Least productive sectors only thing keeping inflation going

Central bankers think steady price increases are a good thing. After all, inflation makes it easier for employers to cut real labour costs and helps monetary policy boost the economy without having to lower (nominal) interest rates below zero.

Whether or not you agree, we thought it would be interesting to look at which products explain the rise of American consumer prices since 1990. As it turns out, just as the bulk of the growth in employment can be attributed to a few sectors where productivity is either low or unmeasurable, a whopping 88 per cent of the total rise in the price level boils down to four sectors of the US economy:

In January 1990, those four product categories only accounted for 30 per cent of the money spent on consumption by the average American. (Housing was about half that.) Even after more than a quarter-century in which prices of these goods and services rose significantly faster than everything else, these four sectors still account for less than 40 per cent of total consumer spending.

Put another way, the Federal Reserve would have completely failed at both of its economic objectives had it not been for the dramatic expansion of a handful of low-productivity sectors.

(The data used throughout this post and any that follow in this vein come from tables 2.4.3U, 2.4.4U, and 2.4.5U of the Bureau of Economic Analysis’s underlying detail tables, which provide monthly frequency and much higher granularity than the standard National Income and Product Accounts. Thanks to James Sweeney of Credit Suisse for pointing them out to us.)

Relatively few dollars are spent on education compared to everything else, but inflation across the entire sector has consistently been far faster than in the rest of the economy. (The only thing that comes close is tobacco, which has been heavily influenced by changes in sales taxes.) This is all the more striking since the BEA estimates real spending on education hasn’t budged since the start of 2000, even though nominal spending grew at an annual average rate of 5.5 per cent:

The bloating of the education sector has also seeped into other categories in the national accounts, including “housing for students” and, even more egregiously, textbooks — a product where the actual volume of goods purchased has barely increased in five decades, and has fallen by more than half since the start of the millennium (note the scale on the y-axis):

Within healthcare, dentistry has been — by far — the component most prone to inflation. The cost of getting your teeth cleaned, etc, has risen about 4.3 per cent each year, on average, since the start of 1990, compared to 3.8 per cent for prescription drugs, 3.5 per cent for hospitalisation, 3.1 per cent for all healthcare services, and 2.0 per cent for the whole basket of consumer spending.

Despite this, the share of consumer spending going to dentists has remained essentially unchanged over the past quarter-century. Nominal spending on dentistry has kept pace with nominal spending on everything else, but the rate of real growth has been much slower whilst the inflation rate has been much faster:

More recently, however, the prices of prescription drugs have been the outlier. Since the start of 2013, overall healthcare service prices grew at an annual average rate of just 0.9 per cent, effectively the same as the overall price of the average American’s consumption basket, whilst dentistry prices have grown at an average yearly pace of 2.5 per cent. Prescription drug prices, however, have grown at an average rate of 3.7 per cent per year. Unlike the rest of the economy, big pharma seems to have had the same sort of pricing power (or suffered from the same sort of inflation) as it has throughout its history.

Intriguingly, this pricing power disappeared from over-the-counter drugs sometime in the mid-1990s:

Nonprescription drugs are not doing anything odd: prices of most physical objects either collapsed or flat-lined during this period. Overall, the price of things rose by an average of just 0.6 per cent each year since the start of 1990, although this aggregate figure masks immense variation. It seems outside the realm of coincidence that the only two consumption goods to have inflicted massive inflation on American households are prescription drugs and textbooks — the main categories of physical objects where competition is limited by tight regulation.

By contrast, thanks to astounding technological innovation, television prices have plunged at an average rate of 12 per cent each year since 1990 and computer prices have fallen more than 18 per cent per year:

Price stability in goods can’t be attributed solely to higher screen resolutions and faster chipsets, because plenty of other physical objects resisted the inflationary trend. The prices of new motor vehicles only just surpassed the highs set in the mid-1990s. “Recreational books”, as distinct from “educational books”, cost the same now as in the late 1990s. Musical instrument prices peaked in the early 1990s and have since drifted lower. Watch prices are the same now as in 1990, and that’s only because of a recent upward spike earlier this year.

Luggage — luggage! — prices have plunged about 44 per cent since the mid-1990s. The prices of “dishes and flatware” have fallen 49 per cent since the peak in 1998 and the prices of “household linens” have dropped 60 per cent from their peak in 1992:

(We suspect the emergence of Asian manufacturing and the admittance of China into the World Trade Organisation were more important to these developments than dramatic spurts of innovation, but we could be persuaded otherwise.)

Less surprisingly, “telephone and fascimile equipment” is 78 per cent cheaper than the peak in 1997, in a remarkable reversal of the previous bout of price increases:

In general, the prices of durable goods are about a third lower now than in 1990, while the prices of nondurable goods excluding commodity products (food, drinks, and fuel, which tend to rise at the same rate as the broader price level over time) and excluding prescription drugs, have also fallen, albeit not by as much. Inflation outside of healthcare and education has generally been modest, with the notable exception of a few small professional services such as tax preparation, lawyers, and funeral homes.

Our next post will look at some other intriguing patterns we found in the underlying detail tables, as well as attempts to explain the BEA’s methodology for making all its complex measurements.

Related links:
More real and (inflation-adjusted) fun with the NIPA tables — FT Alphaville
Obamacare’s Big Gamble on Hospital Productivity — NYT
Economists agree: deflation is either good, or bad, or irrelevant — FT Alphaville
What is the relationship between inflation and investment? — FT Alphaville

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