Cooking GDP, Unemployment, and Inflation numbers

May 2008 Harpers’s Magazine carries an article, sadly not online, titled “Why the Economy is Worse Than You Know” by Kevin Phillips.

Unemployment statistics were redefined starting in the early 1960s by the Kennedy Administration. First they took out the “discouraged”, people who wanted a job, but had stopped looking. Under the Reagan Administration, the workforce was expanded by adding in members of the U.S. military, who were by definition “employed”, thus shrinking the percentage of “unemployed”. The Clinton Administration reduced the number of households sampled from 60,000 to 50,000 and “a disproportionate number of the dropped households were in the inner cities.” Phillips doesn’t talk about prisoners, but we have greatly increased our prison population, most of those incarcerated are working-age men, and none are counted in the workforce. Phillips claims that “Based on the criteria in place a quarter century ago, today’s U.S. unemployment rate is somewhere between 9 percent and 12 percent.” [Poking around at http://www.bls.gov/cps/ reveals that, in 2007, 146 million of us were working, 7 million were unemployment, and 4.7 million were classified as not in the workforce but “wanted a job”; an additional 2.3 million Americans were in prison, presumably due to their energetic work habits in illegal trades. The “U-6” series, published by the BLS but almost never reported by newspapers, shows an unemployment rate right now of 9.1 percent.]

Calculations behind the inflation numbers cited in newspapers are beyond the grasp of any layperson. One of the most obvious distortions in the inflation index is that it is adjusted for “hedonic value”, on the theory that new widgets, made with Chinese slave labor, are better than old widgets, made by the lunchpail Americans for whom Barack Obama feels pity. The $500 Whirlpool dishwasher from the 1996 is replaced by a $1200 Bosch in 2007. Inflation? Not for the civil servants who construct the index; they assume that the Bosch is superior somehow (and it would be for them, having so far generated at least 8 days when they could have taken off work to wait for the repairman). A non-obvious distortion is created by ignoring what homeowners actually pay for mortgage, maintenance, real estate taxes, etc. Starting in the 1980s, the BLS began to use “owner equivalent rents”, i.e., asking homeowners “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?” (source). Under the Nixon Administration, food and energy were going up in price, so these items were removed from the published “core inflation” number, which happens also to be the basis of cost-of-living adjustments that the government must pay for pensions and Social Security. Phillips claims that the true rate of inflation is between 7 and 10 percent, not the 2-3 percent published by the government. [Support for this theory might be seen in the reluctance of foreigners now to trade their euro for dollars except at historically extreme exchange rates.]

Aside from reducing government pension costs, how do politicians and their cronies benefit from a lower published inflation number? Phillips claims that a low inflation rate makes investors comfortable with accepting a lower interest rate, which makes it much cheaper for the government to borrow money and also helps those who benefit from real estate bubbles. Phillips cites a 2007 article by Robert Hardaway saying that the subprime circus (which made a lot of people very rich before it made the Greater Fools rather poor) “can be directly traced back to the [1983] BLS decision to exclude the price of housing from the CPI”.

What about GDP, the source of all wealth? Phillips says that “federal economists used the Gross National Product until 1991, when rising U.S. international debt made the narrower GDP assessment more palatable.” He notes that a full 15 percent of GDP is “imputed”. This includes the fees that banks don’t charge you if you have a “free” checking account and rent that you didn’t have to pay because you owned a house. The CIA factbook says that our population is growing at 0.9% (mostly immigration and the children of recent immigrants) and GDP is growing at 2.2%, but if it doesn’t feel like the average person is getting richer that might be partially because much of the GDP growth is fake (in addition to the hedge fund managers and CEOs taking most of the new money (and much of the old) for themselves). Phillips does not estimate our true economic growth, but claims that much has been illusory, without even resorting to pointing out that much GDP comes from things that add no net value when you compare American lives in 1998 to American lives in 2008, e.g., rebuilding from Katrina and Florida hurricanes, replacing things that are broken or stolen, hiring hundreds of thousands of security guards to deal with risks of terrorism perceived only after September 11, making Iraq safe for Iraqis, reinforcing cockpit doors on airliners, buying guns and running training courses for airline pilots, paying mechanics to patch holes in airliners created when some of those guns accidentally discharge, etc.

The article ends with a whimper. Phillips doesn’t make a convincing argument for how accurate data would help us. By pointing out the collapsed and further collapsing value of the dollar, he implies that foreigners have already figured out the real numbers. So if it makes us feel good to think that very few Americans are unemployed, why shouldn’t we think it? If the thought of 2 percent inflation takes some of the sting out of paying $1000 for dinner and a show in New York City, why shouldn’t we take comfort in our low core inflation rate? If we record a massive improvement in GDP every time New Orleans gets submerged or we equip more troops to go to Iraq, aren’t we entitled to some good news?

[Critics of the Internet Age often complain that Web articles aren’t sufficiently authoritative, yet this Harper’s article is worse. The author is not identified except as the author of a new book entitled Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. There is no way to gauge his credibility by reading other things that he has written or even a biography. The article itself contains no references to fundamental data and only a handful to some newspaper articles (citations incomplete). The average Weblog posting would have hyperlinks to at least some sources.]