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JDI Roundtable on Manufacturing Competitiveness in New Brunswick

Recessions don’t have silver linings

Herb Emery

An underappreciated limitation of economic policy is that we are pretty good at measuring material gains, but we are not so capable of measuring material deprivation and hardship. That in turn leads to a distorted view that the benefits of a strong economy are not shared broadly and that growth benefiting the few comes with high social and environmental costs.

COVID-19 has created a climate where there is support for better managing our capitalist, market based economy with a social conscience. We have seen calls for higher levels of taxation on top earners, more redistribution to the beleaguered middle class and a transition away from heavy industry and resource based industries. We have seen more Canadians reject the idea that economic growth is singularly important for our standard of living. Slow growth is perceived to be an equalizing influence on society.

In support of this new direction for the economy there is an interesting belief among some economists that recessions have a “silver lining”. When GDP falls, our incomes aren’t growing but the prices of goods and services aren’t either. That means that our money goes further. There is a perception that wage inequalities in society decrease with slow growth because the disadvantaged groups in society disproportionately benefit from more affordable goods and services.

Recently I published work on this topic, and we found that the cost of living “silver lining” of recessions is an unfortunate misinterpretation of what is actually a measure demonstrating severe economic hardship and widening economic disparities. A fall recession with a contracting GDP, or, if we are lucky, just slow growth, just as federal income supports start to go away will be painful for many who are the least advantaged in our society.

Cost of living is most often measured by Consumer Price Indexes (CPI) which represent the costs of reference baskets of goods and services. The percentage change in a CPI between time periods is how we measure price inflation, or inflation. CPIs and inflation rates are used to adjust wages, salaries, and government transfers like pensions to maintain the purchasing power of household incomes when prices of goods and services tend to creep up.

Many economists have raised concerns that the CPI is a biased measure of the true cost of living for households. In particular, the official CPI measurements are believed to overstate the true cost of living because of the availability of new goods, the improved quality of goods and changes in household consumption patterns. But a bigger issue with the CPI is that it may not accurately represent the cost of living for households whose consumption differs from that represented by the CPI basket of goods and services.

The CPI is constructed using the data for “representative households”, but consumption by most households could differ from that representative household. The CPI may be more representative of consumption of some identifiable groups like married couples with children, but not so useful for measuring the cost of living of seniors living alone.

We applied a method known as the Engel curve approach to estimate the size of the bias in the CPI, which we in turn use to adjust the official CPI to construct a cost of living measure that better represents the cost of living experienced by households. Economists generally agree that the share of a household’s budget spent on food is an indicator of household well-being. “Engel’s Law” suggests that as you get richer, you spend more on food, but that spending on food rises by less than the increase in your income. Our study applied this approach and found that when the economy is growing, the CPI is not that bad a measure for the cost of living.

But when economic conditions are poor, the CPI appears to be a poor measure of the cost of living. After 2009, our estimates suggested a decrease in the cost of living not measured by the CPI that continued to 2012, after which the experienced cost of living increased sharply to 2015. As painful as the 2008 recession may have been, the experienced reduction in cost of living after it appears to have been a “silver lining” for households. Incomes could go a lot further because the recession dramatically reduced the cost of living. Despite the economic turmoil, it appears that lower cost of living until as late as 2013 means household well-being had increased, after which time a recovering economy increased the cost of living.

An additional silver lining is that economic disparities between men and women, seniors and non-seniors and high and low income households fall in a recession. Women, lower income households and seniors were all benefiting from a lower cost of living than suggested by the official CPI while men and higher income earners had cost of living increases consistent with that shown by the CPI. Recessions would appear to reduce disparities by “levelling up” through reduced cost of living even without wage and income growth.

But if that story seems too good to be true, that’s because it is.

The Engel curve method relies on a naive adherence to the interpretation that food budget shares decline only because real incomes rise. That may be reasonable during periods of economic stability or growth but it is a problematic assumption during periods of economic hardship. If food expenditures fall because of declining purchasing power, then a lower food budget share would indicate a household becoming worse off after an economic shock because they can’t afford as much food.

Research has shown, for example, that unemployed households in the United States experience a decline in food expenditure and food consumption resulting from the unanticipated decrease in income. Unemployment and greater uncertainty over future income means more restricted use of, or access to, credit that influences households’ capacity to increase their expenditure beyond what is reflected in their immediate income.

We found that Canadian households had higher food insecurity risk after 2008, meaning more households were going without food due to a lack of money. A rise in food insecurity along with a falling household food budget share signals that the years after the recession are associated with economic hardship, not unmeasured improvements in well-being. Regarding the differences in real incomes between women and men — aside from potential differences in consumption patterns — the official CPI may miss the influence of gender differences in earnings, job security, access to credit and so on.

Our work cautions that there is no silver lining or gains for these affected groups from a recession or a lack of growth as many will suggest. That in turn should be a warning that we should not be complacent about slower growth or as unconcerned with economic recessions as we seem to be of late.

Herb Emery is a Brunswick News columnist and the Vaughan Chair in Regional Economics at the University of New Brunswick.

This article first appeared in Brunswick News publications – August 12, 2020

The JDI Roundtable on Manufacturing Competitiveness in New Brunswick is an independent research program made possible through the generosity of J.D. Irving, Ltd. The funding supports arms-length research conducted at UNB.