The Alice in Wongaland economy

by Ann Pettifor and Jeremy Smith

Ann was on the BBC’s Today programme this week where she was asked to comment on the retail sales numbers. We thought we would share with our readers some of the data that underpins the “Alice in Wongaland” theory of the economy.

But first that quote from the Chancellor about the need for “A New Economic Model” delivered before the election, on the 24 February 2010. We chose it because it chimes with our analysis that it is the overhang of private debt that continually chokes off the ‘green shoots’ the ‘confidence fairy’ and ‘recovery’. In his Mais Lecture that day, the Chancellor said:

The overhang of private debt in our banking system and our households weighs heavy on future prosperity. We need to head in a completely new direction. We have to move away from an economic model that was based on unsustainable private and public debt. And we have to move to a new model of economic growth that is rooted in more investment, more savings and higher exports. This will require new policies and new institutions.”

He was right then, but wrong now. The British economy today, under his guidance, going in the very opposite direction to that set out in his 2010 ‘new model’. The overhang of UK household debt is still at “140% of gross domestic product compared with 100% in 2000, while real incomes have fallen for six consecutive years” as Simon Nixon noted in the Wall Street Journal on the 13 August.

Many economists – including those at the Office for Budget Responsibility – argue that household debt is not high relative to the value of household assets, notably property. But people do not repay debt by selling the roof over their heads. They repay debt from income. And when incomes are falling it becomes harder to repay debts/mortgages which do not fall in value. Indeed relative to falling incomes debt rises in value.

Given the Chancellor’s analysis back in 2010, it is extraordinary that the idea of “a new model….rooted in more investment, more savings and higher exports” was allowed to gather dust on Treasury shelves. Since the election, the Coalition government has effectively sat on its hands, and adopted a do-nothing-approach because, they argued, cutting public-spending alone, would spur on-private-sector activity, seen as the economy’s only source for recovery. Despite all the evidence of huge spare capacity and high unemployment, the Treasury still stuck to the thesis that public spending ‘crowds out’ private investment.

As a result economic activity has progressively decelerated. The increase in GDP in 2010 was a relatively poor 1.7%; in 2011 this slipped back to 1.1% and in 2012 it required a magnifiying glass to see it at all, being just 0.4%.

Meanwhile the private sector, shaken by the crisis and lacking customers and business, took its lead from government in substantially cutting back investment in capital projects. Indeed, private sector capital investment in the first quarter of 2013 was around 9% lower than when the Coalition government came into office.

The Chancellor’s 2010 quest for “more savings” has also proved illusory. According to the OECD, UK household net saving was negative in the run-up to the ‘debtonation’ of 2007. It was -1.7% of disposable income in 2004 and a startling -4.3% by 2007. Thereafter UK households began to cut back on borrowing and to save. By 2010 net household saving had risen 2.0% of disposable income, but by 2011 Britons had started to spend again, and net saving fell to 1.3% of disposable income.

So not much ‘rebalancing’ at household level, as household debt was hardly de-leveraged. And as Duncan Weldon in his Touchstone Blog noted:

between Q1 2012 and Q1 2013 household consumption rose by around £10.6bn, but household incomes rose by less than £2.0bn. The difference was a £8.7bn fall in gross household savings. (Note – these numbers are all in current prices).”

As for re-orienting towards “higher exports” the trade balance – particularly in goods, but also taking into account services – stubbornly failed to improve, despite a substantial fall in sterling, leaving the UK with the biggest trading deficit in the whole of the EU.

By late 2012 therefore the Treasury had failed to deliver on all three elements of the Chancellor’s proposed ‘new model’ of “more investment, more savings and higher exports.”

At this point the next election began to loom on the political horizon, and politicians began to panic. At this point the Coalition government suddenly proved willing to deploy taxpayer resources into stimulating economic recovery. But the resources were aimed, not at increasing investment in productive activity, but rather at subsidising the weakened banking system and e.g. buy-to-let investors speculating on future house price inflation. This is being achieved through the Funding for Lending scheme and also the proposed “Help to Buy” scheme due to be launched in January, 2014.

This intervention will inflate house prices (and indeed is already doing so), increase household borrowing, and create yet another asset price bubble. At the same time it will encourage already-indebted consumers to borrow more!

They will do so because this initiative has already revived the ‘confidence fairy’ from her languor – and armed with such confidence, consumers have raided their piggy banks, and gone shopping. Current retail sales were already (before today’s announcement) some 1.8% higher than a year ago.

This confidence is not soundly based, because real incomes and wages are continuing to fall, and, as we noted above, debts are repaid out of income, not by the sale of assets.

Britain’s economy as a whole is today driven by a ‘payday borrowing’ culture encouraged by the ‘guardians of the nation’s finances’ – the public authorities. This ‘payday borrowing’ culture leads consumers to pop on to the internet to borrow a couple of hundred quid– a process we are told takes no more than 15 minutes – in order to fund (at an unusustainable rate of interest) that day’s consumption.

This is the delusional, debt-fuelled, short-term approach that the Chancellor so decried back in 2010. It led to the gigantic crash of 2007-9.

So far from moving “to a new model of economic growth that is rooted in more investment, more savings and higher exports” Britain is rapidly becoming an “Alice in Wongaland” economy.