Mr. Feldstein, who was chairman of the Council of Economic Advisers under President Reagan, and is now a professor at Harvard and a member of the Wall Street Journal’s board of contributors, explained in WSJ on Sep 8, 2017 how official economic statistics fail to account for quality improvements and new products. The inherent tendency of the private enterprise economy is to serve customers in better and better ways, demonstrated in improved outputs such as new services and products at lower prices. The government measures only the cost of inputs. Not only should we not believe anything the government tells us, we should also be aware that they often wish to paint a bleak picture, when it serves their needs. We as individuals can actually observe and experience the individual economy, and our own experience is much more accurate.
Government statistics paint an excessively grim picture of what is happening to real wages and the growth of real national income. Although most households’ take-home cash has been rising very slowly for decades, their standard of living is increasing more rapidly because those wages can now buy new and better products at little or no extra cost. The government’s measure of real incomes gives too little weight to this increase in what take-home pay can buy.
The common assertion that middle-class households have seen no increase in real incomes for 30 years is simply not true. And contrary to a common fear, most members of the younger generation will have higher real incomes as adults than their parents had at the same age.
The government’s growth estimates are excessively pessimistic for two reasons. First, government statisticians grossly understate the value of improvements in the quality of existing goods and services. More important, the government doesn’t even try to measure the full contribution of new goods and services.Consider how the government handles manufactured products when their quality improves. Statisticians track a large number of products. For each, they ask the manufacturer two questions: Has the product changed since last year? If so, how much more does it cost to make this year’s model than it would now cost to make last year’s model?
If there is no increase in the cost of production, the government concludes that there has been no increase in quality. And if the manufacturer reports an increase in the cost of production, the government assumes that the value of the product to consumers has increased in the same proportion.
That’s a very narrow—and incorrect—way to measure quality change. In reality companies improve products in ways that don’t cost more to produce and may even cost less. That’s been true over the years for familiar products like television sets and audio speakers. The government therefore doesn’t really measure the value to consumers of the improved product, only the cost of the increased inputs. The same approach, based on measuring the cost of inputs rather than the value of output, is also used for services.
The official estimates of quality change are therefore mislabeled and misinterpreted. When it comes to quality change, what is called the growth of real output is really the growth of real inputs. The result is a major underestimation of the increase in real output and in the growth of real incomes that occurs through quality improvements.
The other source of underestimation of growth is the failure to capture the benefit of new goods and services. Here’s how the current procedure works: When a new product is developed and sold to the public, its market value enters into nominal gross domestic product. But there is no attempt to take into account the full value to consumers created by the new product per se.
Think about statins, the remarkable class of drugs that lower cholesterol and reduce deaths from heart attacks. By 2003 statins were the best-selling pharmaceutical product in history. The total dollar amount of statin sales was counted in GDP, but the government’s measure of real income never included anything for improvements in health that resulted from statins—such as a one-third decrease in the death rate from heart disease among those over 65 between 2000 and 2007.
Or consider consumer electronics. New York University economist William Easterly recently tweeted an image of a 1991 RadioShack newspaper ad and noted that all the functions of the devices on sale—clock radio, calculator, cellphone, tape-recorder, compact-disk player, camcorder, desktop computer—are “now available on a $200 smartphone.” The benefits to consumers from these advances don’t show up in GDP.
It is impossible to know how much the official statistics understate the true growth of real incomes. My own judgment is that the true annual growth rate could exceed the official figure by two percentage points or more, implying that the true annual rate of real per capita income growth during the past two decades has been much more than double the official 1.3%.
Even though real incomes are rising faster than is widely believed, we can and should do even better. Changing our tax rules, reforming regulation and improving education can spur faster growth and a more rapid rise in the standard of living. But even as we pursue these policies we should not lose sight of the economy’s superior performance.
Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of the Wall Street Journal’s board of contributors. Republished from WSJ Sep 9, 2017.