The magic number is 2 percent. The ECB is aiming for this 2 percent benchmark for the inflation rate in order to ensure price stability in the euro zone. While doing so, it is questionable whether this indicator is still realistic and useful because the ECB seems to be doing its calculations without considering the digitization.
For almost ten years now, inflation in Germany has remained constant below the 2 percent mark and in some cases even below 1 percent. However, the Deutsche Bundesbank recently feared that inflation could at least temporarily rise to up to 4 percent. Others go as far as to say that a new financial crisis is winding up on the horizon.
Temporary price increases seem plausible
There are many reasons why prices are rising in 2021 compared to the previous year and many are related to the impacts of the Coronavirus. At first, the pandemic caused the demand for various products to collapse and thus encouraged low prices. Now, in turn, prices are rising due to supply bottlenecks and more expensive raw materials. The fact that governments enter new liabilities and central banks pump money into the market to support the economy does the rest.
However, whether or not there will be a longer period of rising prices, has largely to do with the importance and consideration of technology in the future. After all, technology has a deflationary effect.
Technologization lowers the demand
Where does the claim come from that states that technology is deflationary? There are two main reasons for this effect. One is demand-related, the other is supply related.
With the progressive technologicalization of the society, the demand for labor is decreasing. Many production steps can be taken over by robots. In the service sector, apps and self-service applications already replace personal contact with employees or sometimes even make the hiring of an expert redundant.
As companies require fewer workers, the number of jobs is decreasing. The oversupply of those willing to work lowers wages. This is resulting in a reduced macrosocial purchasing power, which leads to lower demand. Thus, significant price increases get unattractive.
Scalability creates potential oversupply
At the same time, technologization enables companies to scale their offerings at a much faster pace. This leads to one outcome: Demand and thus price fluctuations are more moderate.
If demand increases, providers can supply adequate capacity within a short period of time in order to master even a phenomenal increase in their numbers of customers easily. This has been observed for example shortly after the outbreak of the Coronavirus and the increased demand for video conferencing applications.
But yet, this effect is not just limited to solely tech companies. Since digital applications play a role in every area of life and every industry, less technology-related companies do benefit as well. Compared to previous decades, companies today are in a better position to react quickly to fluctuations in demand: Whereas companies used to need several years to expand production lines in order to cover significant increases in demand, today they can often do so within a few months due to digitally supported production systems and smart workflows.
Due to technological innovations, providers can meet demand in more and more industries at any time. For example, the offer from SaaS companies is structurally hardly limited. This oversupply also leads to reduced prices, so at least in theory.
Relevant for a variety of industries
Skeptics may argue that there are industries in which technologization with its economies of scale does not work. And that’s true. But digital applications often affect sectors indirectly, for example in the education, medicine or the real estate sector.
Diseases may soon be diagnosed with the help of AI applications in a fraction of the time and without the efforts of highly qualified doctors. 3D printers could take over the planning of buildings and the production of construction materials, making them significantly cost-efficient. In these cases, too, digitization leads to cost reductions and thus ultimately to a decline in demand, which has a price-lowering effect. If more competition arises through digital innovation, if new market participants offer customers alternatives, the pressure on prices increases even further.
Theory and practice
So, do we no longer have to fear high inflation rates due to the digital transformation? At first glance, the arguments for the deflationary effect of technology seem consistent to me.
However, especially with successful SaaS companies, I cannot see that the unlimited range of their products leads to declining prices. Over the past 10 years, we have seen an average software inflation rate of around 5% per year. In particular, the pricing of software, which has become mission critical for its customers, has, in my experience, been uncoupled from the simple connection between supply and demand. According to this, the companies are implementing price increases.
Since these effects cannot be seriously measured, it is not possible to quantify the contribution made by tech companies to price stability.