Technology and Economic Growth in the Information Age

Policy Backgrounders | Economy

No. 147
Thursday, March 12, 1998
by W. Michael Cox & Richard Alm

Why Economic Progress is Understated

Table III - Estimates of Bias in the U.S. Consumer Price Index

"Progress is showing up everywhere but in the statistics."

Understanding how free enterprise stimulates progress gives us good reason for optimism about America's future. The system is working to perpetuate and even accelerate advances in living standards. The irony is that the numbers don't agree. Progress is showing up everywhere but in the statistics.

One notable exception is Wall Street, where a bull market has pushed the Dow Jones Industrial Average up over 300 percent since the start of the decade. But other economic statistics, particularly those measuring GDP growth, prices and productivity, paint an increasingly distorted portrait of our progress.

Intangibles Are Difficult To Measure.  The problem, in part, lies in the tools we use. The National Income and Product Accounts, developed in the 1940s, arrive at GDP by toting up the value of goods and services the economy produces. These accounts do a reasonably good job of measuring traditional output - tons of steel, bushels of wheat, cases of toothpaste, tables, chairs, haircuts. Add it all up, and you've got GDP.

Much of what we get, however, isn't actually what we buy. We don't really want cars - we want transportation. We don't really want telephones - we want to communicate. We don't really want light bulbs - we want light.

"Most economists agree that the Consumer Price Index overstates inflation and thus understates the growth rate."

The distinction isn't facetious. The ordinary light bulb, for example, is a readily countable object that can be easily included in GDP: all we need to know is how many are sold and at what price. The light it produces, however, isn't so tangible. Yale University's William Nordhaus looked at the price of light and concluded it has fallen from 40 cents per 1,000 lumen hours in 1800 to a tenth of a cent today, a decline of 99 percent.14 Meanwhile, our measures of inflation show a 180 percent increase in the price of light bulbs and fixtures. By progressing from less to more expensive lighting equipment - from candles to lamps to light bulbs - without accounting for the service each provides (lumens), the price of light is recorded as rising, even though it in fact has sharply declined. The result is an overstatement of inflation and an understatement of true growth.

Inflation Is Overstated.  To arrive at "real" growth, a common proxy for how well the economy is doing, statisticians adjust the GDP numbers to account for rising prices. If the numbers overstate inflation, growth will come out equally low, suggesting that the economy is weaker than it really is. For example, most economists agree the U.S. Consumer Price Index overstates inflation and thus understates the growth rate [see Table III]. The CPI is determined by taking a sample of prices for a weighted basket of goods and extrapolating from that the general movement of prices. The CPI and other price indices affect our estimates of GDP and thus the measured rate of growth.

Economists have recommended changes that would lower our estimates of CPI inflation by an average of 1.1 percent, thus crediting more real growth to the economy.15 That's a huge revision - indeed, a doubling of our estimated growth rate - considering the fact that GDP per capita grew at an average annual rate of just over 1 percent during the 1973-96 period. It means that per capita GDP could be one-third higher than we had thought possible by 2020 and double what we had expected by 2055. 

Statisticians are also likely to reduce the gap between revisions of the basket of goods in inflation index from 11 years to four or five. But even with the changes, they will miss a lot of what's going on.

New Products Are Overlooked.  The measurement problems are particularly acute when technology is progressing rapidly. Take, for example, new goods.

  • Today's VCRs provide better service than those that sold for $1,125 in 1981. But the VCR didn't make it into the consumer price index until 1987, after its price had fallen to under $300.
  • The pocket calculator, invented in 1971, harnesses more computing power than a $750,000 room-sized mainframe of the 1950s but didn't show up in the consumer price statistics until 1978, after its price had fallen from more than $600 to well below $100.
  • The personal computer was ignored by the statistics until 1987, when its cost to the average American had fallen from a lifetime of work to little more than two weeks' pay.

"Technology advances so fast, with an effect on prices, that it befuddles well-intended number crunchers."

When cellular telephones came on the market in 1984, consumers paid as much as $3,995 for the convenience of on-the-go communication. Now the phone often comes free with cellular service, and the average local cellular service bill went from nearly $100 a month in 1987 to under $50 by 1995. But cell phones won't be added to the price index until 1998, when at least 30 percent of Americans will own one. The result, in each of these cases, is an overestimation of inflation and an understatement of real growth and progress.

Our statistics would be more accurate if these gains could be instantaneously tallied in the numbers that track the economy. It simply cannot be done. With rapid advances in technology, new and better products are coming at a dizzying rate. We buy cars that last longer and require less maintenance, manufacture stereos that reproduce truer sound, grow tomatoes that don't turn to mush when frozen, make clothes that fit better and require less care, improve mammograms to detect tumors at an early stage and pluck free information from cyberspace. In each case, we're getting more of what we want at the same or lower prices, befuddling the well-intended number crunchers.

Variety And Customization Aren't Measured.  More measurement difficulties stem from the GDP's failure to value variety and customization. American consumers can enjoy the cuisine of more than 40 countries today, compared with just a handful in the 1970s. We can choose from among twice as many automobile producers, which offer more makes and options than ever. Micro-breweries have brought us an extended array of beers, with some outlets carrying nearly 400 kinds. We have more variety in soft drinks, tennis shoes, magazines, radio stations, martial arts classes, coffee, amusement parks, cereal, sport utility vehicles, toothbrushes and on and on. Variety and customization enrich our lives because they allow us to select characteristics we value highly, but to the statisticians every car is a white Chevrolet.

Improved Prevention Isn't Measured.  Then there are preventive goods and services. Antilock brakes and air bags help prevent collisions and injuries. Safety caps on pill bottles keep children from ingesting poison. Fat-absorbing proteins allow overweight people to avoid expensive diet programs. Statisticians can't measure goods unseen: the accident that doesn't happen. A vaccine might someday eliminate tooth decay. Instead of fixing cavities, dentists might build houses or design Web sites, with no effect on overall GDP. But, meanwhile, we would have the benefit of the holes that aren't in people's teeth. What aggregate statistic could show this gain?

"Statisticians can't measure good unseen: the accident that doesn't happen."

Statisticians keep track of cost - that's all they have to count. The economy produces worth - that's what people want. Cost and value aren't always related, and they diverge even more as technology enables the economy to deliver more worth at less cost. For instance, if medical science invented a 1-cent pill that cured all our ills, it would be worth a lot but cost virtually nothing. Sound ludicrous? Consider the Internet. In trying to find a way to charge customers for accessing Web sites, companies have decided our smallest unit of money - 1 cent - is too much. A 1/10-cent unit is needed. On GDP's radar screen, the Internet is barely registering a blip.16 It is ironic that just when the economy is most successful - when it produces the most worth for the least cost - the gap between true and measured GDP growth is the greatest. The economy gets the least credit when it's accomplishing the most.

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