Economic and Financial Market Update: The Importance Of The Consumer

Summary:

• Consumer spending makes up more than half of total spending in the economy;

• Modest consumer spending growth is one reason there has been modest economic growth;

• Sustainably strong consumer spending will require higher wages growth;

• That is unlikely in the near future;

• The Government is best placed to make up for the shortfall in consumer spending.

‘We’re shopping

We’re shopping'

- Pet Shop Boys

The Pet Shop Boys were one of the great dance bands of the 1980s. Their second album (‘Actually’) had four top ten songs. ‘Shopping’ actually wasn’t released as a single although has been used as background music by the media when talking about retailing. The song actually wasn’t about shopping but a commentary on ‘privatisation’ (the Thatcher Government selling Government-owned assets) and the boom that took place in the financial markets in the 80’s.

One reason why retailors (and consumer spending more generally) gets plenty of attention is that household consumption comprises a bit over one-half of all spending in the economy. This ratio is currently high by historical standards (partly reflecting weaker spending in other areas such as business investment). By global standards, consumer spending in Australia is a bigger part of the economy. That may reflect the relatively higher level of incomes in Australia. It may also reflect that Governments make a greater chunk of the spending in some areas of the economy in other countries (such as health and education).

Consumer spending is also a less volatile than other parts of the economy (such as capex spending and residential construction). As any restaurateur or travel operator will tell you consumer spending also has its ups-and-downs. But even during the economic tough times, most people are employed and most people spend most of their income. The importance of consumer spending is a reason why the post-mining-boom times in Australia have felt muted. Household spending growth since the GFC has averaged around its slowest pace in at least the past 40 years.

The main reason households have not been spending has been very low disposable income growth. Modest wages growth is the key issue. But the Government’s income tax take has also been rising. Interest payments are taking another decent slice of incomes. High debt levels has made consumers focussed on paying back their mortgage as fast as they can. Strong price rises for necessary items (electricity) crimped spending on other goods and services (although utility bills have been more a little more forgiving more recently). 

One outcome is that consumers reduced their saving rate to maintain their standard of living. The risk is that if disposable income growth picks up (as it will with the tax cuts) some will be directed towards boosting saving. This would be even more likely in the event of a decline in wealth (weak growth in house prices and share prices). 

When talking about consumer spending a lot of the focus tends to be on retail sales. Mostly that reflects the release of comprehensive monthly data (total spending is released quarterly). Focussing on retailors as a gauge of the health of household spending is a little misleading as they have been getting a declining share of the consumers dollar for some time. Around one dollar in every five spent by Australian households is devoted to housing. A further twenty percent of consumer budgets is directed towards recreation and finance (insurance premiums, etc). More generally, over the past ten years more of the consumer budget has been on spent on education, housing and health. 

The near-term outlook for consumer spending is cautious. Wages growth is unlikely to pickup any time soon. And there are signs that jobs growth might be slowing. One sign of consumer caution is that the proportion of people not going to a dentist because they are worried about the size of the bill is rising. And when they hit the shops consumers are going to keep focussing on bargains as their expectation about price growth remains at a very low level. 

What does all of this mean:

• It will be difficult for the Australian economy to become sustainably strong unless the consumer starts hitting the shops;

• The weakness of consumer spending has been particularly bad news for smaller retailers;

• The income tax cuts will mean extra dollars being put in consumer pockets. The retail sales numbers over the next few months will be an indicator as to how much has been spent and how much saved (or used to payoff debt);

• But sustainable spending is unlikely to occur until pay packets get fatter;

• And it will be difficult for firms to boost wages unless the economy get stronger, boosting revenues;

• Without the help of the consumer, other areas of the economy will have to do more of the heavy lifting. The obvious candidate is the Government (easier fiscal policy).

For the decade-plus prior to the GFC the consumer was a big part of keeping the economy humming. Their more muted contribution over recent years has meant that the economic times have been a little tougher. One day the dollars will again flow more freely from wallets and purses. For the economy that day cannot come soon enough!

We live in interesting times!

Peter Munckton - Chief Economist