Sunday, February 08, 2009
Is the UK consumer flat on his back?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Wandering round Poundland, as one does, is a bit different from the rarefied atmosphere of Davos but is an experience to be recommended.

In this Aladdin's cave, which has everything from the latest Rupert annual, six-packs of rare incandescent light bulbs and mini tool kits to household goods, toiletries and non-perishable foods, there is a sense of wonder that anybody can make this stuff for 1, let alone sell it.

The Poundland effect underlines how tough things are for higher-priced retailers, which is why it is expanding while many of them are shrinking. That, however, is not the only message.

Just down the road is a 99p shop and, unless my eyes were deceiving me, it was busier. To economists, if not to Poundland, that is gratifying. It shows price signals work, even at low prices and that the fashionable "left digit effect" is alive and well.

This is the effect that makes us more likely to buy at 9.99 than 10. By the same token, 99p is more appealing than 1. I am tempted to open a 98p shop, though experts say that to make a real difference you might have to go to 89p, if not 49p.

The real point is that one of the stories of 2009 will be that consumers can buy cheaply, if they choose to, and not just at the discounters. We are moving into a period where inflation will be negligible, and for periods negative, in spite of sterling's fall.

This, and what will be a very gloomy economic forecast, prompted the Bank to cut interest rates from 1.5% to 1%. As I wrote last week, I would not have done so at this time. But how strange it is that such low rates have become almost commonplace.

Low rates are providing a bonus for borrowers, bringing big reductions in mortgage payments. More generally, low inflation helped by the government's temporary Vat cut will provide a boost to real income growth. Just how big was underlined by the National Institute of Economic and Social Research in its latest review.

It predicts real household disposable income will jump 3.3% this year, well up on last year's increase of 1.5% and 2007's zero growth. If this is right, it will be the best year for income growth since 2001. We will not have had it so good for a long time.

The question is: what will people do with it? Simon Kirby and Ray Barrell, economists at the institute, are pretty sure they will not spend it. Alongside that 3.3% rise in incomes they predict a 3.8% slump in consumer spending. Saving, not spending, will be the watchword this year, they say, with the saving ratio predicted to jump from 1.3% last year to 7.1% this year.

It is an interesting forecast and a brave one. Lots of unprecedented things are happening but that would be an unprecedented divergence between income growth and spending. Barrell points out that something similar happened in the early 1990s, but spread over three years. This time, he said, the effects were coming through much quicker, with falling housing wealth and lack of availability of credit being the two main factors pushing spending lower.

Nobody expects consumer spending to be anything other than weak this year but other economists dispute the scale of the weakness. Robert Barrie at CSFB and David Miles and Melanie Baker of Morgan Stanley think spending will slip by a modest 0.5%. The things we should most worry about said Barrie, were exports and investment.

It is an interesting split, and not just for those reliant on selling into the consumer sector. CSFB and the institute have similar forecasts for this year's drop in GDP, 2.5% and 2.7% respectively, but they have very different views on its composition.

For those who think the recession should be about rebalancing the economy away from the consumer and restoring the saving ratio to something more sustainable, the institute's forecast does the trick. CSFB's story, in contrast, is one where the hit to growth comes from the depressed global economy, and there is no rebalancing.

Surely, you will say, this recession is all about households deleveraging paying off debt and a sharp drop in consumer spending will be a natural consequence of that. But, as I have pointed out before, consumer spending has been rising at a slower rate in recent years and was, in any case, mainly financed out of income growth.

The build-up in UK household debt was both a consequence and cause of rising house prices. It has risen in every country. It rose by more and to a higher level in the UK than in most, because Britain has a higher proportion of owner-occupiers and because house prices rose more, albeit from an undervalued position in the mid-1990s, partly because of a shortage of new homes.

We should not engage in self-flagellation over household debt, though. As Bank of England governor Mervyn King and Lord Turner, chairman of the Financial Services Authority, have pointed out, two-thirds of the rise in lending since the early 1990s was to the financial sector.

The debt story is not complete without also looking at household assets. Figures from the Organisation for Economic Co-operation and Development show UK households have far higher net wealth, as a proportion of income, than their counterparts in America, Japan, Germany and France.

There will be a two-way debt battle in the coming months, rising unemployment making it hard for a minority to service their home loans, while lower interest rates will make it easier for the majority.

Where will this leave spending? Nationwide's consumer confidence index is at a record low, though the proportion of people saying now is a good time for a big purchase has risen again. That is important. Official figures show retail sales held up pretty well through to the end of last year, but that spending on big-ticket items was very weak. Ask any car dealer.

In the end, confidence is the key. Consumer recessions are not caused by people cutting back who have to. They happen when those who are not badly squeezed decide it is prudent not to spend. This is Keynes's paradox of thrift; we would like a higher level of savings but not right now.

It could go either way. But if the institute is right in its calculation of the rise in real incomes this year, I would be quite surprised if it is also right on spending.

PS: So how much did the great snow cost us? 1.2 billion a day, you may have heard, and perhaps 3.5 billion in total. It was in every newspaper and broadcast, so must be true. The figure came from the Federation of Small Businesses (FSB), which must be congratulated on the coverage it got. The media needed a number and it supplied it. Breathless reporters warned of the impact on "productivity" (they meant production).

But how did the FSB arrive at it? It simply took an earlier estimate that every bank holiday costs the economy 6 billion in lost GDP, then divided it by five because apparently a fifth of workers were stuck at home at the start of last week and arrived at its 1.2 billion.
There were two things wrong with this. The supposed 6 billion "lost" GDP on bank holidays is a throwback to days when factory shutdowns and closed offices meant the economy ground to a halt. These days, we probably generate nearly as much GDP on a bank holiday, in shops, theme parks, restaurants and the rest, as on a normal day.

The second problem was the assumption that a fifth of a day's GDP was lost. Most of that output will be made up, easier to do when things are slack. Many people can do work at home, with or without the internet. The weather itself came as a fillip to retailers desperate to unload winter stock and not just sledges.

Weather effects are notoriously difficult to calculate. Floods and other weather events are reckoned to cost the economy 0.1% of GDP annually; about 1.5 billion. Could last week's snow really have cost twice as much as a normal year's bad weather? So how much did it cost? Let's be honest, we don't have a clue.

From The Sunday Times, February 8 2009