In a recent op/ed in the Wall Street Journal, my former boss at the Council of Economic Advisers and Harvard economist Martin Feldstein points out that the data on real incomes in the United States systematically understate its growth. The article is titled "We're Richer Than We Realize," WSJ, September 8 (September 9-10 in the print edition.)
Consider how the government handles manufactured products when their quality improves. Statisticians track a large number of products. For each, they ask the manufacturer two questions: Has the product changed since last year? If so, how much more does it cost to make this year's model than it would now cost to make last year's model?
If there is no increase in the cost of production, the government concludes that there has been no increase in quality. And if the manufacturer reports an increase in the cost of production, the government assumes that the value of the product to consumers has increased in the same proportion.
That's amazing! I knew, and have written about, the fact that the government understates improvements in quality. I had not known how naively the government did that.
Which brings us back to the government data. To compute labor productivity in an industry, the federal government's Bureau of Economic Analysis divides the output of an industry by the number of people employed. Not bad for, say, copper mining, where tons of copper mined is a pretty decent measure of output. But how do you think the federal government, with all its high-powered analysts and its multimillion-dollar budgets for gathering data, measures productivity in the banking industry? The number of transactions per employee? Or maybe the per-employee value of deposits and loans, adjusted for inflation?
Neither. The Commerce Department's august Bureau of Economic Analysis measures output of banking by the number of people employed in banking. This means that if the number of banking employees rises by 10 percent, then the government's data crunchers simply assume that output rises by 10 percent. Therefore, the banking industry's productivity growth is zero, not by observation, but by definition.
Of course, productivity in banking is growing. According to surveys by the Bank Administration Institute, the number of checks processed per hour, a measure of bank workers' productivity, rose from 265 items in 1971 to 825 in 1986, a rate of increase of 7.6 percent annually. Presumably computers were a factor in this productivity growth. And as noted by Martin Baily, an economist at the Brookings Institution, and Robert J. Gordon, an economist at Northwestern University, the per-check processing costs for electronic funds transfers (EFTs), which were made possible by the information technology revolution, are a fraction of the cost of conventional check processing. EFTs still constitute only a small percentage of transactions, but as this segment grows, productivity will increase.
Marty points out another factor that understates growth:
There are other problems that cause the official statistics to underestimate the true growth of real income. A basic government rule of GDP measurement is to count only goods and services that are sold in the market. Services like Google and Facebook are therefore excluded from GDP even though they are of substantial value to households. The increasing importance of such free services implies a further understatement of real income growth.
Sadly, a number of commenters on the Journal's site failed to get his point. I'll quote three and, rather than tell you what's wrong with the commenters' statements, leave that as an exercise for the reader. Remember that these statements are made by people who, it is clear from tone, think they're challenging Marty's argument.
matthew kimball writes:
Another example is food has gone up and quality hasn't, gas has gone up, home price have gone up, clothing has gone up. All the essentials have gone up.
Gregory Weinman writes:
Telling me the LG G6 I bought to replace my LG G4 is far better is immaterial because both cost the same.
John Callahan writes:
Mr. Feldstein sounds much like New York Fed President William Dudley did half a decade ago--out of touch with the average American. Mr. Dudley was in Queens touting improvements in technology in regards to the cost of living- "Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful.... You have to look at the prices of all things." The residents of Queens were far more concerned about rapidly rising grocery and gasoline prices and rightfully so. As one resident noted, "You can't eat an iPad."