Over the last 20+ years, inflation as measured by the Consumer Price Index (CPI) has averaged 2.1%. Not bad, you might think, but what do you find if you bother to look past the average?
CPI, the most well-known inflation measure, is widely used to support cost of living adjustments used in collective bargaining agreements and social security benefit calculations, just to name a few . Starting with the measurement of nearly 80,000 prices, CPI is grouped by components, such as Food, or Energy that are in turn made up of many sub-components. The chart below reflects various examples of CPI components and how their own price changes have diverged over the last two decades.
For those who have encountered, or planned for, the costs of hospital services and the education and care of our children, you know how dramatically these have increased. Nor will it surprise you to see that the costs of televisions and computers have declined dramatically. What the chart also shows is the growing separation between service pricing increases on the one hand, and goods pricing decreases on the other. Taken together, it results in an average inflation rate that seems benign. But can this continue?
As China, and other emerging countries, began their own journey up the economic development curve, propelled by membership in the World Trade Organization in 2001, cheap domestic labor pools allowed the manufacture of goods much less expensively than the U.S. This drove U.S. companies to relocate their production of goods as much as possible to lower their costs and compete more effectively on price. This is how you get televisions to improve quality at the same time prices go down. The degree of manufacturing competition and the easy substitution of one television for another is why those items showing price deflation are mostly goods. Globalization and the willingness to conduct business anywhere in the world drove this process further than ever before.
This does not happen with services. We cannot reasonably relocate services provided by the local hospital or a caregiver. Services are less geographically flexible than goods. How many medical facilities or schools are in your neighborhood? Far fewer than places to buy your next television or computer or toy. For service consumers, there are comparatively fewer ways to benefit from competition and substitute one option for another. A business opportunity exists to flatten the service pricing curves.
However, globalism is now slowing and may start to retreat. Rising labor costs in China were already driving U.S. companies to look elsewhere, but relocating supply chains is a long and complicated process. Growing nationalistic views from various populations hastened this process and Coronavirus will accelerate it. Many companies are looking to place production as close to their customers as possible, often exchanging cheap labor for a reduction in supply chain risk. As this cycle picks up, goods price declines will likely bottom out while service prices continue their ascent. How much cheaper can your next television get?