Impact of Artificial Intelligence on Services Inflation as compared to China’s effect on Goods Inflation
Inflation is the number one worry of central banks and politicians today. After the Covid pandemic, a bout of strong inflation shook major economies and caused monetary policy to tighten significantly.
Numerous economic forecasters and commentators currently believe the Fed and other central banks will keep rates “higher for longer” and that inflation is a lingering issue that will need to be dealt with over decades.
They may be underestimating the impact of Artificial Intelligence, which could be compared to the impact that China’s emergence as a manufacturing super power had on goods prices in the last decades. Let’s have a look at whether there is any meat to that bone.
China’s Rise and Goods Inflation
China’s rapid industrialization and integration into the global economy had a pronounced effect on goods and commodities inflation.
Goods Price Deflation: As China became the “world’s factory,” there was a clear deflationary trend in the prices of many consumer goods. Textiles, consumer electronics, toys, and various household items saw reduced prices or at least slower price growth. China’s ability to mass-produce goods at lower costs was the primary driver of this trend. For many Western countries, this meant that even as other costs rose, many consumer goods became more affordable or saw a slower rate of price growth.
Between 2000 and 2020, the prices of consumer goods such as electronics and clothing saw slower growth or even reductions in many Western countries. For instance, the U.S. Bureau of Labor Statistics reported that the Consumer Price Index (CPI) for apparel dropped by about 8% from 2000 to 2018. The average price of consumer electronics, especially items like TVs and computers, plummeted over the same period. The CPI for TVs, for example, declined by over 90% from 2000 to 2018.
Commodity Price Inflation: On the flip side, China’s growth story drove up the demand (and thus prices) for a range of commodities. This was especially true in the 2000s. Metals like iron ore, copper, and even oil saw significant price upticks due to China’s burgeoning demand. This kind of inflationary pressure was felt globally, especially in countries dependent on imports of these commodities.
During the 2000s commodities boom, the World Bank reported that metals prices increased by over 150% between 2000 and 2008, driven largely by China’s demand.
AI’s Advent and Services Inflation
The proliferation of AI has, similarly, started to make its mark on the services sector, and its influence on inflation is multifaceted.
Efficiency-led Deflation: The automation capabilities of AI can lead to cost savings for businesses, especially in the services sector. Whether it’s through automated customer service solutions, streamlined operations, or predictive maintenance, these efficiencies can lead to reduced operational costs. In competitive markets, these savings might be passed on to consumers, leading to reduced prices or at least a slower rate of price growth. While it’s challenging to tie AI’s impact directly to broad services inflation figures today, specific sectors showcase its influence. For instance, the cost to serve a customer through a traditional call center is typically $6–8 per contact. In contrast, an AI-driven virtual assistant costs a fraction of that, sometimes as low as $1 per contact.
Quality Improvement without Price Increase: AI enables an enhancement in the quality of services without necessarily increasing the cost. For instance, streaming services like Netflix or Spotify can provide personalized content without charging users extra. This is a form of “qualitative deflation,” where the quality of a service improves without a corresponding price increase. Streaming services, like Netflix, increased their content budgets massively (from $2 billion in 2013 to over $15 billion in 2019) to provide more personalized and varied content. Yet, the subscription prices, while increasing, didn’t rise proportionally to content spend, offering more quality for a relatively modest price increase.
Potential Wage Stagnation: Similar to how the offshoring of manufacturing to China put downward pressures on manufacturing wages in the West, there’s a concern that widespread AI adoption could lead to job displacements in certain service sectors, which might exert downward pressure on wages. However, this trend is still unfolding. While comprehensive data is still emerging, there are indications in specific sectors. For instance, in banking, AI-driven systems have reduced the need for certain roles. In the U.S., bank teller jobs are projected to decline by about 15% from 2019 to 2029, according to the Bureau of Labor Statistics.
Similarly to the China effect, AI has also led to inflation in some sectors, with the prices and demand for semiconductors, computing power and cloud computing rising exponentially, as evidenced by Nvidia’s revenue explosion.
“China Effect” vs “AI Effect”
It appears, the “AI Effect” on Services Inflation may not be entirely unlike the “China Effect” on Goods Inflation, which would be a significant development.
Nature of Deflationary Pressures: Both China’s rise and AI’s proliferation exert deflationary pressures but in different ways. China’s effect was more direct, with cheaper goods flooding markets. AI’s impact, while also leading to cost savings, often manifests in improved service quality at the same price, making its deflationary effects more nuanced.
Scale of Impact: China’s impact on goods inflation was broad, touching a wide range of consumer goods across many countries. AI’s impact on services inflation is still unfolding, and while its reach is growing, it’s currently more pronounced in specific sectors like finance, customer service, and entertainment. As of 2020, China produced about 28% of global manufacturing output, up from around 7% in 2000, showcasing the vast scale of its impact on goods production and pricing. AI’s adoption is still growing. By 2021, around 50% of U.S. businesses had adopted AI in some form, up from about 20% in 2018, indicating its rapidly increasing influence.
The overall effect on inflation is hard to grasp, but using current estimates regarding AI’s impact on automation, productivity, scale effects and early historical data its impact on services inflation over the next decade could be approximately 1/3 of the impact that China had on product inflation (:= capital goods & physical goods) in the past 15 years.
Given the relative share of services consumption vs goods consumption in most Western economies, this would translate to a similarly strong overall impact on total inflation for the AI Effect vs the China effect.
The China Effect partly enabled central banks to hold interest rates near record lows for decades, as inflation wasn’t a major issue. The AI Effect may enable a similar regime, which would lead to another boom in asset prices. This would likely be used inflate away the colossal public debt of the US. Main beneficiaries of such a move, next to tech companies, may end up being cryptocurrency markets.
Not advice, just opinion. Written and compiled with ChatGPT 4.0. Edited by me.
