To spend or not to spend? That is the question
Civitas, 12 January 2011
Yesterday, two surveys, one by the British Chambers of Commerce and one by the British Retail Consortium, indicated that 2011 could be a difficult year for some areas of the British economy, due to a decrease in consumer spending. Highlighting this decrease in domestic consumption British retail sales fell in December for the first time since April last year. Such poor spending over the Christmas period saw the BCC estimate that the British economy expanded by 0.4-0.5% in October to December last year down from 0.7% between July and September. The BCC projected that in the first two quarters of 2011 the British economy would only witness growth of 0.2% in each quarter.
The fear for 2011 is that consumer spending will continue to decrease, such fears were echoed by Marks and Spencers who despite a good Christmas period, does not expect such success to continue into 2011. The fear for retailers is that domestic consumer spending will be negatively affected by reduced earnings (earnings increases are set to be sluggish in the private sector and virtually non-existent in the public), savings may also increase as people save to take advantage of lower house prices and an increase in interest rates would also encourage an increase in savings and further reduce spending as the burden of debt increases for British households. Add to this the recent increase in VAT and it is not surprising that areas of the British economy, in particular the domestic services industries and domestic retailers, are facing tough business conditions and are being described by some as a ‘drag’ on growth.
Although worrying for such industries, do these developments necessarily bode badly for the British economy as a whole? It would appear that currently the British economy is travelling at two speeds; whereas the service sector is responsible for the reduction in output, the manufacturing sector, especially manufacturers who base a significant degree of their production around exports, reported the strongest growth in overseas orders and sales since 1994.
Some argue that although the success of manufacturing is important, services and consumption-fuelled growth is more important, due to the fact that the UK economy is based around services and consumption. Proponents of this view often point to the fact that consumption is 65% of the UK’s GDP. If this is the case then perhaps there is a serious cause for concern, however a focus on consumption may be a chimera.
Mark Skousen at the Initiative for Policy Dialogue (IPD) at Columbia University argues that it is a fallacy to believe that consumption is the cause of economic growth in the long-term, using the work of French economist Jean-Baptiste Say (1767-1832) he argues that ‘consumption is the effect, not the cause, of prosperity, in the long run’. He argues that GDP is an imperfect measure of economic output because it only measures the production of finished articles (cars, clothes etc) and services provided at the final point of delivery, and does not take into account the sales at intermediate stages of production (such as the manufacture of the steel that makes the car). This is included in the measure of Gross Output (GO) produced annually by the US Department of Commerce. This measure reveals that consumption makes up only 40% of the US economy (down from 70% when examining GDP) and investment makes up 52%. One can expect a similar reduction in consumption, as a proportion of the economy for the UK, if Gross Output is measured instead of GDP.
If consumption does not make up 65% of the UK’s economy then perhaps an increase in savings (and the necessary reduction in spending) is not such a disaster. Importantly saving leads to investment, which should reduce interest rates in the long-term, stimulating, in turn, more investment. Such investment will eventually be the cause of greater consumption as the private sector expands and British output increases. Indeed, without investment, Britain cannot hope to retain its place as one of the globe’s leading economies.
Skousen sums it up, and warns fans of stimulus spending (as a method to prop-up consumption) everywhere when he states: ‘Government leaders cannot depend on consumers to lead the recovery. They tend to be passive, responding to rather than creating new products and services’. Britain’s recovery will be powered by the creation of new products and services, only possible through saving and investment.