Monday, September 23, 2019

Why living standards continue to rise

For the past 25 years, inflation has averaged 1.8% per year, but that disguises the fact that prices of durable goods have been falling by a significant amount. Is that a problem? Hardly, since a big decline in the prices of durable goods has dramatically increased the purchasing power of the average worker.

Chart #1

Chart #1 it shows the three major components of the Personal Consumption Deflator index (a broader and better measure of inflation than the CPI): services (which are largely driven by wages and salaries), durable goods (e.g., equipment, computers, cars, TVs), and nondurable goods (e.g., food, gasoline, clothing). Total inflation over the time period represented here was 55% (an annualized rise of 1.8% per year), but looking deeper we see that wages rose 85% while durable goods prices fell 38%. At the risk of over-generalizing, this means that wages over the past quarter century have gone up 200% relative to the prices of durable goods (1.85/.62). That's equivalent to saying that one hour of the average person's work today buys three times more durable goods than it did 25 years ago. It's no wonder that these days nearly everyone has a smartphone and nearly every house has at least one big-screen flat TV. 

Such a divergence between wages and prices has never happened before, as I first noted in a post over 9 years ago. Prior to 1995, there was never a time in modern history when any major category of prices experienced a sustained decline. Why did this change beginning in 1995? For one, that's about the time when personal computers began to proliferate. But it's also the case that 1995 marked the beginning of China's emergence as a major exporter of durable goods. China's economy has become a powerhouse of productivity as hundreds of millions of Chinese workers have benefited from the introduction of modern equipment and capital. This in turn has raised the productivity of all workers globally, and it has resulted in a significant increase in global economic prosperity. What's good for China has been good for nearly everyone in the world.

Chart #2

Computer deflation is coming to an end, however, as Chart #2 suggests. Note that this series began in 1998; prior to that the BLS didn't consider it important to create a separate price series for personal computers and peripherals. But by then they were already plunging in price. The cost of personal computers fell 36% in 1998, 22% in 2002, 12% in 2006, and 6% in 2010, but prices are down only 1.3% in the year ending last August. Computers and related equipment are not going to become ever-cheaper for much longer. Plus, the Chinese economy is slowing down and tariff wars are like sand in the wheels of commerce. It's been a great ride, but it's slowly coming to an end.

Chart #3

On the bright side, prices of nondurable goods haven't increased at all for the past 8 years (see Chart #1). And as Chart #3 shows, commodity prices in general haven't gone up for more than 10 years. Wages, in short, continue to go up relative to things. That's another way of saying that living standards continue to rise. 

13 comments:

Christian S. Herzeca, Esq. said...

left out of analysis housing and higher education costs, two significant items

Roy said...

"a big decline in the prices of durable goods has dramatically increased the purchasing power of the average worker."

This conclusion can not be seen in the data provided.

The chart shows nothing about the net purchasing power.

You might as well add another line to the chart that shows how the price of pencils dropped by, let's say, 98% over the period and therefore this, and the rise in wages that purchasing power have increased tremendously.

Maybe it did, but this data does not show it and the conclusion is confirmation bias at best.

steve said...

Technology drops the price of almost everything over time relative to value. Just look at automobiles; what you can buy for $25K today is far higher quality than what you could buy for say $15K twenty years ago. Safer, far better gas mileage, more comfortable an so on.

There is absolutely no argument that standards of living today far outstrip what they were twenty years ago and dwarf those further back. People are jaded or simply too young to have any feel for how much better life is today for people of all incomes than years ago.

steve said...

Sort of off subject but certainly tangential;

https://www.realclearmarkets.com/articles/2019/09/24/lets_be_serious_president_trump_is_certainly_no_free_trader_103924.html

Roy said...

Another issue with the first chart is the absolutely laughable fact that the for top half the length represents 100 to 200 and at the bottom half, the exact same length, is 100 to 50. The sole purpose of this is to give the illusion that somehow both parts balance themselves out.

Scott Grannis said...

Roy: the y-axis is plotted on a semi-log basis. Thus the upper and lower halves are of equal magnitude. Moving from 100 down to 50 represents a reduction of 50%; similarly, moving from 200 to 100 is a reduction of 50%. Moving from 50 to 100 is a doubling, as is moving from 100 to 200. Moreover, the decline in durable goods prices does not offset the rise in other prices, since overall inflation for the period in question is 55%. Obviously durable goods represent only a small part of the overall index. My main point is that wages have increased dramatically relative to durable goods prices, and that is something that has never before happened.

Roy said...

Scott,

1. IMO, it does not represent the data visually in a correct manner.

2. "wages have increased dramatically relative to durable goods prices". Fair enough. That's quite a difference from the previous argument regarding purchasing power. Purchasing power is also the ability to buy services.

Ron Gruner said...

I'm missing Scott's argument relative to cost of living increases the last 25 years. The Personal Consumption Deflator may have risen only 1.8 percent annually, but Scott's Chart 1 suggests the real rate is 2.2 percent.

In 2018 durable goods were 10.5 percent of GDP consumption, non-durables 20.6 percent and services 68.8 percent. Multiplying these weights by the increases in Scott's Chart 1 (+85, +48 and -38) yields an average increase of 64.4 percent from 1995 through 2018, or about 2.2 percent annually -- exactly what the CPI-U calls for.

Durable goods may be declining steeply but they're a small part of overall consumption.

randy said...

It seems to me the real bug-a-boo is health care costs. Insurance premiums and the real risk of financially devastating medical expenses. Even college costs don't bother me so much. A dedicated student doesn't have to signup for the full boat $200k college experience. One does have the option to go to a cheaper state school and work. BTW, that's what I did - parents contributed but still I worked 30 hours a week. Wasn't the end of the world. Anyway.... health care costs are the problem people cannot escape.

randy said...

Timely.

Cost of Employer-Provided Health Coverage Passes $20,000 a Year

https://www.wsj.com/articles/cost-of-employer-provided-health-coverage-passes-20-000-a-year-11569429000?mod=hp_lead_pos2

I my post above I mentioned the transparent costs of consumers for their share of premiums and the potentially devastating costs not covered. What I failed to add is that when people argue about stagnant wages for middle class, they don't factor in that employer contributions to health insurance premiums has skyrocketed. If you add that in and view total compensation and benefits, wages aren't so stagnant.

The Cliff Claven of Finance said...

Living standards are rising for women, but not for men.

Median earnings adjusted for inflation here:

https://el2017.blogspot.com/2019/09/median-earning-for-men-and-women.html

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