Consumption Based Measures of Poverty

Via Mark Thoma comes another consumption-based inequality argument from Alan Reynolds:

No economist who hopes to avoid professional ridicule would try to deny that consumption is a better measure of long-term living standards than the most widely cited income distribution figures, which do not even add transfer payments or subtract taxes … Yet growth of consumption by the bottom fifth grew by 7 percent in 2000, and by another 3.1 percent in 2001. They consumed much more than their apparent money income, which is always the case … If we add figures for 2000 and 2001 to those of 2002-2005, consumption still grew a percentage point faster in the top group (2.2 percent) than the bottom (1.2 percent) and slightly faster than the middle (1.8 percent).

Poor people are consuming more? Mark provides a graph of the consumption and income definitions of poverty drawn from a recent paper by Ronald A. Wirtz of the Minneapolis Federal Reserve, which shows that the consumption based definition has poverty virtually unchanged since 2000 even as the income measure shows an increase in poverty. Wirtz provides two possible explanations of the divergent signals. The first is the same argument that Alan Reynolds would offer:

Some economists prefer to look at consumption because it is less volatile than income on an annual basis for most households. People smooth their consumption based on long-term income expectations. Such a phenomenon is readily apparent among those who lose a job. While their income might plummet, consumption tends to fall much less dramatically. Such households tend to either dip into savings or take on additional debt with the expectation that higher income will return in due time.

As we noted earlier, Reynolds is pushing the permanent income hypothesis where consumption measures expected lifetime income. But Wirtz later notes another possibility that we have discussed before when he quotes Austin Nichols, a research associate at the Urban Institute:

“I disagree that consumption is a better measure of well-being,” in part because researchers don’t know how much consumption is financed by unsustainable borrowing. He added that consumption measures “have just as many problems as income-based measures.”

I would not professionally ridicule Austin Nichols on this latter point.