Welker’s Wikinomics Blog » Surprise: Product prices falling across the world!

Sep 09 2008

Surprise: Product prices falling across the world!

Published by Steve Latter at 6:28 am under

I wonder how many people in countries like the United States, Switzerland, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy, you say! Prices are rising too fast!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, things are becoming less expensive. Of course, the paradox is that although nominal prices (the actual price tag) are, in fact, increasing, nominal income (the average wage) has been growing faster. This is a topic that in economics is called “real income” or a measurement that compares a nation’s income growth relative to the growth in prices that the same income buys.

Let’s take some specific facts:

In the United States real median household income grew from $41,318 to $50,811 from 1970 through 2006 for a total percentage gain of 23% (source: Pew Research Center). Both of the aforementioned median household incomes are stated in 2008 or current dollars which makes the comparison valid. Median household income is an attempt to quantify the progress that the “middle American” family or typical family has made. So, in short, the median household in America can buy 23% more with their income today than they could in 1970. In other words, relative prices are lower to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (23%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated & entrepreneurs driving up real income growth rates much faster for the “average” than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark price increases to income increases to really understand whether things are becoming more expensive. The vast majority of products & services are cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own their own houses, drive more and better cars, have cable and computers. The reason we are led to believe differently is because we are victims of our own human nature which tend to focus on the problem areas (higher relative prices) and not the benefits (lower relative prices). Most all citizens expand out to the last dollar of our incomes and quickly notice about those products that are rising faster than normal like gasoline prices! Hey, even gasoline prices are barely at an all relative price high. If gasoline prices are restated for inflation they are $3.50 today vs. $3.17 in 1981 and $3.50 in 1918!

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether your country’s middle class is enjoying less or more products and services. “Real income” really is just a measurement of the quantity and quality of products and services that you have. The median and average American continually has more actual products & services in the aggregate as U.S. income gains have averaged 3.5% per year outpacing higher price increases averaging 3.0% per year leading to a real gain in products and services. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education, energy, and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

About the author: Mr. Latter teaches various business courses at Paul VI Catholic High School in Fairfax, Virginia (USA) including AP Economics, Accounting, Marketing, and Personal Finance. Mr. Latter is a Certified Public Accountant (CPA) and former Chief Financial Officer with 8 years of high school business teaching experience. Prior to his career change to teaching in 2000, Mr. Latter spent 21 years in various auditing, accounting, and financial positions with Price Waterhouse, Sprint, and Teleglobe.

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7 Responses to “Surprise: Product prices falling across the world!”

# Justinon 09 Sep 2008 at 8:01 am

This may be correct, but there’s a major problem. The Federal Reserve has used easy credit in order to stimulate the economy, and most of the price increases that should have occurred due to that inflation were offset by cheap labor abroad. We’re just now seeing that inflation come back to hit in the United States, as we’re currently inflating at such high rates that even higher productivity and cheaper labor cannot offset there being too many dollars chasing too few goods.

Combine that with the fact that most of our economic growth in the past 15 years has been due to home equity loans from (seemingly) ever appreciating houses, not real gains in income… we’ve got a major problem.

Now we’ve got extremely high consumer debt, increasing inflation, housing prices correcting, businesses contracting, and a federal reserve that can’t postpone the correction due to the threat of hyperinflation, and well, there are plenty of other factors as well, but just these are enough to bring on a crash of epic proportions.

So go one telling people that prices are low now. They definitely are. But they are ever increasing, and our ability to spend is continually decreasing. Its a slow motion disaster.
# Steve Latteron 09 Sep 2008 at 4:53 pm

Hi Justin,

Thanks for the reply. You do make some nice points, but I am going to have to be honest and say that your “facts” are overly exaggerrated, in my opinion, in the pessimistic or negative direction.

You are correct that prices (CPI) in the United States have, in fact, increased 5.6% over the past year (July ‘07 - July ‘08) well above our average annual increase of 3.1%. This was driven by a 29% increase in energy prices over that same period. Excluding volatile energy & food, our inflation rate is pretty well in check with a 2.5% increase in prices over the same period mentioned above. Now, we do need to include food and energy since they are a part of our lifestyle, but LATELY (watch for the newest readings coming up) our inflation rates are LESS than normal since oil prices have fallen by 28% over the last few months. All in all, inflation is not as bad as the press would make you think.

Also, while you are correct that home equity financing in the past has helped fuel spending, real economic growth (more goods and services) is not fueled by spending but rather by productivity. Spending without productivity creates only inflation. The United States continues to astonish the world with gains of productivity in the last 10 years right up to the most current reading. It is productivity, not spending, that has generated the growth in our real incomes that I refer to in my post.

Finally, most economists would say that the FED has not created any problem at all but has helped to alleviate the housing and credit crisis in America. The FED has masterfully orchestrated, in my opinion, a cushioned, necessary correction in the housing and credit markets enabling us to continue to increase output (GDP).

Thanks for your insight and comments!
# Jason Welkeron 09 Sep 2008 at 4:54 pm

Good points, Justin.

Steve definitely takes a long-term view of the US macroeconomy. Since the 1970’s real incomes appear to be much much higher… but since 2000, real income growth probably isn’t so rosy. The business cycle and human psychology make for an interesting outcome… Americans tend to think in terms of the short-term, where as economists like Steve think in terms of the long term. In the short-term, Americans found they’ve gotten themselves in over their head as far as consumer and household debt goes… and now we’re paying the price in the form of weaker purchasing power compared to where we were just a couple of years ago in the midst of a housing boom and record increases in productivity. Our real wealth and income were rising, today our real wealth is falling with home prices, while productivity and cheap foreign labor are still putting downward pressure on prices.

I agree that our spending habits should be more tied to our income, not our wealth… as we have learned, wealth in real estate is risky and subject to fluctuations… repeatedly Americans have failed to recognize bubbles when they’re in one. If our GDP is made 70% up of consumer spending, and our levels of spending are based on the value of our assets like stocks and real estate, then it is no surprise that spending levels will fluctuate drastically, contributing to the cyclical nature of our economy, with the value of the stock and real estate markets.

National savings needs to increase, both among households and the nation as a whole, so that in times of bursting bubbles, consumer spending will not fluctuate as drastically as the value of our homes or our stocks. Strong household consumption is what’s needed to keep nominal incomes rising at home… Easy monetary policy and the Fed’s bailout of the mortgage giants are reactions to an underlying symptom of America’s sick economy, that of low savings, a high average and marginal propensity to consume, and our dependence on our assets as indicators of our wealth and ability to spend.

Great post, great comment from Justin, thanks guys! Keep the conversation going!
# Justinon 09 Sep 2008 at 7:27 pm

Steve and Jason,

Thanks for the responses. Admittedly, I am an amateur at all this. Not much formal schooling, mostly just reading on my own.

I have been concerned to find out that since we don’t calculate CPI the same way we used to (pre early 80s) our inflation numbers have been much lower than they would have been (since we’re not including housing, energy, food). Does that not effect what our GDP numbers are as well? Is GDP not measured indexed for inflation based on CPI? If CPI has been adjusted, in order to keep entitlement benefits from increasing so rapidly, which is how I understand things to have occurred under the Reagan administration, would those lower inflation measures keep GDP artificially above water, when in reality its much lower, possibly even negative at this time?

And I can’t agree that the Fed has done a good job, especially in the last 8 years or so. Greenspan’s rate cuts post 9/11 and and especially keeping rates low after the recession was over, in my opinion lead to the ridiculous speculation, and rapid appreciation of home prices. When its easy to get a super cheap loan, more people buy houses, as prices rise quickly, more people buy in order to make an easy profit, which in turn shoots prices up higher, much higher than a real market with real interest rates would ever take them. This in turn, leads to banks lending money to people who can’t afford it, because they KNOW that house prices will continue to rise at 20 or more percent a year, and people can just refi their 80/20 loans. And we all know what happened once prices stopped rising…
# Steve Latteron 10 Sep 2008 at 5:39 am

Hi Justin,

Yes, GDP as reported by the press is “real GDP” which is restated for inflation. So when you hear them talk about GDP know that it is restated for inflation and know that they almost always drop the “real” adjective so as to not confuse the common citizen.

GDP is not restated by the CPI, but rather a GDP inflation index. Since GDP includes production from both Government and Business (capital equipment), the CPI, which measures household inflation is too narrow.

Incidentally, housing, energy, and food are all included in the CPI. It is true, however, that the Government reports both a CPI without food & energy (”core inflation”) and a CPI with energy & food (”headline inflation”). Headline inflation is more important but the core rate helps one understand how all other less volatile prices are behaving. The FED tries to manage core inflation to approximately 2% or less. They have less control of food and energy although it certainly impacts real income!

In my opinion, the FED has done a great job over the last 8 years. The recession of 2001 was our shortest in history (rate lowering) and then the FED responsibly raised rates back up again and spending remained level. I also think that they have done an excellent job with this current credit and housing crisis, thus far, helping the economy function in a correction mode. People don’t appreciate the challenge that the FED has in balancing their policy to foster both economic growth and stabilize prices at the same time. If you average out economic growth rates (real GDP growth) and inflation rates for the last 8 years I think you will find that they are relatively consistent with our historical averages.
# Nicholas Burnhamon 11 Sep 2008 at 2:42 pm

I find it interesting that in a world where technology is being innovated daily to high standards in order to make jobs easier for people, the value of labour is going up. The fact that people are paying more money for employees to work easier jobs doesnt make sense to me. Its obviously a good thing, it just doesnt make sense. Im relatively new to economics, so im sure there something ive overlooked or dont know about, and i would appreciate you lot giving me a cue as to why this is happening.
# Steve Latteron 11 Sep 2008 at 4:41 pm

Hi Nicholas,

Great question! I can tell you are a thinker and that you want to truly understand things. That will take you far in life.

There are a number of ways I could answer this question for you. I’ll try two approaches:

1. Our productivity resulting in increased supply (more goods and services) created by the entrepreneur results in MORE stuff to enjoy…..and more means that the owner is willing to share the fortunes of his increased supply with you for a lower price than before, increasing the amount of goods and services that you can buy with your income. Forget about money really (I know that statement seems silly on the surface), your “income” should not be thought of as the paper money you get but rather it is what you can exchange that paper for! If the business (entrepreneur) is creating more products via productivity then she is willing to share them with you even though your job might not have changed that much. In short, the entrepreneur is sharing their riches with you in the form of more products and services even though you may not have changed your contribution that much. Some people call this the “trickle down effect”. For example, today’s workers that pick up trash in the park may be likely to have a cell phone and to have used Google within the last week to order a new pair of shoes.

2. Also, I wouldn’t say that jobs are necessarily easier today than yesterday so the higher real incomes are really a reflection of increased, required knowledge and responsibility. Most jobs today, versus “yesterday”, are different with most of them involving more training and education. 25 years ago, Claude’s job might have been to work in an assembly plant using his hands and eyes to assemble products for distribution to market. With a few hours of training he would be ready to perform. Today, however, Claude may be working new technology overseeing the operation of a million dollar machine to produce 1000x more product per day. Pay or income is linked to complexity, responsibility and value creation, not hours or sweat. So in one way, Claude’s job is easier (less sweat and hours), but in another way he has more responsibility and he should be paid accordingly and the economy allocates him more real income.

At the start of my school year, I always try to reduce to simplicity what the best measure of economic success is: it is more goods and services per person, also known as real gdp per capita or real income per capita. It is nothing more than “more goods and services per person”. Paper money is not the key. If we gave every family in America a million dollars, their standard of living (goods and services per capita) would not change…only prices would. A nation’s economic progress has been measured to increase by more capital, better capital (technology), more labor, better labor (education & training), more natural resources, and trade. Money is only a facilitator allowing for specialization.