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A REPORT by economists on the shortcomings of statistics would not normally send politicians' pulses racing. But when it promises to cut billions of dollars from the budget deficit, statistical detail becomes big politics. The findings of a commission set up by the Senate Finance Committee to study the calculation of America's consumer price index (CPI), released this week, do just that. A group of five eminent academics led by Michael Boskin, a professor at Stanford University, has concluded that the CPI probably exaggerates true increases in the cost of living by something like 1.1% a year, although the exact figure could be anywhere from 0.8% to 1.6%.
A correction of this magnitude would have enormous implications for the budget. Around a third of federal spending, mostly in retirement programmes, is directly indexed to changes in consumer prices. Through the indexing of individual income-tax brackets, a change in the CPI affects federal revenues, too. The Boskin commission reckons that correcting the 1.1% overstatement would save the government around $1 trillion over the next 12 years. By 2002, the target year for balancing the budget, around $200 billion could have been saved. Small wonder, then, that many politicians hope to prune public spending by simply improving statistics.
Among economists, the notion that inflation may be mismeasured is nothing new. Zvi Griliches and Dale Jorgenson of Harvard University and Robert Gordon of Northwestern University--all members of the commission--have spent years estimating the size and cause of the bias. Nor does the impact of mismeasurement affect the budget alone. Revising the CPI would substantially raise official measures of America's growth rate and hence of Americans' economic prosperity.
What are the problems? The basic difficulty is that the CPI is not really a measure of changes in the whole cost of living, but rather a gauge of price rises in a fixed basket of goods. This means that the CPI does not keep up with changes in the products consumers buy, or in how and where they buy them. According to the Boskin report, about a third of the mismeasurement (0.4%) is due to the fact that the official price index fails to capture important changes in consumer spending patterns. If the price of hardback books increases, for instance, people may buy more paperbacks. Or if bananas become more expensive, they may switch to apples. These switches do not make consumers feel worse off; but the CPI records a price increase.
A further 0.1% bias is due to the fact that Americans now do more shopping at discount outlets. But the biggest effect (0.6%) comes because the CPI underestimates the benefits shoppers gain from improvements in product quality and from the plethora of new products. Cellular telephones, for instance, are not yet included in the CPI, although 40m Americans now own one.
The Boskin report makes a host of suggestions as to how some of these inaccuracies could be corrected. The main message is that the Bureau of Labour Statistics (BLS), the federal agency that works out the CPI, should explicitly try to build a cost-of-living measure. No one is exactly sure how big an improvement such a change would make, although the commission's boffins reckon 0.4% a year could be achieved fairly quickly. That would bring budget savings of around $80 billion by 2002.
But the BLS, a fiercely independent if rather stodgy outfit, may not want to rush into dramatic changes. It is already trying hard to improve the numbers: a correction earlier this year shaved about 0.2% from the CPI. When the system's weights are next updated in January 1988, a further 0.1-0.2% may be won, although the updated index will still reflect only the buying patterns of 1993. And the BLS is introducing a new index, somewhat similar to the one the Boskin commission proposes, on an experimental basis early next year, although the agency's economists are quick to point out that the new index has drawbacks too.
Assume, for a moment, that the BLS is prodded into introducing such changes. Cost-of-living rises will still be overstated. And, although the report has some ideas about how to account better for quality improvements, they are likely to pare at most 0.2% from the CPI over the medium term. The problem is that the economy is changing too quickly for the statisticians to keep up. However much the statistics are improved, the CPI will still overstate true increases in the cost of living.
This leads to the bigger political point. If the CPI, however revised, is not an accurate guide to changes in the cost of living, should it be the index to which retirement benefits are linked? The Boskin report makes the point explicitly: Congress and the president, it suggests, must decide whether they wish to continue widespread, substantial over-indexing of benefits. In other words, if politicians are looking for budget savings, this report gives them intellectual backing for proposing that retirement benefits should be indexed to something less than the CPI. They could pass a law, for instance, that set future benefit indexation at a rate lower than the CPI, perhaps as part of a budget package.
Legislating for such a change in benefits, however, is politically perilous. Neither the administration nor Republicans in Congress wants to be seen as initiating a proposal that directly hurts America's swelling ranks of retired folk. And, given the uncertainties even now among the experts, the decision on how much to trim from the CPI will remain arbitrary.
Although administration officials are now more willing to review the issue, they are unlikely to make a big proposal. Nor are the Republicans in Congress. William Roth, chairman of the Senate Finance Committee, promised hearings on the CPI early next year. But he was quick to add that "reform will not be successful without President Clinton's leadership."
Nonetheless, the idea already has momentum. The "Blue Dogs", a group of conservative Democrats, proposed reducing benefit indexation by 0.5% as part of last year's budget negotiations, as did a bipartisan group of centrist senators. They are likely to press the issue again this year. As budget negotiations develop, it is just possible that some such measure could become part of the final package.
That would be excellent news. Reducing the rate at which pensions are indexed would not only alleviate short-term budget squeezes, but would be a small step towards that Great Untouchable of American politics--Social Security reform. By boosting the politicians' boldness, Mr Boskin's report could prove enormously useful. But it has not, and will not, save them from the need to make some tough political choices.
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