Scottish Economy Watch

Personal Debt, Spending and Recovery

It is difficult to know what to make of the latest data on household debt (financial liabilities, excluding mortgages) which were published by the ONS this week.

Media reporting of these data took some comfort, e.g. here, in the evidence that at £2,500 Scotland had, in 2008/10, the second lowest median of personal financial debt in the UK. Wales at £2,000 had the lowest, while the South East at £4,200 had the highest. Scotland, Wales, West Midlands and London were below the GB average of £3,200 - see chart below.

Why is it an apparent good thing that Scottish household debt is lower than the GB average and several other regions?

The answer is that high levels of household debt are considered to be a major factor in damaging consumer confidence and lowering household spending after the financial crisis and recession of 2008/09.

There is Bank of England survey evidence that concern about high levels of debt leads households to desire to cut spending. And the recent ONS data show that the percentage of individuals reporting financial debt as a burden has increased between the two waves of the survey i.e. 2006/08 and 2008/10. In 2006/08, 47.5% of individuals living in households in financial debt reported their debt as either a heavy burden or somewhat of a burden, compared with 49.4% of individuals in 2008/10; an increase of 1.9 percentage points.

So, can we conclude that because of the lower level of debt Scottish household spending while continuing to be restrained, should be less restrained than in Britain as a whole and in most other GB regions?

Possibly but not certainly!

Economists who believe the "Financial Instability Hypothesis", which was developed by the American economist Hyman Minsky, emphasise the rate of growth of debt as well as its level. Steve Keen, for example, suggests that

"the ratio of debt to GDP — and the rate of change of that ratio — as the key determinant of the state of the economy .."

Superficially, the argument is that the greater the acceleration the more heavily the brakes are likely to be applied. In the debt context, the faster the growth of debt the more rapidly spending will be cut back once the 'Minsky moment' is reached.

If the growth of debt is important, and we are talking hypotheses here, then what do the data show for Scotland in the recent ONS release? The chart is here

The growth in Scottish non-mortgage median household debt (19%) was faster than the average in Britain (14%) but less than some UK regions.

I'm not sure how significant this statistic is. But my main point is that we should not draw too much comfort from the evidence that the level of Scottish household debt is lower than GB and most other UK regions.

Scottish retail sales: weaker or stronger?

The latest Scottish retail sales index for the final quarter of 2011, which was published today, reveals growth of sales volumes at basic prices(seasonally adjusted) of 0.7% compared to growth of 0.9% in Great Britain. However, over the year the volume of sales grew by 0.7% compared to a 0.3% increase in GB. This latter figure allows John Swinney to claim that not only is Scotland outperforming the rest of Britain but it

underlines the importance of the measures we are taking to enhance economic and consumer confidence in the face of difficult trading conditions.

A close look at the data suggests the position is more nuanced than that. The following chart shows the quarterly growth in retail sales volumes as a four-quarter moving average.

What is clear is that sales growth is still on a downward trend in both Scotland and GB due to the recession. A stronger recovery would have flattened the trend or reversed it in a positive direction. The downward trend in Scotland is slightly stronger than in the GB, so there is little for the Scottish government to crow about.

It looks as if it will be some time yet before sales growth in both Scotland and the GB gets back to more 'normal' rates over a sustained period.

Fiscal austerity, expenditure and UK GDP growth

I have been thinking further about the prospects in 2012 and beyond for both Scotland and the rest of the UK economies. The latest outturn and survey data suggest that growth weakened further in the final quarter of last year. Consumer price inflation (CPI) is now clearly reducing as predicted. Today's CPI figures for the year to December indicate a rate of 4.2%, a sharp fall on the 4.8% increase to November. Christmas discounting in clothing stores and supermarkets plus the softening of fuel prices played a big role. But whether directly or indirectly, the slowing of inflation reflects a weakening of demand in the domestic and global economies.

The November 2011 forecast from the Office of Budget Responsibility (OBR) predicts weak growth of 0.9% this year followed by a bounce back to 2.1% in 2013, almost to trend. Forecast growth strengthens thereafter to 2.7% in 2014 and 3% in both 2015 and 2016.

What is more interesting than the aggregate forecast is the contribution to GDP change of the key expenditure components - see first chart.

So which components contribute the most to recent growth and to forecast growth?

The bounce in inventories in 2010 was a temporary influence on growth. Further adjustments might be expected if companies' expectations of demand are not met. But the OBR is not expecting much impact on forecast growth.

Between 2010 and 2011 there are two key narratives.

First, there was a switch from domestic demand to external demand as the main driver of growth. Private consumption went from 0.7% growth to a contraction by the same percentage. Business investment similarly went from 0.1% growth to a fall of -0.1%.

Secondly, government consumption and investment expenditures contributed positively to growth in both years by 0.4% points and 0.3% respectively. "Hang on!" I hear you say. "I thought the economy was suffering from the effects of fiscal consolidation. What is going on?"

A good question.

It is important to be clear about what is happening. Even amongst people who should know better there is a tendency to present the slowdown in the recovery as being unrelated to the government's fiscal austerity programme. So in their recent analysis in the FT Chris Giles and Andrew Bounds suggest that

A core problem has been deficient growth, which has persistently fallen short of expectations and kept unemployment well above the levels of most of the 1990s and 2000s. ..... Most economists see the fierce political arguments as of little relevance to the question of why the economy has disappointed expectations so greatly. The Office for Budget Responsibility, the independent body charged with advising on the public finances, explains its forecast downgrades not with reference to spending cuts or tax increases but by "higher than expected inflation squeezing household incomes and consumption".

It would be easy to read this and conclude that fiscal austerity is not slowing the economy and that the slowdown is due to a reduction in real personal disposable incomes due to higher inflation than expected.

Of course Giles and Bounds are not talking about the slowdown in the recovery per se. They are actually discussing why the OBR got its forecasts for 2011 badly wrong. This is a different issue. The following chart, again from the OBR, shows the outturn and OBR's forecast for the contribution of government spending to UK GDP growth in subsequent forecasting rounds.

What is clear from this is that government spending in 2010 made half the contribution to growth as in 2009. In 2011, which contains a forecast for the fourth quarter and outturn for the first 3 quarters, government spending again made a positive contribution to growth, all be it somewhat less than in 2010. The reduced contribution of government spending to growth represents the direct effect of the fiscal spending consolidation so far.

It seems probable that the positive contribution to growth in 2011, when the OBR had previously been forecasting a negative government spending contribution, is the result of the effect of automatic stabilisers on spending. The effect of automatic stabilisers is usually considered in terms of transfer payments such as unemployment benefit and tax receipts but there is academic research evidence that current spending on goods and services by government also has a counter-cyclical element.

The other side of this coin is the OBR's failure to forecast accurately the contribution of household demand or private consumption to GDP growth in 2011 as this chart shows:

The large negative contribution of private consumption to growth in 2011 may have been heavily influenced by "higher than expected inflation squeezing household incomes and consumption." But the drop in household spending may also have been due to the net effect of tax rises, such as the VAT increase, on real incomes.

The OBR's forecasts for 2012 to 2016 envisage a recovery mainly in private consumption, business and dwellings investment, with net trade contributing weakly to growth over the period. The switch from domestic demand to external demand appears temporary - see first chart. The direct effect of fiscal austerity on spending is forecast to bite from this year and gets progressively worse to 2015 and 2016. But the forecast deploys assumptions about private consumption, which, even with inflation falling back to a target 2%, seem 'heroic'.

I expect that the radical difference between the OBR's forecast and the outturn for private consumption seen in 2011 may be seen again over this forecast horizon if the present fiscal policy stance persists.

Consumer spending is stagnant

Inspired by Tim Duy's recent post on the recovery of household consumer spending in the United States, I thought I'd try and do a similar exercise for Scotland. Tim Duy's piece reveals that the recovery of household spending in the US is on a slightly weaker trend than prior to the recession.

The current trend is buoyed by a resurgence of spending on durables, which he argues won't last. Looking simply at the spend on services he notes a much weaker recovery trend.

The worry for the US is whether the restrained consumer spending path will continue.

For Scotland, we have only experimental statistics from the Scottish National Accounts Project in nominal terms. There is no disaggregation only data on total household spending is available. In the absence of a Scottish price deflator I have applied a UK consumption deflator from the ONS. So, a health warning is appropriate. But here is the result:

Oh, dear!

A short-term fiscal Stimulus

Back in November I argued in the Fraser of Allander Institute's latest Economic Commentary that the sluggishness of the UK and Scottish recoveries meant there was still scope for some fiscal easing without damaging our fiscal credibility in the long-term. When pressed later by journalists on what specifically should be done I mentioned raising unemployment benefits and cuts in national insurance. The former because household in receipt of unemployment benefit would almost certainly go out and spend it quickly (Technical: the households have a high current marginal propensity to consume). The latter because it would inter alia reduce the marginal cost to firms of hiring additional labour.

The argument for increases in unemployment benefits was met with hostility in comments from Scottish business organisations and in some letters to newspapers from supporters of the UK government's current austerity policy.

Here is some supporting evidence from the Congressional Budget Office (CBO) of the United States in testimony to the Committee on the Budget of United States Senate on 15 November 2011. See chart:

The CBO conclude that

• Policies that would have the largest effects on output and employment per dollar of budgetary cost in 2012 and 2013 are ones that would reduce the marginal cost to businesses of adding employees or that would be targeted toward people who would be most likely to spend the additional income. Such policies include reducing employers' payroll taxes (especially if limited to firms that increase their payroll), increasing aid to the unemployed, and providing additional refundable tax credits in 2012 for lower- and middle-income households.
• Policies that would primarily affect businesses' cash flow but would have little impact on their marginal incentives to hire or invest would have only small effects. Such policies include reducing business income taxes and reducing tax rates on repatriated foreign earnings.

But the CBO warn that

If policymakers wanted to boost the economy in the near term while seeking to achieve long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade.

Grim news from the high street

The latest data from the Scottish Retail Consortium (SRC) present a worrying picture of the state of the Scottish high street. In their words:

"Total sales in November were 1.3% down on November 2010, when they had increased 3.4%. This was the worst fall in total sales for any month since the survey began in 1999. Like-for-like sales were 2.1% lower than a year ago, the worst since August and the sixth decline in the past seven months."

This weakening in household spending is in line with our forecasts in November but the rate of contraction comes sooner and is faster than we expected.

To be certain that these data are providing an accurate picture of Scottish retail spending we need to benchmark a seasonally adjusted series against the household spending data published by the Scottish Government's Scottish National Accounts Project (SNAP). However, the SRC do not appear to publish a long run of the data. More data are behind a pay wall. But releasing the aggregate time series data would help analysis and reinforce the public's perception of the value of the survey, without prejudice to the commercial interests of SRC.