Just because the general price level goes up by some proportion it does not mean that every category of spending should change by the same proportion. Keep that in mind when evaluating private and public budget proposals.
Most people know about the Consumer Price Index. Many assume it is the single correct measure of inflation for all purposes.
They apply a variation of Mr. Micawber’s criteria for happiness and misery. Charles Dickens’ famous character famously said, “Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
These people reason, “Spending increase less than CPI: good financial management. Increase more than CPI: waste and incompetence.”
This is an error. The logical flaw is that the CPI was constructed to measure overall price changes of items purchased by consumers. It is based on a “market basket,” a long list of goods and services that households buy. This market basket is representative for consumers but often wildly irrelevant in relation to the items purchased by state or local government, individual private businesses or specific departments within government or business.
Just because the cost of thousands of items including tacos, toilet paper, towels, toaster and tools goes up by four percent does not mean that tuition or road construction or running a church or corporate marketing department should go up by exactly that amount.
Yet that is what people often assume.
The head of the finance committee tells the congregation “The increase in the total budget for next year is below the rate of inflation.” Good job!
A mid-level business manager returns from a drawn-out budget battle and tells her staff, “We are getting stiffed this year, our budget is not even keeping up with inflation.” Rank injustice!
A state highway commissioner announces “Construction bids are up 11 percent this year on comparable projects.” Out-of-control government spending!
All such snap judgments are wrong. If the particular things a church or business department purchases have gone up less than those bought by consumers, a below-CPI budget increase is not necessarily restrained spending or hardship.
If the prices of fuel, asphalt, Portland cement and steel have increased more than common consumer items – as is true right now — highway construction and maintenance budgets must increase or the amount of work done must be cut. This is not mismanagement or government waste.
It would be nice if we had a price index for every sub-sector of the economy. In some cases, the price information is already tabulated. All that would be required would be constructing a relevant “market basket” with appropriate weights indicating the importance of each item.
But failing that, judgments about prudence of many spending changes should not be based solely on how they compare to a national index relevant to consumer items.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.