Is Real Income Stagnation a Real Thing?

April 24, 2015

At NPR’s Planet Money, Quoctrung Bui has put together an attractive and interesting data visualization on real income growth in the United States. As he describes it, there are two distinct eras for income growth since 1917:

In the first phase, known as the great compression, inequality fell. Incomes rose for people in the bottom 90 percent of the income distribution, as the postwar boom led to high demand for workers with low and moderate skills.

At the same time, income was basically stagnant for the top 1 percent of earners. A combination of high marginal tax rates (around 80 percent) for the wealthy, and social norms, may have kept a lid on wages at the top, according to the economists who gathered the data we used to make the graphs.

In the last 35 years, the reverse occurred. Top marginal tax rates fell sharply. Incomes rose for those in the top 1 percent, largely driven by rapidly rising pay for top executives.

The changes in relative incomes are an important story backed by sound data and common sense.

The changes in absolute incomes, though – using inflation adjustments to determine real income – result in a story that doesn’t seem to comport with common sense. Specifically: does anyone truly believe that top 1% incomes purchased a better standard of living in 1917 than in 1963? Because that’s what the chart is showing.

In 1917, someone in the top 1% might have had an automobile, though it would probably have been a Ford Model T, the very first mass-market automobile. They would not have access to commercial radio, which didn’t come about until the 1920s. They might have to worry about since-cured diseases like polio. For example, Franklin Delano Roosevelt, a wealthy young future president, contracted the disease in 1921 and was permanently paralyzed from the waist down.

In contrast, by 1963, these things were a lot better. The “big three” Detroit automakers were offering a variety of far-superior vehicles for sale. People not only had access to commercial radio, but television too. And for those who could afford it, some shows were broadcast in color. Lastly, polio had been virtually eradicated thanks to the vaccine developed by Jonas Salk. Only a few hundred cases remained in the U.S. for a disease that at one time struck tens of thousands.

So again, does anyone think they’d be better off with a top-1% income in 1917 than in 1963? Anyone? Anyone? Bueller?

The issue here is whether inflation adjustments are appropriately measuring real standard of living improvements. There is good reason to believe that they aren’t. Inflation adjustment is hard – you are aggregating the changes in price of many different goods into a single number, which is arguably an impossible exercise that loses too much information to be worthwhile.

Even if you believe inflation adjustments can be made well in theory, few economists believe we’re currently doing it in practice. They often note that they do a poor job of accounting for the ways that technology allows people to substitute their consumption towards higher-quality or more convenient alternatives.

Harvard professor Kenneth Rogoff observed in a blog post this week that he’s skeptical of the more recent claims of stagnation. (For example, the visualization from NPR shows stagnant growth for bottom 90% earners after 1980.)

Rogoff writes, eloquently, that perhaps growth in recent years has been better than the economic statistics show:

What of Solow’s famous 1987 remark that “You can see the computer age everywhere but in the statistics”? Perhaps, but one has to wonder to what extent the statistics accurately capture the welfare gains embodied in new goods during a period of such rapid technological advancement. Examples abound. In advanced countries, the possibilities for entertainment have expanded exponentially, with consumers having at their fingertips a treasure-trove of music, films and TV that would have been unimaginable 25 years ago. Quality-of-health improvements through the low-cost use of statins, ibuprofen and other miracle drugs are widespread. It is easy to be cynical about social media, but the fact is that humans enormously value connectively, even if GDP statistics really cannot measure the consumer surplus from these inventions. Skype and other telephony advances allow a grandmother to speak with a grandchild face to face in a distant city or country. Disruptive technologies such as Uber point the way towards vastly more efficient uses of the existing capital stock. Yes, there are negative trends such as environmental degradation that detract from welfare, but overall it is quite likely that measured GDP growth understates actual growth, especially when measured over long periods. It is quite possible that future economic historians, using perhaps more sophisticated measurement techniques, will evaluate ours as an era of strong growth in middle-class consumption, in contradiction to the often polemic discussion one sees in public debate on the issue.

I tend to agree. And I am skeptical of the claim that middle-class income since 1980 has been stagnant for the precise same reasons that I am skeptical of the claim that upper-class income from 1917 to 1963 was stagnant.

I think the graphic at Planet Money is a great visualization that neatly proves the main thesis of the piece: that there have been two different eras for income data, one in which incomes became more equal and one in which incomes became less equal. But I think it also is strong evidence of another thesis: the idea that we don’t do inflation adjustments very well.

As a result, our “real” income data might not be very real after all.


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