Priced to Move
The CPI can't keep up with a dynamic economy.
By Virginia I. Postrel
Styling aside, would you rather have a brand-new 1972 car or the equivalent 1997 model? A new house circa 25 years ago or one built today? The medical care of 1972 or 1997? The restaurants? Winter fruits and vegetables? Disposable diapers, shampoo, TV sets, diet soda, panty hose, sneakers, bathroom cleansers, alarm clocks, contact lenses, or stereo systems?
The past few decades have witnessed extraordinary progress in the quality and variety of goods and services. Nor does that progress end with the microprocessor and its well-publicized offspring, however amazing and important they may be. It encompasses adhesives (in everything from Post-It notes to beltless sanitary napkins to easily removable price tags), packaging (remember when shattered glass shampoo bottles were a real danger, store-bought cookies were always hard, and metal toothpaste tubes crumbled with age?), fibers (wrinkle-free slacks, harder- to-run hose, stain-resistant carpet), and chemicals galore (from scrubbing bubbles that attack soap scum to Retin-A that attacks wrinkles). Cars last longer, airplane rides are smoother, long-distance calls are clearer, and even the bread tastes better.
Americans are, however, a forgetful lot. We take our good fortune for granted and concentrate on what we don't have. That restlessness can itself be a spur to progress, but it can also become perverse: GenXers who have never seen a blurry TV picture or lived without central air conditioning grouse about their hard lives--and they're often more optimistic than their elders. The answer to the question, "Are you better off than you were 25 years ago?" is widely assumed to be no. Indeed, when REASON published a cover story in December 1995 arguing that by numerous objective measures--from the size of new homes to the length of work weeks--the standard of living has been rising since the early '70s, many readers were outraged. (See "The Good Old Days Are Now," December 1995.) Conservatives believe the good old days were yesterday, while leftists just hate capitalism and, increasingly, progress as well.
This debate is at the heart of a seemingly technical report titled "Toward a More Accurate Measure of the Cost of Living," prepared for the Senate Finance Committee by an all-star team of economists led by Stanford's Michael Boskin. Released in early December, it argues that the consumer price index has been significantly overstated at least since the 1970s and should be revised. It's rare for a handful of economic technicians to make big news, but the Boskin Commission did--and will continue to over the coming year.
That's because the commission's recommendations, which include ideas for creating a truer cost-of-living index, have significant budgetary implications. Even before the final report was out, journalists were warning of "a looming stealth attack on the deficit and growing entitlement programs," in the words of Susan Dentzer of U.S. News & World Report. The CPI drives both automatic increases in federal handouts, notably Social Security, and inflation adjustments in income tax rates. But, says the commission, the CPI overestimates inflation by at least 1.1 percentage points a year. That translates into more than a trillion dollars in federal taxes and outlays between now and 2008. Not surprisingly, the entitlements lobbies have geared up big time to attack the commission's conclusions.
But there's even more at stake in this debate. By questioning the CPI, the commission is challenging not only some big items in the federal budget but the conventional wisdom about our recent economic history. The entire gloom-and-doom industry is threatened. As Boskin wrote in The Wall Street Journal, "The implications of overstating inflation for understanding economic progress are equally striking. Instead of falling by 13%, real hourly earnings have risen by 13% from 1973 to 1995. Certainly, there has been a slowdown in wage growth, but not a decline. Real median family income over the same period grew 36%, not the puny 4% in the official statistics that deflate by the CPI."
The commission's report identifies several sources of error in the CPI, all stemming from a central fact: the dynamism of the American economy. "If the American economy was quite static," says the report, "with very few new products introduced, very little quality improvement in existing products, little change in consumers' income, and very small and infrequent changes in the relative prices of goods and services, measuring changes in the cost of living would be conceptually quite easy and its implementation a matter of technical detail and appropriate execution. Fortunately for the overwhelming majority of Americans, our economy is far more dynamic and flexible than that."
As a result, pricing an essentially static "market basket" of goods--without considering how consumers switch among products in response to price changes, how people change where they shop, what new products have been introduced, or what quality improvements have taken place-- tends to make the cost of living appear to rise faster than it really has.
In real life, we don't stick with a fixed market basket...
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