Saturday, January 29, 2011

CPI Bias Revisited

I disagree with Tyler's thought provoking core thesis presented in this piece.   Innovation is sharply reducing the quality adjusted prices of all sorts of major goods we consume in markets.  This raises our real incomes.  Local pollution has sharply improved in the U.S.  This raises our real "hedonic" income.

In 1962, the Internet, the Smart Phone and Facebook would have been expensive to use.  These new products have generated a huge amount of consumer surplus.  Let's see a smart young IO economist quantify that!  Yes, new cereals and mini-vans generate consumer surplus but I want an estimate of Facebook's value added. Now Tyler would say that such improved leisure doesn't appear in the income statistics but you don't have to be Nordhaus or Tobin to argue that this means that the accountants haven't measured what matters.  Recall their classic;  "Is Growth Obsolete?"

Let's turn to life expectancy;  if I'm reading this ugly Google graph correctly for the United States;

Life expectancy has increased about 8 years since Tyler's birth.  That's valuable stuff!  to an optimistic like me, that sounds like progress.

Note that Tyler doesn't mention pollution in his article.  Urban water pollution and air pollution in the United States were much worse in 1960 than now.  Think of Los Angeles smog, Pittsburgh haze then versus now.  Think of the quality of our urban rivers then versus now.

CPI doesn't reflect non-market goods.  The "price" of clean air has plummeted over time ---In the past (in 1970), you'd have to live in expensive Malibu to purchase clean air. Now you can live in dozens of Los Angeles communities to purchase such clean air.  Innovation has played a key role in mitigating the nasty issues of air and water pollution.   These examples highlight how innovation can improve our quality of life without being explicitly seen in GNP accounts.  Tyler's grandma would be quite impressed with our Green Cities. You should all read my book on this topic. You can find chapter 1 on my UCLA webpage.

Recall that CPI (consumer price index) measures inflation.  I believe that continued improvements in the quality of new goods at such a rate that there is negative inflation over time. The real purchasing power of a dollar rises.  Take a look at this paper by Robert Gordon.

What is the right market test of progress?  We need a time machine and we need to know how much you would need to be paid to get in it to live your life in the past (while knowing that you won't know who will win the Super Bowl in 2010, I can't let you change the course of history).  In symmetric fashion, for people like Tyler's grandmother born in 1905 --- how much would she be willing to pay to have been born in 1962 versus 1905?

I believe that my son (born in 2001) will have a better life than my solid (1966) life.   Expected Innovation is a major piece of my optimism.

I've met others deeply concerned about terrorism, climate change and the general U.S malaise who believe that our next generations will not have a better life than ours.


Lord said...

I am not sure I would want to travel 50 years in the past for double the income and wealth, but I know I would be willing to go 30 years, and possibly 40 years though the 70s were an awful period. Inflation may be overstated, but not by much.

Matthew said...

A while ago Prof. Cowen put a post on his blog looking at the 1900 Sears Catalog and saying that he would rather buy $10,000 worth of contemporary items rather than $10,000 of stuff from that catalog at 1900 prices.


I think that even he would agree that even if you only look at private goods, price indices don't account for quality improvements very well.

Drew said...

I think the test then, is to show the relative percentage of the "total income" (both market and nonmarket income) is made up of nonmarket goods. While I agree with your point that he does not take nonmarket goods such as improvements in air quality into account, I have to wonder how much that would affect the final result. I find it hard to believe (although this statement could show my ignorance on the exact health effects of clean air) that clean air, for example, would increase that number significantly. I am surprised, however, that Tyler has not mentioned information as a public good that could raise what you call "hedonic income" (though I'm not 100% sure that it could be included in hedonic income as knowledge can be both a market and nonmarket good as well as a private or public good depending on the type of knowledge). I think that, if nothing else, the knowledge level of the median person is significantly higher so as to make a difference in "total income" numbers.