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Why Don't Economists Care More About Rising Resource Prices?

10/03/2014 16:24 GMT | Updated 10/05/2014 10:59 BST

Britain faces many economic challenges: the need to restore macroeconomic stability, improve competitiveness, protect living standards and address rising inequality. These challenges have spurred much creative thinking by economists in areas such as monetary policy, taxation, labour market reform and education and training. Yet far less prominence has been given to an issue that affects all of these economic challenges: the impact of rising resource prices.

Resource prices are significantly affecting our economy

Over the past decade world food prices have doubled, metals prices have trebled and energy prices have quadrupled, all driven by strong growth in emerging markets. This has raised UK prices and made the job of controlling inflation harder for the Bank of England. Inflation excluding energy and unprocessed food prices has averaged 2.1% over the last decade, almost exactly in line with the Bank's target of 2%. By contrast, once these energy and food prices are included, average inflation rises to 2.6% and has more frequently breached the 3% threshold which triggers an explanatory letter from the Bank's governor. And, in the latter years' of Mervyn King's tenure, he penned no fewer than 14 of these letters, all of them citing rising resource costs as a key driver of above target inflation.

Rising resource prices have also played a pivotal role in declining living standards in the UK. Without the faster price rises for energy and food, real wages could have actually risen rather than fallen over the last decade. And the average household could have saved as much as £1,000 a year on its household food and energy bills. It is those on lower incomes who have been most affected, as energy and food make up nearly a quarter of their spending, compared with just 12% for the most well off.

As the UK now runs hefty trade deficits on energy, food and other commodities, rising prices are having increasingly adverse economic impacts. The extra we have to pay for energy and food is money we cannot spend on other goods and services or use to pay down personal debts. This can only slow our ability to recover from the financial crisis.

UK businesses also risk being held back by rising resource costs and concerns about security of supplies. To remain competitive, they will have to pay increasingly close attention to reducing resource costs and ensuring that supply disruptions do not curtail their operations.

Yet, despite the profound economic consequences, few macroeconomists see rising resource costs as a central issue. Some assume the market will deal with the problem, with high commodity prices providing sufficient incentive to find new supplies. Although this is happening, new sources of supply can be more expensive to extract. And once the world economy finally emerges from the financial crisis, stronger global growth should push up demand again. Throw into this mix the supply risks coming from unstable geopolitics - such as the unfolding crisis in the Ukraine - and you have a recipe for uncertainty and volatility in the future.

We need to get serious about resource efficiency

Perhaps the obstacle is simply that many of the solutions to the resources problem do not involve the usual economic policy levers. Instead, if we are to control our resource bills when we cannot control world markets, then we need to get much more serious about resource efficiency. This means that there is a need for a diverse range of practical initiatives across the economy.

For instance, according to analysis by McKinsey, we can save 36% of our electricity demand by 2030. Examples of what we need to do include, new ecodesign regulations for lighting and appliances, and regulation or incentives to use the best available technology in commercial buildings. And on raw materials, there is huge scope to bring resource recovery and recycling up to international best practice and lower the cost inputs for UK industry. The challenge is to build a coherent strategy around the many diverse initiatives that are needed to achieve this.

And this calls for more industrial policy

Some of this will require strengthening our industrial policy to address market failures relating to information and co-ordination, that can hamper the emergence of a more resource efficient economy. Unfortunately, after the discredited industrial policies of the 1970s, this still remains a problematic area for many economists. However, instead of looking to our past, we should consider what we can learn from examples of successful modern industrial policies, such as those of Germany and Singapore.

Economists need to pay more attention to resources as there is a clear and pressing need to develop greater resilience to commodity price shocks. While this will not solve all our economic problems, it can make an important contribution to many of them. For this reason, the careful management of resources should be right at the heart of economic policy.