Introduction of the Pensioner and Beneficiary Living Cost Index

ABS Paper 6466.0

Under a side heading “Changes in quality” the ABS paper contains the following
paragraphs:
In concept, quality embraces all the attributes of an item which consumers
would consider before making a purchase. For example in the case of tinned
tomato soup it would include the volume or weight of the contents as well as
the concentration and flavour.
As the PBLCI aims to measure price changes for a fixed basket of goods and
services over time, identical or equivalent items must be priced in successive
periods. However, products do change; their components or ingredients may
change resulting in an improvement or degradation in quality. As the
characteristics of products are altered, the statisticians responsible for the price
index attempt to separate the effects of a quality change from any underlying
price changes so that the PBLCI measures 'pure' price change.
The requirement to take account of changes in quality, to ensure that the index
reflects only pure price change, often poses difficult measurement problems
and in some cases is impossible in practice. For example, although it is fairly
easy to monitor changes in rail or bus ticket prices, it is difficult to attach a
dollar value to changes in the quality (e.g. frequency or punctuality of the
service).

Comment
These paragraphs make clear that the new PBLCI is to be constructed using only pure
prices. The increasingly stringent admittance of only pure price changes to the
estimation of the CPI by the ABS over the last twenty or so years has been in keeping
with a world wide trend spearheaded by the USA and blessed by the OECD to report
the lowest possible levels of inflation. In keeping with this trend any increase in a
shelf price that can be attributed to an improvement in quality is subtracted from the
shelf price before estimating the CPI. This adds to the growth of productivity reported
for the economy and improves the economic image of the nation.
On the other hand the move to discounting prices for all possible changes in quality
has wrecked the CPI as an index of what is needed to maintain the real world
purchasing power of an amount of money such as a pension or a benefit. This is
because the CPI no longer represents the movement in the shelf prices of a basket of
goods.
This is best illustrated by example. The CPI contains an element for the movement in
the price of an ordinary domestic clothes washing machine. If that element is used to
index the price of a basic washing machine from one period to a later period the result
in any real life circumstance will not be sufficient to buy a basic washing machine in
the later period. This will be because the quality of a basic washing machine in the
later period will have been assessed to be superior to the quality of the basic washing
machine in the base period and the shelf price in the later period will have been
discounted by the ABS to determine the movement in that element of the CPI.
For a pensioner the difficulty is that the old model of washing machine will almost
certainly be no longer available. All that is available in the later period is the
“improved” model with a shelf price not matched by the price of the old model
updated by the appropriate CPI element. This is the mechanism whereby someone
who is dependent on a pension indexed to CPI finds their purchasing power gradually
eroded.
An example of this effect is the movement in the USA price index (adopted and
followed by the ABS with only minor adjustment for timing) for personal computers
between 1994 and 1998. Between these years the index fell by 33.3% pa, of which
7.7% pa was due to a fall in the shelf price and 25.6 % pa was due to improving
quality1.
Other examples are contained in the recent Harmer Pension Review Report. At page
62 the report says:
Over the past 20 years, the CPI index for the purchase of motor vehicles has
increased by just 7.3 per cent. This in part reflects the extent to which cars
today are better equipped. From a consumer perspective, where such quality
upgrades are often taken as granted or involve changes that consumers may
not necessarily have chosen to purchase, the estimate is seemingly at odds
with the prices of any particular model of new car, which may have risen by
some 25 to 50 per cent over the same period.
A third area in which the pricing to constant quality approach to the CPI may
differ from consumer experience concerns the cost of renting. While the CPI
rental component increased by 22.9 per cent between December 1994 and
December 2005, the average rent paid by private tenants, as surveyed in the
ABS Survey of Income and Housing over the same period, increased by 41.2
per cent (ABS 2005–06). Again, much of this difference can be related to
improvements in the quality of the rental stock.
One of the difficulties with this subject is that the ABS does not publish any explicit
data about the quality adjustments that it makes to prices or about the precise extent of
past and present practices in this respect. All that we know is that many years ago
quality adjustments were limited to obviously needed adjustments for quantitative
changes such as a change in the size of a tin of baked beans. Today the ABS seeks
information from many manufacturers and importers about quality improvements for
all kinds of products and converts that data into pricing reductions based partly on
obscure statistical techniques and partly on judgement.
However the few examples quoted above are sufficient to demonstrate how
discounting shelf prices for perceived quality changes to arrive at a pure price
movement means that a pension indexed by CPI cannot maintain purchasing power. It
might be argued that it maintains purchasing power in relation to products that were
available at an earlier period but rapid obsolescence and model changes which are a
feature of modern markets makes that an impossible proposition to sell to a pensioner
living in the real world.

1
J. Steven Landefeld and Bruce T. Grimm, A Note on the Impact of Hedonics and Computers on Real
GDP, Bureau of Economic Analysis, Survey of Current Business, December 2000. p. 20.

2
There are some aspects of the design of the PBLCI that might improve its relevance to
the indexation needs of pensioners and beneficiaries but these will be completely
swamped by the use of pure pricing and not shelf pricing. Appendix 1 to the ABS
paper provides an indication of how little the PBLCI is likely to vary from the CPI.
Moreover, there is the unpleasant possibility that the PBLCI will be used
mischievously by interests in the community seeking to drive down benefits to
pensioners and beneficiaries in the pursuit of other fiscal purposes. Today we see
many examples of how the unscrupulous seek to perpetuate what was once true but is
now patently false that CPI indexation maintains the real purchasing power of a
pension.
The PBLCI should be based simply on shelf prices. The ABS already collects data on
shelf prices as it has done for years and returning to past practice for the estimation of
the PBLCI should not be a difficulty for it. Failing that the interests of pensioners and
beneficiaries will be best served if the ABS terminates its development of the PBLCI
forthwith. The Government in the Budget provided $18.5m over four years to the
ABS to develop and maintain the PBLCI. Terminating that requirement now should
generate a saving of a significant part of that sum.

Tom Hayes
4 July 2009