FRBSF Economic Letter

97-30; October 17, 1997

Assessing the Benefits of Economic Growth

On September 29, 1997, the U.S. Census Bureau released its annual report on family income and poverty in the United States. The report showed that, by official calculations, economic growth is finally benefitting a majority of Americans. While this news prompted much fanfare, there is reason to suspect that most Americans have been benefitting for much longer than these official numbers would suggest. This Economic Letter reports on recent research by Burkhauser, Crews, and Daly (1997) (hereafter BCD), which uses the decade of the 1980s to highlight the sensitivity of family income analyses to measurement issues. BCD find that studies of family income in the United States frequently exaggerate the losses of middle and low income persons by mixing cyclical with secular differences, using a narrow definition of income sharing units, and applying an upwardly biased cost-of-living index. Employing alternative measures BCD find that, even in today's highly competitive global economy, growth improves the economic well-being of most Americans.

Counting economic winners and losers

The simplest way to examine how the benefits of economic growth during the 1980s were distributed throughout the population is to compare the distributions of real income by percentile for selected years. Figure 1 shows two related methods of making this comparison, using years commonly discussed in the family income literature, 1979 and 1992. First, the two black lines show that the 1979 and 1992 distributions cross at about the 56th percentile of income. This means that one must go to the 56th percentile before real income in 1992 exceeds the real income for an equivalent person in 1979. According to this view, the lower 56 percent, or more than one-half of the population, were economic losers in 1992.

The second way of making the comparison is to take the difference between the first two lines--this difference is shown by the dotted line. The benefit of this measure is that it shows the size of the gains and losses experienced by those on both sides of the cross-over point. Although these diagrams typically report the percentage change in real income on the vertical axis, the absolute difference in real income is reported here. This "cross-over point" methodology provides a simple knife-edge categorization of winners and losers from which the effects of changes in measurement suggested by BCD are easily seen.

Characterizing the 1980s expansion

If real growth during the 1980s occurred for all portions of the income distribution, the cross-over point in Figure 1 would not be at the 56th percentile, but at zero. Using this fact, numerous authors have argued that the benefits of economic growth during the 1980s did not trickle down to the poor and middle class (for an example, see Danziger and Gottschalk 1995).

However, BCD argue that this rather bleak picture of economic expansion during the 1980s is extremely sensitive to the years compared, the income sharing unit chosen, and the inflation adjustment employed. Their analysis shows that issues of definition and measurement, although frequently relegated to an appendix or left undiscussed entirely, are important components of accurately describing income changes over time. Parallel research by Jencks and Mayer (1996), on changes in child poverty rates over the past three decades, confirms this view.

To demonstrate these sensitivities, BCD use data from the March Current Population Survey (CPS) and the cross-over point methodology employed in Figure 1. The March CPS is a nationally representative sample of more than 50,000 households and is used frequently in studies of income distribution. Income in this analysis refers to the combined pre-tax, post-transfer real resources of all members of an income sharing unit. To account for the fact that $20,000 a year provides a higher standard of living for a single person than it does for a family or household with multiple members, all incomes, including those in Figure 1, are adjusted by the size of the income sharing unit. See Daly (1997) for a more detailed description of this adjustment.

Measurement matters

Figure 2 displays the results of the analysis using different years, different income-sharing units, and an alternative inflation index.

Years compared. Although most economists take for granted that any examination of changes in the income distribution over time will be sensitive to the years being considered, BCD find that research in this area frequently has failed to distinguish between changes associated with movements in the business cycle and changes that occur between two similar points in the business cycle. While there are no formal rules for choosing comparison years, a brief review of the economic fluctuations over the past two decades illustrates the potential problem with selecting analysis years randomly.

The early 1980s were marked by the worst recession since the Great Depression. Real median family income fell from a 1979 business cycle peak of $39,227 to a 1982 business cycle trough of $36,326. In addition, unemployment rose from 5.8 percent in 1979 to 9.7 percent in 1982. However, seven years of uninterrupted economic growth followed, so that by the next peak in the business cycle in 1989, real median family income had increased to $40,890, and unemployment had fallen to 5.3 percent. Although the business cycle of the 1990s has not fully played out, in terms of unemployment it appears 1992 is the trough year with unemployment rising to 7.4 percent and real median income falling to $38,635. In 1993, real median income fell to $37,905, but unemployment decreased to 6.8 percent.

The effect of the business cycle on the income distribution and on the assessment of who won and who lost during the 1980s can be seen by comparing Figure 1 and the curve labeled "Families 79-89" in Figure 2. One reason that the cross-over point in Figure 1 is so high in the income distribution is that 1979 and 1992 are peak and trough years, respectively, of different business cycles. In contrast, the "Families 79-89" curve in Figure 2 shows the cross-over point in the income distribution when business cycle peak years 1979 and 1989 are compared. Using these years, the cross-over point becomes the 36th percentile. Hence, for almost two-thirds of the population, family size-adjusted real income increased between the two 1980s business cycle peaks. This is a more favorable economic outcome than is implied by the peak-trough comparisons of Figure 1.

Resource sharing. Another factor affecting characterizations of economic progress is the treatment of resource sharing among individuals living in a common residence. In the CPS, one can use the family or the household as the unit of income sharing. This choice determines how the income of unrelated individuals is combined. Under the family definition, only those related by blood or marriage are assumed to share resources. Anyone else who lives in the dwelling is treated as a single-person "family." Applying this definition, two people cohabitating and sharing resources, but not officially married, would be counted as two separate single-person families. Since there are economies of scale from living together--two can live together for less than the sum of each one living separately--treating cohabitators as separate, single-person families may overstate the number of people in the lower tail of the income distribution.

The curve labeled "Households 79-89" in Figure 2 illustrates the importance of the choice of income sharing units. Using the household sharing unit, BCD find that the cross-over point moves from the 36th to the 26th percentile. Under a household sharing unit definition, three-quarters of all persons gained from economic growth between the two peak years of the 1980s.

Cost-of-living adjustments. Finally, it is also important to recognize the effect that the cost-of-living adjustment has on the analysis. Increasingly it is argued that the CPI cost-of-living index overstates inflation. Boskin (1995) offers the most systematic criticism of the CPI and proposes alternative indices for the 1980s. Following Boskin, BCD apply an index based on yearly measured price changes that are on average 1 percentage point lower than those reflected in the current CPI for 1979 and 1989. The curve labeled "Boskin 79-89" in Figure 2 shows that under a Boskin-CPI index the cross-over point goes to zero. All individuals gained from economic growth between the two peak years of the 1980s.

The distribution of economic growth

Unlike previous periods of economic growth, the decade of the 1980s and to some extent the current expansion of the 1990s frequently are characterized as periods when the wealthiest have gained while those in the middle and at the bottom have stagnated or lost. However, BCD have shown that this view of recent periods is sensitive to the years compared, the income sharing unit chosen, and the inflation index used. Their analysis shows that previous studies using peak-to-trough years of comparison, a narrow definition of the income sharing unit, and an upwardly biased cost-of-living index have exaggerated the number of people who lost ground during the 1980s. When other reasonable measures are used, the 1980s is more similar to previous decades in which economic growth lifted most, if not all, boats.

What does this tell us about the 1990s? Simply this: while official statistics are just now revealing the benefits of the current expansion, these benefits may have been present for some time.

Mary C. Daly
Economist

References

Boskin, M. 1995. "Toward a More Accurate Measure of the Cost of Living." Interim Report to the Senate Finance Committee from the Advisory Commission to Study the Consumer Price Index, September 15.

Burkhauser, R.V., A.D. Crews, and M.C. Daly. 1997. "Recounting Winners and Losers in the 1980s: A Critique of Income Distribution Measurement Methodology." Economics Letters 54: 35-40.

Daly, Mary C. 1997. "The 'Shrinking' Middle Class?"

FRBSF Economic Letter