CONTEMPORARY ECONOMIC MYTHS

If you only read the major newspapers and listen to the major electronic media, you probably have ingested and internalized a number of myths about the turn-of-the-century economy. Here are five that are commonly heard, none of which are true as stated.

Myth: The cost of living has steadily risen throughout the 20th century, especially the last few decades.

The ultimate measure of the cost of consumption goods is the labor time needed to purchase them. A pair of pants might cost $20, but if the average industrial wage is $2/hr then those are more "expensive" than if the average industrial wage is $10/hr. Five times more expensive, we might add. When looked at this way, the real cost of living has dropped significantly and consistently over the course of the century and the last few decades.





Table 1: Changes in the Labor Time Cost of Various Consumer Goods 1920 1950 1980 Latest (1997) 1/2 gal of milk 37 mins 16 mins 8.7 mins 7 mins 1lb loaf of bread 13 mins 6 mins 4 mins 3.5 mins gallon of gasoline 32 mins 11 mins 10 mins 5.7 mins 100 miles of air travel 12 hrs 46 min (1930) 4 hrs 7 mins 1 hr 27 mins 1 hr 2 mins three minutes coast-to-coast long distance call 30 hrs 3 mins 1 hr 44 mins 11 mins 2 mins pair of Levis 10 hrs 36 mins 4 hrs 2 hrs 48 mins 3 hrs 24 mins 3lb chicken 2 hrs 27 mins 1 hr 11 mins 18 mins 14 mins 100 kwt hrs of electricity 13 hrs 36 mins 2 hrs 45 mins 38 mins computing power of 1 MIPS n/a 515,000 lifetimes 41 weeks 16 hrs

9 mins 9 mins

How does process of progressive cheapening happen? What happens is the spread of new technologies and products from the rich to the masses. The rich pay the big up-front costs by purchasing them when they are very expensive. This enables firms to continue to do R&D and cut production costs and bring down prices. Think of any technological gadget of the last 30 years. And note the way that current new technologies like digital cameras and DVD players are going through the same process.

Also think about the variety of products available now in comparison to the past. Think of potato chips now vs. say 30 years ago! Compare all the varieties available now vs. then. Or milk, or any good you can think of. Not to mention new products that didn't even exist however many years ago. The increase in variety is one of the best signs of increasing well-being and a rising standard of living.

Some things do cost more, even in terms of labor hours: houses and cars to name two. Is that a problem? Probably not. Why? In both cases, the goods in question are of significantly greater quality than in the past. Compare the standard features on late 90s cars and homes with those of 20, 40, or 100 years ago. Yes, they cost more, even in real terms, but what you get for your money is substantially more.

Myth: The 1980s were a decade of greed.

Table 2: Charitable Giving in the 80s and before 1955-1980 ann. avg. increase 1980-1989 ann. avg. increase Percentage Change Total Charitable Giving 3.3% 5.1% +55% Individual Giving 3.1% 5.2% +67.7% (per capita) (per capita) (per capita) Total Charitable Giving 2% 4% +100% Individual Giving 1.8% 4.1% +127.7%

Compare these increases to the increases in expenditures on jewelry and watches (41%), alcohol (< 1%), eating out (21.9%), tobacco (-12.1%), personal services (37.9%). The percentage increase in charitable giving per year over the 80s was greater than the increase in expenditure on each of these "luxury" items. The only major expenditure item that grew faster than giving was cars (59.8%) and it was not by much. This could be a hangover from the 70s, when high gas prices and fuel-hogging cars discouraged car purchases. As conditions improved in the 80s, this pent-up demand might have let loose.

As a percentage of national income, total and individual giving reached all-time highs in 1989 . In addition, these levels of giving were ahead of what one would have predicted given past data. Therefore, it's not just that the economy was better (as if that were an argument in favor of the "greed" view of the 80s), but people's preferences seem to have changed. That is, people didn't just give more because, with a fixed preference for charity, they simply had more income to give. Rather, it appears as though people became absolutely more charitable.

Myth: The rich are getting richer and the poor are getting poorer.

Table 3: US Income Distribution by Quintile, 1997 Top 20% Second 20% Middle 20% Fourth 20% Lowest 20% Percent of Total Income 49.4% 23.2% 15.0% 8.9% 3.6%

We can see how these numbers compare over time by looking at US Treasury data comparing the top and bottom from 1975 to 1997..



Table 4: US Income Distribution to Top and Bottom Quintile:

1975 vs. 1997 Top 20% Lowest 20% 1975 43.2% 4.4% 1997 49.4% 3.6% Change in income +$37,633 +$207

So in the following sense it is true that, and read carefully: "the people who were rich in 1979 earned a smaller share of total income than those who were rich in year 1988 and the folks who were poor in 1988 earned a smaller share of total income than those who were poor in 1979." Does this show the rich are getting richer and the poor are getting poorer? Not really. The problem with this analysis is that it's way too static, and here are at least two considerations to keep in mind:

1. Even if the relative shares of the poor declined, this doesn't take account of the overall growth in income. The first two rows above are only in percentages of total income, not absolute amounts. Would you rather have 1/6th of a pizza or 1/9th? Doesn't it depend on how large each pizza is? If the economy has grown significantly, even a drop in the relative income share of the poor might mean a jump in the absolute amount they have. In fact, if you look at the data, that's precisely the case. The US economy grew substantially between 1975 and 1991, and the average income of those in the bottom quintile did rise in real terms ($207 on average), albeit not by very much. So even though the relative share of the poor fell, their absolute income rose.

However, that's not the big problem.

2. The people who were poor in one year ARE NOT THE SAME PEOPLE WHO ARE POOR IN THE LATER YEAR! It's comparing apples and oranges in some sense. The data in Table 4 does NOT say that the people who were poor in 1975 earned even less income on average in 1997. Why not? Because each quintile is made up of different people in each year! It turns out that most of the people who were poor in 1975 were no longer poor in 1997! What we'd like to know is how did the people who were poor in the earlier year do in the later year. We do have data that track specific households over time. Here are two such data sets.





Table 5: Income Mobility 1979 to 1988 (US Treasury Data) Bottom 20% (1988) Fourth 20% Middle 20% Second 20% Top 2-20% Top 1% Bottom 20% (1979) 14.2 20.7 25.0 25.3 14.4 0.3 Fourth 20% 10.9 29.0 29.6 19.5 10.8 0.3 Middle 20% 5.7 14.0 33.0 32.3 14.6 0.4 Second 20% 3.1 9.3 14.8 37.5 34.8 0.6 Top 2-20% 1.1 4.4 9.4 20.3 59.4 5.3 Top 1% 2.2 0.4 3.8 7.7 38.6 47.3

Table 6: Income Mobility 1975 to 1991 (UM Data) Bottom 20% (1991) Fourth 20% Middle 20% Second 20% Top 20% Bottom 20% (1975) 5.1 14.6 21.0 30.3 29.0 Fourth 20% 4.2 23.5 20.3 25.2 26.8 Middle 20% 3.3 19.3 28.3 30.1 19.0 Second 20% 1.9 9.3 18.8 32.6 37.4 Top 20% 0.9 2.8 10.2 23.6 62.5

Table 7: Absolute Average Income Change, by Quintile 1975-91 (1997 dollars) Avg. Income 1975 Avg. Income 1991 Absolute Change Bottom 20% $1,263 $29,008 $27,745 Fourth 20% $6,893 $31,088 $24,195 Middle 20% $14,277 $24,438 $10,161 Second 20% $24,568 $34,286 $9,718 Top 20% $50,077 $54,431 $4,354

If we compare two years, some/most of the people who were poor in the first year will not be the same people who are poor in the later year. Some highlights of these last three tables: The biggest is the number of people who start in the bottom quintile and work their way out. In table 5, over 85% of the poorest quintile in 1979 were no longer in that quintile in 1988. In table 6, the number is almost 95% for the longer period of 1975 to 1991. The vast majority of the people poor in year x are not going to be poor in the near future. (If you are thinking this is only a long-run phenomena, consider this: according to the Census Bureau, between 1984 and 1985, 18.2% of families in the lowest quintile had moved up one or more quintiles. For 1985-86, the number is 18.4% and it's 17.0% for 1987-88. So there are steady year-by-year gains.) Even for the rich, there's no guarantees. Granted, if you started the period rich, you were more likely to stay in your quintile than were the poor, but even there the odds were roughly 50/50. Over 1/3 of the top 20% of income earners in 1975 were no longer in the top quintile by 1991, and the numbers are comparable for the 1979-88 data.

Table 7 is fascinating as well. This table shows the average income gains of the specific households that were tracked over the 16 year period. The dollars are all converted to 1997 dollars to take out the effects of inflation. Families who were in 1975 in the bottom 20% had an average income increase of almost $28,000 by 1991, while the folks in the top 20% only gained an average of $4,354. So the rich did get richer over this period, but the poor's income grew substantially more than that of the rich! That is, the rich got richer but the poor got even richer, not just in percentage terms but in absolute terms. Again, this data is tracking specific families.

One footnote to all of this: among those who began in the lowest quintile in 1975, 98% had higher incomes (in real terms) over the course of the next 16 years, even if not all of them got out of the lowest quintile. Two-thirds of those who were in the lowest quintile in 1975 had higher incomes in 1991 than the middle quintile had in 1975. You need to remember that as the economy grows, the range of the quintiles grows as well, so even those who remain in each quintile are going better in absolute terms.

It also seems appropriate to mention that all of these gains by the poor were during the so-called Decade of Greed, pillioried by those on the left for its supposed cold-heartedness and mistreatment of the poor. You can make your own call on that claim.

A good deal of this is explained by demographic factors. For example, the bottom quintile tends to be disproportionately young people and as they age, they move up the ladder. Even if that explains a good deal of what we see here, so what? It still contradicts the usual understanding of the data. The real policy question here is income mobility. How easy is it for folks who start poor to move their way up? The answer to that is "pretty easy." That paints a far different picture of how the poor are doing over time than the static and misleading idea that the poor are getting poorer that is taken from year-to-year comparisons of the quintiles.

Myth: Wages have fallen in the last 20 years and the market is only creating bad jobs.

real hourly wages

However: if this were true, especially the loss of "lifestyle," it should show up in consumption, which it does not. If "lifestyle" is measured by the things we buy and have in our homes, people are doing better than ever! It's apparently not the case that our standard of living as worsened. How can that be, if real hourly wages are falling? What gives here?

Here is the standard piece of data that gets reported: From 1953 to 1973, average hourly wages grew at an annual rate of 2%. From 1973 to 1978, they stagnated. And then from 1978 to 1996, average hourly wages fell by an average annual rate of 0.7%. The total decline over that last period is 15%.

What's the problem with this apparent fact? There are three issues here.

1. The wage figures include only monetary wages, they neglect other forms of compensation, including health benefits, retirement benefits, stock plans, etc.. The total compensation from a job includes more than just the wage. Granted, this is less true for lower wage jobs, but even there, total compensation is greater than just monetary wages. This is especialy true of retirement benefits. Even hourly workers have made gains from the stock market boom, as the value of their retirement plans have skyrocketed. In addition, the number of workers covered by employer-provided health insurance has grown steadily over the period. Non-monetary benefits as a percentage of wages have increased by 33% since 1970. When we switch over to total compensation rather than wages, the last 25 years have seen growth, albeit slightly slower than the period prior, but growth nonetheless. The cumulative gain in total compensation since the early 1970s is 17%. Again, that's slower growth than previous decades, but still a real gain.

2. Even that figure is problematic: people earn income in other ways than via wages. Those figures neglect interest, dividends, and capital gains and the like. When we look at per capita income rather than wages or total compensation, we get a continuation of the same upward trend we saw from 1953 to the mid 1970s, albeit once again at a slower rate. In the 1950s and 60s, annual increases in per capita income averaged about 2.6%. Since 1974, that average has been 1.6%. Slower again, but still improvement. This, along with the falling costs of many goods, explains how hourly wages can fall, but consumption can be up. Again, for the poor, most of their income is wage income, so this point is somewhat less telling. Nonetheless, given the data on income mobility, even most of the poor are doing better, so that income must be coming from somewhere.

3. But there is even a further problem. In computing the real wage data, economists take nominal wages and adjust them for inflation using the Consumer Price Index (CPI). Most economists (both left and right) think that the CPI overstates inflation by some amount. If we assume that it does so by 1.1% per year (an average of various estimates by economists), the decline in real wages since 1978 becomes a 12% increase, and the slowdown in per capita income growth disappears. It also adjusts upward almost every other measure of economic health since the mid-70s. Even a difference of 1% of year will make an enormous difference compounded over 20 years.

It's surely true that more women are working than before. However, this has little to do with falling wages and the like. In fact, it has everything to do with rising wages for women. As market opportunities have become more attractive, and as technology has reduced the need for human labor in the home (compare the microwave to a regular oven, or a washing machine to hand washing clothes), more and more women have entered the labor force. This is a sign of strength in the US economy, not weakness. And, perhaps most important, the gap between women's wages and men's wages is rapidly shrinking. In 1996, women aged 28-33, who had comparable education/training, experience, and uninterrupted time on the job as their male counterparts earned 98% of what the men did. If you control for the normal variables (like those in the previous sentence) that affect wages, you find that the gender gap in wages narrows progressively as you move from older workers to younger ones. For women in college today, there is a legitimate expectation that they will earn pretty much the same as their male counterparts, if they have the same training, etc..

Okay, say the critics, but surely the jobs we've created have been "burger flipping" jobs, no?

It's true that most of the jobs created over the last 25 years have been in the service sector, but that's part of a long term trend that is the most basic sign of economic growth: we need fewer people to produce physical stuff, freeing that labor to provide the services we wish to have with that stuff. One hundred years ago fully 50% of Americans worked in agriculture. Now that figure is less than 3% and we manage to feed a much larger US population as well as exporting a great deal of foodstuffs. The reduction in agricultural labor (which is the flip-side of the rise of the industrial and service sectors) is the most fundamental sign of human progress there is. We need so much less labor for our sheer survival.

Consider the following example: suppose a very poor person wishes to eat chicken. Odds are she is going to raise her own chickens or go to the store to buy the cheapest chickens they have, normally a whole uncut chicken. As wealth increases, what happens? Well folks tend to move up to buying cut up chickens, saving them the labor of raising chickens or cutting them up themselves. Even wealthier folks will just buy the best parts, or perhaps head out to Boston Market for a prepared dinner. The very wealthiest will head to a fancy restaurant for free-range chicken in some fancy sauce. Societies go through the same process as average income rises. What's the difference between all of those chicken dinners? Services! The home-raised chicken involves no market purchase of services and hence no service-sector jobs. Each other act of chicken consumption adds an increasing amount of human labor to the process, and more skilled labor at that. Increasing wealth leads people to substitute market-bought services for their own labor (another reason why as wealth increases, more women work - households can purchase the things that they used to produce themselves). The rise in the number of service sector jobs is a sign of, and result of, our prosperity.

But don't those service sector jobs pay lousy? In fact the average wage in the service sector is $11.80/hr compared to $13.20/hr in maufacturing. Not a huge difference and one that is rapidly shrinking. However, if we recognize that what keeps services low is retail jobs, often held part-time by non-primary income earners, then the picture changes a bit. Take out retail and service wages are 5% higher than manufacturing wages! So if you compare full-time workers in the two sectors, things look very different.

Here's some other recent data: Between February 1994 and February 1996, 68 percent of the net growth in full-time employment occurred in industry/occupation groups paying above-median wages. Over half the net growth occurred in the top 30% of job categories, mostly in non-traditional service sector jobs. The vast majority of these jobs were full-time.

More radically, we should celebrate the destruction of jobs! When jobs are destroyed, it is a sign of progress. Labor is freed to be allocated to more valuable uses. It's a good thing that there are no more horse and buggy makers or coopers or the like. We don't need that labor for those purposes any more. Of course one problem here is that jobs tend to be eliminated in big chunks, while they are created in dribs and drabs. The media covers it when ATT announces 30,000 jobs are being cut, but it's not news when a small hi-tech firm hires 5 people this month and 3 more the next month. However, if you add it all up, the economy has created far more jobs than it has destroyed in the last few years, and most of those jobs have been created by firms with less than 500 employees. Between 1991 and 1995, firms of less than 500 employees created 10,846,000 new jobs. Firms between 500 and 5000 employees created 193,000 jobs. Firms of 5000 or more destroyed 3,375,000 jobs. The total number of jobs created in the period was 7,664,000. It's also worth pointing out that the vast majority (84%) of the jobs created by small firms were created by firms who opened for business within that period. It is the new, small firms who are creating the jobs in our economy. We hear all about the job cuts, but no one celebrates the firms that have created thousands of jobs over the last couple of decades. Let's rectify that by honoring some of the big job creators:





Table 8: Some Major Job Creators (1985-96) Firm Jobs created Firm Jobs created 1. Wal-Mart 624,000 6. Dayton-Hudson 90,000 2. UPS 183,500 7. Seagate Technology 82,300 3. Lucent Technologies 124,000 8. General Dynamics 80,200 4. Lockheed Martin Marietta 102,200 9. Viacom 79,100 5 .Limited 97,800 10. Disney 75,000

Myth: We are running out of various resources.

There are a number of flaws in this argument, including a lack of evidence for it. One flaw is that it assumes that the effective quantity of resources is independent of population. One of the advantages of a growing population is that more people means more knowledge and a finer division of labor. People are not Pac-Men, consuming everything in sight. We are also thinkers, creators, and producers. When there are more people, there are new ideas and overall productivity/efficiency increases. With more people we can do things more efficiently, using fewer resources in the process.

In addition, there is the process of substitution. As a particular resource becomes scarce, its price rises, creating an incentive to substitute a cheaper resource in its place. Entrepreneurs find substitutes. As they do, the real cost of achieving the end in question falls. What we care about are the services that resources deliver not the resources themselves. For example, consider the way we transmit voice data. In the early 60s there was a major concern with running out of copper for phone wires. The price rose, stimulating research on substitutes. The result? Fiber optics. There's plenty of sand, and one kilogram of sand can transmit thousands of times the data of one ton of copper. We get immensely greater volume at extremely low cost. Other examples include plastics for metals and man-made materials for leather. Notice how this process is also tied to the destruction of particular jobs. Recently, even gas prices were at their lowest in history, even ignoring the labor-hours calculation!!

One piece of evidence for these claims is the famous bet between Julian Simon and Paul Ehrlich. Simon was willing to wager that any selected group of mineral resources would become less scarce (as measured by their real price) over any time period. Ehrlich and some colleagues took the bet in 1980, chosing copper, chrome, nickel, tin, and tungsten, and picking a ten year period. In September of 1990, "not only had the sum of the prices, but also the price of each individual metal, had fallen." (Simon, p. 35) Simon has offered similar bets since then and had no takers until his untimely death in February of 1998.

By almost every measure, resources, especially food and arable land, are more plentiful than ever. As long as we give humanity the free reign to continue to make the imaginable the real, we have little to worry about.

Sources:

Cox. W. Michael and Richard Alm. Myths of Rich and Poor: Why We're Better Off Than We Think, New York: Basic Books, 1999.

My favorite book of the year (so far) by two guys who do some fascinating research. Their previous work on the declining real cost of living in America was nothing short of excellent, and their work on income distribution was also very good. This book combines that research with other material on economic change over the last few decades to produce an optimistic, well-researched and easy to read guide to what's really going on the US economy. In a nutshell, things have never been better. People are living better, the opportunities to move up the income ladder have never been greater, and quality jobs are plentiful.

McKenzie, Richard. What Went Right in the 80s. San Franciso: Pacific Research Institute, 1994.

The definitive book for defending the much maligned decade. Was it a decade of greed? Nope, charitable giving was at an all-time high. Did the rich get richer and the poor get poorer? Nope, like Cox and Alm, McKenzie presents very credible empirical evidence to suggest that it was, in fact, the poor who did best during the 80s. He also takes a close look at the twin deficits issue, the savings and loan bailout and other 80s classics and shatters the myths about all of them.

McKenzie, Richard. The Paradox of Progress, New York: Oxford University Press, 1997.

A more recent book by a prolific analyst of current economic problems. McKenzie explores the apparent paradox that the standard of living in the United States has never been higher, yet more people are worried about their future and believe things are getting worse than ever before. He offers powerful empirical evidence in favor of the "things have never been better" argument, and he recaps his discussion of "what went right in the 80s." He also has a great discussion of the role of "cyber-economy" in creating more opportunities and more freedom than we've ever known. Of particular interest are his exploration of the morality of the market, through a discussion of Hayek, and his suggestions about why we often refuse to recognize the very progress in our midst.

Postrel, Virginia. The Future and its Enemies, New York: The Free Press, 1998.

The much-anticipated book by the editor of Reason is worth the wait. Postrel tries to cut through various ideological positions of the late 90s by grouping people into groups of either "stasists" or "dynamists" depending on their attitudes to the unpredictable change that a spontaneously-ordered society brings in its wake. On the "stasist" side are right-wing protectionists like Pat Buchanan, right and left-wing cultural critics, and environmentalists of many stripes. Of particular note is her continual and pointed criticism of the classic elitist-stasist Al Gore. Postrel does a very nice job in providing tons of examples of her dichotomy at work as well as solid explanations of why decentralization and dynamism work. Her chapter on "play" is just great and the general feeling of optimism and openness that pervades the book is wonderful.

Simon, Julian. The Ultimate Resource 2, Princeton: Princeton University Press, 1996.

The one book to read to be able to respond to environmentalist doom-and-gloomers. Calling it the "anti-Gore" would be to elevate Gore! Simon tackles every environmental, population and immigration issue imaginable with tons of empirical data and his unflagging optimism about humanity's ability to progress. This book is full of sound economic reasoning and plenty of food for thought.

Smiley, Gene. The American Economy in the Twentieth Century, Cincinnati: South-Western, 1994.

A nice readable textbook to give you some basic facts and figures on the US economy in the 20th century.



