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Andrew Sissons
Researcher, Big Innovation Centre
T 020 7976 3609
Andrew  Sissons

We cannot rely on consumer spending to drive a strong recovery

Authors: Andrew Sissons Andrew Sissons

15 November 2012

Some of the UK’s economic commentators have become afflicted by a very strange idea recently: that consumer spending is going to rescue the UK economy. At the end of September, the front page of The Economist had the British economy “Heading out of the storm”; the leader inside contained the sub-heading “Consumers to the rescue”. The argument was that job creation, rising real incomes, falling inflation and “pent-up demand” was soon to release a burst of consumption-fuelled growth.

The idea already looks a little worn after this week’s economic news – the surprise rise in inflation, the weak growth in retail sales and Mervyn King’s belief that he can no longer control the economy have all poured cold water on the case for consumer-led growth. The economy may have grown strongly in the third quarter, but the seasonal effects behind that figure were so great that the Bank now worries that they may tip the economy back into contraction in the run-up to Christmas.

But even setting the recent bad news aside, the consumer-led recovery hypothesis was always ill-conceived, for at least two reasons.

First, those proposing it seem to have short memories. The financial crash of 2007 onwards was partly caused by an unsustainable rise in consumption, fuelled by households and banks building up unmanageable debts. For the most part, those debts are yet to be paid off – McKinsey’s now famous Debt and Deleveraging report estimated the UK’s combined debts at more than 500% of GDP at the start of 2012. If people’s incomes do rise, the chances are that much of the extra cash will go on paying these debts, not on extra spending.

Second, there is little cause to believe that people’s incomes are about to begin rising steadily. The surprising strength of the job market has been the economy’s big success story of recent years, but it comes at a cost. Productivity and real wages are being squeezed, and will continue to be unless the economy begins to grow. Reading between the lines of Mervyn King’s comments yesterday, Chris Dillow suggested that incomes may keep falling for the next decade, which would be a disastrous outcome.

The lesson here is simple, and hasn’t changed since the 2008 recession began: the UK economy is unbalanced, and cannot afford to re-inflate the bubble of debt-fuelled consumption that caused the problem in the first place. Instead, it needs to focus on investment, exports and innovation. We need to raise productivity (the only reliable way to boost people’s wages in the long term), and we need to close our trade gap with the rest of the world. If, by building more world class British businesses and finding more demand from overseas, we can raise productivity and wages, consumer spending will eventually increase, but it will be a follower and not a leader.

None of this is to say that consumers don’t have a role to play in the economic recovery. If the UK can get an initial boost in productivity from investment and innovation, consumer spending will help to sustain this boost. Moreover, today’s consumers can play an active role in the innovation process, helping firms to improve their products, and enabling innovative ideas and businesses to take off. But it is still the Chinese, Brazilian or Indian consumer, rather than British consumer, that is most likely to drive our recovery, and we must not lose sight of that just because things aren’t going entirely to plan.