The bonds that tie low inflation to the information society
Tuesday 14 January 1997
The most obvious products where prices are stable or falling are those connected with information technology: computers, telecommunications and the like. If you can't afford some equipment, wait a few weeks and it will be bound to be cheaper. As the graph below shows, in the UK the price of computers has fallen by one-third over the last decade - though because the weighting in the producer price index is only 1.3 per cent of the total (which seems astonishingly low) this has not done much to contain the rise in that index.
But, of course, the influence of the information age on the world economy goes far beyond the fall in the price of the kit. So it is an attractive notion to explore the nature of the link between information and inflation. This is the subject of a new paper by David Owen of Kleinwort Benson, the first of a series of long views into the future to be published by the bank.
His thesis runs like this. The development of information technology should be good for world growth and it will tend to go on holding down world prices. But it is one of the forces leading to growth in income differentials in the West, as it enables the people with the most marketable skills to sell their output to a wider global market, while those with fewer skills find themselves competing against similarly skilled from lower wage economies. One obvious implication for investors is that inflation will stay low; and this will be good for fixed-interest investments.
It is certainly an interesting thesis, but is it right?
To some extent it must surely be valid. The fall in the cost of computer and telecommunications has a long way to run, for several reasons. These include the probability that the technology of computing will carry on advancing for another couple of decades, maybe longer; the fact that the full decline in the cost of telecommunications that has already taken place has still to be passed through to consumers; the inevitable lag in the sophistication with which we use the new equipment as it becomes available; and the likelihood that better communications will speed up technology transfer in unrelated areas of economic activity, so that good practice in each activity becomes more universally applied.
There is, almost certainly, also some relationship between the rise in income inequality that is taking place and the rise in the need for skills that the information age demands. A vast amount of work has been done on this, particularly in the US but it remains very difficult to pin down with any precision the connection between the two. For example, the greatest surge in incomes in the US has been in the finance and legal industries, but these have been affected by the cult of the celebrity rather than the need for information skills. True, in theory, the growth of a global media industry has enabled Hollywood film stars to distribute their output more easily to other countries and may have increased their earnings. But a Wall Street corporate financier or a New York lawyer is basically still selling his or her services to the US market. And some of the information technology that has been applied has enabled service industries to use lower-skilled people than they would have done.
What has, perhaps, had more impact on widening differentials is the spread of the market economy to low-wage countries, particularly in East Asia. That is, in part, a function of the information boom, but it is more the transfer of practical manufacturing know-how. A firm in China can buy as good a plant as one in North America, Japan or Europe - and maybe buy in the design and marketing skills too. While the number of actual workers displaced in the US, Japan and Europe by such imports is still quite small relative to total employment, the surge in cheap imports has the effect of holding down general price levels, and hence wages, in the domestic industries.
But then again, the number of areas where imports from East Asia are significant are quite limited. Aside from electronic consumer durables, toys, footwear and some other clothing, and limited imports of cars, the impact of East Asia on prices has been very small. Expect it to grow, but the fall in inflation so far must have other causes.
If, however, one defines the information age more widely to include the impact that the instant information has had on financial markets, then there has been one area where it has already exerted a powerful downward force on all prices: instant high-quality information has surely increased the power of the bond markets, and it is that power which has been the main reason why the inflation dragon has been slain.
Of course the really big question is this. Does the continuing development of information secure this collapse of inflation? I think it will certainly help to do so, for three main reasons. The first is that it will become possible to import more and more on-screen services from lower-wage economies, so that the downward pressure on costs in things like consumer electronics will extend to a range of services, too. You can see this already with activities such as airline accounting being handled in Bombay, or software written in Bangalore.
The second is that the power of the bond markets will be underpinned by the spread of good financial practice by governments around the world, and that spread will itself be encouraged by the increase in information about government behaviour. Governments are being "trained" by the markets to up their performance.
Finally, I suspect the West's ageing voters will become more favourably inclined to low inflation, and will be able to "vote" their preferences in a variety of ways: not just through the ballot box, but also through opinion surveys and most importantly, where they place their own savings.
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