How Real Is Real Income?
The second highlight of the Pew report on economic mobility is the finding that, for men in their thirties, median income has fallen slightly between 1974 and 2004. The implication is that American men today are doing worse than their fathers.
The most obvious problem with this analysis is that it doesn’t appear to control for the big demographic shift that’s occurred over the past 30 years. Specifically, the share of the total population born in foreign countries has jumped from 5 percent in 1974 to 12 percent in 2004. Relatedly, people of Hispanic origin have climbed from 5 percent of the population in 1974 to 14 percent in 2004.
The huge wave of Hispanic immigration over the past generation has been good for the immigrants and their families, and good for the country as a whole. But this big influx of relatively low-skilled immigrants has to have depressed median income compared to what it otherwise would have been. Unfortunately, I’m not aware of good studies that quantify the effect.
But there is a much deeper problem, I think, than the comparison of demographic apples and oranges. And that is the comparison of purchasing power apples and oranges.
The issue here is the one of calculating “real income” in constant dollars. The problems associated with such calculations are usually framed in terms of correcting for inflation — i.e., for changes in the overall price level. But a far bigger problem, especially when you are comparing incomes over relatively long time periods, is that an increasingly major component of purchasing power in the later time consists of the power to purchase goods that weren’t available at any price in the earlier time.
Let’s take an easy case. Do your best job of coming up with a deflator that takes care of changes in the price level, and calculate the dollar income in 1800 that is the “equivalent” of an income of $100,000 in 2007. Then try with a straight face to convince somebody that the earner in 1800 and the earner in 2007 are equal in terms of material well-being.
Now let’s go to the comparison that’s at the heart of the stagnating median incomes argument: incomes today and incomes in the early 1970s. Do what you want as far as adjusting for inflation, but there’s still the problem of all the goods that simply weren’t available back then: personal computers, the World Wide Web, cell phones, cable and satellite TV, DVDs and iPods, airbags, anti-lock brakes, automatic teller machines, aspertame, LASIK surgery, CAT-scans, home pregnancy test, and ibuprofen, just to name a few.
Of course economists do their best to deal with this problem, but I believe the task is hopeless. I’ve come to the conclusion that, in today’s technologically dynamic world, the concept of real income has a useful time horizon of no more than a couple decades. Stretched beyond these limits, calculations of trends in real income simply aren’t worth very much.
I don’t see how anybody without an ideological axe to grind can maintain seriously that ordinary people in the ’70s had the same material well-being as their counterparts today — yet that’s the implication of saying that median real incomes have been stagnant.
May 31st, 2007 at 12:04 pm
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June 1st, 2007 at 3:53 am
I understand and agree with your point – especially if you bring up 1800 v. today. However, that does not mean it is impossible to make meaningful comparisons – there are always some deficiencies in comparisons, but it does not mean that they lack any real value. It is like comparing companies in different industries on profitability, where one has enormous fixed assets and the other does not. As a result, straight comparisons on income to asset ratios will give misleading comparisons. However, you can usually get around this based on reasonable standardization benchmarks to say, for example, that GE has been historically better run than Northwest Airlines.
Similarly, we can make some sort of comparison between the past and today, particularly when we have the quite recent past like the mid-1970’s. DVDs and Lasik are nice, but there were other excellent means of amusing yourself and correcting vision. Insofar as these are reasonable – if slightly inferior – substitutes, we can make comparisons of where you’d rather be.
In terms of the specifics of your past, you can reasonably say that to be very rich in teh 1970’s is better than being a poor person today. You can then slide up and down that scale to see where exactly the even or switching point sits. Our current inflationary numbers do a generally good job of correcting for most differences in nominal v. real money in terms of goods that are available in both times. and if we say that today’s average men are able to buy less food, cars (albeit without CD players, but with 8-track tapes with arguably cooler designs), and entertainment is still a pretty damning statement. This becomes doubly true if similar studies show that this was not the case in the past – if we were better off in real terms in 1985 v. 1955, for example, so that the technological advances were then only a bonus – and we have thus deteriorated v. our benchmark (our past rate of improvement).
For the immigration issue, your analysis is entirely correct, I think. We should separate 1. how native born people are doing generation on generation and 2. how new immigrants are doing today v. yesterday. Both are interesting studies which would spur national debate / policy, and they can be combined in interesting ways, but I think they should probably be analyzed separately so that the effects do not influence each other.
Love the blog, the insights you consistently show, and am looking forward to reading your book – just bought it from Amazon.