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Special Topic: The internet, the downturn and me: 4 reasons why households and firms can afford a smile

The internet is coming of age

The internet has been much-hyped for its potential to drive economic growth. From e-commerce to the knowledge economy, the internet has promised the world while delivering mixed results. This promise was best punctuated by the dot-com bubble of 2000. Investors ignored fundamentals like price-to-earnings ratios in the belief that technological advancements would lead to profits later. The profits, for the most part, never came.

We argue that, despite the disappointments to date, the internet is coming of age economically - well actually it may have already done so. So what is different?

We offer 4 reasons as why the internet over the next few years will drive productivity and economic growth, while at the same time contributing to the battle with inflation and ultimately allowing higher real consumption. We also offer 4 implications for the wider economy.

Reason 1 - we all love a bargain

The internet is unleashing its power at just the right time - during a retail downturn. One might argue that these features may have happened anyway. Nonetheless, we all love a bargain. And when do consumers love bargains the most? Answer: during a downturn. Figure 6 below shows the recession in real core retail sales from 2007 to 2009 followed by the continued low growth up to the present.

Figure 6 - Real Core Retail Sales Growth
Figure 6 - Real Core Retail Sales Growth.
Source: Statistics New Zealand

A recent study by economists at the Reserve Bank and Motu showed that the fraction of discounting increased during the recent (retail) downturn (Figure 7). So where are the best discounts or at least where are the discounts easiest to find? Answer: the internet.

Figure 7 - Fraction of all CPI groups discounted and Real Core Retail Sales
Figure 7 - Fraction of all CPI groups discounted and Real Core Retail Sales.
Source: Statistics New Zealand, Motu, RBNZ

The advent of sites like priceme and price spy, naming just a couple, gives consumers the ability to compare prices in one place easily and quickly. Consumers like this ability. A survey by Macquarie Bank showed that the number one reason for online shopping was price (55%), more than double the next reason (convenience at 25%). While this survey was conducted in Australia, one can assume that New Zealand online shoppers share similar preferences.

Reason 2 - it's as easy as 1-2-3

The internet has broadened its function from high-powered user-friendly library to include economic match-maker. Economically speaking, this addition means lower search costs for both firms and households. While in lay terms, this translates to: it's easy to find what you and I want to buy and it's easy for businesses to access the customers they are targeting.

Compare pamphlets to grabone. Retailers deliver pamphlets to an entire neighbourhood, regardless of interest in the product or service advertised. It's costly, requiring printing, distribution and then delivery. In summary, pamphlets are hit and miss with a majority ending up in the recycling bin. Grabone offers, on the other hand, are sent out via email subscription, twitter or facebook. The marginal cost is close to zero. Importantly, grabone can target customers. With information on your interests, preferences and recent purchases, online firms can better predict those interested in a deal and market directly to them.

Reason 3 - it's growing fast with room to grow

In the March 2011 quarter, the US Census Bureau reported that e-commerce sales grew 17.5% from March 2010, over double the 8.6% growth in total retail sales. And while e-commerce grew from 1.3% to 4.5% over the nine years to March 2011, the 4.5% share indicates that e-commerce has a lot more room to grow. While the equivalent New Zealand data are not available, a 4.5% share would represent $2.9 billion out of total retail sales of $65.5 billion.

Reason 4 - the sum of reasons 1, 2 and 3

The last reason is the interaction between the first three reasons. Consumers' ability to find bargains will drive a competitive response among firms. Also, with markets for many goods and services borderless, many firms will compete globally and on an increasingly large scale. With more competitors, firms will need to innovate to increase their productivity so they can lower their costs and remain competitive.

As a result, someone, somewhere on the internet is bound to be having a sale. And with consumers' ability to find bargains, we argue that the preference for bargain hunting will persist as the economy improves. In other words, Briscoes will not be the only place running regular sales.

Implication 1 - cheaper for longer

Following on from reason 4, online-induced competition is likely to lead to lower inflation over time. The gap between tradable and non-tradable inflation demonstrates where competition has contributed to lower inflation. Tradable inflation has averaged 1.3% since 1995 and non-tradable inflation 3.4% (Figure 8), while total inflation has averaged 2.3%.

Figure 8 - Tradable and non-tradables inflation
Figure 8 - Tradable and non-tradables inflation.
Source: Statistics New Zealand

Tradable inflation covers goods and services where domestic firms compete globally, eg. clothing and apparel, while non-tradable inflation covers firms only competing domestically, eg. hair cuts and electricity supply. Roughly half of the CPI basket of goods and services are tradable and half non-tradable.

We argue that more of the CPI basket will become tradable or at least more competitive. Take the household energy subgroup of CPI with a weighting of around 4%. The study by Reserve Bank and Motu economists found that the average discount for this group was zero, indicating a less competitive sector. However, this study covered the period up to 2009, before the advent of Powershop and WhatsMyNumber. These sites allow households to compare power prices, switch suppliers and or use multiple suppliers. In turn, this ability should spur more competition between power companies.

If, for example, these and other internet developments increased competition so that the tradable non-tradable split increased to 60-40, then the long run inflation rate could potentially fall by up to 0.3 percentage points to 2.1%. Ultimately, lower inflation will allow households to buy more and thus be better off or, economically speaking, allow higher real consumption.

Implication 2 - more bargains for some, less for others

Like many areas of growth, some groups will benefit more than others. In this case, the internet-savvy will grab more of the benefits. While data on internet literacy is hard to come by, we do have data on online purchases by age.

Figure 9 - Individuals Who Made Online Purchases Over Last 12 Months
Figure 9 - Individuals Who Made Online Purchases Over Last 12 Months.
Source: Statistics New Zealand

Figure 9 shows that the highest percentage of online purchases were made by the 25-44 age group, followed by the 45-64 group, the 15-24 group and then the two groups over 65. If you equate the number of online purchases to internet-savviness, then the groups making more online purchases stand to gain more.

While the less-internet-savvy will gain less, they will benefit as traditional retailers strive to remain competitive. Interestingly, the 15-24 group's 3rd ranking is unlikely to be due to low internet skills, but rather their lower purchasing power and also because many may not possess a credit card for online purchases. Visa debit cards may mean this last factor is less of a constraint in future surveys.

Implication 3 - hello 3D glasses, good-bye video rentals

The face of store retail is changing. Trends already evident in shopping malls indicate that growth sectors will focus on experiences and be social and or service-based, eg. 3D movie theatres, cafes and spas. On the flip side, sunset sectors will include products with low-differentiation, be transportable and/or have obsolete technology eg. book and music stores, video and DVD hire, and clothing. In general, stores selling goods and services with a difference that is not easily replicated and or transported via the internet will remain competitive.

Accordingly, many traditional retail firms will have to adapt; many will struggle and some will go out of business. This will also lead to some structural unemployment in this segment of retail and workers will need to retrain in many cases.

Implication 4 - can we measure and tax it?

The benefits of the internet are difficult to measure and current statistical measures may not fully capture the gains discussed above. Statistics NZ measures online prices for such things as domestic airfares and digital download, uses a mix of online and store prices for other things such as contact lenses and mobile phones, leaving other online prices largely unmeasured. While Statistics NZ updates methodologies from time to time, the growth and development of online retail is likely to outpace these updates, meaning that the measured benefits are likely to lag the actual benefits to households.

International online purchases are exempt from GST and duty (depending on the item) up to $400, providing an additional incentive to purchase online. As a result, domestic firms - both online and store-based - are at some disadvantage. Moreover, as international online purchases grow the government will increasingly forgo revenue.


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