The magic number is 2 percent. The European Central Bank (ECB) aims for this target inflation rate to ensure price stability in the Eurozone. However, it is questionable whether this figure is still realistic and meaningful, as it does not take into account the impact of digitization.
In Germany, inflation has remained consistently below the two percent mark for almost ten years, sometimes even below 1 percent. Recently, the Deutsche Bundesbank expressed concerns that inflation could temporarily rise to as much as 4 percent. Others also see a new financial crisis looming on the horizon.
Temporary price increases appear plausible
The fact that prices are rising compared to the previous year in 2021 has many reasons, and many are related to the COVID-19 pandemic. It caused demand for various products to plummet, thus favoring lower prices. Now, prices are rising due to supply shortages and more expensive raw materials. Additionally, governments taking on debt and central banks injecting money into the market to support the economy also play a role in this phenomenon.
Whether there will be a longer period of rising prices depends significantly on the importance of technology in the future. After all, technology has a deflationary effect.
Technologization lowers demand
Where does the assertion that technology has a deflationary effect come from? There are primarily two reasons for this effect, one driven by demand, and the other by supply.
With the advancing technologicalization of society, the demand for labor decreases. Many production processes can be taken over by robots. In the service industry, apps and self-service applications replace personal staff contact or even the engagement of experts altogether.
As companies require fewer labor resources, jobs are eliminated. The oversupply of willing workers reduces wages, and the resulting overall decrease in purchasing power leads to lower demand, which makes significant price increases unattractive.
Scalability ensures potential oversupply
At the same time, technological advancements enable companies to scale their offerings at a much faster pace. As a result, demand and price fluctuations become more moderate.
If demand increases, such as during the outbreak of the COVID-19 pandemic for video conferencing applications, providers can rapidly expand their capacities to accommodate the explosive growth in their customer base.
But the effect is not limited to pure tech companies. Since digital applications play a role in every aspect of life and every industry, less technology-focused companies also benefit. Compared to previous decades, companies today are much better at rapidly responding to fluctuations in demand. While it used to take companies several years to expand production lines to accommodate significant increases in demand, today, with digitally supported production systems and smart workflows, they can often achieve similar capacity increases within a matter of months.
Thanks to technological innovations, providers in more and more industries can satisfy demand at any time. For example, the supply from SaaS (Software as a Service) companies is structurally hardly limited. This oversupply also has a price-reducing effect – at least in theory.
Relevant for a wide range of industries
Skeptics may argue that there are industries where digitization and its scale effects don’t apply, and that’s true. However, in many areas, digital applications have indirect effects, such as in education, healthcare, or the real estate sector.
The diagnosis of diseases may soon be possible in a fraction of the time and without the need for highly qualified doctors, thanks to AI applications. 3D printers can take over the planning of buildings and the production of building materials, making them much more cost-effective. In these cases as well, digitization leads to cost reductions and, ultimately, to a decrease in demand, which has a deflationary effect. When digital innovation leads to more competition and new market participants offer alternatives to customers, it increases price pressure even further.
Theory and practice
So, thanks to digital transformation, do we no longer need to fear high inflation rates? The arguments about the deflationary effect of technology seem quite plausible to me at first glance.
However, especially with successful SaaS companies, I cannot see that the unlimited supply 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. Especially the pricing of software that has become mission-critical for its customers has, in my experience, decoupled from the simple relationship between supply and demand. Accordingly, the companies behind it are able to implement price increases.
Since these effects cannot be quantified in a credible manner, it is not possible to quantify the contribution of tech companies to price stability.