The price of progress

The advance of semiconductor technology, one of the last surviving deflationary forces from the pre-pandemic decade, is running out of steam.

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The COVID pandemic boosted demand for, and affected the supply of, semiconductors. Those impacts are fading, but while semiconductor technology is likely to remain disruptive for some occupations, industries and businesses, there are good reasons to think it will no longer have the deflationary influence it once did.

"It is not a stretch to consider the use of semiconductors so widespread and the call on resources so large that diminishing returns are already being seen.”

Technology costs have become a preoccupation for many businesses. One company told me recently that after labour, it is projecting its next largest increase in costs next year to come from higher technology expenses. It does not seem to be an anomaly.

Semiconductor prices themselves suggest there is, at the very least, some fire behind the smoke.

Taiwan, South Korea and Japan do not publish comparable price indexes, but according to measures of U.S. semiconductor import costs, prices have been rising since November 2021, the first meaningful sustained increase since 1993.

The rise in chip prices in 1993 was something of a fringe event, unlike today's. Around 100 billion chips were delivered worldwide in 1993, compared with 1.15 trillion in 2021. In 1993, the Mosaic web browser, the first that could display images from the internet, was introduced. Last year, ChatGPT arrived.

It is important to recognise that any particular new technology does not stay as a permanent deflationary force. The 20th century saw more technological advancement than any other but living standards and inflation both rose substantially. In the U.K., an economy with centuries of data history, gross domestic product per capita rose fivefold but price levels rose 55-fold.

Technological advancement introduces efficiencies - boosting returns on investment and incomes for some and disrupting jobs and business models elsewhere. But ultimately the number of jobs rises as the call on resources from the technology itself scales up and the greater wealth generated by the technology is spent.

Admittedly, it is difficult to be confident the rise in living standards engendered by semiconductor advancement has contributed to the strength of global demand and inflation of recent years.

It is, at the very least, interesting that the decade in which semiconductor penetration increased exponentially was the most deflationary in modern history. Apple announced the iPhone in 2007; within 10 years, 58 per cent of the world's population had a smartphone.

It is clear the semiconductor industry itself now consumes enormous resources.

Notably, some 85 per cent of the world's population now has a smartphone. As a result, semiconductor manufacturing's call on physical resources is now very large - much larger than that of many traditional industries viewed as contributing to inflation.

Construction has begun on an estimated $US500 billion worth of chipmaking facilities since 2021, according to industry lobby group SEMI. In comparison, Reuters estimated in 2021 that global automakers would spend $US515 billion over the entire following decade on EV production capacity.

Geopolitical realignment has both increased semiconductor investment and reduced efficiency. The 2022 U.S. CHIPS and Science Act has resulted in as much as $US200 billion in announced private investment. Germany has recently brought out its own €20 billion semiconductor investment plan.

Semiconductors' call on labour has also risen. An estimated 55 million people were employed globally in the technology sector in 2020, more than triple the number working in the auto industry.

The sector's call on physical resources cannot rise exponentially, particularly as its call on labour rises. Even influential technology analyst Azeem Azar, in his book Exponential, notes every technology that “increases the use of physical resources must eventually run into physical limits. Positive returns to scale must eventually turn to diminishing returns to scale”. Bitcoin alone is estimated to consume 127 terawatt-hours of electricity a year, more than the usage of half the world's economies.

It is not a stretch to consider the use of semiconductors so widespread and the call on resources so large that diminishing returns are already being seen.

Further investment in and consumption of semiconductors still advances living standards but is no longer deflationary. As such, conditions increasingly mirror the broad inflationary trends of the 20th century, rather than the rare and temporary periods of deflation that may accompany new technologies.

It is clearly conceivable semiconductors themselves are yesterday's news and artificial intelligence is tomorrow's. We may now be in the early stages of an AI-driven technology wave that ushers in the next period of technology-driven deflation.

While only time will tell, it is worth noting AI has enormous computational demands that may actually increase use of physical resources. Until AI's influence is clearer, we should presume the world is fundamentally more inflationary than it was in the pre-pandemic decade.

Richard Yetsenga is Chief Economist with ANZ

This story originally appeared in Nikkei Asia on 14 September, 2023

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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