Thursday, March 30, 2006

Inflation or Other Phenomena

I posted on this earlier, but now economist Don Boudreaux from Cafe Hayek has another article, this time published in the Pittsburgh Tribune-Review, on inflation and living standards as measure by the Sears catalog. This little excerpt got me thinking:

One objection to drawing conclusions from this research is that many things that Americans buy are not sold in department stores. If the prices of these nondepartment-store items -- such as housing and higher education -- have risen faster than wage rates, then ordinary Americans might still be worse off.

In fact, the amount of time the ordinary American worker must work today to purchase a house, a car and a four-year college degree is greater than it was in 1975. But houses today are larger and much-better equipped than they were 30 years ago; automobiles are enormously improved and more durable; and the addition to lifetime earnings generated by a college education is significantly higher.

Even discounting the factors he mentions in the second paragraph, are rising housing and education prices really even a reflection of falling standards of living, even if they are "inflationary".? Rising housing prices is largely caused by the scarcity of real estate. There is no practical way of creating more real estate, so it will continue to become increasingly more expensive, especially in highly populated areas. This isn't a sign of falling living standards, but of rising living standards as people increasingly want to live in these areas.

Education, on the other hand, is basically the purchase of labor, in this case your professor. Monetary policy aside, inflation is reflected by productivity. If I have to work 1 hour in order to earn 10 widgets, and then next year, due to automation, I only have to work 30 minutes to earn those same 10 widgets, then you can say that there is deflation. The cost of those widgets has dropped in half. At the same time though, the effective cost of my labor, when measured in widgets, has doubled. So if it cost me 1000 widgets per semester to pay my professor before, his labor is now worth 2000 widgets. Is this a sign of inflation and falling living standards, or the simple fact that as productivity increases in non-labor intensive processes, the relative cost of labor will go up?