Thursday 28 Mar 2024
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This article first appeared in Forum, The Edge Malaysia Weekly, on October 10 - 16, 2016.

 

As we stand on the brink of the fourth industrial revolution, the technological change can seem daunting: self-driving cars, intelligent machines and robots everywhere. There is an idea that global inflation rates will collapse as new technology increases efficiency and lowers costs. The Apple iPhone 7, in short, could cause global deflation.

This idea is wrong. It is based on confusion between the price of a single item and the prices of the multiple things that form inflation. If the price of one thing is changing, that tells us something is happening in the market for that thing — that the efficiency of supply has changed as a result of technology, for instance.

Policymakers should not normally worry about a price change in a single market. If the prices of multiple things in the economy are changing, that tells us something is happening in the wider economy. That is inflation or deflation, and that matters to policymakers.

There are three reasons investors should not expect deflation to be the automatic consequence of technology.

The first reason is history. The technological change of each of the previous industrial revolutions was accompanied by high inflation and hyperinflation somewhere. The first industrial revolution (late 1700s and early 1800s) saw high inflation in the UK, the cradle of the revolution. France had hyperinflation. The second industrial revolution (late 1800s and early 1900s) saw hyperinflation in North America, France (again), and several other European economies. The third industrial revolution (1970s) was marked by hyperinflation in South America and near hyperinflation in the UK and Japan. The deflationary technology story clearly has not worked in the past.

The second reason is the difference between relative and general price changes. Technology may lower the relative price of some goods and services, but that tells us nothing about what is happening with the price of other goods and services. With populations ageing in many countries in Asia and Europe, what is going to be the more important part of consumer spending in the future — the latest smartphone or medical care? Falling smartphone prices tell us nothing about the price of healthcare. The salary of a nurse is likely to be more important to future inflation than is the price of the latest smartphone, however matte the black of the smartphone’s casing.

The final reason is that demand patterns will shift, with price implications. If technology lowers the price of some goods and services, the relevant economic question is what happens with the increase in real disposable income? If consumers spend less on a smartphone, they have more money to spend on other things. If demand for other things increases, what happens to the price of those things?

One macro example of this is the role of China in the world economy in recent years. China’s increased involvement in the global economy has raised global inflation — China increased the supply of certain low-cost products, lowering their global price (just as technology might do); China also increased its demand for commodities at the same time, raising their global price. The net result was that China’s increased global engagement raised global inflation.

If technology increases the efficiency of some things, it should lower the relative price of those things when their prices are compared to less technology intensive things. This tells us nothing about the general price level in the economy.

Inflation can go up or down with an industrial revolution — indeed hyperinflation is very possible in an industrial revolution. The iPhone 7 tells us nothing about the future course of global inflation; only an economist can do that.


Paul Donovan is global chief economist, UBS Wealth Management . His latest book The Truth About Inflation was published by Routledge in April 2015.

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