What is in a price? And what does it all mean for our standard of living?
Automation, roboticisation and miniaturisation are changing wondrously the way we produce and consume goods and services, including the medical treatments that can keep us alive for longer and with much less morbidity. To which forces of change we could add the internet of things that connects us ever more effectively and commands so much more of our attention.
The benefits of this technological revolution that we can see and feel are not at all obvious however in the measures we use. We are informed that US productivity continues to grow very slowly. And real GDP is growing as slowly, as are wages and incomes adjusted for inflation. Apparently Americans are not getting better off at the pace they used to and are frustrated with their politicians they hold responsible.
Is our intuition at fault or the way we compare the prices of the goods and services we consume over time? All measures of output and incomes are determined in money of the day, calculated and agreed to in current prices. They are then converted to a real equivalent by dividing some sample of output or wages estimated at current prices, by a price index or a deflator. A price index measures the changes in the prices of some fixed “basket” of goods and services thought to represent the spending patterns of the average consumer. The deflator calculates the changes in the prices of the goods and services consumed or produced today, compared to what would have been paid for them a year before.
Both estimates attempt to make adjustments for changes in the quality of the goods and services we are assumed to consume. A car or a pain killer or cell phone we buy today on today’s terms may do more for us than it would have done at perhaps a lower price, or possibly a higher price (think dish washers or calculators) five or 10 years before. It is not the same thing we are making price comparisons with.
A piece of capital equipment today, robotically and digitally enhanced, is very likely to produce many more “widgets” today than a machine similarly described 10 years ago. And it may cost less in money of the day. It is a much more powerful machine and firms may well make do with fewer of them. Their expenditure on capex – relative to revenues – may well decline, indicating (wrongly perhaps) a degree of weakness in capital expenditure. The problem may not be a lack of willingness of firms to invest more, but how we measure the real volume of their investment expenditure – quality adjusted.
There is room for moving the rate at which a price index increases (what we call inflation) a per cent or two or three higher than they would be if quality changes were implied differently and more accurately. And if s,o GDP and productivity growth would appear as equivalently faster.
It is instructive that the US Fed targets 2% inflation – not zero inflation – because 2% inflation (quality adjusted) may not be inflation at all. And zero inflation may mean deflation (prices actually falling) enough to discourage spending now, to wait – unhelpfully for the state of the economy – for better terms tomorrow.
Over the past three months there have been no increases in prices at retail level in SA. The annual increase in retail prices (according to the retail deflator) fell below 2% in January 2018 and is far lower than headline inflation. (see below). The Reserve Bank would do well to recognise that the state of the economy – coupled with what the stronger rand provides businesses in SA – leaves both manufacturers and retailers with very little pricing power. Nominal borrowing costs – well above business inflation – are in reality applying a significant real burden for them. They could do with relief. 12 April 2019
