Search This Blog

Thursday, March 26, 2009

Wages and Standard of Living

One constant refrain from socialists and statists is that capitalism is unfair because the rich are getting richer and the poor and getting poorer. Often cited in support of this statement is that wages of the middle and lower classes have been stagnant for decades, the implication being that the standard of living for those classes has also been stagnant. The obvious flaw in this reasoning is that stagnant (i.e., not getting richer) is not the same as getting poorer.

However, the more important flaw is subtle; stagnant wages do not necessarily imply a stagnant standard of living for the lower classes. There are several reasons that there is not a direct link between wages and standard of living.

First, nominal wages have not been stagnant at all - they're much higher than they were a few decades ago. What's meant when referring to stagnant wages is that they have been relatively stagnant when converted from nominal wages to real wages by comparing them to the inflation rate. The inflation rate is an average inflation rate across all goods and services. However, [T]he rich have faced a higher effective rate of inflation than the poor have. Examples:
  • The price of fish eggs (caviar) has increased much more than the price of chicken eggs (not to mention chickens).
  • The price of high end wines have gone through the roof, while two-buck chuck (Charles Shaw wines) provide far more value per real dollar (in my opinion) than has ever been available.
  • Ferraris have really gotten expensive, but my Hyundai Elantra was amazingly cheap and good and there are even less expensive cars.
The inflation rate for the poor is lower than the official (average) inflation rate and therefore the poors' wages have not been stagnant with regards to purchases that poor people typically make. In other words, the poor can buy more than they used to. That's not stagnation, that's improvement in their standard of living.

Second, wages aren't the same thing as compensation. Compensation includes vacation, sick leave, health care, perks such as cars or meals, and other benefits in addition to wages. As Daniel Griswold elaborates, measures of real wages only are misleading:
A more accurate measure of earnings is “real hourly compensation,” which includes not only wages but benefits. The Bureau of Labor Statistics data on wages and benefits combined tell a more accurate and encouraging story about the well-being of the average American worker. Since 1973, average real hourly compensation for American workers has increased 45 percent, for an average annual growth rate of more than 1.1 percent. Figure 2 shows that real hourly compensation has not only climbed since 1973, but its rise has accelerated in the past decade along with America’s growing economic openness. The average American worker has not suffered from “stagnant” earnings in the past three decades but in fact has enjoyed real gains.
Third, while it should be obvious, many pundits seem to overlook that fact that the wage data from decades ago are for different people than the current wage data. The people who were in the bottom quintile of income back then have generally moved up to higher quintiles (see here and here for more information). Those are then replaced in the lowest quintile by immigrants, students, etc. who will then also attain higher incomes over time.

Next, standard of living is not directly dependent on income. That might seem like a surprising statement, but if you think about it, standard of living is mostly dependent on "outgo". It's your ability to spend, not your income that determines how well you can live. These days, many more of the poor get substantial assistance that's not considered income. For example, the vast majority of students have low incomes, but because of financial aid and parental help, they mostly live far better than their incomes would otherwise indicate. Other programs like the Earned Income Tax Credit and Food Stamps also help lower income families have higher outgo and therefore a better standard of living.

Also, median family size has fallen by about 3% per decade over the last few decades. So even a stagnant household wage would still mean that the typical person in the median family is better off.

The bottom line is that the poor from the past are, in general, significantly better off now and this is corroborated by the fact that poor households typically have numerous amenities that their counterparts from decades past did not have. If the current Administration and Congress don't blow it too badly, the trend of the poor having an ever better standard of living will probably continue.


Hey Skipper said...

I took on a liberal over this very same topic a year or so ago.

I have read recently that focusing on wages completely ignores the unavoidable fact that consumption patterns between the rich and the poor have never been flatter.

Everyone has air-conditioning, anti-lock brakes, color TVs, etc. The stuff that the rich have may be fancier, and they undoubtedly travel more, but in terms of pure functionality, there is little difference to be had.

Which leads to the next problem you kind of hinted at: hedonic inflation.

A car as good as your Hyundai would not have been available for any amount of money 30 years ago. So how is it exactly we calculate the inflation rate for car prices?

erp said...

Outgo is as important as income. We live as well as baby boomers whose income is far higher because our outgo is far far lower and since we have no debt, what we have isn't wasted paying the piper.

Bret said...

Hey Skipper:

That was quite an exchange with lonbud! I call it an "exchange" instead of a "conversation" because you and lonbud seemed to be generally addressing completely different topics - you were writing about his post, he was writing about anything under the sun except his post and the points you were making.

I can summarize those many thousands and thousands of words in a once sentence summary though: lonbud thinks that "something" ought to be done about income inequality because it's really awful and all that but lonbud can't really say what that "something" ought to be.

Better luck to you next time on trying to nail jelly to a wall.

I did write this post, BTW, so that the next time I run into a lonbud type, I have some material ready without having to go through the huge effort you did.

Regarding hedonic inflation: to me the main purpose of measuring inflation is to determine if there is a change in price for goods and services in order to adjust the money supply to provide price stability. In other words, as long as a reasonably consistent methodology is used, a change in the inflation rate can be detected and that's what's needed by the Fed for their purposes.

Otherwise aggregate inflation measures have limited usefulness because every individual experiences inflation differently because we live life differently and use different goods and services which have different levels of importance (i.e. value) to us.

So that becomes a fundamental problem when trying to compare standards of living over significant time spans. If somebody's most important consumption item is caviar and their income/outgo hasn't changed much then they are far worse off given the price for caviar. Can't argue with it.

On the other hand, if playing cool computer games is the fundamentally important aspect of their lives, then wow! they're wildly better off now than they were 30 years ago pretty much no matter how their income changed during that period.

But what is true, is that those things that the poor typically buy have had lower inflation (even without the hedonic component) than inflation overall, and especially relative to inflation for luxury goods.

Hey Skipper said...

Something else not mentioned much with respect to this whole topic (which is treated with as much journalistic pig-ignorance as the savings rate) is that the flip side of wages is prices.

China's export driven growth strategy is, no doubt, responsible for depressing wages in the US.

At the same time, though, and only an inveterate axe grinder could ignore it, prices are much lower than they would be, otherwise.

I agree that keeping a consistent inflation rate measure is more important than continually futzing with it to make more accurate.

However, those who cite the headline inflation rate as proof that US living standards have stagnated are either [stupid | pig ignorant | fundamentally dishonest] when they fail to note hedonic inflation, which pervades our economy.

Hey Skipper said...

BTW -- I subsequently made a bet with lonbud over what the state of the US economy would be come last December.

I lost.

I happened to have a San Francisco layover about six weeks ago, and bought him dinner.

Turns out he is a pretty decent guy, less overtly liberal in person than in pixels.

Still, the difference between liberals and conservatives came though pretty clearly. (IMHO) Liberals are constitutionally incapable of the kind of critical analysis that leads to the conclusion that people are under no obligation to be the way one desires them to be.

Bret said...

Hey Skipper wrote: "I agree keeping a consistent inflation rate measure is more important than continually futzing with it to make more accurate."

Especially since inflation is experienced subjectively, there really is no objectively accurate measure.

In addition to the choices of "[stupid | pig ignorant | fundamentally dishonest]" I would claim "unobservant" might fit the bill also (this is related to "pig ignorant" but with the "pig" part). Hedonic changes, outside of electronics, are fairly slow and difficult to observe.

A second problem with hedonic changes is that they often relate to a secondary purpose of the product. For example, my inexpensive car (Elantra) gets me about town with far greater safety and comfort than just about anything 30 years ago, however, since the primary purpose of a car is to transport a person from point A to point B, it's hard to value the secondary functionalities of the car like the nice sound system or built in heaters in the seats.

Hey Skipper said...


Especially since inflation is experienced subjectively, there really is no objectively accurate measure.

I'm not so sure.

The true baseline value is time. Consider personal transportation. How many hours has it taken to purchase and perform the ability to go, say 100,000 miles.

1000 years ago, that number would have been infinite, since such distances were simply impossible in a lifetime.

100 years ago, it would have been very high, but not out of reach -- certainly one could buy enough enough ocean liner tickets.

More pertinently, over, say, the last forty years, how has the amount of time an average worker must devote to purchase and maintenance costs for an average car and 100,000 miles of travel varied?

I have no idea what the answer is, but I think it is, in principle, knowable.

Then, knowing how much time is required, it would be a fairly simple matter to see the difference between then and now in terms of dollars per unit time.

Hedonic changes, outside of electronics, are fairly slow and difficult to observe.

Electronics are certainly the most obvious example. However, recently I happened to see a gurney get loaded onto an EMT vehicle. In terms of sheer design, there is no comparing a gurney of 20 years ago with its contemporary counterpart.

That is also true for my bicycle.

I think Moore's law has distracted us from gradual, pervasive, design improvements.

A second problem with hedonic changes is that they often relate to a secondary purpose of the product.

Except when they don't: ABS, dynamic stability control (one of our cars has it, and, absent gross stupidity, there is simply no tossing it off the road), greatly improved corrosion resistance, multiple airbags, vastly lower maintenance costs, usw.

Each of these either makes the car cheaper to run, less likely to have an accident, more survivable in the event, and have a much longer economically useful life (which, BTW, is a large part of the automakers' overcapacity problems -- 40 years ago, a car was good for four-ish years; I have a car that is 17 years old, 210,000 miles, that has been through 8 salty winters -- it is reliable, looks great, and runs even better.)

Bret said...

Hey Skipper wrote: "The true baseline value is time."

For tools, at least partly true. But even for cars, due to speed limits, they all pretty much get you from point A to point B in the same amount of time for decades now. Being able to eat a steak faster doesn't add to it's value. No matter what stereo I listen to a song on, it still takes the same amount of time. So there's a lot of exceptions to the time thing.

Hey Skipper also wrote: "That [design improvements] is also true for my bicycle."

No kidding! I'm amazed when I ride my bicycle as well. On the other hand, it wasn't cheap and it turns out that you can still buy a pretty crappy bicycle. In fact, in buying my children's bicycles, I'd say that due to safety concerns, modern low-end bicycles are much heavier and more unpleasant to ride than when I was a child.

Nonetheless, I think we're in agreement, that for whatever reason, we find it difficult to observe "gradual, pervasive, design improvements."

Hey skipper also wrote: "Except when they [hedonic changes] don't [relate to secondary purposes]."

Some of those changes aren't hedonic. Cost per mile (or in general, cost per unit) is a fundamental measure that's used in calculating inflation.