Eurozone: Disinflation engulfs the industrial goods sector

Press conference by Olli Rehn, Member of the European Commission, on the spring economic forecasts for 2012-2013. (EC Audiovisual Services)

Press conference by Olli Rehn, Member of the European Commission, on the spring economic forecasts for 2012-2013. (EC Audiovisual Services)

 

In three months, from July to September this year, inflation in Eurozone fell from 1.6% to 1.1%, with a brief stopover of 1.3% in August. The European Sting has been sounding the alarm for months now, over this fast deceleration of consumer goods prices. This trend is present all along this year, starting from the very low inflation levels of the beginning of 2013, to 1.2% last April and now 1.1% in September. The news for this new steep drop of inflation came from Eurostat’s September flash estimate for Eurozone’s annual price change rates, published yesterday night.

If looked in a bit more depth, Eurostat’s estimates are even more alarming. According to this source, all-items inflation excluding energy, food, alcohol & tobacco fell to just 1% in September. Some weeks ago Sting writer Suzan A. Kane stressed that, “…energy prices in the European Union and the Eurozone may be considered as exogenous factors. The reason is that the largest part of energy goods comes from abroad and its prices are not determined at home…As for the other large category of consumer goods ‘food, alcohol & tobacco’, its price determinants also belong largely to non-economic factors. Prices of fruits and vegetables which constitute the largest item in this sub category depend greatly on weather conditions which for obvious reasons are exogenous. For different reasons the same is true for the prices of alcohol & tobacco. Those prices are determined almost entirely by the excise taxation imposed on them”.

What market services?

For all those reasons Eurostat publishes its inflation estimates for the core economic sectors, without the effects from energy, food, alcohol & tobacco. What is left if those categories are taken out, it’s the items under two headings; non-energy industrial goods and services. Those two categories however represent between them 69.66% of consumer spending, that is the bulk of family budgets. I detail now price inflation rates in non-energy industrial goods and services are 0.3% and 1.5% respectively.

Unquestionably the category of services is the most important item as far as consumer spending is concerned, with a weight of 0.423, always according to Eurostat. This means 42.3% of consumer spending is absorbed by services. However this sector’s structure contains market and non-market services. Services pricing in the last sub category of non-market services, is determined by the administration, rather artificially without close relation to market factors as its very title implies.

As for market services, the largest component of ‘production cost’ in this domain depends on labour costs, due to the labour intensive character of the sector. It’s not only that though. The institutional environment in which the market services sector operates and the way services workers are engaged depend largely on the rules set by the administration or other regulatory and professional bodies. These rules do not depend on the day-to-day developments in the economy and are set largely with non-market criteria. In many respects then, even market services pricing is largely determined by non-market factors.

Industrial disinflation

As a result what is left to genuinely represent the state of the economy and the short term developments in production structures, is the sector of the non-energy industrial goods. This sector absorbs more than one-fourth of consumer spending (27.4%) and its pricing policies constitute the best indicator of the state of the economy. Manufacturing in Eurozone may be in a long-term downward path, but still it represents the core abilities and the strong points of the European economy.

Unfortunately, the sector is clearly in a state or close to disinflation. According to Eurostat, price changes of non-energy industrial goods during September 2013, was restricted to only 0.3%. Subdue price changes have been haunting the sector for quite some time. All along this year the relevant inflation sub index falls steadily from slightly below the unit to a mere 0.3% in September. The reasons for this development might be a weak demand or production overcapacity or both. Whatever the causes, the fact is that this core sector of Eurozone’s economy is heading or already has entered in a disinflationary spiral.

No doubt then that the threat of disinflation is more than real, and policy makers in Brussels, Berlin and elsewhere in the euro area must think twice before insisting stubbornly on the currently applied austerity policies.

 

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