Why do prices rise so much over time?
Take a look at this table of average Canadian household expenses from the 1920s, most of which are food items. Now compare it to this table of average food prices in Canada from last year, 2019.
As you might have expected, everything is way more expensive now. A pound of bacon was 55.9¢ in 1920. Almost a century later, in November 2019, it is now $6.66 (calculating from $7.34 for 500 g), an increase of 11.9 times. A pound of plain white bread was 9.3¢ in 1920. In November 2019, that pound of bread was $1.90 (calculating from $2.82 for 675 g). That’s an increase of 20.4 times.
Inflation has become an accepted fact of life. But where does it come from?
Many economists say that inflation is the result of there being more money in the world. The economist Milton Friedman famously said that “inflation is always and everywhere a monetary phenomenon.” Others say that inflation happens when the demand for commodities rises faster than their supply. This is called the demand-pull theory.
Certainly there needs to be more money in the world for prices to go up. And prices do tend to go up when demand rises faster than supply. But once supply catches up to demand, prices should return to normal. For inflation to be so persistent, there has to be a commodity that is scarce more often than it is abundant, so that its price rises more often than it falls. This commodity also has to affect the prices of many other commodities, so that when it gets more expensive, everything else gets more expensive along with it.
There is, in fact, such a commodity: labour.
Labour scarcity happens frequently. The supply of labour does not respond quickly to labour demand. First, each worker can only work for so many hours in a day. Second, new workers can only come from births or immigration. Babies typically take at least 15 years to develop into workers. Immigration can supply new workers faster, but in many positions employers prefer workers with local experience. All in all, it can take quite a long time for labour demand to be satisfied. And when labour is scarce, employers compete for workers, and wages go up.
And, since labour is needed to produce just about everything, higher labour costs make everything more expensive. But workers can afford these higher prices, because of their higher wages. In fact, if their wages are high enough, workers can end up buying more than before, creating shortages that further increase labour demand. This results in an inflationary spiral.
On the other hand, when labour is abundant, workers compete for jobs, and wages go down. And since these wages are used to buy just about everything, lower wages push down prices in the entire economy. But even at these low prices, workers don’t buy very much, because of their low wages. If their wages are low enough, workers can end up buying even less than before, leading to even lower labour demand. This creates a deflationary spiral.
To see how prices and wages rise and fall together, we can combine the average weekly budget from the 1920’s in the table we saw earlier with data from this table, which show average annual wages in manufacturing industries, for select years from 1917 to 1943. Adding the average weekly budget figures for 1932–1936 from this table, and we get this graph:
As incomplete as this data set is, we can still see how prices and wages track each other, especially between 1929 and 1936. The slide in both prices and wages from 1929 to 1933 was the Great Depression. In 1933, the worst year of the recession, wages fell to almost what they were in 1917, 16 years before. After 1933, wages did not climb back to pre-Depression levels until 1940.
But besides showing the devastation of the Great Depression, this graph also shows that it was not the norm, but the exception. There were two other exceptions: a fall in wages from 1920 to 1921, and another slight dip from 1937 to 1938. But in all other years, there was a rise in wages. The rise after 1939 was especially breathtaking, and very likely had to do with the great increase in labour demand made by World War 2.
Despite the Great Depression, by 1943, average wages were more than double what they were in 1917. Last year, in 2019, the average hourly wage in manufacturing industries in Canada was $27.54. Assuming a 40-hour work week and 50 working weeks, this translates to an average annual income of $55,080. That is more than 72 times the average annual income in 1917.
Inflation has persisted over the years because labour scarcity is more common than labour abundance. To put this in another way, work abundance is more common than work scarcity, and economy growth is more common than economic contraction.
A look back at life a century ago makes this clear. We have microwave ovens, smartphones, flat-screen TVs, computers, none of which existed in 1920. Washing machines and cars were not nearly as common as they are today. The difference becomes more obvious the farther back in time we go.
In short, persistent inflation is a reflection of the persistent progress of humanity. History, as they say, is a rising road.
