Second of Two Pieces on Income

Martin Feldstein is a macroeconomist from Harvard (probably their oldest). He’s been well-known since before I started college (he was one of Reagan’s economic advisors in the early 80’s).

In a September 8 op-ed piece in The Wall Street Journal entitled “We’re Richer Than We Realize” he argues that real GDP (and its growth rates) are understated.

The common assertion that middle-class households have seen no increase in real incomes for 30 years is simply not true. And contrary to a common fear, most members of the younger generation will have higher real incomes as adults than their parents had at the same age.

There are two reasons for this, and he argues that both of them are getting more severe.

First, government statisticians grossly understate the value of improvements in the quality of existing goods and services. More important, the government doesn’t even try to measure the full contribution of new goods and services.

On the first count, the government is basically “old school”. They view quality improvements as largely proportional to costs. This might make sense for home construction, but not so much for smartphones.

… In reality companies improve products in ways that don’t cost more to produce and may even cost less. That’s been true over the years for familiar products like television sets and audio speakers. The government therefore doesn’t really measure the value to consumers of the improved product, only the cost of the increased inputs. …

The official estimates of quality change are therefore mislabeled and misinterpreted. When it comes to quality change, what is called the growth of real output is really the growth of real inputs.

The second issue is about the introduction of new products. We’re OK at counting the value of the new products, but we don’t make much of an attempt to figure out how much richer we are from mitigating the problem the new product solved:

Think about statins, the remarkable class of drugs that lower cholesterol and reduce deaths from heart attacks. By 2003 statins were the best-selling pharmaceutical product in history. The total dollar amount of statin sales was counted in GDP, but the government’s measure of real income never included anything for improvements in health that resulted from statins—such as a one-third decrease in the death rate from heart disease among those over 65 between 2000 and 2007.

Think about that: one third of deaths from the biggest killer eliminated in 7 years. That’s a ridiculous improvement to leave unmeasured. But, of course, the techniques for counting GDP were developed before things like this happened regularly.

It is impossible to know how much the official statistics understate the true growth of real incomes. My own judgment is that the true annual growth rate could exceed the official figure by two percentage points or more, implying that the true annual rate of real per capita income growth during the past two decades has been much more than double the official 1.3%.

I don’t know if I’d go that high, but I wouldn’t even debate a 1% mismeasurement.