It's a buyer's market - and going down

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WHISPER it low, but Britain may have achieved stable prices - and if it has, there are enormous implications for all of us. Most people at the moment assume that inflation will remain low, perhaps under 5 per cent, but very few would expect the general price level to remain stable in the long term.

People still have a general expectation that house prices will tend to rise and that wages and salaries will go up. The experience of prices rising tenfold in the past 30 years has left such a scar that the assumption under which our grandparents and great- grandparents lived most of their lives - that prices were as likely to go down as up - seems almost absurd.

But is it realistic to speak of us facing no inflation at all? And in a week when VAT has started to be levied on fuel bills? True, the main official measure of prices, the retail price index, shows prices up 2.4 per cent on a year ago, while the underlying rate of increase (excluding changes in mortage interest rates) is 2.8 per cent. But it may well be that the RPI is overstating inflation, so that in fact we have already achieved stable prices.

This suggestion comes from S G Warburg, the City investment bank. We have always known that the RPI finds it very difficult to allow for improvements in quality: the fact that when a new product comes out it is generally an improvement over the one it replaces. But the Warburg team has gone a stage further and identified 20 specific reasons which, taken together, suggest that, on a conservative estimate, the RPI is overstating inflation by at least 1 and maybe as much as 4 per cent.

These reasons have a commonsense appeal. For a start, the RPI does not allow for our purchases of cheap alcohol and tobacco brought back across the Channel. It does not allow for the fact that we shop around for the cheap offers of the week in the supermarkets, or that we will switch brands - and indeed products - when they are cheaper. We are, so to speak, shopping harder than we used to - a point that is accepted by the supermarkets as they bring out their various cost- cutting programmes in response to the challenge from the discounters.

There are also some items of spending which the RPI deliberately excludes. Among these are new car prices, which have fallen sharply recently. New types of product do not enter the index until they have been on the market for some years, by which time their price has fallen. A good example is the microwave oven, which cost about pounds 300 in the late Seventies, but was not included in the RPI until 1987, by which time its price had fallen to pounds 100.

As well as types of spending which are excluded, there are types of people: the richest 4 per cent (who account for about 14 per cent of spending) and pensioners (who account for about 5 per cent of spending). Price rises of services (which tend to be bought by the rich) and of food (which accounts for a high proportion of spending by the elderly) have both been below average in recent months.

Finally, there is a string of other distortions which the RPI does not take into account: the growth of interest- free credit; special two-for- one offers from restaurants; 'happy hours' in pubs; the fact that we apparently do not disclose some types of spending, such as betting; the fact that many shops will negotiate prices if shoppers push for it; and the growth of shoplifting and the black economy.

There are two central points in all this. First, we as consumers are behaving much more aggressively than we used to. Second, retailers and other sellers of goods and services are behaving much more competitively than they used to. The RPI, by assuming that shoppers just pay the advertised price for a given basket of goods and services, has failed to catch up with the way we shop now.

But this is not just a matter of misrecording the effect of a behavioural change and therefore overstating inflation. The behavioural change will of itself tend to hold down inflation. In the Seventies and Eighties, people accepted that prices would rise as a matter of course; and, while they might not like that, at least they could understand it. If a manufacturer put up its prices too fast then it could wait and allow the others to catch up. And buyers who paid over the odds could console themselves with the fact that they had at least bought more cheaply that they would have done a few months later.

Now the relationship between buyer and seller is quite different. Producers who are seen to increase prices in an unjustified way may well be forced into an embarrassing retreat and actually have to revert to their previous prices. And shoppers who pay over the odds have to live with their error, rather like the home-buyers of 1988-89.

Furthermore, there is no pressure to buy early because of impending price rises - rather the reverse, for it may make sense (as it has for some time with computers and cellular phones) to wait until the price falls. So the balance of advantage in the timing of a purchase is very much on the side of the buyer, rather than the seller. To tempt the buyer, the seller has to offer something special.

Anyone looking at the adverts in the newspaper or on television will be aware of this. Not only is there a host of special offers - zero finance on household durables, free servicing for cars, new special discounts in supermarkets - but a fair number of the advertisements are boasting that prices have come down. Both BT and British Gas have been running campaigns stressing how their prices have fallen in real terms, while BT has abolished its peak rate.

The more we become accustomed to zero inflation, the more likely we are to keep it. Even on the published figures, inflation this cycle has remained much lower than the economists predicted when sterling came out of the exchange rate mechanism.

One important reason is increased consumer sensitivity to price rises. Maybe as many as one-third of people in employment will have had no increase in money wages in the past year. To maintain their standard of living they have to shop harder.

Even people who have seen a rise in pre-tax pay will find that after-tax pay has not risen. So they too will respond by refusing to accept price rises, even if that means changing the brand they buy.

A lot of relearning is now taking place. Retailers who cut prices are learning that they can achieve sharp increases in volume, while those who increase them will be punished. Wage bargainers are learning that the rules of centralised bargaining - the old RPI plus X formula - no longer apply. Instead, pay levels are being set by the demand for specific skills.

The relearning may extend to matters of tax. Nobody likes paying more tax, but in a world of high inflation tax rises are easier both to conceal and, maybe, to accept. The particularly hostile response this week to the rise in taxation may reflect a feeling that in a world of more-or-less stable prices, taxes should be stable, too. Of course, people cannot easily shop around for cheaper taxes as they can for cheaper supermarket prices, but that impotence may have the effect of increasing their hostility to higher taxation.

For the rest of our spending, though, there is an easy remedy to higher prices. Don't pay them.