Internet shopping is for life, not just for Christmas

Even if the Net effect is quite small, it is terrifying retailers who fear losing chunks of business

IT IS - or rather it will be - the first Christmas of the Internet. Of course the Net has been running now for several years, but this will be the first Christmas spending season where large numbers of Britons will experiment with electronic commerce to buy some of their presents.

It will also, in all probability, be the first Christmas since the Second World War when prices in the shops will be lower than the previous year. We don't know that for certain, of course, but that was the suggestion of a CBI survey this week about retailers' expectations - more than half expect prices to be lower.

Is there a connection between the two? And - a bigger question - to what extent will the Net continue to exert downward pressure on prices in the next few years, radically increasing the deflationary forces in the world?

To argue that there is a link between prices in the shops and the Net might seem a bit far-fetched. The fall in inflation, not just here but throughout the developed world, has been a 20-year trend. It has already led to falling retail prices in Japan, where Net penetration is relatively low and e-commerce in its infancy. Just as people were surprised by the surge in inflation in the 1960s and 1970s, in recent years here the actual out-turn of inflation has been consistently below expectations - as shown by the top left graph, taken from the Bank of England's latest Inflation Report.

But that might not stop e-commerce becoming a powerful additional force for deflation, reinforcing an existing trend. That view is supported by a new paper by Sushil Wadhwani, one of the independent members of the Bank's Monetary Policy Committee. The thrust of the paper is to argue that wage pressures will remain low despite high demand for workers (see story on page 22), but part of his case for this view is that retail conditions are such as to squeeze the costs of the distribution chain. One of those squeeze points is the effect of the Net.

Is penetration high enough yet to affect retail prices? As the top right graph shows, the Internet has spread throughout the world far more quickly than other communications technologies. It is also totally global in a way that, say, television has never become. While UK Net penetration remains below that of the US, it is also well above that of the large continental countries. True, many people with Net access - maybe most of them - would not necessarily use it for buying Christmas presents, but I suspect those that do are already starting to squeeze prices. The "never knowingly undersold" motto of the John Lewis Partnership is a powerful totem for many retailers.

Here's why. Anyone buying a high-ticket item who can show that it is available cheaper elsewhere can usually deal to get the price down. But that has meant traipsing round competitors. Now, as the Net price comparison services develop, that work is done by someone else. Even if the Net effect is still quite small, it is certainly terrifying retailers, who suddenly see that a large chunk of their business might disappear. The mainstream retailers are scared, for what is happening is beyond the experience of any of them. Eventually they will develop effective e-commerce strategies themselves, using the fact that they have high-street presence to buttress their e-sales divisions. But their immediate response is to discount.

There has been a surge in discounting in recent months. In September the Bank of England's regional agents produced a report on discounting. This showed both the increase (bottom left-hand graph) and the perceived reasons for it (bottom right). The Net is not mentioned as such, but it must be one of the reasons for perceived increase in competitive pressure under the consumer behaviour and new competition heads.

Note that this perception of greater competitive pressure comes at a time when there is strong domestic demand. Retail sales are running up at an annual rate of over 3 per cent - faster than the growth of the economy as a whole. So the problem, from the retailers' point of view, is not that people are short of cash to buy or lack the confidence to do so. It is that they have become more aggressive about the prices they are prepared to pay. I suppose that the publicity about "rip-off Britain" has reinforced this.

Put this all together, and my guess is that we are in the early stages of a commercial revolution that will run hard for another couple of decades before it too becomes mature and settles down to incremental growth. E- commerce is not just for Christmas - it is for life.

It is easy to see all this from a micro-economic view - to be able to say that some portion of retailing will go online and then have an interesting debate about whether this will end up as 10 per cent of retail sales, or 20 per cent, or 30 per cent, or more. You can talk about the way in which different industries will be affected - will banks be harder hit than booksellers? We will get the answers wrong, but at least we know the questions.

It is much harder to make sense of the macro-economic picture. We don't have any experience of a technology that is both a new market-place, a new product, and a new way of organising production. We know that new products stimulate demand - look at the way the spread of consumer durables helped sustain rapid growth through the 1950s and 1960s. We know that new marketplaces lead to greater competition and remove the protection previous supplied by national boundaries - look at the way the internationalisation of financial services is forcing change on national providers. And we know that a new production method can over time make radical cuts in costs possible - look at the way Henry Ford's production line made cars a mass- market product.

What we don't know is what happens when all these changes come together. My guess is that it adds both to productivity growth and to deflation. If that is right, there will be a long period of stable or falling prices in which people will get richer largely as a result of these lower prices rather than by earning higher wages - a period not unlike the last quarter of the last century. But that is a guess, nothing more.

The interesting thing about this Christmas, though, is that it gives us a taste of the future. Nice, isn't it, to glimpse that while celebrating something that happened 2,000 years ago.