensive.

To be fair, though, it's unreasonable to expect comprehensiveness from a 63-page pamphlet. Within that narrow scope, to illuminate one particular aspect of a social problem is no small feat.

Joel Schwartz is an adjunct senior fellow at the Hudson Institute.