Samuelson on standard of living

by Russ Roberts on September 3, 2008

in Standard of Living

Robert Samuelson does a nice job explaining why living standards are rising even though we sometimes hear otherwise:

Just last week, the Census Bureau released its annual study of household incomes, poverty and health insurance — often called the nation’s “economic report card.” Its hard numbers seemed to confirm how many Americans feel. Sure, we’re prosperous, but prosperity is fraying. Except for the rich, living standards are stagnant. Poverty is up; health insurance coverage is down. Naturally, both Barack Obama and John McCain seized upon the report to claim that their policies would restore progress.

Hold it.

Though echoed by policy wonks, pundits and politicians — last week, Bill Clinton — the conventional wisdom is wrong or, at least, misleading.

A couple of high points from the rest of the article. FIrst, he argues (as Don and I have frequently argued here) that low-skilled immigrants distort the measurement of our standard of living:

Low-skilled immigrants, concentrated among Hispanics, outnumber the high-skilled. They drag down median incomes and raise poverty and the number of uninsured. One way to filter out the effect on income is to examine groups with few immigrants or their American-born children. Consider non-Hispanic white families. From 1997 to 2007, their median incomes rose about $6,000, to $69,937, a gain of about 9 percent. For black families, the increase was also about 9 percent, though only to $40,222. Again, not stagnation.

Census counts only money income — wages, salaries, dividends, interest payments. But compensation growth is increasingly channeled into fringes. From 2000 to 2007, only 53 percent of the increase in average compensation came from wages and salaries, says economist Gary Burtless of the Brookings Institution. The rest went to health insurance (21 percent), pension contributions (19 percent) and payroll taxes (6 percent).

On the negative side, Samuelson says:

Americans understandably feel they’re on a treadmill. They don’t see fringe benefits in their paychecks, and small year-to-year cash gains barely register.

A nit-pick: take home pay is deflated by the CPI which includes health care. Because health care is a big part of the rising CPI in recent years, deflating take home pay with the CPI (which is what everyone does) distorts the purchasing power of take-home pay for people with generous health care plan. Suppose all of your health care costs are insured by your employer. Health care costs double but all other prices fall so that the overall CPI is unchanged. Suppose your total compensation is unchanged—your take home pay declines exactly offsetting the increase in the value of your fringe benefits. The drop in take home pay makes it look like your standard of living has fallen. But because the price of non-health care items has fallen, your actual command over goods and services is unchanged.

In recent years, take home pay for some has not kept up with inflation or maybe has just kept up with it, suggesting the standard of living is stagnant. But if take home pay grows slower than inflation, you can actually be getting ahead as long as your fringes are covering the part (health care) that’s growing rapidly.

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{ 9 comments }

spencer September 3, 2008 at 5:20 pm

You are right health care distorts the CPI.

Health care has a weight of only 6.3% in the CPI because it only includes out of pocket expenses.

If the weight of health care in the CPi were anywhere nears its weight in the economy — some 16% — or its share of total compensation the reported inflation rate would be much higher.

Charlie September 3, 2008 at 6:02 pm

How can we discuss health benefits without considering that a dollar of healh insurance is almost certainly not as beneficial as a dollar of wages? Even if you don't buy Robin Hanson's arguments, health care is tax deductable. That is, if I am taxed at the 25% rate, thus my take home pay is 75 cents. Won't I demand payment in health care benefits until the gain I get from them is each dollar is worth 75 cents?

Also, I didn't like how he shifted from talking about median income to average compensation. I don't know if health care benefits rose more at the top or less, but it is certainly within the realm of possibilities.

And I thought grabbing 1997 to 2000 was pretty cheap, 63% of the growth in median white, non-hispanic wages comes from that period. It isn't even any sort of relevant business cycle period. Then he grabs the benefits data from 2000-2007? Why? The median wages went up less than half a percent a year for whites non-hispanics in 2000-2007 period (3.2% total). It seems like he went out of his way not to mention that. It seems looking at the data this way, the man on the street has a pretty reasonable view that things were really good in the late 90s and pretty crappy in the 2000s. Maybe it isn't all the media after all.

I agree with Russ that the standard of living in America is rising, though I expect considerably more than a positive sign. But that doesn't mean this was a good article.

Charlie

Russ Roberts September 3, 2008 at 6:41 pm

Spencer,

Excellent point. I'll look into that.

Charlie,

Read the whole article. He was partly responding to people who compare the latest data to 2000 which was the peak of the latest boom.

Russ Roberts September 3, 2008 at 7:08 pm

Spencer,

From the BLS web site:

The CPI measures inflation at the retail level, and reflects the average price change over time for a constant quality, constant quantity market basket of goods and services. In most cases it approximates what households spend out-of-pocket on goods and services used for day-to-day living. Therefore, medical care indexes are limited to items with an out-of-pocket expenditure, although in the case of medical care the term out-of-pocket includes any health insurance premium amounts that are deducted from employee paychecks.

spencer September 3, 2008 at 7:24 pm

Yes, Russ, that is exactly what I said.

spencer September 3, 2008 at 7:28 pm

Yes Russ, that is exactly what I said.

Charlie September 3, 2008 at 10:38 pm

-Russ

"Read the whole article. He was partly responding to people who compare the latest data to 2000 which was the peak of the latest boom."

That isn't even true. The household series he uses peaked in 1999, if other people were trying to be devious they'd use that date. And if you are using macro lingo "the peak of the boom" was in March 2001.

It looks a lot more like he just looked at the data and said, "hmmm, there's a lot of wage growth between 1997 and 1998. I better make sure I include that one."

spencer September 4, 2008 at 8:28 am

the problem with the health care part of the CPI does not really impact the wage portion of compensation. The real distortion is in estimates of real fringe benefits.

Fringe benefits are dominated by two roughly equal components. One is employer contributions for retirement benefits, including social security. The other is employer contributions for health care, including medicare and medicaid.

Retirement benefits grow with wages and there is no problem with deflating them with the overall CPI.

However, health care benefits grow with health cost and are the reasons fringe benefits grow faster than wages. Health cost generally rise two to three percentage points more than the CPI — occasionally, like last year the overall CPI is greater — deflating this share of fringe benefits with the CPIcauses estimates of real fringe benefits to overstate real fringe benefits growth.
I "guesstimate" the distortion is something on the orders of one percentage point annually.

Martin Brock September 4, 2008 at 2:43 pm

A nit-pick: take home pay is deflated by the CPI which includes health care. Because health care is a big part of the rising CPI in recent years, deflating take home pay with the CPI (which is what everyone does) distorts the purchasing power of take-home pay for people with generous health care plan.

Nit-pick nit-pick: Samuel also says that fringe benefits are high proportion of increasing compensation, so the more highly inflated health care benefits contribute disproportionately to the rise in compensation.

Suppose all of your health care costs are insured by your employer. Health care costs double but all other prices fall so that the overall CPI is unchanged.

All other prices have risen recently, particularly "volatile" food and energy prices.

Suppose that all of my health care costs are "insured by my employer", i.e. 100% of my health care premium contributes to my compensation as a fringe benefit. Health care prices double. All prices (including health care) rise four percent, but most prices rise much less. Non-health-care prices rise only one percent.

My health care premium is five percent of my total compensation and it doubles, so my nominal compensation rises five percent. I don't really consume more health care. I only pay more for it.

In this scenario, my "real compensation" rises two percent, but my buying power falls. All of the five percent rise is health care inflation. The balance of my income doesn't change, but it still loses loses buying power, so my compensation effectively falls.

Some economists spin figures one way while other economists spin them another way. We know less about the real world than we know about the way people spin figures. Russ is right about that, but he's inevitably a player in the spin game himself. So am I, of course.

Average household income above the 99th percentile rose over 200% in three decades while average income below the 90th percentile rose only 10% during the same period. In an earlier three decade period, income below the 90th percentile rose 80% while income above the 99th percentile rose only twenty percent. We've hardly discussed this change.

Falling household size accounts for a bit of the change, but average household size didn't fall 800% for households below the 90th percentile, and household size above the 99th percentile certainly didn't increase ten fold.

The household size explanation is off by an order of magnitude as an explanation of the observed change. So why are we satisfied with this explanation? We're only playing a political game with the figures. Right?

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