When it comes to policies, they must address the root causes of a problem, but doing so effectively is genuinely difficult. Due to confusion in information and a rigid understanding of authority, there is a high probability that the clarity of policy judgment might be affected, ultimately resulting in poor policy outcomes or complete ineffectiveness.
Data has long clearly shown that China's current sluggish consumption has become rather severe. Regarding this problem, one recognized cause is that heavy household debt burdens have eroded purchasing power and affected consumption. However, another potential reason may sound surprising to some, and that is structural substitution inflation. This concept means that the current observable price is actually a form of "pseudo-deflation", while the real problem is structural substitution inflation. This inflation means people need to pay more money than before to obtain the goods and services they could originally get.
From the widely accepted understanding that the current situation is deflationary to it actually being inflation naturally carries a significant impact.
What is structural substitution inflation?
Inflation comes in wide varieties. Common types like production, demand, and currency all lead to inflation, but the "structural substitution inflation" mentioned here is a relatively special kind. Inflation is calculated based on a commodity basket. To determine whether prices are high or low, one looks at the commodity basket, and many people usually assume this "commodity basket" remains unchanged. What I am emphasizing here about structural substitution inflation is precisely that this commodity basket has changed, resulting in structural shifts. Consequently, this actually causes price increases, but they are masked by CPI statistical data, leading to the perception that China is currently in deflation. This is where "pseudo-deflation" originates.
Where does structural substitution inflation come from?
To take an example, in the past a flip phone cost anywhere from several hundred renminbi to RMB 2,000, but now the only options are practically smartphones, with prices ranging from RMB 4,000 to RMB 10,000, more than the double of those older phones. In the past, buying a server computer cost only RMB 30,000, whereas buying one today may cost over RMB 100,000. In the past, if one did not consider buying a car at all, yet today if the same person buys a new energy vehicle, the asking price is at least tens of thousands of renminbi, and battery replacements may entail future expenses ranging from tens of thousands to over RMB 100,000. Likewise, previously eating a meal meant paying just a few renminbi per dish; yet many restaurants now have closed down, choices have greatly diminished, and at the remaining restaurants a single dish costs RMB 100 to RMB 200. The dishes themselves have not fundamentally changed, but their prices are significantly higher, and the consumers have almost no alternatives because only those few restaurants remain.
Similar phenomena where things that did not exist in the past but exist now, things that offered choices in the past but offer few alternatives now, and things that had low prices in the past but have higher prices now, mean that the prices of goods and services undergo substitution as technology and structures change. Driven by this substitution, prices continue to climb significantly. This, in a nutshell, is structural substitution inflation. Such inflation is especially prone to occur in an era of rapid technological iteration, during periods when urbanization substantially drives up costs, and when policies virtually force so-called "upgrades". The present time is precisely such a period.
How does structural substitution inflation lead to "pseudo-deflation"? The so-called "pseudo-deflation" means that while CPI statistics show price levels are not high and even exhibit a downward trend, the price levels consumers actually face are quite high.
The reasons for this situation are, first, statistical imbalance. China's cities are widely distributed. In many parts of the northeastern provinces, it is not uncommon for a restaurant dish to sell for only RMB 3 to RMB 5. Outside of tier-one, tier-two, and tier-three cities, there are many such places. These cities experiencing “depression” in low-price regions pull down CPI inflation data. Of course, CPI is the result of a weighted average, but the "pulling-down" effect caused by weight differences still exists. Areas with low prices can indeed lower the national CPI average through statistical weighting, making the inflation experienced by residents in high-price regions much higher than the national data. In fact, national CPI, as an average indicator, cannot fully reflect regional differences, consumption structure differences, and group differences. This is why ANBOUND suggests that the country’s policymakers need to pay more attention to regional CPI, inflation by income group, and the cost of living index, rather than just looking at a single national CPI figure.
Second, the structural changes inside the commodity and service basket do not all happen overnight. Therefore, within the year-on-year or month-on-month comparison channels, continuity is interrupted, and the changes are actually relatively smoothed out, making them look not exactly obvious. Yet the price increases faced by actual demand are rigid and continuously rising. This means CPI data actually loses its meaning in an era of major structural changes and instability.
Third, technical factors have a genuinely massive impact. In the past, buying a piece of software cost RMB 500 as a one-time payment. Today, on the surface, one software might cost only RMB 300, yet the same software must be upgraded every year for another RMB 200, making the price during the usage period significantly higher than previous spending. New energy vehicles and the like fall into this same category. The nature of property tax is identical; when actual expenditures are broken down, the total price shows an increase. There are also medical supplies and drugs; technology-driven price increases are widespread, and prices have clearly gone up in reality.
Fourth, substitutable goods are diminishing. In the past, the diversity of goods and services could enhance substitution. If the price was high, consumers would simply skip it. Now, due to policies, technology, and other factors, an increasing number of products and services are practically irreplaceable. Payment tools are a case in point, leaving people with no other choice and making it impossible to select a lower-priced option even if they wanted to.
Fifth, the booming and overly rapid development of the digital economy is making the reflection of prices even more covert, causing CPI data to fail.
Therefore, taken as a whole, structural substitution inflation may very well manifest in statistical figures as low inflation, or even close to " zero inflation" or deflation. This is precisely a major challenge that traditional price statistics face in an era of rapidly changing economic structures.
When street food sold in Beijing for RMB 2 in the past rose to RMB 5 several years ago, and to RMB 12 today, structural substitution inflation represents a form of inflation that traditional CPI may underestimate. It does not manifest as a general rise in the prices of identical goods, but rather as the disappearance of low-cost choices, the takeover of new technology systems, and consumers being forced into higher-cost structures. Statistical data may present low inflation, but actual living costs may show obvious price pressure. This issue actually touches upon a larger theme that is not the subject of policy research: Is the industrial-era CPI model applicable to the digital economy and the era of rapid technological iteration?
Under such inflationary conditions, economic policies need to be exceptionally prudent. The mapping relationship between indicators and reality is not linear as traditional economic theory suggests. Changes in institutional space and costs will inevitably translate into prices, which are then borne by consumers. Hence, common data may lead to certain illusions, and achieving consumption growth will undoubtedly prove rather difficult.
Final analysis conclusion:
China's current problems cannot simply be attributed to "deflation". A very low CPI does not indicate that the actual living costs of ordinary people of the country are declining. Technological upgrades, changes in consumption structures, and the reduction of low-cost choices may all push households into a higher-cost living system. If policies only focus on traditional price indicators, they are prone to misjudging the situation. The key issue in the future is the actual cost of living faced by households, and how rising costs continue to erode their purchasing power.
