Beginning in May, rumors of an inflation surge began spooking the markets. But as the Bank Credit Analyst explained in a recently issued comprehensive report on inflation, these inflation fears are exaggerated.1
Some worry that the high costs of energy and raw materials will spark inflation as they did in the 1970s. But BCA points out that the astounding increases in productivity and globalization have changed the rules of the game. These new changes have dramatically reduced the impact of traditional inflationary pressures so that they simply can’t exert the same force they once did.
Even in China, the world’s most overheated economy, inflation has not been able to rear its head in this new global economic environment. Once again, it is productivity and efficiency that continue to hold inflation in check, as wages and commodity prices rise. This is because productivity gains cause unit labor costs to decline, even as hourly wages rise.
For example, headline inflation in China is just 1.2 percent. More significantly, just as the Trends editors forecasted, China’s core price data indicates deflation. Prices are falling for nearly everything in China: consumer goods, processed products, durable goods, and even recreation.
At the same time, China’s wages and commodity prices are on the upswing, which has led many to speculate that inflation and a downturn in profitability are just over the horizon. But to the surprise of many pundits, inflation has not risen. Once again, the reason is that we are in a new era of knowledge-driven productivity growth that dampens the impact of rising wages and commodity prices, and makes it much harder for inflation to take hold.
That’s why it’s crucial to make a clear distinction between wages, which are rising, and unit labor costs, which are falling. While per capita income in Chinese urban centers is growing at 12 percent per year, the cost of labor measured per unit output is actually dropping sharply. This is the new economic reality keeping inflation in check.
Higher wages aren’t inflationary if they’re leading to an even faster rate of growth at the output end of the economic engine. When a company can produce more products with fewer people, it can both raise wages and lower prices to be...
