You Are What You Spend (updated x3)

In an article in the New York Times, Michael Cox and Richard Alm tell us You Are What You Spend. Why does this matter? We are always told about the growing gap between "rich" and "poor" but this gap depends on what you measure. As Cox and Alm point out,

It’s true that the share of national income going to the richest 20 percent of households rose from 43.6 percent in 1975 to 49.6 percent in 2006, the most recent year for which the Bureau of Labor Statistics has complete data. Meanwhile, families in the lowest fifth saw their piece of the pie fall from 4.3 percent to 3.3 percent.

But as they also point out,

Income statistics, however, don’t tell the whole story of Americans’ living standards. Looking at a far more direct measure of American families’ economic status — household consumption — indicates that the gap between rich and poor is far less than most assume, and that the abstract, income-based way in which we measure the so-called poverty rate no longer applies to our society.

If you take the ratio of the incomes of the top and bottom fifths of US income eaners, you see a ratio of 15 to 1. If you look at consumption however, the gap declines to around 4 to 1.

A similar narrowing takes place throughout all levels of income distribution. The middle 20 percent of families had incomes more than four times the bottom fifth. Yet their edge in consumption fell to about 2 to 1.

So what is measured really does matter. Why then should we look at consumption? To understand why it helps to consider how our lives have changed over time.

Nearly all American families now have refrigerators, stoves, color TVs, telephones and radios. Air-conditioners, cars, VCRs or DVD players, microwave ovens, washing machines, clothes dryers and cellphones have reached more than 80 percent of households.

Cox and Alm note that

The conveniences we take for granted today usually began as niche products only a few wealthy families could afford. In time, ownership spread through the levels of income distribution as rising wages and falling prices made them affordable in the currency that matters most — the amount of time one had to put in at work to gain the necessary purchasing power.

Look, for example, at the number of hours of work needed to purchase a VCR. At the average US wage to buy a VCR in 1972 took 365 hours of work, today it is just two hours.

A cellphone dropped from 456 hours in 1984 to four hours. A personal computer, jazzed up with thousands of times the computing power of the 1984 I.B.M., declined from 435 hours to 25 hours. Even cars are taking a smaller toll on our bank accounts: in the past decade, the work-time price of a mid-size Ford sedan declined by 6 percent.

Cox and Alm note that there are a number of reason for this increase in the well being of Americans,

... but perhaps the biggest is increased international trade. Imports lower prices directly. Cheaper inputs cut domestic companies’ costs. International competition forces producers everywhere to become more efficient and hold down prices. Nations do what they do best and trade for the rest.

This means that the costs of goods have dropped drastically, lower income families can buy more for their dollar, their well being has increased.

While foreign competition may have eroded some American workers’ incomes, looking at consumption broadens our perspective. Simply put, the poor are less poor. Globalization extends and deepens a capitalist system that has for generations been lifting American living standards — for high-income households, of course, but for low-income ones as well.

Bottom line. It's the command over goods and services that ultimately determines living standards and looking at consumption gives us a handle on peoples command over goods and services.

Update: Art Carden comments here, Don Boudreaux comments here, Greg Mankiw is here, Paul Krugman is here.

Update 2: Commets from the Free exchange blog are here.

Update 3: Tyler Cowen comments here. Mark Thoma is here.