Most applied researchers in macroeconomics who work with official macroeconomic statistics (such as those found in the National Accounts, the Balance of Payments, national government budgets, labor force statistics, etc.) treat data as immutable rather than subject to measurement error and revision. Some of this error may be caused by disagreement or confusion about what should be measured. Some may be due to the practical challenges of producing timely, accurate, and precise estimates. The economic importance of measurement error may be accentuated by simple arithmetic transformations of the data, or by more complex but still common transformations to remove seasonal or other fluctuations. As a result, measurement error is seemingly omnipresent in macroeconomics. Even the most widely used measures such as Gross Domestic Products (GDP) are acknowledged to be poor measures of aggregate welfare as they omit leisure and non-market production activity and fail to consider intertemporal issues related to the sustainability of economic activity. But even modest attempts to improve GDP estimates can generate considerable controversy in practice. Common statistical approaches to allow for measurement errors, including most factor models, rely on assumptions that are at odds with common economic assumptions which imply that measurement errors in published aggregate series should behave much like forecast errors. Fortunately, recent research has shown how multiple data releases may be combined in a flexible way to give improved estimates of the underlying quantities. Increasingly, the challenge for macroeconomists is to recognize the impact that measurement error may have on their analysis and to condition their policy advice on a realistic assessment of the quality of their available information.
Simon van Norden
James P. Ziliak
The interaction between poverty and social policy is an issue of longstanding interest in academic and policy circles. There are active debates on how to measure poverty, including where to draw the threshold determining whether a family is deemed to be living in poverty and how to measure resources available. These decisions have profound impacts on our understanding of the anti-poverty effectiveness of social welfare programs. In the context of the United States, focusing solely on cash income transfers shows little progress against poverty over the past 50 years, but substantive gains are obtained if the resource concept is expanded to include in-kind transfers and refundable tax credits. Beyond poverty, the research literature has examined the effects of social welfare policy on a host of outcomes such as labor supply, consumption, health, wealth, fertility, and marriage. Most of this work finds the disincentive effects of welfare programs on work, saving, and family structure to be small, but the income and consumption smoothing benefits to be sizable, and some recent work has found positive long-term effects of transfer programs on the health and education of children. More research is needed, however, on how to measure poverty, especially in the face of deteriorating quality of household surveys, on the long-term consequences of transfer programs, and on alternative designs of the welfare state.
Brant Abbott and Giovanni Gallipoli
This article focuses on the distribution of human capital and its implications for the accrual of economic resources to individuals and households. Human capital inequality can be thought of as measuring disparity in the ownership of labor factors of production, which are usually compensated in the form of wage income. Earnings inequality is tightly related to human capital inequality. However, it only measures disparity in payments to labor rather than dispersion in the market value of the underlying stocks of human capital. Hence, measures of earnings dispersion provide a partial and incomplete view of the underlying distribution of productive skills and of the income generated by way of them. Despite its shortcomings, a fairly common way to gauge the distributional implications of human capital inequality is to examine the distribution of labor income. While it is not always obvious what accounts for returns to human capital, an established approach in the empirical literature is to decompose measured earnings into permanent and transitory components. A second approach focuses on the lifetime present value of earnings. Lifetime earnings are, by definition, an ex post measure only observable at the end of an individual’s working lifetime. One limitation of this approach is that it assigns a value based on one of the many possible realizations of human capital returns. Arguably, this ignores the option value associated with alternative, but unobserved, potential earning paths that may be valuable ex ante. Hence, ex post lifetime earnings reflect both the genuine value of human capital and the impact of the particular realization of unpredictable shocks (luck). A different but related measure focuses on the ex ante value of expected lifetime earnings, which differs from ex post (realized) lifetime earnings insofar as they account for the value of yet-to-be-realized payoffs along different potential earning paths. Ex ante expectations reflect how much an individual reasonably anticipates earning over the rest of their life based on their current stock of human capital, averaging over possible realizations of luck and other income shifters that may arise. The discounted value of different potential paths of future earnings can be computed using risk-less or state-dependent discount factors.