Who wants a society where we all drive smart cars but our schools are hopeless?

'This low inflation consists of big changes in relative prices: goods are getting cheaper, services more costly'

Prepare for a world of no inflation - except that we may not like it too much when it comes.

Prepare for a world of no inflation - except that we may not like it too much when it comes.

True, the retail price index was up 2.9 per cent last year, thanks in part to oil prices and higher interest rates. But knock off the effect of those mortgage payments, and underlying inflation was just 2 per cent. Knock off tax increases as well and it was only 1.8 per cent. And on the EU measure it is less than 1 per cent, the lowest of any large EU country - though I have never quite managed to understand how the Brussels statisticians manage to get it down so much.

But we don't really accept this, do we? We still have an inflation psychology; understandably, for inflation has dominated the past half century. Some aspects we rather like. Thus most householders feel rather pleased to discover that they have "made a profit" on their home. We certainly like annual pay rises. When we don't like it, we mostly put up with it. So train companies can ascribe higher fares to higher costs. Insurance companies can put up car insurance rates, ascribing this to higher car crime and rising repair charges. And the Government (petrol tax apart) seems to have got away with increasing taxation, thereby increasing the charges for the services it delivers.

In the shops, though, things are completely different. The retail trade has been living with zero price increases for about three years. Clothing and footwear is down more than 4 per cent on the year. The price of computers falls by a little over 1 per cent a month. The motor trade managed to increase sales by cutting prices on average between 10 and 20 per cent.

So our very low inflation actually consists of a lot of things going down in price, and another lot going up. As a rule of thumb, goods are getting cheaper and services more expensive.

Thus cars are getting cheaper but car insurance is going up. Computers are getting cheaper but help-lines are charging more. It's cheap to buy a new fridge but a pig to get the old one repaired. This shows in the stats: thus last year the price of leisure goods was down 2.6 per cent, while leisure services were up 5.1 per cent.

There are three main reasons why this is happening. First, it is much easier to import goods from lower-wage countries than it is to import services. Our cheap new fridge came from China and I hate to think what the poor people who made it were paid. The old one could have been repaired but that means central London wage rates. Two hours' labour, the call-out fee and a lot of tooth-sucking - it was cheaper to buy the new one.

Second, it is much easier to achieve increases in productivity when you make things than when you offer services. Go to a car factory and there is hardly anyone on the lines: much of the work is done by machines. Contrast that with a call-centre, where the bods disappear into the middle-distance. If a depressed region needs to create jobs fast, it would be wiser to persuade companies to put call centres there rather than having to bribe car companies to build a new model.

Third, as our societies get richer, we increase our demand for services and reduce our demand for goods. We can only drive one car or wear one set of clothes at a time; but we seem able to spend more and more on holidays and other leisure activities. The older our societies become, the faster the shift from spending money on goods to spending money on services.

But where will this world lead? Imagine a world where goods are much cheaper even than today, yet services much more expensive. In terms of material possessions it will be possible to be, by today's standards, rich. By comparison to, say, the early Fifties, when hardly anyone owned a car, a television or a washing machine, we already are rich, but imagine this going much further.

On the other hand, many of the services we most want, including health care, will be much more expensive - whether we pay for them privately or through taxation. We worry now about the cost of getting things fixed, of bank and insurance charges, of most public transport. We worry about the tough time young people have bringing up kids. Sadly, that is all going to get tougher still, for the relative cost seems like to rise inexorably.

The cost of government services look toughest of all to contain. You may believe that governments are not the most efficient of organisations, but even if they were, things would be difficult for them because the services they provide inevitably require people.

The danger for government is that voters will become disillusioned, not because governments are inefficient but because however hard they try, they are forced to offer a worse service for higher taxation. And in a world of zero inflation, higher taxes appear an even worse bargain than in a world of generally rising prices.

Do we want a world where just about everyone can afford a BMW but can't afford to get their kids into a decent school? Most of us would say absolutely not. So what is to be done? There can be no magic wand, but here are four suggestions, two for the private sector, two for the public.

First, service industries have to recognise that they must drive down their costs in much the same way as manufacturing ones have been forced to do. They must do so not just to maintain profits or, more brutally, because competition is likely to put them out of business if they don't. They actually have a moral duty to create great services for the not-very-rich: better financial services and cheap pensions. Second, the private sector has to learn how to employ the new technologies to drive down costs. Manufacturing is doing it because it has no alternative, and some service industries - the cheap airlines for example - are well ahead. The laggards need a push.

Third, government must be aware that it loads costs on to service industries by crass regulation and the encouraging of litigation. The industries do not pay the costs; we do, in higher prices.

And finally there has to be a service revolution in government itself. Our present government knows this, but the slope it has to climb is a steep one.

There is no hiding place. A world of no overall inflation is a world where changes in prices, up or down, become more explicit. Neither business nor government can blame inflation for its own inefficiency any more.