Felt inflation, diverging income distribution, and competition for jobs and resources give a feeling to many consumers that things are not the way they are supposed to be.

A Tale of Two Economies

It seems every week a new report comes out claiming a recession in the USA, followed by a report saying the opposite. Similarly, the “decoupling” of the world’s economies keeps making the news. Some say European will probably and Asian economies certainly will go down, too, whereas others predict a decoupling of growth. The public becomes increasingly pessimistic about the future outlook, as dropping consumer sentiment measures across the industrialized world show. Optimistic pundits are getting increasingly exasperated at the seeming disconnect between what their numbers show and the gloomy feelings pervading the common people.

For instance, Brian Wesbury, chief economist at First Trust Advisors, points to all the good news. In an interview on Nightly Business Report he rejects the idea that the USA will go into a recession: 2007 U.S. growth 3% (4% excluding the housing sector), total sales including all of the new stores growing strongly, unemployment rate still at 5%, incomes up.

On The NewsHour with Jim Lehrer (PBS) Stephen Moore, senior economics writer for the Wall Street Journal, defends the good news against Daniel Gross, financial columnist for Slate and Newsweek magazine: a six-year economic expansion, steady job growth, very low unemployment. Nevertheless, Americans have been nervous about the future for over a year.

One Number for All

For starters it is difficult to express in a handful of numbers the experience of 60 million Britons, 65 million French, 82 million Germans, and much less 300 million Americans or 320 million inhabitants of the Eurozone. As Wesbury points out, the Midwest is not like New York City. The real estate market in Berlin, Germany, is not like the one in Paris, France. Certainly, a Consumer Price Index for the USA cannot reflect the many different lives from students to pensioners. A large economy also consists of many numbers. The American “Index of Leading Indicators,” for example, has 10 components. For every good number someone can quote a bad number. Daniel Gross points to the weak jobs report, the contracting manufacturing sector, rising inflation, and high energy prices.

Growing Disparity

The differences in experience show in one particular area in both the USA and Europe. The median incomes barely moved, but incomes at the very high end ran up tremendously. Corporate officers had large pay raises and now make over a hundred times more than their average employee. The radical wage demands of many European trade unions speak to the discontent. But it goes beyond the top. Tobin Smith of ChangeWave Investor justifies the continued strength in consumer spending with the “super-spenders,” the top 20% of earners who account for 40% of U.S. consumption. They saw their income growing at a 5% rate a year. The other 80% did not do as well and consequently feel left behind. Even workers are growing apart, though. The rapidly transforming economies require new skills that leave out many people without the proper education, while even young university graduates can score high paying jobs.

International Competition

By many measures the industrialized countries use far more resources per capita than the emerging economies. For instance, the USA has an Ecological Footprint over 10 global hectare, most Western European countries over 3, whereas most of Asia’s and Africa’s is under 1. In 2004 the USA with about 5% of the world’s population consumed 22% of the world’s energy production. Europe excluding Russia with about 10% of the population took 20% of the energy. For decades these countries could do that almost unhindered. Now, though, large emerging economies like China, India, or Brazil demand their fair share. All morals aside the additional competition drives up the price for resources such as metals, oil, or food. At the same time these countries provide large pools of workers. People in the industrialized world thus get squeezed from both sides. The lower cost labor supply threatens jobs, while the demand for resources drives up prices. While economies as a whole may profit from the increased trade, people feel threatened by the changing world.

Changing Calculations

Daniel Gross contents that the U.S. economy is nowhere near as bad as it was back in 1992. But is it really? Some pundits claim that the U.S. government kept changing the way statistics get calculated to make them look better. They complain particularly about distortions to the government debt, the gross domestic product (GDP), the consumer price index (CPI), and the unemployment numbers. The responsible organizations do not deny the changes, but list economic reasons for them. Some also continue to provide the numbers calculated the old way, but these figures are rarely reported by the media. At the very least comparing the widely reported current numbers to those reported 20 years ago is questionable. If the complaints are true, the new numbers distort reality.

Both the U.S. and European calculations of the inflation rate downplay price rises for real estate. Decreasing the CPI, because the quality of goods such as computers and cars has improved, may have its merits. If I have no choice but to buy the current model at the current price, I do not save any money. My “felt” inflation rate is higher. People that cannot afford new computers or cars to begin with would feel the rate that mainly applies to basic items like food and energy. Focusing on the “core” rate excluding those two has some merit during periods of fluctuation. During periods where food and energy keep going up in price for years the felt inflation rate also exceeds the core rate.

This divergence has real consequences. From 2002 to 2006 the U.S. Energy Information Administration reported the following annualized rises in residential consumer prices for the following products:

• Electricity 3.9%.
• Natural gas 7.4%.
• Gasoline 12.1%

The annualized increase of the CPI for all Urban Consumers was 2.3%. Social security recipients and others who receive pay increases based on the CPI thus got less than their increases in energy inflation for five years running. The situation looks similar for many food and medical items. Understandably, the felt inflation rate for many people is much higher.

Rippling Through the System

The problems continue. Many numbers such as GDP are adjusted for inflation. From 2002 to 2006 the U.S. Bureau of Economic Analysis reports a respectable average GDP increase of 4.7%. If the new calculations understate inflation significantly economic, growth could actually drop below that of Germany’s 1.6%. An ironic thought, since Americans like to deride the German economy for its sluggish growth. It underscores how incorrect numbers can easily distort perception from reality. Not to say, though, that European statistics are immune to this. The problems are not as well documented, but there is anecdotal evidence. For instance, Germany introduced government-subsidized jobs. These allow employers to hire people at very low wages. Even though these earners cost the government almost as much as an unemployed persons, they are not counted in the unemployment statistics. This is similar to the U.S. Bureau of Labor Statistics discounting discouraged workers.

All the conspiracy theories notwithstanding, many problems with the numbers may have simpler causes. Imagine collecting employment statistics in a country with 300 million inhabitants and 50 state bureaucracies like the USA. Even Germany with its registration requirements and a fairly well-organized administration estimates that as much as 20% of GDP goes unreported due to “black labor,” i.e. work done without documentation to evade taxes.

As BusinessWeek discussed, government statisticians may not even know how to correctly calculate such complex numbers as GDP.

Bad Boy Media

Interestingly, journalists get blame from both sides. One group chastises them for ignoring the problems with the numbers and focusing on the “feel-good” ones like core-inflation. Understandably, media organizations whose revenue depends on people feeling good about the stock market have a vested interest in emphasizing the positive. Conversely, people like Wesbury blame them for spreading pessimism. Certainly, sensationalist headlines help sell news for others.

Obviously, the bad headlines alone could drive the people to confusion and despair. Just like there is no one economic number for everyone, there is no one headline for everyone, either. Most likely, a combination of the above factors causes many, many people to feel bad about the economic outlook. As the reasons differ, it will require many different changes for people to feel better, no matter what the economic numbers suggest.