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Relying on the consumer is a risky business

I have doubtless said it before and will doubtless say it again, but it remains true that this is a funny old world - the economic one that is.

rethink: Bank of England Governor Mark Carney has had to back-peddle on his grand idea of 'forward guidance' on monetary policy.
rethink: Bank of England Governor Mark Carney has had to back-peddle on his grand idea of 'forward guidance' on monetary policy.

The ironic humour this time comes as we hear all about the woes of a 'cost of living squeeze' (true) at the same time as we see the strongest GDP growth performance since the recession (also true) - a growth performance largely and disproportionately dependent upon those self-same squeezed consumers.

Meanwhile the level of unemployment is falling far more rapidly than anyone - including and importantly the Governor of the Bank of England Mark Carney - had anticipated. How can this all be consistent? Will interest rates have to rise during 2014? And what does this imply for the way forward? Is the path sustainable? Equally importantly is it balanced?

Clearly stronger growth in GDP at the back end of last year is welcome.

An increase of 1.9% in the year is higher than any year since the 2008 crash and also stronger than many/most other developed nations - certainly stronger than our European friends.

However, total output remains below the peak achieved in Q1 2008, and very considerably below where we would have been if we had experienced growth of even a modest percentage point or two each year since that crash. (We probably 'mislaid' growth of some 10% over those barren years). It is also a fact that this growth remains excessively dependent upon the consumer.

As Government Ministers have stated the consumer will always account for most growth given their role in the economy.

Yes, correct in absolute terms, but the growth rate of consumer spend has been far higher than other components of our economy. That is the concern in two ways. First, this growth of consumption is founded upon increased debt rather than increases in earned incomes. Net take home pay is still declining in real terms - taking account of tax and welfare changes.

The increase in debt comes at a time when existing consumer debt levels remain a cause for concern - and may well be associated with rising house prices and hence enhanced perception of wealth.

As Patrick Harvie of the Scottish Green Party put it rather neatly at a David Hume Institute seminar last week, this is 'not a real recovery more a new phase of the old problem'. That 'old problem' was related to excessive debt.

Mr Carney made an important speech last week on a possible currency union. In addition he has had to back peddle on his grand new idea of 'forward guidance' on monetary policy.

He had intimated that only when unemployment reached 7% would it be time to even contemplate an interest rate rise. But that was supposed to be in 2015 or more likely 2016. Now it may be next month - and the Governor knows raising rates any time now would be really dangerous.

This recovery is insecure. We are attempting to escape from problems caused by excessive indebtedness via stimulation of consumption by means of higher debt levels!

The second reason why this reliance upon the consumer really worries me is that other aspects of our economy are still not moving in the required directions. Exports are in trouble and our trade deficit is sky high - we appear to remain uncompetitive in many areas. Business investment is still not taking off.

My weekly economics missive from RBS tells me that the Bank of England Agents' Survey of Business Conditions 'reads like a feel-good page turner'. However, this survey shows that businesses are still more willing to expand output by hiring more folk than investing in capital.

Why? My suggestion is that they lack confidence in the sustainability of this recovery and know it will be easier to wind down output by shedding some labour than by shutting down newly acquired machinery. Credit availability has improved.

The problem is not the supply of investment funds but the demand for investment funds.

Only when business confidence really improves will investment pick up.

Until then companies wait and watch. Employment increases are welcome for the short term, but lower investment and higher employment means lower productivity - a real problem - and reduced competitiveness; and that will mean problems ahead for business and hence for jobs.

The optimistic side of me says that confidence and business investment will return soon; productivity will recover; competitiveness will improve; and a more balanced recovery will ensue.

The pessimist within says that the Bank of England may have to act to dampen the housing market - in the South East of England in particular - and generally head off another debt-driven consumer boom, and this will mean higher rates later in 2014, before business confidence has recovered.

Coupled with the continuing major squeeze on the public finances the result will be that overall growth will decelerate once more. Meantime we should certainly be worrying about that question of balance.

London may be an engine of growth but this growth can also have pernicious effects elsewhere in the UK.

Even in Scotland the story on employment and business formation is very different in the west than in the east and the north east. Other forms of inequalities - between income groups - also look set to worsen.

We may have growth in output and employment, but I still (reluctantly) have my doubts regarding both the health of this growth and its sustainability.

Jeremy Peat is director of The David Hume Institute.

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