In 2015 I discussed the “Great Moderation” of the 1980s and 1990s and how the most prevalent view among economists is that sound monetary policy was to credit for the macroeconomic stability over that time period. Meanwhile, I learned that a handful of other economists suggest that technology driven inventory management improvements were the driver of this macroeconomic stability. Of course, the operations/supply chain view took the back seat to the financial/monetary view.

Supply chain advancements are credited with efficiency improvements within organizations but are often overlooked for their beneficial economic side-effects (benefit externalities in economics speak). In this case, greater economic stability is the beneficial side-effect of inventory management advancements. In general, I believe that economists tend to overvalue the role of financial and monetary contributions to the macroeconomic environment, while underappreciating the role of business operations, supply chain in particular.

Is Software Also Underappreciated?

In last week’s Logistics Viewpoints blog post titled “A Software Revolution that is Hard to See” ARC’s Harry Forbes explained his optimism about the positive developments occurring in the cloud software world and the productivity potential of these developments. However, he noted that his optimism is atypical due to the lack of physical presence to this software, rendering it largely unappreciated by the general population. I can relate to Harry’s viewpoint about the underappreciation of cloud software, as I believe the same holds true for supply chain software. In fact, software isn’t just hard to see, its economic value is hard to measure.

Difficulty of Measuring Software Productivity

Supply chain software, like other categories of software, may contribute more to productivity than traditional measures such as GDP suggest. There are a number of potential reasons for this “underappreciation.” For starters, technology markets are evolving at a rapid pace. Economists use price indexes to capture price changes for a similar good so that inflation effects are removed from period to period comparisons. However, software and other technologies are progressing at an extremely rapid pace. Therefore, it is difficult to make an “apples to apples” comparison over time. Just think about the difference between a Motorola flip phone and the Apple iPhone 5. They are far from comparable products. It would be inaccurate to account for each product as the same item (cell phone) in a difference time period. Economists use a technique called hedonic pricing to capture the changes in rapidly changing products such as technology. These are imperfect multi-factor models and are updated only periodically.

Furthermore, most products that improve over time with higher quality and greater functionality also command a higher price. But that isn’t necessarily the case with technology due to the rapid advancements and fierce competition. In reality, the iPhone 5 is a five-year-old product that is almost obsolete and worthless today. Similar deflationary pressures affect software markets. However, these products don’t have easily identifiable features that economists can incorporate in their multifactor hedonic models. The abstract nature of software (quantity, reach, features and functions), the lagging nature of hedonic pricing models, and rapid price deflation leave software open to undermeasurement in GDP calculations. I believe that cloud computing and SaaS intensify the abstraction issues with software value measurement. A SaaS solution may have more users and lower implementation and costs for a similar on-premise software solution, however it would be measured as an operating cost rather than a business investment. I’m unsure if price models capture this change. Failure to do so may result in lower measurement for the same product, further hindering contribution to GDP calculations.

Why is Software Experiencing Deflation and What is the Effect?

Why is it that software products advance so quickly, yet do not go up in cost in proportion to their value? I think it may be due to the scalability of the business (what is the marginal cost of producing one more copy of software?) and the fierce competition among technology providers. A popular WSJ article from 2015 titled Silicon Valley Doesn’t Believe U.S. Productivity Is Down discusses the wide-ranging problems with the economic measurement of productivity in the new economy.  In the article, Preston McAffe, Microsoft’s Chief Economist says, “Maybe our mysterious productivity gain is in the form of less inflation than we deserve.” I think he may be onto something. The “China effect” is often noted as a cause for the recent low levels of inflation. But I believe that rapid technological advances and pricing pressures in technology markets are contributors as well. And to go full-circle back to monetary policy, low inflation gives governments and central banks more room for loose monetary policy to stimulate the economy. So, thank you to our supply software developers for enabling macroeconomic stability (the Great Moderation) and providing the economy with the price efficiencies to absorb additional financial stimulus without causing inflation over the preceding global economic downturn!