The far-reaching consequences of the cost of living crisis

Horizons article
October 10, 2023

Investors are occupied by the question of how far central banks will go to reduce inflation by raising interest rates. However, they should also consider the impact on people’s life. Indeed, the cost of living is likely to remain high and even rise in the coming years. Historically, a rising cost of living is a powerful driver of change, as illustrated by the history of high inflation leading to political revolutions. Already, people are reacting. They are voting for more extremist political parties and opting for cheaper living arrangements. Those that can afford it are investing in technologies which allow them to cut costs in the long term. All of these reactions are likely to gain momentum in the coming years.

The cost of living is likely to remain high in the coming years

Globally, the rising cost of living will remain an issue even if inflation cools down to the level of 2% targeted by western central banks, as the negative effect of inflation on people’s disposable income will be locked-in. That is a big if, because three turning points in the global economy suggest that inflation could stay higher for longer than is widely expected. These are climate change, the destabilization of the international system and ageing populations. None of these three forces were relevant in previous decades. Indeed, up until recently, a predictable climate, a stable international system and a growing labor population allowed prices to decline or at least stabilize.

The first turning point is climate change. The European Central Bank has recently estimated that in the coming years, rising temperatures could structurally raise inflation by 1-3%, mainly through food prices. In recent months, we have already seen specific examples of this trend. In Asia, extreme weather led to bad harvests, triggering export bans on food in several countries. In July of this year, India, the world’s largest exporter of rice (with a share of 40%) restricted the export of rice, which led to a nearly 20% increase of global rice prices.

The second turning point is the destabilization of the international system. As we covered in a previous Horizons, international conflict over strategic resources threatens to keep raising the costs of key goods like metals, batteries and semiconductors.

The third turning point is the ageing of populations in the developed world. As the growth of the global labor force has peaked, the bargaining power of working people in the developed world is growing (a topic we also covered in a previous Horizons). In recent months, this trend has accelerated. For example, in the United States, the United Auto Workers union is negotiating for a 20-40% wage increase (over 4 years). Meanwhile, 75,000 healthcare workers have also gone on strike to demand higher wages (the largest healthcare strike in U.S. history). In many countries, the probability of general strikes extending beyond specific sectors like automobiles and healthcare is growing. Indeed, the risk of the “wage-price spiral”, which leads to higher inflation, will become more relevant.

Only if wage growth becomes higher than inflation, the cost of living crisis could disappear. This is unlikely to happen, however, for two reasons. First, economists do not agree on whether real wages (wages adjusted for inflation) have declined, stagnated or grown in recent decades (a question that is difficult to answer straightforwardly because of the factors of occupation and income level). Second, the cost of living crisis is also a matter of perception. If people feel like their wages are buying them less, their resentment will grow despite the economic reality. Indeed, the perception of stagnation in wage growth seems to have taken hold of the developed world in recent years.

Source: UK Office for National Statistics
A rising cost of living is a powerful driver of change

What could be the consequences of the rising cost of living? Historically, a rising cost of living has been a powerful driver of change. Political revolutions, for instance, are often rooted in a period of high inflation, from the French Revolution to the rise of Nazism to the Arab Spring.

We can see three consequences of the rising cost of living in our time: more extremist politics, cheaper living arrangements, and investment in technology that creates the opportunity to cut costs in the long term.

The first consequence is more extremist politics. Research from the Guardian shows that in last year’s national elections, 32% of European voters casted their ballots for anti-establishment parties. This is a significant increase compared to the early 2000s (20%) and 1990s (12%). Many of these parties have positioned themselves as champions against the rising cost of living. An example is the far-right Alternative für Deutschland (AfD) in Germany, which opposes support for the war in Ukraine because of its effect on German energy prices and is now polling as the second biggest party of the country.

The second consequence is cheaper living arrangements and life decisions. An example is the decision to delay raising children, or not have them at all. For a long time, the conventional wisdom was that the declining fertility rate (a smaller amount of children being born) in the developed world was the result of new preferences by people with a higher education and a higher income. Yet recent developments show that a high cost of living is also an important factor. In a recent survey in the United Kingdom, for example, nearly 60% of respondents cited the high cost of living as the key reason to delay or not have children at all.

Another decision that is affected by the cost of living is the living arrangement, or who people choose to live with. For instance, the author Dror Poleg has argued that the rising cost of living in Japan gave rise to Share Houses (a type of shared living), which brings together people who want to save money as well as be part of a community.

Those that can afford it, invest in smart home technologies to cut expenses

A third consequence is people choosing to invest in technology that creates the opportunity to cut costs in the long term. This one is most relevant to investors. After all, consumption accounts for a large share of GDP (up to 60-70% in developed countries).

The most important way in which people are cutting costs is the Smart Home. It refers to the centralization of economic activities within the home (such as energy generation, work, entertainment and healthcare), which creates the opportunity to reduce monthly expenses. In recent years, several signs of this trend have emerged.

The most important sign is the energy transition. Residential solar panels, heat pumps and home batteries allow people, to varying degrees, to eliminate their monthly energy bills by replacing fossil fuels with a capital investment in energy generation and storage at home. Indeed, these markets have been growing significantly since the war in Ukraine began to raise gas prices.

Another sign is the trend of working from home, which began during the COVID-19 pandemic. Some recent studies show that people can save up to $300 per month by working from home (by reducing expenses for food, transportation and clothing). New technological developments like virtual reality could make working from home even more appealing, as illustrated by Meta’s recently showcased face-to-face VR chat application (see the images here).

It is possible that telehealth will also allow people to cut costs. By accessing healthcare services online, people can take less time off work and avoid travel expenses.

Finally, the Smart Home has the potential to affect other aspects of the economy, such as mobility and real estate. Take the example of the home battery. Tesla started making the Powerwall home battery because it can connect with Tesla's vehicles, which illustrates how the home battery is intertwined with both the adoption of electric vehicles and the construction of housing. Indeed, the rise of the Smart Home could influence both mobility (people’s choice of transportation) and real estate (how buildings are built and maintained).

All of this points to a relevant insight for investors. The cost of living will probably remain high and even rise in the coming years. People are already reacting by showing their frustration through voting for more extremist political parties, as well as delaying major life decisions like not having children. Most importantly for investors, people will seek new ways to reduce their monthly expenses, in which the Smart Home could play an important role.


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