Sunday, February 12, 2006
The big squeeze is on as consumers tighten their belts
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

A few years ago the Journal of Economic Psychology carried some interesting research about the link between song lyrics in the Top 40 and the economy. Gloomy lyrics heralded a downturn, and vice versa.

There could be any number of explanations for this. Gloomy lyrics might make people downbeat, lying low in their bedsits rather than going out spending. Or, when consumers are starting to feel gloomy, perhaps they’re more likely to buy songs that fit their mood. Or, least likely, record-company bosses might employ economic forecasters who advise them to time their releases to fit the country’s mood.

This particular link, like many others, may now be obsolete. When did you last hear a milkman whistling a current pop tune? When did you last see a milkman? What with downloads and everything else, the time when you rushed home on a Saturday to put your new 45 on your Dansette record player (younger readers won’t have a clue what I am talking about) are long gone.

The point is that consumers are subject to a variety of influences, some of which have only a marginal effect on their own lives. Gloomy economic news, such as rising unemployment, tends to make people feel more pessimistic, even if they are not directly affected and don’t expect to be. Actually, to refine that, surveys tend to show people are often simultaneously gloomy about the economy — because of what they’ve heard and read — and upbeat about their own prospects.

We are at an interesting juncture. Last week the British Retail Consortium (BRC) ladled out dollops of gloom by reporting the worst January for retailers since 1995. It was, but only on the “like-for-like” measure of sales the BRC uses.

But the CBI, which for much of last year reported the worst retailing results in the 22 years of its distributive-trades survey, also said that, after a good Christmas, January was poor. SPSL’s retail-traffic index, which measures the number of shoppers in stores, was 4% down last month compared with a year earlier.

The message appears to be that after struggling for most of 2005 but perking up in the final few weeks, spending is struggling again. And the question is whether this is just a mood thing or whether something more fundamental is happening.

Some of those fundamentals are well known. Slowly, even subliminally, the message appears to be getting through that we are not saving enough for retirement. By putting the issue of pensions on the map, Lord Turner’s Pensions Commission may be helping to achieve the rise in savings it regards as essential. The saving ratio has crept up towards 6% and is predicted to rise further.

Tied to that, household debt may be approaching its natural limits, at least as a proportion of income. Outstanding debt, approaching £1,200 billion, rose 9% last year but that was smaller than the 12.6% increase recorded in 2004, and 13% in 2003. Unsecured borrowing rose only 5.5%.

The consumer mood is harder to read. Confidence appears to be returning to the housing market, notwithstanding Halifax’s report of a small drop in prices last month, at a time when signs of distress — repossessions, mortgage arrears, insolvencies — are increasing, albeit mainly from a low base.

Nationwide building society’s latest consumer-confidence index shows the mood is gloomier than a year ago; its index is down by 10 points and people are worried about job prospects. But, oddly, the same survey shows a sharp rise in the proportion who believe this is a good time to make a major purchase.

Mood and fundamentals do, however, come together in important ways. When consumer spending slowed sharply in America in the final three months of last year, a large part of the blame lay with the hurricane-related rise in petrol prices. Not only did they squeeze household budgets directly but they hit consumer confidence hard. When a big, visible price changes dramatically, people notice, and worry.

That has been true in Britain of petrol prices, and of other energy prices, with more increases in the pipeline, particularly for gas. The most recent official inflation figures showed 12-month rises of 10.8% for electricity bills, 15.6% for gas and 39% for heating oil. Water bills are up 13.5%.

People notice this, as they notice rising council-tax bills, and rising fares. The Tube fare from Wapping in east London to Westminster if you’re paying cash has just gone up from £2 to £3, a 50% hike. This kind of thing generates more e-mails to me than any other subject.

My usual response is that we are all subject to what behaviourists might call a “bad news bias”. We take good news for granted, but respond adversely to bad news. So, within the Consumer Prices Index, clothing prices have fallen by 4% over the past year, consumer electronics products by 12%. Car prices are also down. Taking the rises and falls together, inflation remains low.

That is true, but only up to a point. Calculations by Morgan Stanley suggest that when we have paid for the necessities of modern existence — interest and debt repayments, council tax and other taxes, fuel bills, other utility bills, insurance and transport — households’ free income will rise by only 1.3% this year. That is low in its own right, and only half last year’s 2.5% increase when spending was subdued.

In the past, wages and salaries would have risen in response to a squeeze on so-called discretionary income of this kind. That is not happening, to the relief of the Bank of England. But it does mean consumer spending will remain subdued; Morgan Stanley suggests 2% growth is the new norm, compared with an average of 3.7% in the recent golden age for consumers, 1997-2004. After last year’s record £47.6 billion trade deficit, some would say that’s no bad thing.

The Bank left base rate unchanged last week, and will be in no hurry to move soon. But the shift in both the consumer mood and the fundamentals suggests we have not seen the last of rate cuts in this cycle.

PS Depressingly, Freakonomics by Stephen Levitt and Stephen Dubner has been the reading matter of choice among aspiring young MPs and ministers in Britain. Seven months after publication it is still in the Amazon top 100 here, and has done even better in America. Loving as I should anything that makes economics popular, I hated it.

I hope some of the tens of thousands who bought Freakonomics dip into a much better book, Strategies of Commitment and Other Essays, by Thomas Schelling. Schelling was the joint winner of the Nobel prize (correctly the Bank of Sweden prize) for economics in 2005. Long before that he advised Stanley Kubrick on the plot of Dr Strangelove — Schelling’s game- theory approach perfectly fitted the cold-war nuclear stalemate — an episode he recounts.

Schelling’s essays are wise and funny, covering everything from climate change to euthanasia. He also tackles one of the age-old questions in economics, dear to my heart: is there such a thing as a free lunch? His answer is an emphatic yes, “there are free lunches all over just waiting to be discovered or created”.

Anything that economists call a win-win situation, such as the gains from trade, represents a free lunch, he argues: “There are not just free lunches but banquets awaiting the former socialist countries that can institute enforceable contracts, copyrights and patents, or eliminate rent-free housing and energy subsidies. How the lunches get distributed matters; but the lunches are there.”

From The Sunday Times, February 12 2006