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  • Writer's pictureSergio Focardi

I go shopping and find higher prices than a year ago: if this is not inflation what is it?

I go shopping and find higher prices than a year ago: if this is not inflation what is it? This question expresses well the concept of inflation perceived by households. It also expresses the concept of inflation adopted by journalists, political commentators and even economists. The famous economics text by Paul Samuelson, winner of the Nobel Memorial Prize in Economics in 1970, defines inflation simply as the increase of consumer prices. Yet, as we discussed in a previous post, the concept of price increase does not apply well to modern evolutionary economies. In this post we try to explain how our previous discussions apply to the current situation.

Before discussing the increase in consumer prices over the last two or three years, let's make a few more general considerations. In 1960 Italy had emerged from a difficult post-war period and was heading towards an economic boom. In 1960 the average wage of a worker was around 50,000 liras net per month. At the exchange rate of 2,000 liras for one euro this salary corresponds to 25 euros per month.

Today, in Italy, a person who earns 25 euros a month would literally starve even if he/she is sleeping under bridges. Today, an average clerical net salary is around EUR 1500 per month. So an average salary today is about 60 times the average salary in 1950. In reality, income inequality has grown so that high wages have grown more rapidly.

So let's look at what the salary increase can buy. The Italian Statistical Agency - ISTAT - data tell us that the consumer price index has grown approximately as described in the following table:

Consumer price index growth :

From 1950 to 2020

40 times

From 1960 to 2020

30 times

From 1970 to 2020

20 times

From 1980 to 2020

5.6 times

From 1990 to 2020

2.2 times

From 2000 to 2020

1.5 times

From 2010 to 2020

1.2 times

We recall from the previous post that the increase in the consumer price index represents inflation calculated with the classical methods. In fact, this index is calculated as the change in the price of a basket of goods whose qualities and quantities remain constant over the period under review, generally one year. At the end of the period the composition of the basket may change. Therefore, the consumer price index represents the change in the prices of goods in the basket.

Consider the change in wages from 1960 to 2020. In this period the average salary of a worker or equivalent function increased from 25 euros per month to 1500 euros per month. However, we see from the previous table that 25x30 = 750 euros cover inflation. That is, half of the wage increase covers inflation. By 1980, the average salary had risen to 180 euros per month. In the period 1980-2020, average wages go from 180 euros per month to 1500 euros per month. However, the amount 180x5.6=1008 euros covers inflation.

These data, however, are not credible. Numerically they are correct (approximately) but their interpretation is misleading. In the period 1960-2020 the Italian economy, like all advanced economies, has experienced a strong qualitative evolution. Product innovation has also been very rapid. Entire sectors of consumer goods have been created. We can mention for example personal computing, mobile phones, cruises, low-cost air travel, and many other product and service innovations.

The idea that half of the wage increase from 1960 to 2020 will cover rising prices is unreasonable. In 2020 the offer of products and services is radically different from that of 1960. But at this point we have to answer the typical question: but not all the products have changed, the products that serve me such as pasta, bread, sugar and coffee have remained unchanged though their prices have greatly increased.

There are two answers to this objection. The first is that even sugar, pasta and coffee have not remained unchanged. It is enough to look at the variety of products available in a supermarket to understand that much has changed even at the level of basic products. But above all, the symbolic value of these products has changed. It is questionable whether the symbolic value corresponds to a real qualitative difference. However, undeniably, even basic products are subject to an intense operation of image formation and diversification of products.

But the real point at issue is that the concept of inflation, even the generalized inflation we have introduced, is a weighted average on many products and services. Obviously it may be necessary for various social reasons to focus attention on particular categories of products. In general, however, it is necessary to look at all the products and services. If there is a strong drive to innovate and expand the offer of products and services, all sectors are involved.

And this brings us to the center of our argument. Inflation in the classical sense does not apply to complex evolutionary economies. Different concepts of generalized inflation are possible, we proposed one in the previous post, but all of them must take into account the evolutionary nature and therefore the qualitative changes.

Our advanced economies are becoming increasingly complex. The value of modern economies is increasingly linked to complexity. We have proposed qualitative growth as an alternative to degrowth in a world that is facing a serious environmental crisis.

But all this has a social counterpart. The fraction of consumption due to wages has progressively decreased in comparison to the fraction due to profit. These data are now available on all websites of international organisations such as the OECD. Not only that, but we are witnessing a dualistic tendency of economies that are fragmented into subeconomies that move at different speeds. The slowest are now formed by masses of people cut off from active economic life.

In the forthcoming article Why should asset management be interested in New Economic Thinking in the Journal of Portfolio Management, we discussed how inflation is ultimately the result of social conflicts, as michal Kalecki had argued.

Certainly there are forms of inflation that must be controlled because they are destructive. But a large part of the inflation problem is related to growing inequalities in income and wealth and the indebtedness of the general public.

Certainly today economic life has some pathologies. Many companies have tried to take advantage of the post-COVID economic recovery to appropriate too high margins. Other problems are related to the rising cost of certain imports. However, the problems related to inflation are exacerbated by the loss of income capacity of wage earners. The real problem is not the increase in the price of pasta and coffee but the wage situation. Wages do not follow the evolution of the economy.

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