Innumeracy Attack!


Source: Yes! Magazine

Yes! Magazine has published a laudable issue that explores the crippling effects of personal debt as well as financial industry practices and laws that combine to immerse and keep us in debt. Then, in characteristic fashion, Yes! discusses steps we can take as consumers and citizens to manage debt and advocate for greater legal protections.

But, the issue as originally published contains a small factual error that inadvertently raises a troubling question that we sometimes hear asked, but almost never answered.

After decades or even centuries of nearly uninterrupted progress, is our standard of living declining?

That turns out to be a damnably hard question to answer and the error in Yes! helps explain why. The issue’s thesis is that in today’s economy we’re borrowing more to pay for things that we used to be able to pay for out of our incomes. Yes! used this chart to illustrate the point.

Source: Yes! Magazine

If you’re sufficiently wonkish, you may notice a problem with the chart. Three of the variables — medical services, house prices, and the Consumer Price Index — are shown as increasing many times over since 1980, but incomes, the money you and I live on, are shown as rising by a tiny nine percent. If you’re like me, you’re probably vaguely aware that income growth has lagged in recent decades, but it doesn’t feel like it has lagged by that much.

And you’re right. It hasn’t. The chart’s error is that it used inflation-adjusted figures for income, but nominal figures for the other variables. The result is an apples-to-oranges comparison that greatly exaggerates the difference between growth in income as compared to everything else.

The good news is that the error is easily fixed. To illustrate the relationship correctly, all you have to do is adjust the other variables for inflation. But, when you do, you encounter another problem.

Data Source: Federal Reserve Bank of St. Louis. Author’s calculations.

Rather than falling behind as the original chart suggested, incomes seem to have generally kept up with the cost of living, which would on its face undercut the Yes! thesis. As a caveat, it should be noted that the Consumer Price Index is a composite figure and the change in prices of individual items may vary significantly. For instance, if you’re paying for higher education or need lots of medical care, your cost of living has probably increased more than the average.

Another body of data also argues that we’re not borrowing more to compensate for lower incomes. We’re actually carrying less debt now than we were before the crash of 2008 and the subsequent Great Recession.

Source: Federal Reserve Bank of New York

Moreover, when you combine historically low interest rates with our lowered level of indebtedness, we now allocate less of our monthly incomes to pay off debts than at any time in recent decades.

Source: Federal Reserve Bank of St. Louis

In an email exchange with the editors of Yes!, they pointed out that a wave of house foreclosures and bankruptcies in the wake of the 2008 financial crash were responsible for much of the reduction in indebtedness and that those things were hardly good for consumers. All of that is very likely true, but it still does not support the notion that we’re now taking on large amounts of debt to pay for things we once paid for out of our incomes. But, before we throw the Yes! thesis out altogether, there is one more variable with which we haven’t grappled.

A closer look shows that since peaking in the late 1990’s our real incomes are falling.

Source: Federal Reserve Bank of St. Louis

This leaves us with a dilemma. If our incomes are falling and we’re not borrowing more, how are we paying for things?

That brings us back to the question of our standard of living, which is a damnably difficult concept to quantify. But, it’s important because, if we can’t pay for things we want and expect out of our incomes and we’re not borrowing to buy them, there’s only one other possibility, which is that we’re not buying them at all — we’re going without.

Put another way, our standard of living is very possibly falling.

That’s a controversial claim because, as was pointed out before, there is no universally accepted definition of “Standard of Living” and, just as products and services, evolve over time, so do expectations of what we require. And all of those factors should enter in to any consideration of what constitutes our standard of living. That point is reinforced by a publication called, “How Do We Measure Standard of Living” from the Boston Fed.

It defines standard of living as the “average real gross domestic product (GDP) per capita”. But, as the preceding chart shows, in a Pikettian world where the fruits of overall economic growth are not proportionately shared, standards of living for a small sliver of society may be on the rise while declining for everyone else. That’s why other organizations and publications use more expansive definitions many of which take into account variables such as health, life expectancy, education, and other factors that contribute to overall quality of life.

In short, there is no easy quantitative measure of standard of living. But, being difficult to measure doesn’t mean it’s not real . . . not felt. In fact, difficult though it is to define, improving our standard of living is what the economy is all about. It is the be all and end all. That’s why, if a decline in our standard of living is the real dynamic underlying the issues raised by Yes!, we have a bigger problem than we thought.