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Monday, October 18, 2010


Twelfth Post

I am back from the Big Apple, and ready to wrap up this seemingly interminable series of posts. One preliminary word: I had an email from my big sister, Barbara [for whom, some readers will recall, I threw that Paris birthday party last summer]. Barbara is currently teaching courses on the latest developments in Evolutionary Biology, but before she retired, she worked for many years at the World Bank. She tells me that among developmental economists and others, there is now a very vigorous discussion about precisely the sorts of covert ideological presuppositions contained in economic indices that this series of posts is about. It would seem that I am reinventing the wheel once again. She mentioned Herman Daly and Sabina Alkire, among others. Who knew?

Anyway, let us continue. [A rational person would put his exposition on hold and go to the library to read what these folks have written. I shall do that eventually, but I am having too much fun spelling out my own understanding of this important question. Oh well, No one ever accused me of being a scholar.] There are serious problems even getting a handle on what is happening to the prices of commodities in one of the vast number of categories one could define, problems of simplification and sampling. These problems are similar to those we encountered in talking about the measurement of unemployment. But there is another much deeper problem that is, in fact, completely intractable.

Put simply, the problem is that for purposes of policy formation as well as comprehension, we need some way to measure the general movement of prices, not merely the movement of the price of a single category of commodity. Obviously, if all prices are moving in the same direction at the same rate, there is no problem. Suppose the BLS carries out its surveys of ten thousand categories of commodities and services [still a massive simplification] and finds that in each and every category, the price of a sample commodity or service has increased by 3% over the previous month. They are then on pretty safe ground announcing that the country as a whole has experienced an inflation of rate of 3% this month.

But of course this never happens. Instead, they find that some commodities and services have risen 3% in price, some have risen 6%, some have soared 20%, and some have actually declined. What is more, over time, the very categories into which commodities are sorted change in fundamental ways. Some commodities and services simply become unavailable [buggy whips and public stables, perhaps] while others [automobiles] are now widely available. It may be impossible in most cities and towns to find a usable block of ice for the icebox, but on the other hand every big box store is selling electric refrigerators. The old commodities and the new may perform the same function [transportation, or keeping food cold], but are they therefore the same commodity? Intuitively the answer is no.

It would of course be possible for the BLS simply to issue an enormous book of statistics every month recording what they have found about movements of prices for every single one of the categories they are tracking. In fact, they do. But that book, fascinating as it is, cannot possibly help us either to grasp what is happening to prices in general, nor can it serve as a guide for actions by the Federal Reserve Board or the Congress. What we need is some way of amalgamating all of that information into a single measure, an Index. We need to be able to say whether prices in general have risen or fallen, and by how much. In short, we have finally come to that point in this discussion at which we really cannot avoid talking about apples and oranges.

Here is what the BLS does. It defines what it calls a "market basket of goods and services" which its surveys suggest more or less mirrors what many people buy with their money in a week or a month: one quart of milk, three pounds of potatoes, a trip to the doctor, enough catfish to serve four at dinner, rent or a mortgage payment, and so on. Then they track what this market basket of goods and services costs, month by month, using the data they have assembled on the movements of the prices in each of their categories. The month by month or year by year change in the market basket then is defined as the "Consumer Price Index" -- "consumer," because this is a market basket of goods and services conceived as being bought by families, not by businesses [there is a Producer Price Index for them]; "price," because the market basket is measured in dollars, not in quarts or pounds or dozens; and "index" because the heterogeneity of the prices and quantities in the market basket is converted by this process into a uni-dimensional number, and that is ;precisely what an Index is.

Well, it doesn't take much brains to figure out the problem with this sort of index. Assuming we can solve the aggregation and sampling problems attendant on tracking the prices of individual commodities and services [a large assumption, to be sure, but one I am willing to make to keep the discussion going], the CPI does a very good job of measuring changes in the price of the particular collection of specified quantities of specified goods and services that have been defined as The Market Basket. The question is, What does that have to do with whether it is getting more expensive to live in America?

Here is the problem in a nutshell: The CPI does not tell you anything about the impact of price changes on you unless you happen to consume the particular market basket of goods and services they are tracking. If you don't eat meat, what good is it to you that steak is relatively cheap. Can you believe that when I was young, lobster was a budget meal? Now, if I want fresh tuna or swordfish from Whole Foods, I have to take out a homeowner's line of credit, but I can get good beef for less than it costs to eat catfish or tilapia.

Let us consider briefly a really important example of this problem -- housing. In the old days, the rule of thumb was a week's wages for a month's rent. Now housing consumes up to half of a household's monthly budget. But changes in housing costs have wildly different differential impacts on Americans. If you own your own home -- 65% of American households, but 83% in Ireland and only 43% in Germany -- then like as not you have a mortgage. Now -- this is for my foreign readers -- in the United States it is possible, indeed, usual, to get a long-term mortgage whose cost to you does not change for the entire life of the mortgage. This is called a fixed-rate mortgage, and the typical term of such a mortgage is thirty years. It is literally the case that with such a mortgage, you will pay exactly the same number of dollars each month for thirty years. Over that same period of time, through good times and bad, the CPI may soar. Since 1980, thirty years ago, the urban CPI has gone up 240% [yes, the BLS even differentiates between urban and rural price changes -- it really is a state of the art operation.] But if you have had a thirty year fixed rate mortgage for those thirty years, then your last payment is exactly the same as your first payment. Now, during that time, housing has increased dramatically in cost, even taking into the account the collapse of the housing bubble of the past two years. BUT NOT FOR YOU. Thus, a BLS market basket that includes housing, used to measure price inflation, will completely misrepresent the impact of price changes on you, but it may accurately reflect those changes if you rent, or if you are now buying a new home.

Let me stand back from these details and summarize what we have found. The concepts we use to get an epistemic handle on social reality are unavoidably shaped by our conception of the way society is and the way it ought to be. We saw that in our analysis of the concept of unemployment, and we have seen it again in our analysis of the Consumer Price Index. The categories we apply to our social experiences [teacher, wife, president, terrorist, bus driver, child, even man and woman], are shaped by social expectations, habits, customs, and institutions. It is always possible to trivialize the problem by simply stipulating the definitions of these terms and making no claims about their relevance to an understanding of society, but in fact no one -- I repeat, no one -- every actually uses the concepts in that antiseptic manner. Not even science fiction writers trying to imagine alien races living in alternative universes are able to disentangle themselves from the rich, complex self-understanding through which we experience and conceptualize social reality. That is why, when those authors imagine first encounters between humans and aliens, it is always numbers or physical constants or musical tones [Close Encounters of the Third Kind] and not social categories ["take me to your vise-president"] that serve as the means of communication.

The challenges to received wisdom, the radical rejections of inherited behavioral norms, the religious inspirations that call into question quotidian reality -- all are themselves completely embedded in an existing culture and recognizable as such.

So Luke's Mother, that, in brief, is how to study society.

Next question?


wallyverr said...

There is an overview of Sabina Alkire's Multidimensional Poverty Index (MPI) on

including an interactive world map to let one compare different countries on different dimensions.

The MPI will apparently be featured in the forthcoming UNDP 2010 Human Development Report –“The Real Wealth of Nations: Pathways to Human Development”

Robert Paul Wolff said...

Thank you. I am apparently the laast person to hear about it! I will take a look right away.

JP said...

AS I understand it (not an economist, but I love these topics) the first thing needed is to disentangle real from nominal rises in the price level. This is done by noting that inflation (qua monetary phenomenon) should affect all goods roughly equally, but inflation (qua things are actually more expensive) will not. For example, if oil becomes scarce commidities will be unequally affected, but if government prints money everything should get equally more expensive. Add some cunning stats techniques and we can do a decent job of separating these two differnet phenomena.

I agree that the CPI calculation causes some deep practical and conceptual problems, though I am less convinced these cause ideological trouble. I am thoroughly unconvinced that we have a clear idea of what we are, in principle, measuring, and am actually supposed to work on this topic with a economist friend.

Thanks so much for this informative series of posts. I propose you start a new series when you feel like it as your audience does enjoy it a lot.

Mike said...

I've got lots of questions but I'll limit myself to just two.

You say that "the concepts we use to get an epistemic handle on social reality are unavoidably shaped by our conception of the way society is and the way it ought to be." Does this apply only to social reality or to reality in general? If it applies only to social reality, why does the study of natural reality permit the kind of objectivity that a study of social reality does not? If we can objectively study nature, why not society?

Second, even though the CPI has its problems, I trust you'd agree that there are better and worse ways to compute it. Studying the prices of typical consumer goods seems to give us a better sense of what's going on in the economy as a whole than would studying, say, the price of Faberge eggs and golden scepters. But to concede this much, it seems, would commit you to the view that there are facts of the matter about economic performance, and that some methods of discovering these facts are preferable to others. Isn't that good enough for an objective study of society? It seems good enough for an objective study of nature.