Connor MacDonald

Head of Economics and Social Policy Read Full Bio

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Producer Price Inflation shows supply-side reform is urgently needed

Jun 24, 2022

 

This week’s inflation numbers made for grim reading. It is a testament to just how difficult the current inflationary moment is that 9.1% annual CPI is seen as ‘on the lower end of expectations’. Core inflation is still far too high, though it fell slightly from 6.2% to 5.9%.

And worse, producer prices rose by the highest amount ever recorded, up by more than a fifth. The steep rise since 2021 is shown clearly on the graph below. The last year has been brutal for many businesses, and these producer price rises will invariably be passed on to consumers. If there is any silver lining it is hopefully that this will galvanise Government to pursue ambitious supply-side reform.

Figure 1: ONS

The average petrol price is now 165.9p, the highest on record, and a 30.4% increase on May last year. Worryingly for manufacturers and importers, food, metals, and non-metallic minerals provided the largest upward contributions to producer inflation. Because the UK is a large importer of raw materials, it is remarkably vulnerable to imported inflation, and the data has borne this out.

But just because the UK is vulnerable to external shocks does not mean the UK Government is powerless, especially when it comes to developing regulatory and fiscal rules to help business.

The British Government has already proven that it can help consumers, as the Chancellor’s cost-of living package delivered relief to the tune of 1.5% of GDP. But business has received little. The rise in NICs and the fact that businesses do not enjoy the protection of an energy price cap have further exacerbated their problems. The windfall tax is already deterring investment, even with high allowances.

The cost-of-living crisis is hammering consumers, but it is pulverising enterprise too. The very bad PPI numbers mean that the Chancellor and the Government need to focus the next budget specifically around how businesses can be encouraged to invest and innovate. Sunak’s Mais Lecture, delivered on the day of the Russian invasion of Ukraine, was ambitious. The Chancellor correctly diagnosed Britain’s business underinvestment as a key challenge for the UK economy, as well as the need to invest more heavily in research and skills. In the context of the cost-of-living crisis, this supply-side agenda is only more pressing.

There are definite steps the Government can take now to deregulate and to strengthen enterprise. The UK should start thinking seriously about critical minerals, so that businesses can manufacture and Net Zero does not place undue burdens on our economy. Canada and Australia, are thinking about how to produce more — we should be thinking seriously about how to secure our supply chains too.

In the next budget, the Chancellor should postpone, or indeed scrap, the planned corporation tax hike. This is the wrong message to send in the midst of an economic slowdown.

Finally, the Chancellor should push his colleagues to deliver meaningful regulatory reform. The childcare market in England is too restricted, as Senior Fellow Ruth Kelly has said. Too few families, especially families with irregular work hours, have the options they need to increase their workforce participation. The UK’s pension regulatory regime is less able to attract domestic investment, so large foreign funds are actually investing more here than we are. Finally, the UK will need to do more housebuilding — the constraints imposed by high housing prices impacts consumers and businesses alike, and diverts investment away from more productive uses.

If consumer confidence and business confidence is to rise, we will need to get costs down while growing the economy. As my colleague Gerard Lyons has written, we are quickly moving from the main challenge being inflation to one where economic growth splutters out. Both can be tackled together with serious supply-side reform. There is no time to wait.

Connor MacDonald

Head of Economics and Social Policy Read Full Bio

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