Monday, 18 March 2013

Consumer spending - the key to recovery

The coalition government have been pilloried for the lack of an industrial policy and for the terrible performance in productivity and exports , but the truth is that these are pretty irrelevant.  When looking for pertinent commentary that illuminates rather than obfuscates the current economic situation in the UK and globally look no further than The Economist.  While the Chancellor, George Osborne, prattles on about ‘the march of the makers’ and turning the UK into a magnet for corporate in-ward investment, The Economist is happy to point out the elephant in the room. 

The elephant in question is that private consumption is the biggest slice of GDP, accounting for a massive 63% in 2012.  It will be impossible to turn the economy around without giving hard pressed consumers (who create a huge proportion of private output) some breathing space. Disposable income has been protected for those on low incomes but this is a tiny proportion of the £1.5 trillion of total consumer spending.  The government’s efforts to tackle the deficit have focused on getting middle income earners and savers to bail out the rest of the country.  These people have been burdened with tax increase, benefit withdrawals, institutionalised inflation in energy and transport and institutionalised deflation in savings income.  The net result is that the UK’s engine room for growth is flat on its back and in need of some intensive care.

He can see us but do we see the elephant in the room

The problem is that disposable income is quite marginal.  The Economist explains better than I can but basically a person on average income of £37,000 ($56,000) only has about £15,000 of disposable income a year after paying for Taxes, housing costs, utilities and transport.  Since 2008 pay increases have been less than 2% a year and prices have increased at 3.5%.  Five years of real earnings decline at 1.5% annually means a reduction of £2,600 or a whopping 17% of disposable income. This squeeze combined with a rising saving rate, has sucked all the energy out of the economy.  The good news is that Britons have lowered their debt-to-income ratios rapidly, by a quarter in four years.  In part people have increased saving because QE has decimated returns (artificially low interest rates) and people need to put more money into their pension and other savings.
The budget should focus on two things:

1. Handing back money to consumers with a VAT cut funded by the accelerated privatisations of Lloyds and RBS (facilitated by the a government owned Bad Bank)

2.  Improving returns for savers - less QE and some gentle raising of interest rates, which would have a minimal effect on mortgage payments.

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