Measuring living standards & poverty: income or expenditure?

1. Measuring living standards & poverty:income or expenditure? Andrew Leicester Institute for Fiscal Studies andrew_l@ifs.org.uk

2. “… if we don’t raise the standard of living of the poorest people in Britain we will have failed as a government.” Tony Blair, 1997

3. Living standards • Comparisons over time – are we better off? • Comparisons over individuals / countries • Inequality • Poverty • Lots of measurement issues • Adjusting for living costs (inflation, PPP exchange rates) • Adjusting for family composition / national demography • What is the right indicator?

4. Income?

5. Income: advantages • Data widely available • Traditional measure of living standards • Strongly correlated to other indicators • Measure of ‘opportunities’ • People ‘maximise welfare’ • Choices over how income is used • Government influence • Tax and benefit system • Basis for e.g. poverty reduction targets

6. Income: disadvantages • Measurement difficulties • Concealed income sources: survey design? • What counts as income? • Variability • Long run changes over life-cycle • Short run changes • ‘Permanent’ or ‘transitory’ income: is spending a better measure of living standards?

7. Expenditure smoothing £ Spending Income Saving Using assets Borrowing Age

8. Smoothing in practice • Evidence that expenditures are smoother than incomes over the life-cycle • Lack of data makes it hard to be sure • People do not perfectly smooth spending • Cannot always borrow and save • People make mistakes in their expectations • Some shocks are unexpected • We should be talking about consumption smoothing not expenditure • Consumption: flow of benefits from what we have • Important for e.g. durables, housing • Cannot observe consumption; need to estimate or just ignore

9. Spending not problem free … • What should be included? • Housing costs, insurance costs, taxes … • Problems of expenditure surveys • Hard to record durables, “lumpy” expenditure • Under-recording of ‘sin’ items • EFS finds about ½ the spending on alcohol and tobacco recorded in National Accounts

10. What do the data show? • Income and expenditures taken from FES/EFS between 1974 and 2005/6 • Measured in real terms (adjusted for RPI inflation), 2007 prices • Adjusted (‘equivalised’) for household composition • More people sharing a given income mean household is worse off • Different ways to equivalise, we use OECD scale • Income after housing costs (AHC) • FES P-codes, household-level net income • Expenditure excluding housing (rent, mortgage, council tax, water charges) • Expenditures mapped to RPI inflation categories back to 1974 • Housing costs calculated from FES B-codes

11. Average income and spendingLiving standards rising over time Source: IFS calculations from FES/EFS data, 1974 – 2005/6

12. Relative poverty: income and spending • Relative poverty – key government target • Child poverty targets for 2010 and 2020 • Pensioners have also been focus of policy • Poverty relative to average living standards • income: some people temporarily poor • “Poor” households • less than 60% of median income/spending • Poverty rate • fraction of population living in households below poverty line

13. Poverty lines 2005/6 £/week

14. Income and spending poverty ratesWhole population Source: IFS calculations from FES/EFS data, 1974 – 2005/6

15. Income and spending poverty ratesChildren Source: IFS calculations from FES/EFS data, 1974 – 2005/6

16. Income and spending poverty ratesPensioners Source: IFS calculations from FES/EFS data, 1974 – 2005/6

17. Why do poverty rates differ? • Temporary low income • Maintain spending through borrowing or using savings • In 2002/3, self employed had income poverty rate of 23% and spending poverty rate of 13% • Those seeking work had income poverty rate of 70% and spending poverty rate of 50% • Income understates living standards? • Failing to spend income • Not “running down savings” as theory suggests: uncertainty in retirement? Saving to make bequests to children? • Retired households had income poverty rate of 22% and spending poverty rate of 33%. But housing important. • Income overstates living standards? • Measurement problems in both

18. Low income, high spending?EFS 2001/2 – 2002/3 data Source: Brewer, Goodman and Leicester (2006)

19. Policy conclusions? • Reductions in child/pensioner poverty not so clear if spending taken as measure • Increases in short-term incomes not feeding through into longer-term living standards? • Focus on very low income households may be misguided – may be transitory • Spending-based measures of living standards ought to be monitored regularly • Complement to but not replacement for income-based • Spending particularly important in developing world

20. Data conclusions? • Income and spending both measured with errors, largely unavoidable • FES / EFS does relatively good job at measuring spending via diary and recall • Though worrying recent downward trend in ability to capture National Accounts expenditure aggregates • FES / EFS still does better than many comparable international surveys • Some data improvements desirable: • Relatively low sample size: hard to draw accurate interpretations for sub-groups of population • Good measure of spending but not consumption • Better information on housing and durable ownership helpful