Sunday, June 01, 2014
No longer downhearted. A nation on happy pills
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

During the worst of the global financial crisis, people were fond of quoting Montek Singh Ahluwalia, deputy chairman of India’s planning commission. In his phrase: “Confidence grows at the rate a coconut tree grows but falls at the rate a coconut falls.”

Confidence rises only gradually but drops sharply. During the crisis business and consumer confidence collapsed. The edge of the abyss looked dangerously close. Many feared plunging over.

If you were looking for a single reason for the turnaround in the economy, you could do worse than look at confidence. Rising business and consumer confidence partly reflect stronger growth and rising employment but are also driving that growth.

Not so long ago we were stuck in a mire of weak growth and depressed confidence. Now it has turned into a virtuous circle of rising confidence and strengthening growth. It is hard to overstate the importance of the return of confidence.

The latest figures from the European Commission tell the story. The main economic sentiment measures, covering business and consumer confidence, rose in May in both the EU and the Eurozone and, perhaps surprisingly, are a little above their long-run (1990-2013) averages.

The picture for Britain was even more encouraging, indeed remarkable. Though the overall sentiment measure slipped a little in May, it was nevertheless at its second highest since 1988, the highest having been achieved in April.

The Commission’s consumer confidence figures for Britain suggest a nation on happy pills. Overall confidence is at its highest since the series began in 1985. The related GfK-NOP measure is rising at its fastest rate for 37 years. In the detail, as Michael Saunders of Citi points out, is the highest proportion of consumers who think the economy has improved over the last 12 months since 2000, the most optimism on unemployment since 1998 and the best time for major purchases since 2007.

Full-time employees are more optimistic than at any time since the question was first asked of this group in 1990, while for other workers optimism is at 16-year highs. Perhaps most surprising of all, optimism among young (16-29) people is also at its best since 1990.

Businesses are, if anything, firms even more upbeat than households. The longest running of all the surveys, the CBI’s industrial trends, has business optimism at its highest since April 1973.

All this is very encouraging, but raises three important questions. Why is it happening? Is this as good as it gets? And, for the politicians, why amid so much optimism is there so much discontent, as we saw across Europe in last weekend’s parliament elections?

Why is confidence so high? Households, we are told, have rarely been more squeezed and businesses are frozen into inactivity by caution, hardly the recipe for confidence at multi-decade highs.

As regular readers will know, I think the extent of the squeeze on households is exaggerated by the regular average earnings figures. Real household disposable incomes in aggregate only had one really bad year, 2011, and on a per capita basis recovered to pre-crisis levels in the second half of last year. Real take-home pay has being doing better than real earnings, because of the big increase in the personal income tax allowance. Wages and salaries data from the national accounts suggest a stronger real wage picture for some time.

I would accept, however, that compared with previous periods, this is not a time of strong growth in real incomes or wages. In the late 1980s, for a while, average earnings were growing by 7.5% against inflation of 2.5%.

Firms, meanwhile, have been building up cash in readiness to start spending and are doing so. The pick-up in investment, though not rip-roaring, stretches back five quarters.

In both cases, confidence is up so sharply because things have turned out better than expected. Confidence is all about expectations. When they are exceeded, it goes up. In the case of employment growth, which has been very strong, it has easily exceeded expectations.

Will it last? The fact that confidence is so high should make us cautious about predicting further big gains. Sometimes confidence soars just before something nasty happens, as in 1973 and 1990, both on the eve of recession. Mainly, confidence levels off or slips back because expectations are merely achieved rather than exceeded. That is not bad news: people come to expect stronger growth and their expectations are validated.

There may be a particular reason now why confidence is high, and why it will not go up much from here. The economy is in the sweet spot in which growth has come through strongly but the Bank of England has yet to respond with higher interest rates.

That will not last. With the monetary policy committee’s Martin Weale warning that rates will need to rise “sooner rather than later” the debate is hotting up.

He and some other MPC members are probably sceptical of the impact of financial policy committee measures directed at the housing market, echoing the scepticism expressed here last week. The first votes for higher rates could come in late summer or autumn. I still think the first hike will come next year, though some City economists are now targeting November 2014.

Higher rates need not derail the recovery, and I don’t think they will, but they are likely to create enough uncertainty to rein back confidence.
Finally, why when confidence is so high are elected politicians having such a tough time? In Europe, the return to growth and the end of the worst phase of the eurozone crisis did not prevent a surge in the Eurosceptical vote last weekend.

In Britain, with confidence high, the coalition parties might have expected to reap the benefits of recovery in the May elections more than they did. But while the Tories avoided collapse, the Liberal Democrats did not.

It may be that another year will do the trick but clearly more is happening than just confidence and recovery. While Labour is blamed for over-spending and failing to regulate the banks, the coalition parties get the blame for austerity and, in the case of the Tories, will always be seen as too close to the City. Curiously Nigel Farage, the only party leader who worked a long time in the City – more than 20 years – gets away with it. The coming general election could be one where a strong economy benefits the incumbents less than usual.

Confidence is very important. Its economic effects are seen in stronger growth in consumer spending and business investment, both of which should last. Its political effects are harder to judge.