Life In Canada Has Become Way More Expensive Than The Official Data Suggests
The consequences of relying on an inaccurate inflation gauge are far-reaching
Why aren’t younger Canadians getting ahead?
This seemingly innocent question has become an inflammatory topic of discussion. Almost everyone has a strong opinion, but there isn’t much consensus on the answer.
Generally speaking, young people feel that the system has been rigged against them. Getting a good education that leads to a successful career is no longer enough to afford all that it would have in the past, like the ability to purchase a home.
At the same time, many older Canadians blame the lack of prosperity of younger generations on a weak work ethic or poor financial habits. The consensus seems to be that if young people stopped spending so much money on luxuries such as vacations and overpriced brunches, they would be able to afford a home.
These arguments all boil down to one point of disagreement. Are young people failing to get ahead because of something within their control, or has it objectively become harder to get ahead?
In my view, this topic has become so contentious partially because both sides can point to evidence supporting their assertions.
Claims that skyrocketing home prices have made life exceedingly unaffordable are quickly dismissed because, according to our government, wages have actually grown in recent years, even after accounting for rising prices.
So which side is right? Has life become more expensive, or not?
We’ll answer this question today by looking at some data.
Supposedly, young people are earning as much, if not more, than their parents did
A little while back I published a post containing an image similar to the one below, which describes how inflation-adjusted wages have evolved in Canada over the last few decades.
Here, the graph depicts that in 2020 the incomes of younger workers (between the ages of 25 and 34) were essentially the same as they were in 1980.
Last time we discussed this image my goal was to point out how crazy it is that despite all of the advancements since the 80s, workers are still earning a similar amount.
However, this image could also be interpreted in another way.
The income data above is inflation-adjusted, meaning that, at least in theory, it accounts for rising costs. So, one could reasonably conclude from this chart that life is not any more expensive than in the past.
The fact that inflation-adjusted wages have held steady over time suggests that the rising cost of living has been offset by wage gains.
If the earnings of today’s young people are similar to those of their predecessors, they should be able to afford that same standard of living. If they can’t purchase necessities that the generations that came before them could, like a home, it’s probably because of their exorbitant spending habits.
Before we commit to this conclusion, let’s take a detour to discuss some details about the data we are using.
What is inflation-adjusted data, and why do we need it?
Inflation adjustments are necessary to make comparisons across time.
Imagine a scenario where wages double, but the cost of everything triples. Despite higher incomes, people would really be earning less since they couldn’t afford as many goods and services as before.
Purchasing power is eroded by costs growing faster than incomes.
Comparing wages directly in this situation would paint the misleading picture that people were better off after incomes doubled, even though their paycheques wouldn’t go as far as they used to.
This is where the inflation adjustment comes in.
A good inflation adjustment would account for the fact that costs had risen by more than wages. In our example, inflation-adjusted wages should fall to reflect the loss of purchasing power.
How does Canada adjust wage data for inflation?
The green line is the median income for Canadians 25-34, without any inflation adjustment. It rose steadily over the last few decades, but as we discussed above this isn’t terribly useful information. It’s not clear from the green line alone how much incomes rose relative to the cost of living.
The blue line is the inflation-adjusted version. It’s the same blue line as in the previous chart. Statistics Canada, the government agency that produced this data, created the blue line by using the Consumer Price Index (CPI) to adjust the green line for inflation. The CPI values published by Statistics Canada are supposed to represent how price levels throughout the economy change over time.
The first step in the inflation adjustment is to use CPI to determine how much higher prices were in 2020 (the final year in the series), compared to each of the preceding years. Next, the incomes for each of these preceding years are adjusted upwards by however much prices were found to have risen.
For example, if in some previous year price levels were half of what they were in 2020, then the inflation-adjusted income for that year would be double the unadjusted income level. This was the case in 1987, when CPI was calculated to be 69, compared to 137 in 2020. The median income in 1987 was around $19,000 before, and $38,000 after, the inflation adjustment.
The problem with relying on CPI to make inflation adjustments
CPI is synonymous with inflation in Canada, but it’s essential to recognize that CPI is just one way of measuring inflation. As I’ve written about extensively for Generation Squeeze, CPI is a poor inflation gauge because it does not reflect the cost of purchasing a home. CPI’s insensitivity to property values means that it dramatically underestimates the erosion of purchasing power experienced by Canadians hoping to one day own a home.
As we’ve seen, wage data adjusted for inflation using CPI suggests that earnings are about the same now as they were in the 80s. A more realistic inflation measure, one that incorporates the cost of buying a home, would tell a very different story.
Remember, the size of the inflation adjustment of wages is determined by how much lower prices were in the past relative to where they are now. More price growth means a bigger adjustment. CPI underestimates how much prices have grown because it doesn’t account for the rising cost of purchasing a home, so the adjustment is smaller than it should be.
If the inflation adjustment accounted for the cost of purchasing a home, the blue line in the charts above would be downward-sloping, not flat, illustrating that earnings have actually decreased over time since they haven’t kept up with the rising cost of living.
Young Canadians are earning far less than in the past
There are some examples that make this clear in a previous edition of People Over Profits, where we discussed a Generation Squeeze report. Here are a couple of the key findings:
In 1976 it took a typical Canadian 5 years to save up for a 20% down payment, today it would take 17 years on average.
For a typical young person to afford a mortgage at current interest rates average Canadian home prices would need to fall $341,000 (half of their 2021 value) or average full-time earnings would need to increase to $108,000/year (double the current levels).
To me, the below image puts things in perspective by demonstrating how much the home-price-to-income ratio has risen in recent years. Since 2005 home prices have grown from around 7x to 17x the median income.
With all of this in mind, it seems pretty obvious that young people today are not earning as much as their predecessors. Purchasing a home used to be within the reach of most hard-working Canadians. Now, incomes need to double for a mortgage on an average home to become affordable. This doesn’t sound like a situation where earnings have held steady, as the official data tells us. If they had, the time to save up for a downpayment wouldn’t have grown more than threefold.
Our reliance on CPI to measure inflation is leading us astray.
Money doesn’t go as far as it used to, largely because of sky-high property values. CPI, Canada’s measure of inflation ignores this phenomenon. This systematic underestimation of inflation enabled years of ultra-low interest rates, which in turn helped drive our housing market out of control.
To add insult to injury, dwindling earnings are disguised in our official wage data by the use of CPI to adjust for inflation. This can mislead us into thinking that young people have the same opportunity their parents did.
But let’s be clear, life is way more expensive now than it has been in recent history, despite what the official statistics claim. Young Canadians are failing to get ahead because costs have skyrocketed relative to wages, not because of something they have done something wrong.
That’s all for this time!
If you have any questions/comments/feedback, I would love to hear from you.
Thanks for reading,