Technological Deflation is a Gift - May 21, 2003
by Stephen S. Poloz, Vice-President and Chief Economist
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Deflation is a word generally uttered with a sense of dread. Japan’s deflation experience has been devastating, and some observers are now worrying about deflation in the U.S. and Europe.
For the ordinary consumer, a little deflation may not seem so bad. The fact that DVD players may be purchased for under $100 today is clearly better than having to pay $500 as we did in the past. That difference of $400 is a major increase in purchasing power – a gift of technology. Yet, deflation truly hits home when the price of the product you are producing is falling. With the global manufacturing sector operating with around 25% excess capacity, many manufacturers are cutting their prices just to stay in business. They can only do so indefinitely by reducing their costs – using new technology or processes to lower headcount or otherwise boost productivity.
Those producers facing technological deflation often point to China as the source of competitive pressure. China’s economy is going through a massive reform process. Inexpensive freed-up labour is being given new equipment to produce excellent products at low prices. The situation is quite similar to when the American economy really took off in the mid-1800s. This, too, produced a major increase in global productivity, which threw a wave of deflation onto the producers of old Europe. One result was the Victorian depression of the late 1800s, as producers in the old economy struggled to meet the new competition coming from North America.
The key to surviving technological deflation is to incorporate the new low-cost producers into existing supply chains. Indeed, a growing number of Canadian companies are outsourcing some of their labour-intensive manufactured components to China. Meanwhile, they concentrate their domestic efforts on the components that require less labour but more engineering or a higher level of technology. This outsourcing boosts their productivity and profitability and strengthens sales, thereby creating more higher-value jobs to replace those outsourced to China.
Technological deflation is quite distinct from generalized macroeconomic deflation, as experienced in Japan during the past decade and more broadly during the 1930s depression. Generalized deflation sees all prices falling because of insufficient demand. The economy cannot break out of its deflationary trap because consumers hold off on spending, awaiting still lower prices – a vicious deflationary spiral that only an aggressive central bank can break.
Importantly, the difference between healthy low or zero inflation and disastrous deflation is not a razor’s edge. In a low-inflation world, such as we live in now, many prices are likely to be falling, often for technological reasons. Other prices rise by a higher rate – in the past year, insurance costs are one example. Measured inflation is simply an average of these different trends.
The bottom line? Today’s symptoms of deflation are mostly fortuitous, even though they pose challenges to manufacturers. The potential emergence of the more deadly form of deflation cannot be dismissed lightly, but is unlikely given continued stimulative monetary conditions.
Stephen S. Poloz
Vice-President and Chief Economist
Export Development Canada
spoloz@edc.ca |
