Andy Xie's price convergence theory revisited

Many economists are puzzled over why inflation remains so low globally. For example, in General Glut's latest post, he writes: "Strangely, annual PCE inflation is still just 2.2%, though, and even lower over the last six months (1.9% annualized) and three months (1.4% annualized)." Earlier, Brad Setser had written that "the fall in China's inflation rate [is] a bit of a puzzle".

And yet, there seems to be much resistance to Andy Xie's idea that low labour cost in places like China is forcing prices elsewhere to converge towards Chinese levels.

Incidentally, apart from explaining low inflation, Xie's postulate, which is essentially based on the concept of a huge excess labour supply in China forcing down wages, when combined with the offshore outsourcing phenomenon, also directly helps explain productivity improvements and low employment growth in developed economies. It also indirectly explains high commodity prices globally, low capital expenditure in developed economies and low interest rates.

When a theory uses one factor to explain so many observations, I tend to treat it with great respect. But at the moment, it remains only a plausible theory, albeit a highly plausible one. Economists should spend more time gathering hard evidence to prove or disprove Xie's theory. Otherwise, the debate threatens to degenerate into one where irrational fears clash with wishful thinking.