Arthur Okun developed the “misery index” as an economic indicator to proxy the welfare of a country. By adding the unemployment and inflation rates, the index is an indicator of the hardship caused by a lack of jobs coupled with rising prices amongst a population.
The misery index might be a good way to allude to economic hardships suffered in the present, but what of the future? To give a feel for this, I’ve propose here the “Miserly” Index.
Accept for the moment the broad sweeping generalization that your well-being is determined by the income you have with which to buy satisfaction. As the old saying goes, “the best things in life are free.” While we can’t put a price on love, we can significantly increase our options to find it with a little more cash. Add to that the health, educational, vacation, and lifestyle possibilities that greater income allows for, and you can see that money does indeed make your world go ‘round.
What factors detract from your income? Taxes are the big one, but inflation also comes to mind. What of government debts? They need to be paid off some day so you probably have that day of reckoning in mind as make your plans today. This latter point is what we refer to as Ricardian equivalence – the idea that government spending is not a “free lunch”, so to speak, and that it will be paid off eventually whether through inflation or taxes.
The Miserly Index (MI) accounts for all three of these factors to give a measure of how these three aspects interact to determine how miserly you can expect to live your life in the future. In short, the MI is the sum of, 1) the inflation rate, 2) the average tax rate, and 3) the present value of the perpetuity payment which would be needed to retire a country’s public debt burden (all expressed as percentages).
In this way all three variables are percentages affecting income, which has the appeal that they can be summed. This is one primary benefit my MI has over its Misery counterpart, to the extent that the Misery Index adds two variables with different units, namely, the percentage of people not working with the percentage increase in prices.
Thus, the sum of the percentage of lost income due to inflation, plus the percentage of lost income due to taxes, and finally the percentage of lost income due to payment of the current debt (and expected deficits) comprises the Miserly Index. We can see the results for some select Eurozone countries in figure 1
Figure 1: Miserly Index for select Eurozone countries
Notably every single country is more miserable today than it was at the advent of the euro. In some cases this is very apparent. The average Greek citizen can expect to lose 70% of his income due to the combination of debt repayment, inflation and taxes. (The sudden drop since 2011 is only the result of the haircuts imposed on large swaths of Greek government debt.) In Ireland we have a similar phenomenon. The Euro crisis took a heavy toll on Spain in this regard. As recently as 2007 a Spaniard could expect to keep more than 60% of his future income. Today that figure has dropped to roughly 45%, and continued public deficits and low growth prospects compound the problem.
Germany is the only country whose MI has not significantly changed since 2000. Today the average German can still count on giving up about 47% of his future income to inflation, taxes and government debt repayment. Yet, as figure 2 makes clear, the composition of how these future expenses will be paid also counts.
Figure 2: Components of the Miserly Index (2012)
Since the MI is just an extrapolation of current conditions, in all countries the threat of inflation robbing citizens of purchasing power remains low. With inflation within most of Europe running around 2%, the average citizen has little to be alarmed about. At least, not relative to the larger threats looming.
Expected taxes are the biggest cause for concern. Indeed, a German is threatened almost exclusively by future taxes. In some countries the pain of paying off the debts incurred over the past few years will be large. The way things are going in Greece, 25% of future income will need to be dedicated to paying off the country’s debts. Germany is an example at the other end of the spectrum, primarily the result of small deficits coupled with high rates of growth which diminish the future costs of debt repayment.
I offer this case study only in a tongue in cheek way to gauge future unhappiness because of the spend thrift ways of a country’s government in the present. Still, there are some important lessons to take away from it.
First, bills have to be paid sooner or later. Running high deficits might give the illusion that things are going well in the short run, but eventually these bills will get paid – whether through higher inflation, or through taxes. Second, in most countries the rates of taxation are so high as to be the largest concern to citizens moving forward. Finally, and perhaps most importantly, are the expected costs of future inflation. The recession has had the benefit of coinciding with low rates of inflation. This is not for a lack of will on behalf of the central banks of the world to prime the pumps and inject large amounts of liquidity into the markets. Low inflation is also not something we can expect to last forever. The Miserly Index of each of these countries has no higher than 3.3% inflation factored into it (in Italy). From such a low starting point, any upward tick in inflation would have drastic effects in reducing the amount of future income workers can expect to hold on to. If this happens, Europe’s future might be even more miserly than we think.