Internet Companies, Deflation and Bad Economics

Trawling through various blogs brought me upon this gem from Matt Yglesias. In a piece entitled “If the Internet is Deflationary, Where is the Looser Money?” he responds to another piece on the deflationary aspect of internet companies.  Unfortunately, he gets quite a bit wrong.

The title itself contains an implication that is just wrong. The implication being that price deflation is such a bad thing that any instance of it requires a knee jerk flood of money to counterbalance it.  That there isn’t such an injection of money leads him to question the idea that the internet is deflationary, or such is the implication. The reality is that advances in efficiency lead to falling prices, and that should be embraced. A falling price level is the mechanism by which increases in productivity are spread to the masses. It’s unquestionably a good thing for an economy.

Yet Yglesias continues with the scorn for the deflationary result of the internet:

Generally new technologies make things cheaper. And yet, if the overall price level were consistently falling that would be a problem for people. Which is exactly why monetary policymakers normally succeed in maintaining a rising price level even in the face of improving technology.

Consistently falling prices would not be a problem for most people. At all. It’s a stunning conclusion he makes here, yet it’s as oft repeated statement in the economics world. All of us would rejoice if our living costs fell 10 or 20 percent every year. And in consistently productive economies, they do. In the consistently productive internet, or entire technology sector for that matter, it does. Yet internet and technology businesses have no problems making a profit, which is the main rebuttal to the argument I’m making here. This is because, when it comes to making a profit, absolute prices are not what is important, but the price differential between costs and the sale price. In a falling price scenario, your sale price may be lower, but so will your costs. Productivity reduces unit costs, and through increased volume (another way of saying more people in society have access to your product), profits are still had. Policymakers are beholden to terrible economic theories, which is why maintaining a rising price ‘in the face of improving technology’ (as if improving technology is an obstacle) is seen as a success. According to Yglesias, this obstacle of improving technology has left us

… on this slow and steady disinflationary march. Some of that may be attributable to the Internet in the sense that technological change does tend to drive the price level down. But at the end of the day the course of the price level is in the hands of policymakers, and the steady disinflation is a policy choice.

And he’s correct, the price level has been a matter of policy choice. Similarly the statement that technological advancement drives down prices is correct. The problem is the positive connotation attached to the policymakers’ choice of counteracting the price declines. Had policymakers not driven up the cost of energy, housing, healthcare, education, food, etc, we very well may have seen a drop in the general price level. However, we have been robbed of the productivity gains in the internet and elsewhere by the actions of the policymakers. The internet and technology sector is virtually the only sector that performs in the manner a healthy economy should. That is, it’s virtually the only part of the economy that allows the productivity of the industry to spread to the masses via lower prices. It’s also one of the few parts of the economy with a low barrier to entry for new business and little in the way of unnecessary costs and regulations.  If you have a good idea, an internet connection and a laptop, its possible to start a viable business. Given that, it’s no surprise that this space is where most of the new jobs and businesses are coming from right now. And with respect to the economy as a whole, where little if any of those factors exist, it’s little wonder why this economy is where it is.

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