Myths of Rich and Poor: Why We're Better off Than We Think

Myths of Rich and Poor: Why We're Better off Than We Think

by W. Michael Cox, Richard Alm

Popular wisdom holds that the years since 1973—the end of the "postwar miracle”—have been a time of economic decline and stagnation: lackluster productivity, falling real wages, and lost competitiveness. The rich have gotten richer, the poor have gotten poorer, and most of us have barely held on while watching all the best jobs disappear

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Popular wisdom holds that the years since 1973—the end of the "postwar miracle”—have been a time of economic decline and stagnation: lackluster productivity, falling real wages, and lost competitiveness. The rich have gotten richer, the poor have gotten poorer, and most of us have barely held on while watching all the best jobs disappear overseas.As Myths of Rich and Poor demonstrates, this picture is not just wrong, it’s spectacularly wrong. The hard numbers, simple facts, and iconoclastic arguments of this book will change the way you think about the American economy.

Editorial Reviews

Harvard Business Review
Rhetoric and Reality:
Making Sense of the Income Gap Debate

The new economy has brought prosperity to many, but not to all. If the income gap continues to widen, politicians will take action - and business will bear the brunt.
By Frank Levy

Myths of Rich & Poor: Why We're Better Off Than We Think
W. Michael Cox and Richard Alm
Basic Books, 1999

The State of Working America 1998-99
Lawrence Mishel, Jared Bernstein, and John Schmitt
Cornell University
Press, 1999

In the midst of the booming U.S. economy, nagging questions remain: How well are average workers doing? Are rich people getting the lion's share of prosperity?

Economists hold fervent opinions about such questions. The intensity of our disagreements isn't surprising since we are talking about money and perceptions of fairness.

Popular beliefs about how the economy distributes its gains will go far in determining public policy. How do Americans feel about raising the minimum wage? Should a CEO's stock options be valued in a company's income statements at the time they are awarded? Should the steel industry be protected from import dumping? Should the capital gains tax be lowered? Many paychecks ride on the answers to those questions. And the answers depend in large part on how we perceive income trends for various groups.

Unfortunately, it's difficult to analyze such trends in an unambiguous way. With so many different numbers available, an analyst has a lot of discretion in deciding how to spin them. Some 270 million people now live in 100 million households, and they make and spend money in many different ways. In assessing economic well-being, should we focus on individuals or households? Consumption or income? We measure income trends with a variety of statistics on wages, dividends, and nonmoney income like fringe benefits and Medicare. Rarely do these statistics fit together well. And since most statistics have no natural yardstick, an analyst can make a particular number seem good or bad through the choice of comparisons.

It follows that someone with a strong point of view, whatever it is, should have no trouble finding supporting data. Two new books, Myths of Rich & Poor and The State of Working America 1998-99, are clear examples. Both describe U.S. income trends over recent decades, but the similarity ends there. Myths of Rich & Poor, written in the style of supply-side optimism, celebrates the economy's abundance. Working America, written in the style of pre-Clinton liberal pessimism, focuses on the uneven results.

Since I too have strong opinions on income trends- I updated my own book on the subject earlier this year- honesty requires me to show my bottom line early. Each book has merit: Myths is the more engaging read, while Working America's data are more reliable. A full understanding of today's economy requires elements from both of these books, supplemented by a few other key ideas- in particular the tightening nexus between education, equal opportunity, and worrisome levels of inequality.

The Bright Side of Free Markets

The same basic history forms the background for both books. From the close of World War II through 1973, the U.S. economy boomed. Spurred by rapid growth in productivity, real median family income increased from $21,000 in 1947 to $42,000 in 1973 (all figures here are in 1998 dollars). But the boom ended badly. Productivity growth began to slow in the late 1960s at the same time that expenditures for the Vietnam War were making labor markets tight. Workers demanded more pay, and the slower productivity growth meant that higher wages were passed along as higher prices. Inflation accelerated after 1972 because of harvest failures in many parts of the world (resulting in the great Russian wheat sale) and the first OPEC oil price shock. By the mid-1970s, inflation was embedded in the economy, and growth in productivity and median family income nearly stopped altogether.

Political leaders responded to stagflation by opening up the economy. >From the Carter to the Clinton administrations, the government aggressively pursued deregulation. It relaxed restraints on corporate mergers. It permitted, and at times advanced, the weakening of unions. It promoted freer trade with other countries. Finally, it abandoned the goal of managing aggregate demand through fiscal policy. Myths and Working America both assess how this reliance on free markets affected incomes.

Myths argues that the deregulation largely succeeded. Written by W. Michael Cox, a vice president at the Dallas Federal Reserve Bank, and Richard Alm, a business reporter for the Dallas Morning News, Myths is a Texas-style supply-side book with a combative, optimistic faith in laissez-faire. Cox and Alm argue that the new regime has created a tide of prosperity that is rising faster than official statistics indicate and that is carrying most people with it.

Like much supply-side writing, Myths is strongest when it emphasizes the economy's dynamics. Dazzling new products are emerging and finding places in households. More and more goods are being traded globally, leading to improvements in both quality and availability. And individuals are increasing their incomes as they gain experience and move up the promotional ladder- or move to different industries altogether. This emphasis is all to the good. It is hard to look at today's economy without sensing a transformation in how we produce and consume. The transformation may not be as large as those caused by railroads or electricity, but it is generating enormous opportunities.

Does all this innovation show up in workers' purchasing power? Most measures indicate that median wages were stagnant or declining from 1973 into the 1990s. Median family income, now at $45,300, is only $3,700 higher than it was in 1973 despite the growth in two-income families. But Cox and Alm believe that workers have been benefiting from the dynamic economy for a long time. They point to surveys of consumption among other indications that life has improved a great deal. The average household now owns many items, from air conditioners to microwave ovens, that would have been considered luxuries in the 1970s, if they were available at all.

There is some truth to this argument. The consumer price index and other inflation measures do have difficulty incorporating the value of new products like VCRs and Viagra and the subtle benefits of mass customization. As a result, official statistics probably overstate inflation and understate the real value of wages.

But because Cox and Alm are so intent on proving their point, they overrun their data. For example, they say that statistics showing stagnant wages understate progress by omitting the value of fringe benefits and other nonwage sources. They suggest instead that we focus on the rapid growth of a different statistic: per capita income. In their words, "A simple division of total output by the number of people, per capita income isn't skewed by changes in the way we work, the way we live, how we're paid, and what we produce."

This statement is just wrong. Per capita income is skewed by how we work and live- in particular, how the population divides between workers and dependents. When more of the population is receiving paychecks, income per capita (per man, woman, and child) rises even when wages are stagnant. This has happened in recent decades. Young baby-boom teenagers became adult workers. Baby-bust birth rates meant the number of children declined. Large numbers of married women moved into the labor force. In 1970, there were 1.5 dependents for every worker; by the late 1980s, there was only one dependent per worker. We could afford all the VCRs and balsamic vinegar not because average wages were rising briskly- they weren't- but because each paycheck was divided among fewer people.

The authors' discussion of inequality shows insight, this time combined with a more troubling error. They begin with census statistics on income inequality among families. (These numbers aren't comprehensive- they report pretax money income only, with no reductions for taxes paid and no additions for fringe benefits or nonmoney income such as Medicare coverage; still, they tell a clear story.) In 1947, the richest fifth of families received $8.60 for every dollar received by the poorest fifth. Inequality narrowed over the next quarter century; by 1969, the ratio stood at $7.25 to $1. Then inequality began to grow again, and it now stands at $11.24 to $1.

Myths correctly argues that these data are limited in an important way- they are a series of point-in-time snapshots that say nothing about the potential for income mobility, the way in which a family might move up as its breadwinners gain experience and receive promotions. If this mobility were substantial- if most families occupied the upper reaches of the distribution sometime during their careers- then higher point-in-time inequality would be less of a concern.

Cox and Alm estimate the extent of this income mobility with data that track the earnings of a sample of people from 1975 through 1991. They use the data set, from the University of Michigan's Panel Study of Income Dynamics, to track the experiences of individuals rather than families. Most of these people saw their incomes rise a great deal. Among the poorest fifth of earners in 1975, only 5% remained in the lowest fifth in 1991. The rest had moved up, including 29% who went all the way to the highest fifth of earners. The authors imply that similarly impressive mobility rates apply to the income distribution for entire families. Not very likely.

Cox and Alm first published these mobility results several years ago. Because their estimates of mobility were so much higher than other estimates, they drew both attention and reanalysis. As Peter Gottschalk of Boston College has pointed out, the poorest fifth of Cox and Alm's sample started with an average 1975 income of only $3,000 (again in 1998 dollars). Although 1975 was a recession year, it is hard to imagine that so many people in a national sample of workers had incomes that low. The explanation, Gottschalk notes, is that the sample included part-time workers and persons as young as 16. Under these parameters, the "poorest" fifth of workers would be dominated not by heads of families but by teenagers selling fast food after school. These people could become upwardly mobile simply by moving into the full-time labor force as they aged.

Families, by contrast, usually have at least one full-time worker at any time, so they can't make such big jumps. Yet a reader of Myths won't know about the limitations of the sample because the book (unlike the authors' earlier article on this research) omits a full description of it. When medical researchers exercise this much discretion with data, they find themselves in court.

In fact, Cox and Alm's exaggeration is unnecessary. Moderate mobility does exist in the family-income distribution, and it does make the income picture look better than census snapshots of inequality suggest. The authors' apparent reason for exaggerating is that, as they say in their preface, they are writing not just to present a true picture of the economy but also to defend free markets against recent books that paint the economy in pessimistic tones. But when an economy produces both good and bad outcomes, as the U.S. economy has over the last quarter century, no book can achieve both goals. An accurate picture must include pessimistic developments and so give comfort to the enemy.

A Glass Half Empty

The preface to Myths includes a list of the sort of books the authors want to counter. The books were selected for their pessimistic titles- Jeffrey Madrick's The End of Affluence is one example- so the mildly titled State of Working America 1998-99 is not among them. But if content rather than title had determined the list, Working America certainly would have had a place. This biennial volume is written by economists at the Economic Policy Institute in Washington, D.C. The institute was founded in the 1980s in part to provide a liberal counterweight to supply-siders' claims that President Reagan's policies were increasing incomes without adding to inequality.

The new edition of Working America fully maintains the tradition. Lawrence Mishel, Jared Bernstein, and John Schmitt argue that the greater reliance on free markets has failed. Targeting those like Cox and Alm who see a bountiful economy for nearly everyone, they focus on official statistics showing that while unemployment is down and GDP is up, productivity and average income are barely growing. According to these data, workers are seeing only greater inequality and less job security.

Working America has a second target as well. Statistics show that wages of less-educated workers have declined sharply, particularly since the late 1970s. Many economists contend that wage declines among these workers are an unfortunate but inevitable by-product of technological change: unable to keep up with the demands of new produc- tion systems, undereducated workers have been shunted into lower-paying jobs. But Working America says there is little evidence that technological change accelerated after the 1970s. Instead, the authors argue that the eroding minimum wage, weaker unions, and shifts in production toward lower-wage countries are the main drivers for declining pay. The dispute is hardly academic- technological change is unavoidable, but government can do a lot to influence the minimum wage, the strength of unions, and foreign trade.

While Myths tells an engaging story, Working America is mainly a narrative guide to a great variety of data, most of it carefully presented with clear source notes. But like Myths, it suffers from the authors' desire to counter an opposing view. Accordingly, the authors discuss the strong economy of the last two years only in grudging tones- for instance, they acknowledge that wages of the lowest-paid workers are now rising but point out that those wages didn't rise for most of the 1990s.

Similarly, Working America gives only passing notice to the age-related mobility that Cox and Alm emphasize. The book often mentions "stagnant wages" but doesn't explain that this condition still allows for workers to receive higher pay as they age: If in 1988 and 1998, adjusting for inflation, 30-year-old men earned an average of $30,000 and 40-year-old men earned an average of $40,000, wages were stagnant under the definition used by the authors (and by many other people). But men still could see rising wages as they aged from 30 to 40. Presumably, Working America downplays age-related mobility for the same reason it avoids discussing the convenience of ATM machines and the possibilities of the Web: to avoid softening the book's message that freer markets are benefiting only a few.

On the connection between technological change and inequality, Working America overstates a valid point. It's true that economists have too readily accepted the idea that change in technology is the only reason for the decline in the wages of less-educated workers. But technological change surely plays a role. About half of all 17-year-olds still read below a ninth-grade level, yet most well-paying jobs in industry now demand a much higher level of literacy. In automobile repair, a field I've been examining, the introduction of electronics into engines and transmissions has sharply increased the frequency with which technicians must read diagnostic instructions rather than fix problems by executing routines known by heart.

Read Myths of Rich & Poor to appreciate how new technology and expanded trade are now important engines of economic growth. Read State of Working America 1998-99 to appreciate how growth is generating benefits very unequally. If one book portrays the U.S. economy as Silicon Valley writ large, the other sees it as Oakland.

A Mixed Bag

A full picture of today's economy would show that it has been very good indeed. Inflation and unemployment are low, and while average incomes have probably grown very slowly in recent decades, we're now beginning to see faster gains. But more important for the long run, we're now seeing signs of a return to higher productivity growth. Since the early 1970s, productivity has grown at an anemic 1% per year. A return to the historical average of 2% per year would mean a big improvement in the growth rate of total family income.

I emphasize total income because faster productivity growth does not guarantee that all family incomes will rise. The question is whether this should concern us. Some observers argue that we have lived with much worse: that family-income inequality is lower today than it was in the 1920s and not much higher than in 1947. But point-in-time comparisons obscure the issues that Cox and Alm raise- the prospect of mobility within the income distribution and how that prospect may have changed. In 1947, most of the poorest families were farmers, with their very low cash income, and the elderly. Where are these two groups today? Over time, farm families have become a tiny share of the population, while social security and private pensions have boosted elderly incomes. Based on these two movements alone, income inequality should be lower today than before, not higher.

One reason for higher inequality is the growing diversity of family structures. With more families headed by single women at one end of the distribution and more two-income families at the other, some divergence was inevitable. But a larger factor is the greater educational requirements for high-paying jobs. When President Kennedy spoke of a rising tide lifting all the boats, the economy was evolving in ways that generated demand for both better-educated and less-educated workers. Since the 1980-1982 blue-collar recession, the relative demand for less-educated workers has declined significantly. In 1979, a 30-year-old man with only a high school diploma earned an average of $32,000 if he worked full time. Today, his 30-year-old counterpart (adjusting for the greater fraction of young people going to college) averages about $5,000 less, while the income of college graduates has stayed constant at Reserve Board reports that in 1995, the latest year for which these data are available, the richest 1% of households (averaging about $7.75 million) owned about a third of all net worth; the next richest 10% of households ($823,000) owned approximately another third; and the remaining households ($77,000) owned the rest. More households participate in the stock market today than in 1995, but the change is too small to move these figures significantly.

More important, these factors have restricted the chances for mobility. In 1947, much of the inequality reflected geographical differences between urban and farm incomes. A 20-year-old man in a depressed area could usually get on a bus and go to a city where he had the basic skills to get a factory job at higher pay. Today, poor education plays the role that geography did in the past. A 20-year-old without a job can still take important steps, such as going to an inexpensive junior college. But as the economist James Heckman noted in a recent speech, many aspects of what we call the ability to learn may be largely set by the time a young person is 15 or 16. Whatever one's definition of equal opportunity, it does not apply.

The last two decades of economic change have inflicted a heavy blow on less-educated men and women. Their paychecks have suffered the greatest impact, and now they will have to struggle for the educational resources to make sure that their children don't repeat the cycle. While many people in the U.S. are now registering impressive gains, many others are not. In the future, those on the wrong side of the educational divide will find it harder and harder to climb from low income to high income.

The Political Challenge

Economic theory generally addresses efficiency, not equity. From a narrowly economic perspective, growing inequality is not much to worry about. As long as markets freely reward greater effort and ability, income disparities can even serve as spurs to greater effort, as people on the low end of the scale see the riches to be made. In their concluding chapter, not surprisingly, Cox and Alm argue that the key to future prosperity is further acceptance of free markets.

But free markets require that the government do more than simply get out of the way. Markets work only when powerful institutions provide clear and equitable rules for commerce. The legal infrastructure needs to be strong enough for people to have the confidence to invest. These institutions, in turn, depend on public support. If the majority of people feel that markets are operating to their benefit, they'll support this infrastructure while leaving the markets alone.

In this context, prolonged and high inequality is a great danger. If the results of free markets do not accord with widespread conceptions of fairness- if a growing number of citizens feel they are left out of the American dream of advancement- they'll make government do more than take the wageworker's side in occasional policy decisions. Left unchecked, inequality could lead to a renewal of intense industry regulation and trade restrictions. In that case, we'll all be poorer.

Reprint 99505

Floyd Norris
The authors have a story to tell, and an amazing mastery of arcane economic statistics. But the effect is blunted by their reluctance to concede any possible problems...
The New York Times Book Review
Library Journal
Cox, a vice president and economic adviser to the Federal Reserve Bank in Dallas, and Alm, a business reporter for the Dallas Morning News, have written a remarkable book that uses government facts and figures to counter the pessimism regarding the performance of the U.S. economy over the last 25 years. Of particular note are their debunkings of 12 commonly accepted myths about jobs, income, and living standards; their comments regarding the impact of technology on existing jobs and the economy; their observations about income inequality, the individual nature of opportunity, the trade deficit, layoffs, and downsizing; and their prescription for keeping the U.S. economic system humming. A controversial mix that should entice readers in both academic and public libraries.--Norman B. Hutcherson, Kern Cty. Lib., Bakersfield, CA
Tries to show that the pessimism about the American economy is unfounded, that the economy has, in fact, been working better than ever. With jargon and graphs aimed to persuade, the book claims the following are not true: American's living standards have been falling; both adults have to work to maintain a good standard of living; American workers are no longer as productive as they once were; and, as companies ship manufacturing jobs overseas, the U.S. is left with inferior service jobs. The writers, a bank vice-president and business reporter, refer primarily to surveys, magazine articles, and statistics. Annotation c. by Book News, Inc., Portland, Or.
Gregg Easterbrook
Cox and Alm...provide the historical perspective that's often missing form laments about the contemporary economy.
WQ: The Wilson Quarterly
Floyd Norris
The authors have a story to tell, and an amazing mastery of arcane economic statistics. But the effect is blunted by their reluctance to concede any possible problems...
The New York Times Book Review
Kirkus Reviews
Cox, a Federal Reserve economist and adviser to the CATO institute, presents, with Dallas Morning News business reporter Alm, an aggressively rosy report on the nation's economy. I'm all right, Jack, and so are you, they say. Forget eroding living standards, foreign competition, rapacious CEOs, hedge fund crashes and endemic downsizing. Times, on the whole, have never been better, say the authors, and to prove it they offer a plenitude of charts, tables, statistics and figures. It is in the nature of capitalism that there are occasional disruptions-such as corporate downsizing-which they call "churning," but this is still the best economic system, they claim: "Layoffs aren't a sign of failure, not for the economy, not even for most workers." Layoffs take place beside job creation. That a midlevel manager fired from AT&T might, with luck, finally end up as a low-level associate at Wal-Mart is part of the churn, not part of "the hard numbers that define broad trends, averages, medians, per capita figures and rates of change." Good times, the numbers say, are here. We have more money than ever. We spend more for stuff (like VCRs, health care, and stealth bombers) and we spend more time at leisure. In the triumph of capitalism, minorities and women are doing better, too. As we change from a labor to a service economy, technology is improving life faster than ever. Don't mess with success, the authors say. Just protect property rights, keep taxes low, and eschew more regulation. There are, though, some unasked questions. Yesterday Standard Oil had to be dismembered; would a merger of Exxon and Mobil be a good thing today? Will the next decades be like the past 20 years or is somethingfundamental changing? Never mind. Just look at the numbers. Pangloss and Pollyanna tackle what Carlyle once called "the Dismal Science" in a polemic sure to attract dissent. .

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Read an Excerpt

Chapter One

Waking Up
to Good Times

In the America of the 1990s, hard-luck stories weren't hard to find. Just look on the front page of the New York Times. James Sharlow, a 51-year-old Los Angeles resident with two grown daughters, lost a $130,000-a-year job with Eastman Kodak in January 1993. He spent more than two years searching in vain for work, all the while depleting the family's savings. In Baltimore, job instability had gnawed away at Rene Brown's paychecks since the early 1980s, when she earned $8.50 an hour at a meat-packing plant. After that, she worked for $7.25 an hour in a bank's mail room, $4.75 an hour loading newspapers, and $4.25 an hour cleaning office buildings. Connecticut's 51-year-old Steven Holthausen, his marriage a casualty of the family's faltering finances, found work dispensing tourist information for the state at $12,000 a year, barely a quarter of what he once made as a loan officer.

    In less turbulent times, Americans could shrug off the occasional glitches of the capitalist system as something that happened to someone else. We might listen to stories of economic misfortune with sympathy for laid-off, downsized, and marginalized workers, but with little sense of foreboding. Not today. Almost without exception, the steady drumbeat of stories about downward mobility and dead-end jobs are offered up as cautionary tales: There but for the grace of God ...

    The experiences of Sharlow, Brown, and Holthausen, when amplified by the stories of thousands caught in similar misfortunes,leave the impression of a nation going downhill, its economy failing in ominous ways. Do these discouraging snapshots of American life indicate what's in store for the rest of us? Are ordinary Americans trapped in a system incapable of raising living standards? Anecdotes can only illustrate, not prove. In good times and bad, workers and their families move up and down in society's pecking order. Individual fortunes can vary year in and year out, reflecting new jobs, promotions, layoffs, retirement, the rise of one industry, and the fall of another. One person's hardship may be offset by others' successes, all with a randomness that doesn't tell us much about how well the overall economy is working.

    Making an argument for declining American living standards cries out for more broad-based evidence. More often than not, the argument rests on falling real wages. At first glance, the trend appears decidedly grim: After adjusting for inflation, average hourly wages rose at an annual rate of 2 percent from 1953 to 1973. Then they stagnated for five years before beginning a long slide, falling at an average annual rate of 0.7 percent through 1996. The total decline over two decades exceeded 15 percent (see Figure 1.1). If Americans earn less, it stands to reason they can't muster the financial wherewithal to maintain their standards of living. Case closed.

    Not quite. At best, real wages are an indirect barometer of how well we're doing. If we want to know about living standards, it's better to use direct indicators of what Americans own, what they buy, and how they live, not some proxy, whether it be earnings or income. Before accepting wholesale the verdict of the data on real wages, Americans should at least consider what's happening to consumption. If the data indicate that the average family doesn't have as much now as in the early 1970s, it will confirm the case for the country's economic decay. An America consuming more than ever, however, would go a long way toward refuting a pessimistic view that relies on anecdotes and the data on declining real wages.

    Fortunately, there's plenty of hard evidence. Each year, government and private-sector number-crunchers collect boatloads of data on nearly every aspect of our lives. The diligent researcher can look up the size of our houses, the appliances we own, the cars we drive, the hours we work, the money we spend at restaurants, the trips we take, and much more. The numbers are plentiful, reliable, and readily available to anyone who spends a few hours in the library or on its electronic equivalent, the Internet.

    The statistics on consumption—the most direct measure of Americans' well-being—point to a nation that's better off now than at any other time in its history. Yet they rarely find a place in discussions of the nation's living standards, a debate dominated by measures of income and earnings.

What We Had Then,
What We've Got Now

In looking at what an average American consumes, comparisons to the early 1970s are what matters most. After all, few of us could possibly doubt that the country is much better off today than a century ago, when our great-grandfathers and great-grandmothers lived without electricity, telephones, refrigerators, indoor plumbing, and disease-fighting antibiotics. The past quarter century is the crux of the controversy: For those who perceive economic decay in America, the early 1970s were a turning point, when just about all the widely cited gauges on the economy started to slip, bringing to an end a golden era when growth was steady, paychecks were getting fatter, jobs were secure, and gasoline sold at the rock-bottom price of 35 cents a gallon.

    Was the early 1970s the U.S. economy's great watershed? Finding out will require a fresh perspective. So imagine a modern-era Rip van Winkle, an economist this time, rather than the indolent farmer of Washington Irving's fable. He falls asleep in 1970 and reawakens on a bright spring day in the late 1990s, rubbing sleep from his eyes. Among his memories before dozing off: Watching George C. Scott portray Patton on the big screen, tuning in Rowan & Martin's Laugh-In on television, and listening to the Beatles sing "Let It Be." President Richard Nixon had ordered U.S. troops into Cambodia to attack Viet Cong bases. New York's once-hapless National League team had transformed itself into the "Miracle Mets," going into the 1970 season as defending World Series champs.

    Although just over 25 years hove passed since the start of his long slumber, Rip quickly realizes that the world around him has changed quite a bit. Events since 1970 have indeed been world-shaking. The Soviet Union has fallen apart. The global village has grown together. And, judging from the sights and sounds of everyday life, America has made great leaps of economic progress. To Rip's eyes, fresh from a quarter century of undisturbed sleep, America in the 1990s looks richer by far than the country he left behind. He sees acres of new housing and roads filled with cars. He sees stores stocked with exciting new gadgets. He sees Americans enjoying life in myriad ways.

    As Rip wonders the world of the 1990s, however, he encounters more angst than optimism. At almost every opportunity, commentators and scholars grumble about the American economy's great failures, which condemn the average family to growing poorer and expose workers to the ravages of downsizing. Bewildered by the hand-wringing, our Rip van Winkle sets out to discover the truth about the American economy. As a researcher, he knows where to find the right facts and figures. After poring over the data for the years of his slumber, Rip concludes he wasn't just daydreaming. Americans are indeed better off—on average, possessing more of just about everything (see Table 1.1).

    A good place to start is where we live—home sweet home. The nation has continued to odd to its housing stock: In the middle of the 1990s, home builders finished more than 1.1 million single-family residences a year, well above the annual average of 1970 to 1975, a time when the coming of age of the Baby Boomers flooded the market with new buyers. As building continued at a brisk pace, our houses have also gotten bigger. From 1970 to 1997, the typical new home increased in size by the equivalent of two 16-by-20-foot rooms. Homes aren't just larger. They're also much more likely to be equipped with central air conditioning, decks and patios, swimming pools, hot tubs, ceiling fans, and built-in kitchen appliances—all included in the purchase price. Fewer than half of the homes built in 1970 had two or more bathrooms; by 1997, 9 out of 10 did. In 1997, 87 percent of new homes included garages, up from 58 percent in 1970. The garages, moreover, had also gotten bigger: Three-quarters of new homes had space for two or more cars, compared with little more than a third in the early 1970s (see Figure 1.2). Today's new homes also contain more energy-saving features, including thicker insulation and double-paned windows. These improvements are doing their job: In a new house, average energy consumption, measured in BTUs per square foot, fell by at least a third from the 1970s to the 1990s.

TABLE 1.1 The World Through Rip's Eyes

Item 1970 Mid-1990s(*)

Average size of new home (square feet) 1,500 2,150
Average household size (persons) 3.14 2.64
Average square feet per person in the household 478 814
New homes with central heat and air-conditioning 34% 81%
New homes with a garage 58% 87%
Housing units lacking complete plumbing(a) 6.9% 2.3%
Homes lacking a telephone(a) 13.0% 6.3%
Households with computer 0% 41%
Households with no vehicle(a) 20.4% 7.9%
Households with two or more vehicles(a) 29.3% 61.9%
Households with color TV 34.0% 97.9%
Households with cable TV 6.3% 63.4%
Households with two or more TV's 30.7% 72.8%
Households with videocassette recorder 0% 89%
Households with answering machine 0% 65%
Households with cordless phone 0% 66%
Households with computer printer 0% 38%
Households with camcorder 0% 26%
Households with cellular phone 0% 34%
Households with CD player 0% 49%
Households with clothes washer 62.1% 83.2%
Households with clothes dryer 44.6% 75.0%
Households with a microwave <1% 89.5%
Households with coffeemaker 88.6% 99.9%
Households with dishwasher(b) 26.5% 54.6%
Households with vacuum cleaner 92.0% 99.9%
Households with frost-free refrigerator <25% 86.8%
Households with outdoor gas grill(c) <5% 28.5%
Mean household ownership of furniture(b) $2,230 $3,756
Mean household ownership of appliances(b) $943 $1,547
Mean household ownership of video and audio products(b) $308 $2,671
Mean household ownership of jewelry and watches(b) $728 $1,784
Mean household ownership of books and maps(b) $731 $1,074
Mean household ownership of sports equipment(b) $769 $1,895
Mean household net worth(a) $86,095 $126,843
Median household net worth(a) $27,938 $59,398
Vehicles per 100 persons aged 16 and older(a) 53 94
Work time to buy gas for a 100-mile trip 49 minutes 26 minutes
Annual visits to doctor(d) 4.6 6.1
Per capita consumption of bottled water (gallons)(b) <1 11.1
Americans taking cruises 0.5 million 4.7 million
Air-travel miles per capita 646 >2,260
Per capita spending on sporting goods(b) $60 $213
Recreational boats per 1000 households(a) 139 173
Manufacturers' shipments of recreational vehicles(a) 30,300 281,000

(*) Mid-1990s data are for 1997, except where indicated.
(a) Data for 1995. (b) Data for 1996. (c) Data for 1993. (d) Data for 1994.
All monetary figures are in constant (1997) dollars.

    Why focus on just new homes? New, single-family dwellings that come on the market in any given year are just a small part of the housing market, but they are the best measure of what buyers demand and what they can afford at any time. Looking at the entire housing stock, including homes built a century or more ago, will tell us little about how housing has changed over a 25-year period. In effect, we'd be measuring what the economy of the past could provide.

    Bigger, better-equipped homes would be a mirage if only a few well-heeled families could afford to own them. The rich do live in the fanciest houses, no doubt about it, but the average family hasn't been left out. Home prices are a lot higher than they used to be, of course. The median price of a new, single-family dwelling rose from $23,400 in 1970 to $145,500 in 1997, but the comparison tells us little about affordability. Families can pay more for today's homes because incomes are higher—four times greater than they were in the early 1970s. And mortgage rates are lower, a 30-year conventional loan having fallen from 8.6 percent to less than 7.0 percent. We shouldn't forget, moreover, that today's higher prices pay for added square footage and amenities. In the late 1990s, most of us can afford the essential part of the American dream—a home of our own. Proof comes in home-ownership rates: In the third quarter of 1997, 66 percent of households, a total of 68 million individuals and families, owned homes—an all-time record.

    If housing is affordable, why don't even more American families own their own homes? Current rates of home ownership may match the nation's preference for buying versus renting. Today's economy provides a wealth of housing options, including apartments, lofts, condominiums, town homes, high-rises, and gated enclaves. Young Americans often prefer the flexibility and camaraderie of apartment living—and there's a place for them. Senior citizens might gladly dispense with the rigors of maintaining a home and yard—and there's a place for them. Longer-term trends add some perspective. Home ownership was quite low in the 1920s, less than 25 percent of the population. In the boom that came after World War II, the proportion quickly rose to about 60 percent; it has climbed only slightly since then, to 66 percent. A fairly steady rate over several decades, in good times and bad, indicates that affordability isn't the primary reason more families don't own their own homes.

    The average age at which Americans buy their first home has increased roughly four years, from 27.9 in 1970 to 32.4 in 1996. Pessimists might attribute the delay to deteriorating economic conditions: With paychecks pinched, young families must wait four extra years before they can afford a house. Jumping to that conclusion ignores lifestyle changes. The median age at the time of first marriage, an event that often precedes home buying, increased from 22 in 1970 to 26 in 1996—once again, four years. In the mid-1990s, an additional 8 percent of us decide never to marry, so even the financially well-off might delay house hunting for a few years. The number of children per household has declined from 1.3 in 1970 to 0.9 today, suggesting that more families don't include children. All these changes no doubt affect home-buying patterns, and they're most likely responsible for the extra time Americans take before settling down.

    Rip's survey of then and now finds plenty of good news beyond housing. His research shows that Americans in the 1990s have stocked up on the amenities that make everyday life easier and more enjoyable. The percentage of families with dishwashers, clothes washers and dryers, blenders, toasters, vacuum cleaners, swimming pools, automatic sprinklers, and outdoor gas grills has increased since the early 1970s. In 1996, manufacturers turned out an incredible 100 million small appliances, from electric knives to waffle irons. The average number of televisions in a household rose from 1.4 in 1970 to 2.4 in 1997, a gain made all the more striking by the fact that each home, on average, had fewer people to watch them. In fact, televisions are rapidly approaching the level of one per person. More than 40 percent of American households owned personal computers in 1997, a product that didn't even exist in the 1970s. Comparing 1970 to 1996 and adjusting for inflation, the typical American family owned 8.7 times more audio and video equipment. It had 68 percent more furniture and 64 percent more kitchen appliances. Books and maps? They were up 47 percent. Even kids shared in the nation's prosperity: Per-child spending on toys, adjusted for inflation, quadrupled since 1970.

    America's love affair with the automobile can't be denied. More than 9 of 10 households now own passenger vehicles. Nearly two-thirds have two or more. Among those 16 years and older, vehicles per 100 people rose from 53 to 94 in just 26 years. Within a few years, the country may become the first in history to have more passenger vehicles than people. Dozens of automotive innovations improve performance, safety, and comfort: antilock brakes, air bags that cushion occupants during a collision, turbochargers, cruise control, automated air conditioning and heating, sun roofs, adjustable steering wheels, and windshield-wiper delays. Today's cars are loaded with "power." They're more likely to have power steering, windows, seats, door locks, and rearview mirrors. They're also more likely to have radial tires and tinted glass (see Figure 1.3).

    Americans are enjoying more luxuries, too. The average amount spent on jewelry and watches, after adjusting for higher prices, more than doubled from 1970 to 1996. A typical American drinks 11 gallons of bottled water, up from less than 1 in 1970. For fun and games, an average family possesses more than twice the gear for sports and hobbies. Per-household ownership of pleasure boats rose by 25 percent in the past two or three decades. Manufacturers' shipments of recreational vehicles are nine times what they were in the early 1970s. In the quarter century up to 1996, per-person annual outlays rose from $60 to $213 for sporting goods, including gains of 14 percent for bicycles and, just since 1980, 26 percent for snowmobiles. While American households consumed more, they had enough money left to dig deeper into their pockets for worthy causes: Per capita donations to charities, adjusted for inflation, rose from $402 a year in 1970 to $569 a year in 1996.

    The average American's spending on services has risen 83 percent since the early 1970s. We're taking advantage of health clubs, financial advisers, landscapers, dating services, caterers, pest-control companies, dry cleaners, car-detailing shops, valet parking stands, and literally hundreds of other businesses that entertain us, pamper us, and save us time and effort. We eat out more often. After accounting for inflation and a growing population, spending on restaurant meals is up by 45 percent. We travel more often and to more exotic destinations. On a per capita basis, average annual miles flown on commercial flights more than tripled in the past 25 years. We take nine times as many cruises. Per capita spending on overseas travel and tourism is nearly three times what it was in the early 1970s. In nearly every city and town, there's added convenience in more places to shop. The number of stores per capita rose by more than 20 percent in the past quarter century—in itself an indication that Americans are buying more than they used to. More of us take advantage of the convenience of shopping without a cash stash. General-purpose credit cards reached the mass market in the 1960s. In 1970, only 16 percent of Americans carried one. Now, almost 66 percent of us pack "plastic money" in our wallets and purses.

    The statistics on consumption don't jibe with the pessimists' view of an economy on the fritz, no longer delivering on the promise of prosperity. Compared to the early 1970s, Americans have more of almost everything, from living space to gadgets, cars to baubles. In terms of consumption, the average American in the 1990s is far better off than ever before.

The Saving Grace

Americans could, of course, be paying for a fin-de-siècle spending spree by depleting their assets. There's been plenty of hand-wringing over the country's low saving rate, compared with that of other nations, and persistent worry over rapidly rising consumer debt. It's probably wise to ask whether American families are trading their tomorrows for the instant gratification of today's consumption.

    The answer can be found by looking at Americans' wealth. If the country were on a reckless spending spree, households would be running down their net worth, depleting tomorrow's nest eggs to keep up with the Joneses. It's just not so. Although many Americans may not be socking away enough money for rainy days and retirement, we're not, on average, squandering our assets. Including savings deposits, stocks, bonds, pension plans, certificates of deposit, real estate, and other tangible assets, U.S. households had an inflation-adjusted average net worth of $216,843 in 1995, compared with only $86,095 in 1970. It's certainly true that rich Americans are accumulating a lot of the wealth. Yet the gains didn't come solely at the top end of the income distribution. Half of American families had a net worth of at least $59,398 in 1995, more than double the median net worth of 1970.

    Savings are fertilizer for economic growth. The United States might well be better off if Americans saved more of their income. For the individual, however, decisions on how much to spend and how much to save are really about lifetime consumption. In effect, we choose between spending now or later—perhaps much later when it comes to estates. Most people set aside money in their peak earning years, so they'll have it later in life, primarily for their children's college costs and for their own living expenses after age 65. As Baby Boomers move into their peak earning years and begin to contemplate retirement in the next century, they probably will funnel more money into savings. Indeed, there are signs Americans are becoming avid investors in this decade, particularly in stock and bond mutual funds. From 1990 through the end of 1997, at a time when they were buying bigger houses, fancier cars, and all those consumer goods, Americans poured more than $1.5 trillion into mutual funds. It paid off handsomely as financial-market indicators roared upward by more than 200 percent through the end of 1997, a big windfall for families with the foresight to invest. Counting just net financial holdings, a figure that doesn't include home equity and other real property, households averaged $211,923 in 1997, up from an inflation adjusted $118,488 in 1990, $64,847 in 1980, and $33,007 in 1970. A typical family's wealth is rising rapidly in the 1990s, so Americans now have the best of all worlds—more consumption and more savings.

    Is consumer debt the Achilles heel of our consumption boom? There's no denying that Americans are deeper in hock than ever before. In 1997, the average household owed $12,514 in consumer debt, a figure that includes credit cards, retail-store accounts, automobile loans, and similar obligations but not mortgages. The consumer-debt burden has risen fivefold since the early 1970s. Debt, of course, becomes excessive only when it rises beyond the ability to pay. If Americans have higher incomes and more financial assets, they can carry more debt. Consumer credit as a percent of income is up, but only by about two weeks of annual earnings. In 1970, an average household would need 11 weeks' income to pay off its consumer debt. Now it would take about 13 weeks. As a proportion of net financial assets, average consumer debt in 1997 stood just about where it was in 1970, at roughly 5 percent, although the burden did creep up slightly, to almost 7 percent, in the late 1970s and early 1980s. The narrow range suggests American families stay in a comfort zone, willing to assume more debt when they're at 5 percent and cutting back as they approach 7 percent.

    Some Americans no doubt get into trouble with easy credit, but there's no compelling evidence that the typical American family faces overwhelming debt. In fact, there may be a hidden message of hope in our willingness to borrow money. When consumers anticipate hard times, they hunker down. They pay off existing obligations, and they're wary of taking on new ones. Perhaps the fact that millions of Americans feel optimistic enough to borrow suggests that most of us aren't convinced the economic future will be bleak.

Progress and Poverty

What about those at the bottom echelons of society? The nation could very well be consuming and saving more, with all the goodies going to the upper and middle classes and with the poor worse off, not just in relative terms but absolutely as well. At least one statistic seems to suggest that many low-income Americans aren't keeping up: The nation's poverty rate rose from 12.6 percent in 1970 to 13.3 percent in 1997—a widely cited blemish on our economic performance.

    Although the country hasn't done as much to eradicate poverty as we might hope, the record isn't entirely bleak. Digging beneath the poverty rate uncovers data indicating that the poor are better off than they were a quarter century ago. Once again, it's important to look at consumption rather than income. The numbers show that America's poor—those with incomes of $13,220 or less for an average-sized family in 1996—are living better than they used to. Home ownership among poor families rose from 37 percent in the early 1970s to 41 percent in the 1990s. In addition, today's poor households are more likely than those of a decade ago to own appliances and motor vehicles. The percentage of poor households with washing machines rose from 58.2 percent in 1984 to 71.7 percent in 1994. Ownership of dryers rose from 35.6 percent to 50.2 percent. Three-fifths of poor families had microwave ovens in 1994, up from one-eighth a decade ago. Nine of 10 poor households had color televisions, and 6 of 10 could play movies on videocassette recorders. Almost three-quarters of the families owned at least one car (see Table 1.2).

    Perhaps most astonishing of all, poor households of the 1990s in many cases compared favorably with an average family in the early 1970s in owning the trappings of middle-class life. For example, almost half of the poor households had air conditioners in 1994, compared to less than a third of the country as a whole in 1971. The pattern holds true for dryers, refrigerators, stoves, microwaves, and color televisions. What's more, today's poor are less likely to be excluded from the benefits of our consumer society. For example, they have greater access to credit. In 1970, only 2 percent of families in the bottom 9 percent of the income distribution had general-purpose credit cards. By the mid-1990s, the percentage had grown to 26.5. The logical conclusion: Being poor doesn't entail the same degree of deprivation it once did. In fact, by the standards of 1971, many of today's poor families might be considered members of the middle class.

TABLE 1.2 Even the Poor Have More

Percent of Households With: 1984 1994 1971

Washing machine 58.271.771.3
Clothes dryer 35.650.244.5
Dishwasher 13.619.618.8
Refrigerator 95.897.983.3
Freezer 29.228.632.2
Stove 95.297.787.0
Microwave 12.560.0<1.0
Color television 70.392.543.3
Videocassette recorder 3.459.7 0
Personal computer 2.9 7.4 0
Telephone 71.076.793.0
Air-conditioner 42.549.631.8
One or more cars 64.171.879.5

    At first blush, it's not apparent how the poor can increase their consumption yet still not escape from the poverty statistics. Part of the answer lies in spending patterns. Among households below the poverty line, outlays for food, clothing, and shelter were down to 37 percent of consumption in 1995, compared with 52 percent two decades earlier, 57 percent in 1950, and 75 percent in 1920. Over time, the prices of necessities have fallen relative to average hourly wages, so just getting by takes less effort. The smaller the share of income going to meet basic needs, the more money left over to purchase the goods and services that most poor households once had to do without.

    Another part of the puzzle involves a widening gap between earning and spending for low-income households. The poverty rate tells us how many Americans are trying to scrape by on meager incomes. It gives an incomplete accounting of the resources available to families on society's lowest rungs. Most households in the bottom fifth of the income distribution consume well beyond their current earnings. In 1995, an average low-income household made $6,305 a year before taxes. Consumption—what the poor spent, not what they earned—totaled $13,130 (see Table 1.3).

    How can poor families consume more than they earn? Many supplement their income through unemployment benefits, Aid to Families with Dependent Children, Medicare, Medicaid, food stamps, school lunches, rent subsidies, and other programs. Moreover, many low-income households can tap into other resources. Workers temporarily laid off make little money, but they can usually fall back on their savings rather than reduce their standard of living. Although many retirees have low incomes, their houses, cars, and furnishings are in many cases paid for, and they've got a nest egg for spending on vacations and grandkids. In 1993, 302,000 families with incomes of less than $20,000 lived in homes valued at more than $300,000.

    University of Texas economist Daniel Slesnick recalculated the poverty rate on the basis of inflation-adjusted expenditures rather than income. To remove the vagaries of inflation, he adapted the government's definition and put a household's poverty threshold at three times the annual cost of consuming a nutritionally adequate diet for all its members. Slesnick's results show that the proportion of poor in the United States, measured by consumption, fell steadily from 31 percent in 1949 to 13 percent in 1965 and to 2 percent at the end of the 1980s. If the problem of poverty is one of access to goods and services, then this lower rate might give a better indication than the official poverty figures of how well the American economy has done in lifting poor families over the past three decades.

    Looking at consumption, moreover, shows an even greater leveling of society. At the bottom of the income distribution, households are smaller—an average of 1.8 persons, 0.6 of whom are working. Households in the top fifth of income averaged 3.1 persons, 2.1 of them holding jobs. Top-income households outearned bottom ones by a factor of 14 to 1. When it comes to consumption per person, the gap shrinks to only 2.3 to 1. What's more, poorer households work less, so they have more time to meet their needs through home production—such tasks as cooking, house cleaning, maintenance, child care, yard work, and laundry. Although these chores make families better off, they aren't included in statistics that measure consumption. Yet when high-income earners pay cooks, maids, nannies, gardeners, and others to perform the same services, it gets captured in reports on consumption expenditures, making them appear to be better off.

TABLE 1.3 How People Spend Their Money

Lowest Fifth Middle Fifth Highest Fifth

Household income (before taxes) $6,305 $28,242 $89,011
Household consumption
Food $2,490 $4,270 $7,522
Clothing $759 $1,502 $3,402
Shelter $2,741 $4,423 $8,919
Telephone, utilities $1,460 $2,122 $3,044
Transportation $2,021 $5,745 $11,155
Health care $1,099 $1,700 $2,417
Other $2,560 $5,563 $15,747
Total consumption $13,130 $25,325 $52,206
Average household size 1.8 2.6 3.1
Consumption per person $7,294 $9,741 $16,841
Other uses of income
Taxes $1,004 $4,672 $16,643
Cash contributions $284 $697 $1,914
Education $308 $273 $1,172
Financial flows(a) ($8,421)($2,725)$17,076

(a) Insurance, pensions, investment expenses, and dissaving plus government transfers. Data are current dollar figures for 1995.

    Mathematics makes no compromises. It dictates that 20 percent of American households will lie at the tail end of the income distribution, always relatively "poor" by the standards of society, no matter how much they consume. No one wants to minimize the plight of the truly down-and-out. America's low-income families, however, are better off now than they were at any time in the past. The data on consumption lead to an unmistakable conclusion: The poor are not getting poorer.

Real-Wage Reality

Data on consumption and saving provide overwhelming support for the notion that American living standards are still improving, not just for the well-to-do but for low-income families as well. Yet all the numbers fail to dispel the nagging issue of declining real wages. How can Americans afford to increase their consumption when their earnings slipped by 15 percent in two decodes? One possibility: The data on real wages, even if compiled accurately, aren't a good measure of Americans' economic fortunes over the past quarter century.

    As it turns out, there are other ways of evaluating Americans' earning power. A straightforward alternative to real wages is inflation-adjusted per capita personal income. Its virtue is that it captures all sources of income—not just wages but interest, dividends, rent, and profits. A simple division of total output by the number of people, per capita income isn't skewed by changes in the way we work, the way we live, how we're paid, and what we produce. Trends in per capita income belie the downward mobility found in real wages. These statistics indicate that Americans grew consistently richer during the entire post-World War II era. The growth rate did slow down. Real per capita income has risen by an annual average of 1.6 percent since 1974, compared with 2.6 percent in the 1950s and 1960s (see Figure 1.4).

    The statistics on real wages suffer from a glaring omission: fringe benefits. Over the past two decades, as tax rates grew steeper and incomes rose, the country witnessed a surge in nonwage benefits. Workers chose to take more of their compensation in the form of additional health care, contributions to retirement savings, or employee assistance programs. Compared with a generation ago, more employers are providing eye care, dental benefits, paid maternity leave, and stock-purchase plans. Today's most progressive companies are starting to offer day care, paternity leave, and spouse-relocation benefits—all virtually unheard of in the early 1970s. Overall, nonmonetary benefits as a percentage of wages have increased by a third since 1970. The extras cost money, and they're properly part of workers' earnings. When fringe benefits are included in measuring income, statisticians call it "total compensation." Like per capita income, total compensation shows slower growth in the past 20 years. Once again, though, the bottom line differs sharply from real wages: The average worker is better off than his or her counterpart in the early 1970s, with a cumulative gain in total compensation of more than 17 percent. Both per capita income and total compensation, by showing greater purchasing power, make it plausible that Americans would be able to increase consumption over the past quarter century.

    Looking beyond real wages gives a truer picture of how we're doing, but even per capita income and total compensation have their flaws. Most important, they tend to shortchange our economic gains by using price indexes that overstate inflation. This glitch makes today's earnings seem punier than they really are when presented in "real" terms. The fault lies in the Consumer Price Index (CPI), duly reported each month in just about every newspaper in America. Statisticians can easily survey stores and markets, noting how prices change on televisions, oranges, sporting goods, toothpaste, taxi fares, visits to the dentist, and nearly 90,000 other goods and services. What they fail to adequately capture, however, is the constant introduction of new products and the perpetual tweaking of product design. When prices rise, it sometimes means consumers pay extra for the same goods and services, so they're worse off. However, well-being doesn't fall as much when higher prices reflect better quality and new bells and whistles. Especially over long periods of time, the CPI captures both types of "inflation," and it can't adequately separate the two.

    The CPI emerges from a slowly evolving "market basket" of goods and services put together from a detailed survey of 29,000 consumers. Devising a product list that captures the great diversity of American consumption is expensive and time-consuming, so the government has revised the basket only every decade or so. As a result, new goods and services usually enter the inflation index only after they've been on the market for several years. Pocket calculators showed up on desks and countertops in the early 1970s, but they didn't make the price index until 1978. The statistics ignored personal computers and videocassette recorders until 1987. Cellular telephones didn't show up in the CPI until 1998, when nearly 40 percent of households owned one. The delay means the CPI doesn't reflect what Americans actually buy. More important, goods and services typically start out very expensive, then go through a period of rapidly falling prices as they enter the mainstream of our consumer culture. Videocassette recorder prices, for example, fell 70 percent before entering the price index. The CPI misses the price decreases of new products but fully accounts for higher prices of older goods and services.

    Better quality and new features present another stumbling block to accuracy in measuring inflation. We've already seen how the higher prices for new homes reflect added space and other amenities. It's a problem with just about all products. The price of an automobile tire rose from $13 in the mid-1930s to about $75 in 1997. With some adjustments for better quality, the CPI put the increase at 1.5 percent a year. However, today's steel-belted radial tires last more than 10 times longer than the old four-ply cotton-lined tires. In terms of cost per 1,000 miles, tires are now cheaper than at any time in the history of the automobile. Yale University economist William Nordhaus calculated that the price of light, including the bulb, fixtures, and electricity, has fallen from 40 cents per 1,000 lumen hours in the 1880s to a tenth of a cent today, a decline of 99 percent. By conventional measures of inflation, however, light bulbs and fixtures are up 180 percent since 1880.

    The CPI covers a tremendous array of goods and services, and it would be an overwhelming task to decide how much of each month's price increase to allocate to higher quality. As America approaches the twenty-first century, new and better products are coming fast and furious, making it likely that the CPI is falling farther and farther behind the marketplace. Government statisticians are aware of the bias caused by new and improved products. To improve the quality of the data, they're likely to reduce the gap between revisions of the inflation index from 11 years to 4 or 5. Even with the change, the numbers will miss a lot of what's going on and will consistently overstate inflation and understate growth in wages, income, and productivity.

    In the mid-1990s, scholars found that the CPI overstates inflation by a little more than 1 percentage point a year (see Table 1.4). The errors aren't just statistical aberrations of interest only to the cloistered fellows of academia. The mismeasured CPI affects the allocation of resources in the federal budget—particularly the more than 50 percent of it classified as "entitlements." It affects the wage and price calculations of private industry. Just as important, it can distort our view of the nation's economic performance. Inflation errors feed into many of the angst-inducing numbers on real wages, income, productivity, and growth. If we correct inflation by a little more than a percentage point a year over two decades, the decline in real wages vanishes, turning into a 12 percent increase since 1978. Per capita income no longer slows down. There's no ebbing of productivity growth, a measure of output per worker. If inflation were more accurately measured, growth rates would appear more robust, with a mediocre 2.4 percent transforming into 3.5 percent. Small statistical distortions might not seem worth worrying about, but they add up to significant long-term implications. Correcting a one-percentage-point error in the CPI over 25 years would increase our measures of real income per capita to $37,015 in 1997, a gain of $8,857 for every man, woman, and child. A mere percentage point of faster real growth cuts the time required to double living standards from 70 years to 34 years.

TABLE 1.4 Estimates of the Bias in Consumer Price Index Inflation

Authors Percentage Points

Advisory Commission (1996) 1.1
Michael Boskin (1995) 1.5
Congressional Budget Office (1994) 0.5
Michael R. Darby (1995) 1.5
W. Erwin Diewert (1995) 1.5
Robert J. Gordon (1995) 1.7
Alan Greenspan (1995) 1.0
Zvi Griliches (1995) 1.0
Dale W. Jorgenson (1995) 1.0
Jim Klumpner (1996) 0.4
Lebow, Roberts, Stockton (1995) 1.0
Ariel Pakes (1995) 0.8
Shapiro and Wilcox (1996) 1.0
Wynne and Sigalla (1994) 1.0

Average 1.1

    The pessimistic view of the economy begins to unravel once we look at how much more Americans consume today. The data speak loud and clear: Both average-income and low-income American households enjoy higher living standards than they did 25 years ago. The conclusion rests on direct measures of what everyday Americans actually possess. This material wealth cannot be simply ignored in favor of the worst-case scenario that emerges from trends in real wages and other statistics, especially with their faults. Once we correct the biases in our statistics and see that the free-enterprise system is still delivering higher pay and growth, we needn't scratch our heads over how the country has been able to afford a record-smashing consumption binge. Perhaps best of all, our Rip van Winkle hasn't yet exhausted the evidence of the country's continuing economic progress over the past quarter century.

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Meet the Author

W. Michael Cox is senior vice president and chief economist of the Federal Reserve Bank of Dallas. He has written for The New York Times and was interviewed in Wired magazine; his annual reports for the Federal Reserve Bank are often controversial and receive nationwide publicity.Richard Alm is a business reporter with the Dallas Morning News. W. Michael Cox is senior vice president and chief economist of the Federal Reserve Bank of Dallas. He has written for The New York Times and was interviewed in Wired magazine; his annual reports for the Federal Reserve Bank are often controversial and receive nationwide publicity.Richard Alm is a business reporter with the Dallas Morning News.

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