World misery index puts Venezuela at the top but it is actually worse

The accepted world index has Venezuela as the most miserable place on earth but the actual situation is far worse once all factors are considered

PUBLISHED : Tuesday, 06 May, 2014, 12:42am
UPDATED : Tuesday, 06 May, 2014, 12:42am

The recession grinds on, and as it does, politicians of all stripes are asking: "Just how miserable are our citizens?"

The chattering classes offer a variety of opinions, but there is a straightforward way to measure misery.

The late Arthur Okun, a distinguished economist who served as chairman of the President's Council of Economic Advisers during president Lyndon Johnson's administration, developed the original misery index for the United States.

Okun's index is equal to the sum of the inflation and unemployment rates.

The misery index pours cold water on the current critique of free markets and fiscal austerity

Harvard Professor Robert Barro amended the misery index by also including the 30-year government bond yield and the output gap for real GDP. Barro used his index to measure the change in misery during a president's term. The data in the misery index chart speak loudly.

Contrary to left-wing dogma, the Reagan "free-market years" were very good ones. And the Clinton years of Victorian fiscal virtues - when President Bill Clinton proclaimed in his January 1996 State of the Union address: "the era of big government is over" - were also very good ones.

The misery index pours cold water on the current critique of free markets and fiscal austerity - a critique that has taken on the characteristics of a religion embraced without investigation.

But does the misery index accurately measure misery? If the economy is doing poorly during a president's term, the likelihood for this president to have a low approval rate is high, and vice versa (correlation of -0.54).

For most people, their quality of life is important.

Constituents prefer lower inflation rates, lower unemployment rates, lower lending rates and higher GDP per capita. By combining the poll rankings and the misery index, we can calculate a standardised ranking from one president to another.

This type of analysis is not limited to the US. The misery index can be applied to any country where suitable data exists. A sum of inflation, lending rates and unemployment rates, minus year-on-year per capita GDP growth has been used to construct a ranking for 89 countries.

When measured by the misery index, Venezuela holds the ignominious top spot, with an index value of 79.4.

But, that index value, as of December 31, 2013, understates the level of misery because it uses the official annual inflation rate of 56.2 per cent. In fact, I estimate that Venezuela's annual implied inflation rate at the end of last year was 278 per cent. That rate is almost five times higher than the official inflation rate.

Why is there such a huge gap between the official inflation rate and my estimate of the true inflation rate?

Venezuela imposes a complex web of government price controls. In consequence, when one observes prices for the items that comprise Venezuela's price index, many of the prices will be those mandated by the government, not the market. So, the inflation rates for the basket will be artificially low. The official inflation reading will be for what is termed "suppressed" inflation.

And that is not the end of the story. Indeed, with binding price controls, many goods in the official price index basket are nowhere to be found. In Venezuela, 28 per cent of basic products are not available.

Binding price controls spawn black markets. Many of the goods and services subject to controls migrate to black markets. For example, in German-occupied Poland during the second world war, price controls prevailed and the black market flourished.

Everything from basic food and industrial goods to foreign exchange traded on black markets. There was even an illegal stock market. The scale of the black markets was impressive, with 80 per cent of all food being supplied via illegal markets.

One way to estimate the rate of true, open inflation, in cases such as Venezuela's, is to track down the free-market prices - including the black-market prices - for all goods in the official basket.

But such a procedure would be very difficult, if not virtually impossible, to implement. That is why no country has ever accomplished such a herculean task.

As an alternative, I have developed a procedure for estimating the true, open inflation rate for an economy in the grip of high inflation and price controls. While it is impractical to determine the free-market (ie black-market) prices for all items in an official basket, it is often quite easy to observe the free, black-market exchange rate. Because this is the most important price in the economy, changes in the free, black-market exchange rate can be used to estimate the true, open inflation rate for an economy.

By using the bolivar/US dollar rate, we can accurately estimate Venezuela's annual open inflation rate.

At the end of 2013, this true, open inflation rate was five times higher than the official rate.

And the associated true misery index was 301, not 79.4.

It's not surprising that President Maduro's popularity has plunged 16 percentage points since he took office in April 2013. And if that wasn't bad enough, politically motivated street violence has claimed 39 lives since mid-February 2014.

Steve Hanke is professor of applied economics at Johns Hopkins University. He is also a senior fellow and director of the Troubled Currencies Project at the Cato Institute in Washington