The latest consumer confidence figures from the European Commission point to consumer confidence in the UK remaining at around its long-term average. Despite this, confidence is markedly weaker than before the outcome of the EU referendum. Yet, the saving ratio, which captures the proportion of disposable income saved by the household sector, is close to its historic low. We consider this apparent puzzle and whether we can expect the saving ratio to rise.
The European Commission’s consumer confidence measure is a composite indicator based on the balance of responses to 4 forward-looking questions relating to the financial situation of households, the general economic situation, unemployment expectations and savings.
Chart 1 shows the consumer confidence indicator for the UK. The long-term average (median) of –6.25 shows that negative responses across the four questions typically outweigh positive responses. In October 2018 the confidence balance stood at –5.2, essentially unchanged from its September value of –5.8. While above the long-term average, recent values mark a weakening in confidence from levels before the EU referendum. At the beginning of 2016 the aggregate confidence score was running at around +4. (Click here to download a PowerPoint of the chart.)
Chart 1 shows two periods where consumer confidence fell markedly. The first was in the early 1990s. In 1990 the UK joined the Exchange Rate Mechanism (ERM). This was a semi-fixed exchange rate system whereby participating EU countries allowed fluctuations against each other’s currencies, but only within agreed bands, while being able to collectively float freely against all other currencies. In attempting to staying in the ERM, the UK was obliged to raise interest rates in order to protect the pound. The hikes to rates contributed to a significant dampening of aggregate demand and the economy slid into recession. Britain crashed out of the ERM in September 1992.
The second period of declining confidence was during the global financial crisis in the late 2000s. The retrenchment among financial institutions meant a significant tightening of credit conditions. This too contributed to a significant dampening of aggregate demand and the economy slid into recession. Whereas the 1992 recession saw the UK national output contract by 2.0 percent, this time national output fell by 6.3 per cent.
The collapses in confidence from 1992 and from 2007/08 are likely to have helped propagate the effects of the fall in aggregate demand that were already underway. The weakening of confidence in 2016 is perhaps a better example of a ‘confidence shock’, i.e. a change in aggregate demand originating from a change in confidence. Nonetheless, a fall in confidence, whether it amplifies existing shocks or is the source of the shock, is often taken as a signal of greater economic uncertainty. If we take this greater uncertainty to reflect a greater range of future income outcomes, including potential income losses, then households may look to insure themselves by increasing current saving.
It is usual to assume that people suffer from diminishing marginal utility of total consumption. This means that while total satisfaction increases as we consume more, the additional utility from consuming more (marginal utility) decreases. An implication of this is that a given loss of consumption reduces utility by more than an equivalent increase in consumption increases utility. This explains why people prefer more consistent consumption levels over time and so engage in consumption smoothing. The utility, for example, from an ‘average’ consumption level across two time periods, is higher, than the expected utility from a ‘low’ level of consumption in period 1 and a ‘high’ level of consumption in period 2. This is because the loss of utility from a ‘low’ level of consumption relative to the ‘average’ level is greater than the additional utility from the ‘high’ level relative to the ‘average’ level.
If greater uncertainty, such as that following the EU referendum, increases the range of possible ‘lower’ consumption values in the future even when matched by an increase in the equivalent range of possible ‘higher’ consumption values, then expected future utility falls. The incentive therefore is for people to build up a larger buffer stock of saving to minimise utility losses if the ‘bad state’ occurs. Hence, saving which acts as a from of self-insurance in the presence of uncertainty is known as buffer-stock saving or precautionary saving.
Chart 2 plots the paths of the UK household-sector saving ratio and consumer confidence. The saving ratio approximates the proportion of disposable income saved by the household sector. What we might expect to see if more uncertainty induces buffer-stock saving is for falls in confidence to lead to a rise in the saving ratio. Conversely, less uncertainty as proxied by a rise in confidence would lead to a fall in the saving ratio. (Click here to download a PowerPoint of the chart.)
The chart provides some evidence that of this. The early 1990s and late 2000s certainly coincided with both waning confidence and a rising saving ratio. The saving ratio rose to as high as 15.2 per cent in 1993 and 12.0 per cent in 2009. Meanwhile the rising confidence seen in the late 1990s coincided with a fall in the saving ratio to 4.7 per cent in 1999.
As Chart 2 shows, the easing of confidence since 2016 has coincided with a period where the saving ratio has been historically low. Across 2017 the saving ratio stood at just 4.5 per cent. In the first half of 201 the ratio averaged just 4.2 per cent. While the release of the official figures for the saving ratio are less timely than those for confidence, the recent very low saving ratio may be seen to raise concerns. Can softer confidence data continue to co-exist with such a low saving ratio?
There are a series of possible explanations for the recent lows in the saving ratio. On one hand, the rate of price inflation has frequently exceeded wage inflation in recent years so eroding the real value of earnings. This has stretched household budgets and limited the amount of discretionary income available for saving. On the other hand, unemployment rates have fallen to historic lows. The rate of unemployment in the three months to August stood at 4 per cent, the lowest since 1975. Unemployment expectations are important in determining levels of buffer stock saving because of the impact of unemployment on household budgets.
Another factor that has fuelled the growth of spending relative to income, has been the growth of consumer credit. In the period since July 2016, the annual rate of growth of consumer credit, net of repayments, has averaged 9.7 per cent. Behavioural economists argue that foregoing spending can be emotionally painful. Hence, spending has the potential to exhibit more stickiness than might otherwise be predicted in a more uncertain environment or in the anticipation of income losses. Therefore, the reluctance or inability to wean ourselves off credit and spending might be a reason for the continuing low saving ratio.
We wait to see whether the saving ratio increases over the coming months. However, for now, the UK household sector appears to be characterised by low saving and fragile confidence. Whether or not this is a puzzle, is open to question. Nonetheless, it does appear to carry obvious risks should weaker income growth materialise.
- Draw up a series of factors that you think might affect consumer confidence.
- Which of the following statements is likely to be more accurate: (a) Consumer confidence drives economic activity or (b) Economic activity drives consumer confidence?
- What macroeconomic indicators would those compiling the consumer confidence indicator expect the indicator to predict?
- How does the diminishing marginal utility of consumption (or income) help explain why people engage in buffer stock saving (precautionary saving)?
- How might uncertainty affect consumer confidence?
- How does greater income uncertainty affect expected utility? What affect might this have on buffer stock saving?
Would you like to be a millionaire? Of course you would – who wouldn’t, right? Actually the answer to this question may be more complicated than you might think (see for instance Sgroi et al (2017) on the economics of happiness: see linked article below), but, generally speaking, most people would answer positively to this question.
What if I told you, however, that you could become a millionaire (actually, scratch that – think big – make that “trillionaire”) overnight and be deeply unhappy about it? If you don’t believe me see what happened to Zimbabwe 10 years ago, when irresponsible money printing and fiscal easing drove the country’s economy to staggering hyperinflation (see the blogs A remnant of hyperinflation in Zimbabwe and Fancy a hundred trillion dollar note?. At the peak of the crisis, prices were increasing by a factor of 130 each year. I have in my office a 100 trillion Zimbabwean dollar note (see below) which I show in my lectures when I talk about hyperinflation to my first year Economics for Business students (if you are one of them, make sure not to miss it next February at UEA!). How much is this 100 trillion note worth? Nothing (except, may be, for collectors). It has been withdrawn from circulation as it ended up not even being worth the cost of the paper on which it was printed.
The Zimbabwean economy managed to pull itself out of this spiral of economic death, partly by informally replacing its hyperinflationary currency with the US greenback, and partly by keeping its fiscal spending under control and reverting to more sane economic policy making. That lasted until 2013, after which the government launched a Zimbabwean digital currency (known as “Zollar”) that had a nominal value set equal to a US dollar; and forced its exporters to exchange their greenbacks for Zollars. It then started spending these USD to finance a very ambitious and unsustainable programme of fiscal expansion.
The Economist published yesterday a story that shows the results of this policy – wild price increases and empty supermarket shelves are both back. According to the newspaper’s report:
At a supermarket in Harare, Zimbabwe’s capital, the finance minister is staring aghast at a pack of nappies. ‘This is absolutely ridiculous!’, exclaims Mthuli Ncube. ‘$49!’ A manager says it cost $23 two weeks ago, before pointing out other eye-watering items such as $20 Coco Pops. […] Over the past two weeks zollars have been trading at as little as 17 cents to the dollar. The devaluation has led to a surge in prices—and not just in imported goods like nappies. Football fans attending the Zimbabwe v Democratic Republic of Congo game on October 16th were shocked to learn that ticket prices had doubled on match day.
How long will it take for the 100 trillion Zollar to make its appearance again? We shall find out. I am sure Zimbabweans will be less than thrilled!
Articles and Report
- A fist full of zollars: Zimbabwe’s shops are empty and prices are soaring
The Economist (28/10/18)
- Shelves Empty as Specter of Hyperinflation Stalks Zimbabwe
Bloomberg, Paul Wallace, Godfrey Marawanyika and Desmond Kumbuka (12/10/18)
- imbabwe currency crisis: No cash, no bread, no KFC
BBC News, Andrew Harding (12/10/18)
- Hyperinflation in Zimbabwe: money demand, seigniorage and aid shocks
Journal of Applied Economics, Tara McIndoe-Calder (Volume 50, Issue 15, 18/9/17)
- Understanding Happiness
A CAGE Policy Report: Social Market Foundation, Daniel Sgroi, Thomas Hills, Gus O’Donnell, Andrew Oswald and Eugenio Proto (January 2017)
- Using an AS/AD diagram, explain the concept of hyperinflation. How can irresponsible fiscal policy-making lead to hyperinflation?
- What are the effects of hyperinflation on the people who live in the affected countries? Search the web for examples and case studies, and use them to support your answer.
- Once it has started, what policies can be used to fight hyperinflation? Use examples to support your answer.
- How does speculation affect hyperinflation?
Policymakers around the world have used Gross Domestic Product as the main gauge of economic performance – and have often adopted policies that aim to maximise its rate of growth. Generation after generation of economists have committed significant time and effort to thinking about the factors that influence GDP growth, on the premise that an expanding and healthy economy is one that sees its GDP increasing every year at a sufficient rate.
But is economic output a good enough indicator of national economic wellbeing? Costanza et al (2014) (see link below) argue that, despite its merits, GDP can be a ‘misleading measure of national success’:
GDP measures mainly market transactions. It ignores social costs, environmental impacts and income inequality. If a business used GDP-style accounting, it would aim to maximize gross revenue — even at the expense of profitability, efficiency, sustainability or flexibility. That is hardly smart or sustainable (think Enron). Yet since the end of the Second World War, promoting GDP growth has remained the primary national policy goal in almost every country. Meanwhile, researchers have become much better at measuring what actually does make life worthwhile. The environmental and social effects of GDP growth is a misleading measure of national success. Countries should act now to embrace new metrics.
The limitations of GDP growth as a measure of economic wellbeing and national strength are becoming increasingly clear in today’s world. Some of the world’s wealthiest countries are plagued by discontent, with a growth in populism and social discontent – attitudes which are often fuelled by high rates of poverty and economic hardship. In a recent report titled ‘The Living Standards Audit 2018’ published by the Resolution Foundation, a UK economic thinktank (see link below), the authors found that child poverty rose in 2016–17 as a result of declining incomes of the poorest third of UK households:
While the economic profile of UK households has changed, living standards – with the exception of pensioner households – have mostly stagnated since the mid-2000s. Typical household incomes are not much higher than they were in 2003–04. This stagnation in living standards for many has brought with it a rise in poverty rates for low to middle income families. Over a third of low to middle income families with children are in poverty, up from a quarter in the mid-2000s, and nearly two-fifths say that they can’t afford a holiday away for their children once a year. On the other hand, the share of non-working families in poverty has fallen, though not by enough to prevent an overall rise in poverty since 2010.
Their projections also show that this rise in poverty was likely to have continued in 2017–18:
Although the increase in broad measures of inequality were relatively muted last year, our nowcast suggests that there was a pronounced rise in poverty (measured after housing costs[…]. The increase in overall poverty (from 22.1 to 23.2 per cent) was the largest since 1988. But this was dwarfed by the increase in child poverty, which rose from 30.3 per cent to 33.4 per cent. […]The fortunes of middle-income households diverged from those towards the bottom of the distribution and so a greater share of households, and children, found themselves below the poverty threshold.
A simple literature search on Scope (or even Google Scholar) shows that there has been a significant increase in the number of journal articles and reports in the last 10 years on this topic. We do talk more about the limitations of GDP, but we are still using it as the main measure of national economic performance.
Is it then time to stop focusing our attention on GDP growth exclusively and start considering broader metrics of social development? And what would such metrics look like? Both interesting questions that we will try to address in coming blogs.
- What are the main strengths and weakness of using GDP as measure of economic performance?
- Is high GDP growth alone enough to foster economic and social wellbeing? Explain your answer using examples.
- Write a list of alternative measures that could be used alongside GDP-based metrics to measure economic and social progress. Explain your answer.
I admit it, the title of my blog today is a little bit misleading – but at the same time very appropriate for today’s topic. Nancy Sinatra certainly wasn’t thinking about emigration when she was singing this song – it had nothing to do with it, after all. It is, however, very relevant to economists: Indeed, there are many economics papers discussing the effects of skilled immigration on host and source economies and regions.
Economists often use the term ‘brain drain’ to describe the migration of highly skilled workers from poor/developing to rich/developed economies. Such flows are anything but unusual. As The Economist points out in a recent article, ‘[I]n the decade to 2010–11 the number of university-educated migrants in the G20, a group of large economies that hosts two-thirds of the world’s migrants, grew by 60% to 32m according to the OECD, a club of mostly rich countries.’.
The effects of international migration are found to be overwhelmingly positive for both skilled migrant workers and their hosts. This is particularly true for highly skilled workers (such as academics, physicians and other professionals), who, through emigration, get the opportunity to earn a significantly higher return on their skills that what they might have had in their home country. Very often their home country is saturated and oversupplied with skilled workers competing for a very limited number of jobs. Also, they get the opportunity to practise their profession – which they might not have had otherwise.
But what about their home countries? Are they worse off for such emigration?
There are different views when it comes to answering this question. One argument is that the prospect of international migration incentivises people in developing countries to accumulate skills (brain gain) – which they might not choose to do otherwise, if the expected return to skills was not high enough to warrant the effort and opportunity cost that comes with it. Beine et al (2011) find that:
Our empirical analysis predicts conditional convergence of human capital indicators. Our findings also reveal that skilled migration prospects foster human capital accumulation in low-income countries. In these countries, a net brain gain can be obtained if the skilled emigration rate is not too large (i.e. it does not exceed 20–30% depending on other country characteristics). In contrast, we find no evidence of a significant incentive mechanism in middle-income, and not surprisingly, high-income countries.
Other researchers find that emigration can have a significant negative effect on source economies (countries or regions) – especially if it affects a large share of the local workforce within a short time period. Ha et al (2016), analyse the effect of emigration on human capital formation and economic growth of Chinese provinces:
First, we find that permanent emigration is conducive to the improvement of both middle and high school enrollment. In contrast, while temporary emigration has a significantly positive effect on middle school enrollment it does not affect high school enrollment. Moreover, the different educational attainments of temporary emigrants have different effects on school enrollment. Specifically, the proportion of temporary emigrants with high school education positively affects middle school enrollment, while the proportion of temporary emigrants with middle school education negatively affects high school enrollment. Finally, we find that both permanent and temporary emigration has a detrimental effect on the economic growth of source regions.
So yes or no? Good or bad? As everything else in economics, the answer quite often is ‘it depends’.
- Open future: What educated people from poor countries make of the “brain drain” argument
The Economist, R.S. (27/8/18)
- Brain drain, brain gain, and economic growth in China
China Economic Review, Wei Ha, Junjian Yi and Junsen Zhang (April 2016)
- A Panel Data Analysis of the Brain Gain
World Development, Michel Beine, Ric Docquier and Cecily Oden-Defoort (Vol 39, No 4, pp 523–532, 2011)
- ‘The brain drain makes a bad situation worse, by stripping developing economies of their most valuable assets: skilled workers’. Discuss.
- Using Google, find data on the inflows and outflows of skilled labour for a developing country of your choice. Explain your results.
- ‘Brain drain’ or ‘brain gain’? What is your personal view on this debate? Explain your opinion by using anecdotal evidence, personal experience and examples.
- Referring to the previous question, write a critique of your answer.
The IMF has just published its six-monthly World Economic Outlook. This provides an assessment of trends in the global economy and gives forecasts for a range of macroeconomic indicators by country, by groups of countries and for the whole world.
This latest report is upbeat for the short term. Global economic growth is expected to be around 3.9% this year and next. This represents 2.3% this year and 2.5% next for advanced countries and 4.8% this year and 4.9% next for emerging and developing countries. For large advanced countries such rates are above potential economic growth rates of around 1.6% and thus represent a rise in the positive output gap or fall in the negative one.
But while the near future for economic growth seems positive, the IMF is less optimistic beyond that for advanced countries, where growth rates are forecast to decline to 2.2% in 2019, 1.7% in 2020 and 1.5% by 2023. Emerging and developing countries, however, are expected to see growth rates of around 5% being maintained.
For most countries, current favorable growth rates will not last. Policymakers should seize this opportunity to bolster growth, make it more durable, and equip their governments better to counter the next downturn.
By comparison with other countries, the UK’s growth prospects look poor. The IMF forecasts that its growth rate will slow from 1.8% in 2017 to 1.6% in 2018 and 1.5% in 2019, eventually rising to around 1.6% by 2023. The short-term figures are lower than in the USA, France and Germany and reflect ‘the anticipated higher barriers to trade and lower foreign direct investment following Brexit’.
The report sounds some alarm bells for the global economy.
The first is a possible growth in trade barriers as a trade war looms between the USA and China and as Russia faces growing trade sanctions. As Christine Lagarde, managing director of the IMF told an audience in Hong Kong:
Governments need to steer clear of protectionism in all its forms. …Remember: the multilateral trade system has transformed our world over the past generation. It helped reduce by half the proportion of the global population living in extreme poverty. It has reduced the cost of living, and has created millions of new jobs with higher wages. …But that system of rules and shared responsibility is now in danger of being torn apart. This would be an inexcusable, collective policy failure. So let us redouble our efforts to reduce trade barriers and resolve disagreements without using exceptional measures.
The second danger is a growth in world government and private debt levels, which at 225% of global GDP are now higher than before the financial crisis of 2007–9. With Trump’s policies of tax cuts and increased government expenditure, the resulting rise in US government debt levels could see some fiscal tightening ahead, which could act as a brake on the world economy. As Maurice Obstfeld , Economic Counsellor and Director of the Research Department, said at the Press Conference launching the latest World Economic Outlook:
Debts throughout the world are very high, and a lot of debts are denominated in dollars. And if dollar funding costs rise, this could be a strain on countries’ sovereign financial institutions.
In China, there has been a massive rise in corporate debt, which may become unsustainable if the Chinese economy slows. Other countries too have seen a surge in private-sector debt. If optimism is replaced by pessimism, there could be a ‘Minsky moment’, where people start to claw down on debt and banks become less generous in lending. This could lead to another crisis and a global recession. A trigger could be rising interest rates, with people finding it hard to service their debts and so cut down on spending.
The third danger is the slow growth in labour productivity combined with aging populations in developed countries. This acts as a brake on growth. The rise in AI and robotics (see the post Rage against the machine) could help to increase potential growth rates, but this could cost jobs in the short term and the benefits could be very unevenly distributed.
This brings us to a final issue and this is the long-term trend to greater inequality, especially in developed economies. Growth has been skewed to the top end of the income distribution. As the April 2017 WEO reported, “technological advances have contributed the most to the recent rise in inequality, but increased financial globalization – and foreign direct investment in particular – has also played a role.”
And the policy of quantitative easing has also tended to benefit the rich, as its main effect has been to push up asset prices, such as share and house prices. Although this has indirectly stimulated the economy, it has mainly benefited asset owners, many of whom have seen their wealth soar. People further down the income scale have seen little or no growth in their real incomes since the financial crisis.
- Clouds gather over global economy, casting long shadow on Europe
Politico, Pierre Briançon (18/4/18)
- IMF warns rising trade tensions threaten to derail global growth
Reuters, David Lawder (17/4/18)
- IMF outlook contains cause for celebration but a horrendous hangover is looming
The Guardian, Greg Jericho (18/4/18)
- World trade system in danger of being torn apart, warns IMF
The Guardian, Larry Elliott (17/4/18)
- IMF Warns of Rising Threats to Global Financial System
Bloomberg, Andrew Mayeda (18/4/18)
- IMF issues warning on global debt
BBC News, Andrew Walker (18/4/18)
- The IMF has a simple message: the global recovery will peter out
The Guardian, Larry Elliott (17/4/18)
- Global growth is built, alas, on shaky foundations
The Irish Times, Martin Wolf (18/4/18)
- Government debt
The Economist (19/4/18)
- This Is How Much Money the World Owes
- For what reasons may the IMF forecasts turn out to be incorrect?
- Why are emerging and developing countries likely to experience faster rates of economic growth than advanced countries?
- What are meant by a ‘positive output gap’ and a ‘negative output gap’? What are the consequences of each for various macroeconomic indicators?
- Explain what is meant by a ‘Minsky moment’. When are such moments likely to occur? Explain why or why not such a moment is likely to occur in the next two or three years?
- For every debt owed, someone is owed that debt. So does it matter if global public and/or private debts rise? Explain.
- What have been the positive and negative effects of the policy of quantitative easing?
- What are the arguments for and against using tariffs and other forms of trade restrictions as a means of boosting a country’s domestic economy?