Your average employee will not see their real wage return to the pre-recession level until the last few weeks of 2015, or so the latest data from the Office for Budget Responsibility (OBR) suggests. But actually, to understand the true picture you need to rewind the clock back to the millennium, and then the image that is revealed tells a story of corporate savings creating a debt crisis.
Since 2000, and maybe even before that, household income as a share of GDP has been falling, or so said the OBR report out yesterday. But consumption as a share of GDP largely remained flat. And that’s surely what caused the build-up to today’s problems.
Of course, back in the days of the boom, economists didn’t see it that way. There was no consumer boom, they said. Consumption as a share of GDP didn’t rise during the boom years. Therefore, it was concluded, the economy was on a sound footing. The rise in household debt was sustainable. After all, as debt rose, asset prices, namely house prices, rose even higher. This was the line taken by the Bank of England, which argued that a fall in house prices would not have too big an impact on the economy.
But what they forgot is that if personal income as a share of GDP was falling, then theoretically, so should consumption. Bear in mind, too, that while the noughties didn’t see a consumer boom, the late 1990s did. During the last few years of the last century, it seems likely that consumption rose to an unsustainably high level. The OBR put it this way: “Over the past decade, the sum of household consumption and investment exceeded income.” It continued: “However, this borrowing was not used to finance a consumption ‘boom’ … consumption has been broadly stable as a share of GDP so that the sharp decline in the saving ratio was therefore driven by a declining household income share of GDP. At the same time, households increased their residential investment spending – effectively borrowing money to purchase increasingly expensive houses.”
But drill down a little deeper, and the story gets more interesting.
As the OBR said: “In the decade from 2000 to 2009 the household sector borrowed, on average, around 1.6 per cent of GDP each year … In 2002, the corporate sector moved from being a net borrower to a net lender. Corporate lending averaged 2.8 per cent of GDP from 2002 to 2007 rising to over 7 per cent over the course of the financial crisis.”
In other words, at least some of the debt the UK built up during the noughties was funded by corporate savings. Not all, of course; we also borrowed from abroad.
But it is clear that if an economy is seeing GDP grow faster than household income, then that economy may well have a problem in the making.
But looking forward, the situation looks more tricky.
First, this is what the OBR said: “The sharp fall in asset prices in the recession has not been fully recovered, which will have worsened households’ financial position, at least relative to their previous expectations. It therefore seems likely that households think some adjustment to their balance sheets will be necessary in the medium term.”
But more to the point, this is what their forecast projections say:
|Difference between RPI and average wages||1.2||-1.7||-1.2||-0.7||0.7||1.0||0.8|
|Cumulative difference between average wages and RPI from 2009||1.2||-0.5||-1.7||-2.4||-1.7||-0.7||0.1|
So this is it in a nutshell. During the recession, households became better off. The fall in interest rates meant mortgages became cheaper. The RPI measure of inflation reflects this, hence RPI inflation lagged behind growth in average earnings. Alas, looking forward for 2010, 2011 and 2012, average wages will lag behind RPI inflation.
So, the good news: the OBR reckons the economy will probably grow for the next few years. But this growth will not be reflected in the finances of households. Meanwhile, house prices are coming under pressure, all at a time when household debt is worryingly high.
Maybe the problem is that corporate profits are rising faster than wages.
So what’s the solution? George Osborne wants the UK to become more competitive, and hopes to find ways of clawing back the advantages enjoyed by countries such as Ireland with their lower corporation tax. He is probably right. But frankly, if the UK is suffering from profits growing faster than wages, this is an argument for higher corporation tax, with the proceeds funding cuts in income tax. The problem is, the UK dare not do this because the loss of competitiveness would be disastrous.
But the problem of wage growth lagging behind corporate growth is not unique to the UK. This is a world-wide problem. It’s a problem in the US, and it is very much a problem in China.
Maybe the solution, and it’s a solution that is highly unlikely to be forthcoming, would be for some kind of global corporate tax.
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