Sep 10, 2021

Bring on the goods' inflation

Prices of goods have recently risen faster than those of services, for the first time in 25 years. We think this special Covid trend will turn around again soon. A pity, actually.

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What connects Donald Trump, the Covid pandemic and William Baumol, a prominent U.S. economist who died in 2017? All three can help us explain our Chart of the Week.

It shows how different the price trends in services and goods have been in the U.S. economy. Since the mid-1990s, the prices of services have risen fast while those of durable goods have been negative. But that trend has recently seen a remarkable change: since May 2020 durable goods prices have risen again. And faster than those of services.

What might have caused that? It might seem that the Trump administration’s policy of weakening globalization could be the reason. But that idea can be refuted. The U.S. President’s tougher stance toward China had already made itself felt in bilateral trade statistics in early 2018. Back then, goods imported from China and made more expensive by punitive tariffs fell sharply in volume – but their prices, too, continued to fall. It was only later, during the Covid-induced lockdown, that durable goods’ prices surged. The reason is well-known. As theaters, concerts and restaurants were removed from the list of possible pastimes, all sorts of goods were ordered online. These quickly became scarcer and more expensive, yet they continued to be purchased blithely. Direct stimulus checks to U.S. households also helped.

Productivity advances are concentrated in goods that can easily be automated.

We do, however, expect a reversal of this reversed trend. First, consumers' appetites are met for now, and fiscal-aid payments in the U.S. are due to expire this month. Second, globally traded goods are exposed to more competition than services that are mostly provided locally. And third, Baumol's Law[1] should make itself felt again. As early as 1966 he reflected on the so-called "cost disease"[2] he describes as follows: Productivity advances are concentrated in goods that can easily be automated. The cost advantage is passed on partly to customers and partly to the (reduced) workforce in the form of higher wages. But to prevent these higher wages from drawing more workers into the industry and leaving other sectors understaffed, wages must also rise elsewhere. In other words, in areas where labor's contribution cannot be replaced by machines – such as teaching, music, massage treatments or mail delivery.

Different inflation paths (U.S. data)

20210910_CotW_Inflation of goods and services_CHART_EN.png* Personal Consumption Expenditures (PCE) Price Index
** Measure of inflation, which is the ratio of the nominal gross domestic product of a year to the real gross domestic product.

The relative cost of these services therefore increases compared to more abundantly or cheaply produced goods.

Now, there are two common ways for consumers to avoid spending more: reduce the quantity or the quality of the service itself.[3] But there is a third way, which from a sustainability point of view is more desirable: increasing the price of goods. For example, by imposing higher taxes on CO2- and resource-intensive products. In our view, the European Central Bank (ECB) will have no objection to this kind of inflation as it should benefit the Eurozone's CO2 footprint. The U.S. Federal Reserve (the Fed) might be more concerned, however.

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1. Baumol, William J.; Bowen, William G. (1966). Performing Arts, The Economic Dilemma: a study of problems common to theater, opera, music, and dance. Cambridge, Mass.: M.I.T. Press.

2. Given the complexity of the subject, especially when international trade is added, this theory only covers part of the subject for which many more theoretical models are circling.

3. For example, instead of taking a one-hour guitar lesson with a Maestro, you could go for 45 minutes or choose a less accomplished teacher.

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