Does digitalization lead to low inflation?

Prolonged low inflation. Recently, economists have questioned why inflation remains low for a long time, while it is expected that when the economy picks up, inflation will also rise due to higher wages, higher energy costs and resource use. At the moment the economy is apparently behaving differently than “normal”. The question is asked whether this phenomenon could be related to digitalization. Many large-scale change processes are taking place as a result of digitalization, of which the following probably have the most influence on the economy and inflation.

Firstly, many physical products are being replaced by digital products. The smartphone is the best example of this. The smartphone accommodates more and more digital services, which were previously available as a physical product. Think of photo and film cameras, diaries, newspapers, books, music and many other digital services, for which somebody used to have a laundry list of physical products. All those physical equivalents are no longer manufactured. This means less waste of raw materials, less transport, less energy consumption and higher quality per equivalent digital product or service compared to the classic product. In the end, the consumer is cheaper out with a smaller quantity of goods and with a much higher quality level per unit of product or service.

Second, we see the phenomenon of the shift from offline versus online buying. Thanks to online purchases, consumers get their products efficiently, cheaply at home and don’t have to go out anymore. Of course, the parcel deliverer is replacing the logistics of the shop visiting consumer. But that one parcel deliverer, who delivers parcels for dozens of people, is replacing the countless individual store visits by people who would otherwise pick up their own parcel at a store. Net, the total logistics of online is likely to be more favorable than the total logistics of offline, if one includes the individual visits of citizens to stores. For many other digital services, such as online banking, hotel bookings, travel, similar reasoning can be set up.

Thirdly, digitalization leads to globalization. As a result, global efficiency strikes take place in production chains accompanied by “disruptions” of business models and chains. Many traditional, national products and services are being replaced by international digital services. These digital internationalizations lead to major efficiency strikes, resulting in better digital services with far fewer costs and raw materials. See the “winner-takes-all” movements of the tech giants.

Fourthly, digitization, and now certainly due to the corona pandemic, leads to much more working from home. That means less transport of individuals than before. For employers, however, this leads to lower costs, because less office space is needed and for employees it means lower transport costs and a waste of time. For society, this means sustainability gains through less hydrocarbon emissions and less transport.

The net effect of all these major operations are great efficiency gains and quality improvements per type of product or service. It is therefore obvious that mass digitization and globalization are leading to the economy now behaving very differently than usual and inflation is rising less than expected.

As a result of digitization, a recovery of the economy is no longer linearly linked to an increase in raw materials and energy consumption or labour costs, respectively. On the contrary. A recovering economy in these times means that companies will start digitalization and divest themselves of their traditional way of working. This will often mean: working more digitally with considerably fewer people. Introducing digital production processes to replace traditional ones, leading to less energy and raw material consumption and better quality of end products or services for lower costs.

If the above reasoning is correct, it is to be expected that we are in a long period of low inflation. It will last until classic products and services have been replaced by their digital counterparts and successors. That will take decades, because in many sectors the digital transformations have yet to start. Think of banks, insurance, governments, education, healthcare for example. Digitization still has to get off the ground in many countries as well.