The shutters come down on retail prices

Economics

WE ARE in an age of disinflation and the pain that home buyers and office developers have been experiencing for the last seven years is spreading to other sectors of the economy.

Last week, it was the turn of the retailers to be reminded that buyers will punish sellers who think they can simply pass on rising costs in higher prices. The most dramatic evidence of the chill winds in the high street came from WH Smith in the shape of a sharp fall in profits but more significant was the echo later in the week in the shape of a profit warning from Sainsbury. To some extent, the news was specific to the two companies, both of which for different reasons have found the going much tougher than it used to be. But it is also generic in the sense that all retailers are being squeezed - just that some are coping better than others.

What's up? We know that a world where prices are as likely to fall as to rise creates a quite different dynamic in markets from one where prices will inevitably rise, if at an uncertain rate. The pressure in one is for the buyer to hold back until the time of his or her choice before making the purchase; the pressure in the other is for the buyer to grab the deal that is available, knowing that even if the price is too high, inflation will make it seem all right in a few months' time. The puzzle is more why should it take so long for retailing to feel the same pressures as other segments of the economy.

The explanation comes, I think, in three parts. First, retailing as a whole has been subject to enormous cost pressures over the last five or so years, but most of that pressure has been directed at segments of the market that do not shout very loudly. The big supermarket chains have still managed to increase their market share and maintain their margins, largely by displacing their smaller cousins. For department stores or specialist chains - shoe shops and the like - the story has indeed been one of unrelenting pressure. But because when we think of retailing we think of the giants, we are less aware of the problems of the rest of the industry.

Second, there are two specific blows that have struck retailers in the last 18 months - Sunday trading and the lottery - both of which require an adjustment. Sunday trading need not increase retailers' costs, indeed ultimately it should reduce them because their capital equipment, their trading space, is used seven days a week instead of six. And the six-hours- a-day deal is probably the optimum from a profitability point of view, for it enables most potential shoppers to buy what they want while adding the minimum of additional labour cost to the stores' wage bill.

But while the more efficient use of floorspace means that fewer new stores will have to be built to meet any particular level of demand, in the short- run the effect of extra trading hours is the same as a sudden increase in capacity without any corresponding increase in sales. If you can use that capacity, fine; but it is not much fun if you cannot.

Then there is the lottery, which has undoubtedly hit some of the low- ticket items such as sweets, and has cut the overall rise in retail sales. Contrary to popular opinion, some areas of consumer spending are doing very well at the moment: car sales shot up in the last quarter of last year, and passengers on the airlines are running about 8-10 per cent up year-on-year. But elsewhere there is a squeeze, and since there seems to be more of a squeeze than there was during the recession, that may well be lottery-related.

Next, retailers seem to have made a collective error in forecasting demand. The two charts show a very different pattern in stock control in manufacturing and retailing, with the trend of manufacturers' stocks heading steadily downwards and only making a small blip up last year, but with retailers not showing any corresponding decrease through the second half of the 1980s, if anything the reverse. Since the middle of 1994, things have deteriorated further with a sudden surge in retail stocks, which is hard to explain except in the simple terms that they called the market wrong.

That can be corrected. Charterhouse, which drew attention to this surge in its latest economic quarterly, reckons the process started to reverse in the latter part of last year. The good Christmas will have helped. I am more disturbed by the seeming inability of the retailers to live with lower stocks in general. The development of "just in time" management has pervaded manufacturing but not, it seems, distribution. That really is surprising, for you would imagine that among the most significant beneficiaries of the IT revolution are the retailers: they have gained the ability to know precisely what item is sold at what time and in what quantity in a way that would have been unthinkable before electronic tills came into use. Either the figures are wrong - always possible but surely unlikely - or retailing as a whole is failing to use properly its array of electronic kit.

This is not going to continue. It is not going to continue because shoppers will not allow it to do so. There are quite long lags in people's perception of inflation. Just as it took years for investors in gilt-edged securities in the 1950s to realise that inflation was eating away at their capital and switch their investment to equities, so now the financial markets demand a risk premium on fixed-interest securities even though inflation prospects seem better than they have done for perhaps 40 years. If the professional investors take a while to adjust, ordinary consumers can be forgiven if it also takes them a while to cotton on.

This may now be happening. Any estate agent will say that pricing is vital: an over-priced house will not attract any interest, while a keenly priced one will sell straight away. That is what you would expect in a world of stable prices, and you would expect it to spread across the board to retailers. Sainsbury itself gives a good example of an effort to meet this mood, by choosing to cut prices savagely on a number of basic lines.

If this is right, we are indeed in the early stages of a seismic shift of behaviour, as we begin to adjust to the idea that prices, in the normal course of events, ought to be stable or maybe come down. Sir Kit McMahon, former deputy governor of the Bank of England, gives an interesting insight into Britain's inflationary psychology in the February issue of Prospect, in which he argues that until the 1950s Britain's inflationary experience had been very good, better in fact than that of the US and vastly better than Germany's. From early last century to 1945 - a period including two world wars - prices had fallen in 57 years, almost exactly the same number as those in which they had risen, 60 years. This coloured views in the 1950s and 1960s, just as our expectations now have been dominated by recent experience.

It will take some years, he argues, until we readjust our expectations again; meanwhile, our interest rates, set ultimately by our willingness to save and invest at any particular level or rates, will have to be higher than they would otherwise need to be to allay our fears.

That is the eagle's eye view of inflation. The worm's eye is to see what happens in the shops when they try to stick up prices: we shop elsewhere. So in one sense, the plight of retailers is good news for the rest of us. It is one more milestone on the path not just to stable prices but to lower interest rates and sustainable growth.