Labor Costs Will Get in the Way of Commodity Deflation

The US Producer Price Index is declining, and the trend will continue into next year as the US industrial economy tips into recession. As a result, the Consumer Price Index (CPI) will reflect ongoing disinflation – i.e., diminishing consumer price inflation.

Producers whose competitive advantages are strong enough to keep sales up in an environment of business cycle decline will be able to use the deflation in the cost of production to repair, improve, or maintain their margins, if they maintain current pricing. The upcoming industrial sector recession may make that difficult. Additionally, it is not the only challenge ahead.

Producers utilizing commodities as inputs – such as aluminum, copper, steel, and others – will see their input costs decline (though these producers also tend to be under greater pressure to pay their savings forward). A bump in copper prices related to China’s reopening following the end of its zero-COVID policy will prove to be brief, with the overarching declining trend extending into next year.

Commodity prices falling as input costs is one important factor. Labor is another. Labor costs tend to compound as materials and components flow downstream. Generally, a product closer to the end-use state has had more labor involved in its production overall, while products closer to the intermediate and early stages have had less.

The labor factors

Unlike commodities, wages are not volatile and, absent serious economic distress such as a Great Recession scenario, do not tend to decline. Supporting this position at present is the still-high ratio of job openings to unemployed persons.

Because of the wage/labor component, it is unlikely the decline in overall Producer Prices will match the trend in in commodities.

It remains prudent to reduce labor dependence where feasible.

Mitigating labor costs

The main solution to labor costs – adding automation to your production process – is simple in concept but not easy to execute. Furthermore, interest rates are high, as are prices. The capital requirement involved in reducing your dependency on labor is higher than it was during the period of cheap money, necessitating careful planning. Keep in mind within the context of that planning that we see the coming period of business cycle as mild, and it will be followed by a prolonged period of ascent.

What to do

Consider using wage inflation data in your negotiations. In his April webinar, “2023 Commodities Outlook,” available to ITR Economics Insider™ members, ITR Economist Jeremy Bess presented a comprehensive look at pricing, commodities, wages, and related matters. He noted that producers at various stations in the supply chain should use wage data when negotiating prices with customers.

ITR Economics can help you identify and access that data, and we can also help you find the best pricing benchmark for your products and services. If that benchmark does not already exist, we can build it for you.