Growth, levels & frames

On Radio 4's Broadcasting House yesterday, Bonnie Greer said that the UK's living standards are the "lowest since 1870." This is, of course, absurd pish: she's confusing the level with the rate of change. However, this confusion isn't confined to her. Two things tell us that people put great weight upon changes in incomes rather than levels.

One is that China's Global Times said recently that the UK is “no longer any kind of big country" and is only “suitable for tourism and overseas study”. In fairness to it, Cameron's visit to China did seem like a supplicant pleading with a rich man. But this misses the fact that the UK is massively better off than China. UK GDP per person is, according to the IMF, four times that of China. It's us that's should be lecturing them, not vice versa.

Secondly, everyone seems to agree that we have a cost of living crisis, on the basis that the real income of the median (pdf) non-retired household is 6.5% below its 2006-07 level. However, those same incomes are 18.6% higher in real terms than they were in 1998-99. And yet then was a time of high optimism - the tech bubble - whilst now is one of anxiety.

Rates of change of income thus have a big impact upon public mood. China's big growth - from a low level - breeds optimism and arrogance. Our decline from a high level gives talk of a crisis. All this vindicates Adam Smith:

The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining, melancholy.

What's going on here is a reference effect. When we ask "how well off am I?" we tend to compare our incomes to those of recent years. By this metric, most Chinese are doing well and most Brits not - even though a look at levels of income says the opposite.

This helps explain the Easterlin paradox. If our well-being depends upon the change in incomes rather than levels, then the same rate of GDP growth will give us the same level of well-being, regardless of the level of income.

However, I'm not sure there's a necessary, logical reason for this. My real income is barely half what it was 20 years ago and yet I feel comfortably off. One reason for this is that I was never stupid enough to confuse the size of my pay cheque with the size of my talent, so I saved a lot - and compound interest (and house price inflation!) is a powerful force. For me, my income of a few years ago is not the reference point. Instead, it's: "how much do I need to be comfortable?"

This, I think, helps explain a paradox - that at the same time as many are talking about a cost of living crisis and secular stagnation, others are speaking of abundance and the desert of plenty. There's less contradiction here than you might think. If your reference point is your income a few years ago, you might well think there's a crisis. But if it's the amount you need to be comfortable, then if you're  an older person who's had years of top-quartile earnings, abundance is near.

In this sense, talk of abundance and crisis coexist not merely because of differences in class and generation - important though these are - but because of differences in how we frame our incomes.

Comments

[jacobyte]

Why have you stopped publishing full RSS feeds?
It's a blight to have to break out to the web site from Feedly to read your blog

[Tim Worstall]

If our well-being depends upon the change in incomes rather than levels, then the same rate of GDP growth will give us the same level of well-being, regardless of the level of income.

And it should be possible to test this too. The information from the past few years might do it. The stnadard happiness surveys have been going on across Europe as some countries continue to grow and others shrink.....30 odd countries, 5 or 6 years of data....

[Luis Enrique]

is saying we care about rates of change the same thing as saying we have asymmetric reactions to changes in levels? i.e. feel having something taken away more sharply than having same thing given.

Also I wonder if relative price changes have an effect, which could be obscured by calculations of real income changes based on consumption baskets. So underneath that data saying real incomes have risen or fallen x% since 1980 or 2007, what we were able to afford more of when incomes rose (CDs, clothes from Primark) differs from what we are now less able to afford when real incomes have fallen (central heating, transportation) so what we've lost hurts more than what we gained because we lost and gained different things.

[aragon]

Well you can't realise your house price inflation without downsizing and compound interest when interest rates are negative and inflation is compounded too and a devaluation in the pound (now reversed?).

Food and energy inflation in double figures and how much do you need to be comfortable, as capital expended on living is a wasting asset.

And by definition three quarters of people are not in the top quartile. And if you were in the bottom quartile you would not own your house or ever have enough income to save.

Any loss of income is catastrophic and immediately impact on living standards.

Personal debt at 1.43 Trillion for the UK households.

http://www.bbc.co.uk/news/business-25152556

http://www.theguardian.com/money/2013/nov/20/personal-debt-mental-health-report

"Poorer people are "bearing the brunt of a storm" during which average household debt has risen to £54,000 – nearly double what it was a decade ago, the report by the Centre for Social Justice thinktank warns."

"Pond said: "With falling real incomes and increasing costs of basic essentials, many – especially the most vulnerable – are sliding further into problem debt. The costs to those affected, in stress and mental disorders, relationship breakdown and hardship is immense. But so too is the cost to the nation, measured in lost employment and productivity and in an increased burden on public services.""

While Mr Micawber is still comfortable, many are not. Given the inequality and extremes in wealth average statistics can hide a multitude of sins.

And GDP is not a useful measure.

[pablopatito]

"And GDP is not a useful measure."

^ this

[Luis Enrique]

"And GDP is not a useful measure."

^ not this

[Citizen 470001000201]

If our real disposable incomes have gone up so much, then why are we also at record levels of debt, both including and excluding mortgages? Why not record levels of saving?

And are pensions included in disposable income? If so, why?

[joe]

Peter gets a 10% pay rise - very happy.
Paul gets a 9% pay rise and is furious as to why he has been discriminated against. If Peter had got an 8% rise, Paul would be very happy with his 9%. Judgements are based on relativities and perceived fairness rather than any absolutes.

Politicians remain loath to tell the truth that good paying jobs are to be relatively scarce in the future as computerisation, world-wide competition and outsourcing continue. Investment in future UK growth is near zero. Rising debt, high rents and the Nation's vast capital lying dead within housing stock, consume the little that might have been available to spark any rebalancing of the economy towards a sustainable model. Most households are running on empty and sense there may be no way out.