My teaching session on national income accounting always yields the same question: “How can anyone live on $400 a year?” In the United States, per capita income was $29,676 in 1999, while in Bangladesh it was under $380.
Anyone in this country with income less than $8,959, or a family of four with income of $17,761 is “poor.” Many Bangladeshis must have incomes below their national average, meaning they’re getting by on 2 or 3 percent of what we consider the poverty line. How do they do it? What sort of lives do they lead?
The answer is that many people in Bangladesh or Mali do, indeed, lead lives of deprivation. But it’s also true that the dimensions of their plight are exaggerated by the way we calculate output and income, and by how we compare monetary values between different nations.
Understanding these calculations not only gives one a better insight into the situation of the world’s poor but also reveals some quirks in our own nation’s figures on household income.
To measure income, economists first try to measure output or production of goods and services. Gross Domestic Product, the most common output measure, is the money value of all final goods and services that an economy produces in a year.
“Final” goods are those in the form in which they will be used. The idea is to avoid double counting. A hamburger in the diner’s hand is a final good, but the wheat or wheat flour that went into the bun or the old dairy cow ground up for the patty are not.
But in terms of comparing incomes, the critical thing in how we define output is the phrase “money value.” If I buy five pounds of potatoes in my neighborhood grocery, I might pay $1.49. A Peruvian buying the same quantity in a village market might pay the equivalent of 10 cents.
It costs me at least $13 to get a hair cut. My friend Rodolfo, who lives in a suburb of Rio de Janeiro, may pay about $2. Someone in an interior Brazilian village might pay 25 cents.
An experienced U.S. schoolteacher may earn $3,500 per month. Someone with the same education and experience in rural Bolivia might earn $150.
Many goods or services have such substantially different prices, and they all go into calculations of GDP for their country at the local market prices. The “money value” of goods that are exactly identical except for the location where they are sold might vary by a factor of 10 or 20 times. But 10 pounds of spuds provides the same nutritional value to a family whether the table they are served on is in St. Paul or Chuquibambilla.
Another complication is that GDP and income tabulations do not include non-market goods and services. If I change the oil in my own car, only the oil and filter get counted in GDP. If I go to a rapid oil change station, $32 of oil, filter, labor and overhead all get counted. If I paint my own house, only the material counts. If I hire professionals, the full $4,000 tab gets counted.
The agencies that tabulate output and income do attempt to quantify the value of household-produced goods in subsistence economies. But doing so is very difficult, and there usually is a substantial under-tabulation.
In any case, once the value of output is added up, national income and per capita income are derived from those figures. Income is not calculated from income tax returns as many people think. Most countries do not even tax income and, even in the United States, legal tax returns do not include all income.
Tabulating the value of output and income are always done in the domestic currency. Peruvian potatoes are valued in soles, Red River Valley spuds in dollars. When one wants to compare Peruvian incomes to those in the United States, an exchange rate has to be used. Market exchange rates may or may not reflect the domestic purchasing power of each currency. To the extent that exchange rates are determined by differences in investment flows and interest rates unrelated to the relative prices of goods and services in each country, comparisons of income or poverty between countries can be distorted seriously by market exchange rates.
As an example, take a lower-middle class Argentine household with a monthly income of 700 pesos. In December 2001, their income was equivalent to U.S. $700. This week it would only equal U.S. $350. Did the real value of their output or income fall by half in two months? Of course not.
The 1-to-1 exchange rate that prevailed in December overstated their earnings, and the February 2-to-1 rate may understate it. Argentina’s devaluation will raise the cost of some things the family buys, but the price of meat, rice, bread, haircuts and movie tickets did not double. Their income fell in dollar terms, but their standard of living did not fall by nearly as much.
The lesson here is that the poor in developing countries really are poor. But the ways we tabulate output and income, the failure to take subsistence production adequately into account, and the tenuous way in which market exchange rates reflect purchasing power all render simplistic dollar income comparisons misleading.
Some of these considerations affect our perceptions of our own lives.
As women’s roles in the economy changed over the past three decades, we’ve moved from less in-household production of meals, child care, home cleaning and sewing and mending. Buying take-out, paying for day care, paying a cleaning service all add directly to tabulated GDP and per capita income.
But they don’t increase the goods and services available to the household as the raw numbers might indicate.
Few women with careers want to return to the June Cleaver role, and few real-life families in the 1950s had quite that ideal an existence. But the increase in U.S. GDP during the past four decades probably overstates real increases in living standards.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.