Sitting still and being clipped by the price scissors

Prices are rising – but not all at the same rate. Entrepreneurs see the prices of their inputs rise somewhat faster than the yield prices over the longer term. Agricultural economists used to call this the 'price gap': if you make a graph of it, the prices of the means of production rise over time, those of the products much more slowly, and sometimes they even fall. Like the two legs of an open pair of scissors, ready to cut the entrepreneur. Entrepreneurs who complain that everything has become more expensive again are often right.

The difference between the prices of the means of production and the products is compensated by productivity improvements as a result of innovation. For individual entrepreneurs, this often happens abruptly: if you buy a new combine after 10 years, the cutterbar is suddenly 10% wider. For a large group of companies, this is usually 1% to 1,5% per year over a longer period of time. Due to this innovation, yield prices are under pressure. Sometimes that is extreme: in the egg sector, the productivity improvement was so great for decades that retail prices remained nominally stable. And in the computer industry, innovation is so strong that the price of a chip is halved within a year and a half.

Phenomenon the Baumol effect
If you look within the package of means of production, the prices of services by, for example, accountants, certifiers, bankers, veterinarians and government institutions often rise faster than those of goods. This phenomenon is called the Baumol effect, named after the American economist William Baumol. He pointed out in the XNUMXs that in sectors with high productivity development (high innovation) it is easier to raise wages and thus attract labor and allow the sector to grow, because consumers buy more of the lower-priced rising product. A sector that innovates less must then follow along and will have to pass the bill for the rising wages on to the consumer, who buys less of it so that part of the employees can leave for the innovative sectors.

In addition, innovation is relatively difficult, especially in the service sector. You can make a combine wider, but the Concertgebouw Orchestra cannot perform a Bach symphony 10% faster or with a few fewer violinists. As an aside, there are economists who think that's why smaller pop groups and rappers have become more popular, but I doubt that. There is more than economics.

Let's wait and see how successful AI is
Of course, some innovation is also possible in the service sector: after an operation you now spend much less time in hospital than twenty years ago. Sometimes automation works wonders, such as with banks. But for the time being it appears to be easier to increase the capacities of machines (and also crops and animals through breeding) than those of human judgments and actions. The makers of artificial intelligence software are now trying to change that, but we just have to wait and see how successful that is.

For the time being, the trend is that the share of purchased services in the cost price of products is growing at the expense of the share of purchased goods. Also because some of the services can often not be missed in the production process, or are even required by the government. And so the cost price will consist more of fixed costs, which in turn has an increasing scale effect. Innovation brings prosperity, but it's not easy when you're in a sector where you're sitting still and you're being cut by the price scissors.

Krijn J. Poppe

Krijn Poppe worked for almost 40 years as an economist at LEI and Wageningen UR and now holds a number of advisory and management positions. For Boerenbusiness he dives into his bookcase and discusses current developments on the basis of studies that have become classic.

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