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December 1, 1996

So, Maybe It Wasn't the Economy


ECONOMIC statistics are thrust into the news every day, with a portentious exactitude that can send Wall Street soaring or reeling, influence Government policy, even sway elections. Did consumer prices rise one-tenth of a percent more than was expected? Was economic growth a half percentage point less than people had been hoping?

But what if the statistics are wrong? And what if they are consistently wrong in the same direction? Over time, that can produce a very distorted picture of the economy, with unfortunate effects brought about not by the economy but by our perceptions of it and with those perceptions having effects of their own. In making the economy look much worse than it really is, one seemingly small miscalculation can skew political debate, with big effects; remember "it's the economy, stupid"?

This week a commission headed by Michael Boskin, the Stanford economist and former adviser to President Bush, will report to the Senate Finance Committee that inflation, as measured by the Consumer Price Index, has been rising at a far slower pace than we had thought. Economists who have studied the issue now generally agree that inflation has been overstated, although some argue that the error is relatively small and may not make a significant difference. Social Insecurity

The commission was appointed last year because of serious doubts about how changes in benefits and tax brackets, which have a major effect on the deficit, are calculated. A conclusion that the Consumer Price Index has been overstated could lead to efforts to reduce the automatic increases in certain benefits, notably Social Security.

That's sure to provoke a fight.

But perhaps even more important are changes that may be necessary in our view of the economy for the last two decades. For much of that time, even as America came roaring back into a preeminent position in technological leadership and the stock market zoomed, economists have been looking at statistics that showed a weak economy. And politicians have been trying to address public angst over economic decline.

"The central paradox of the American economy today is that we are apparently in an era of extremely rapid technological progress in which economic progress has slowed dramatically, and according to some measures stopped," Leonard Nakamura, an economist with the Federal Reserve Bank of Philadelphia, writes in a forthcoming issue of that bank's Business Review.

Mr. Nakamura is known for his work on inflation, which he has concluded has been overstated for at least a couple of decades, with the overstatement growing worse in recent years. His estimates of the overstatement are among the largest, although he believes they are conservative given recent evidence. He puts the overstatement at about 1.25 percent annually in the mid-1970's, rising to about 2.75 percent now.

At the request of The New York Times, Mr. Nakamura mapped out his view of economic change, choosing 1975 as a baseline.

For example, the official wisdom says wages have risen more slowly than inflation. But Mr. Nakamura

concludes that average hourly wages, after adjusting for inflation, are now 35 percent higher than they were in 1975, while Government figures show a 9 percent decrease. He thinks the economy has grown twice as much during that stretch as the official figures indicate, and argues that productivity is up three times as much. Explaining the Nonexistent

If Mr. Nakamura's figures are accurate, much of the economic debate of the last couple of decades has been misguided, with economists and others trying to explain a decrease in productivity growth and a slowdown of economic growth that either did not exist or was much milder than the official statistics indicated.

And if the estimates are right, that doesn't alter the fact that the economy has produced quite real anxiety -- that if things are so good how come so many people feel so swamped with bills they can't afford to pay?

The very technological leadership and improvement that Mr. Nakamura hails as so important in boosting real productivity and holding down inflation have hurt some industries, and their workers, while creating whole new ones. For many Americans, it has been a period of economic pain, as more have gone to work for longer hours just to maintain their living standards. But statistics on the broad economy are supposed to capture averages, and it may be that those in pain were not typical.

It's likely that the Boskin panel will come up with numbers indicating that inflation was not as severely overstated -- and economic growth not as robust -- as Mr. Nakamura says it was. But it seems clear that the economic stagnation portrayed in years of statistics has reflected flaws in the numbers, at least to some extent, rather than in the economy.

Why do inflation numbers matter so much? In large part, it is because the Government, like anyone else, can only directly measure nominal numbers. You know how much money you made last year, and how much you are making this year. But to know what an increase really means, you have to adjust for inflation.

If the rate of inflation is overstated, your real gain will be understated.

A percentage point or two doesn't sound like much, but over time the effect can be dramatic. It is all the more dramatic if, as Mr. Nakamura contends but some doubt, the overstatements have been getting worse.

Consider the reported decline in real wages. It has led to a debate with some pointing to free trade as a destroyer of high-paid American jobs and others pointing to excessive Government regulation. But Mr. Nakamura contends that real hourly wages rose by an average of 1.45 percent a year during the 21-year period. That is not as rapid a gain as the 1.6 percent of the previous decade, but there would have been less hand-wringing had the Government reported increases.

The reasons for the inflation overstatements vary, economists say. One is that the service economy has become a bigger part of the whole, and gains in productivity are a lot harder to measure there. And Mr. Nakamura says that in many industries, the Government has had a devil of a time figuring out increases in quality. The rise in car prices, for example, does not take into account all the improvements in vehicle life and gas mileage, he says.

Then there is the trend economists call "price discrimination." Cigarettes provide an example: prices have risen, but not as rapidly as the Government figures indicate. Some years ago, tobacco companies introduced discount brands, at about two-thirds the price of regular brands. The Government classified these as a new product, Mr. Nakamura says, which had no immediate impact on the inflation rate.

Then, over time, as those brands drew loyal customers, the price advantage was whittled away, to about 10 percent.

In the Consumer Price Index, the result was that those brands rose faster than premium brands, and so the overall inflation rate exceeded the increase in the premium brands' price.

Had the companies never introduced discount brands, and then raised premium brands by the amounts they actually did, the reported inflation rate would have been lower. Yet smokers are paying less than they would have under that scenario, Mr. Nakamura adds, so the calculation makes no sense.

Mr. Nakamura's figures do help explain one remarkable trend: the bull market in stocks. The Standard & Poor's index of 600 stocks is now more than eight times as high as it was at the end of 1975. It is hard to believe that such a sustained increase could occur if the economic news over that stretch was really as glum as the official figures indicate.

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