Official figures and a survey by the CBI next week are both likely to show that retailers are struggling. But might things get better in 2013? One thing at least suggests so – cointegration.
The idea here is simple. Over time, our incomes and our spending should rise at roughly the same rate: if this were not the case, then we would end up either as very rich misers or as hugely indebted spendthrifts, but most of us are neither. This implies that if our spending is high relative to our incomes, we subsequently cut back, and if it is low we let ourselves go and subsequently spend more. Incomes and spending are like a drunk and his dog walking home from the pub. At any point in time, the two might be far apart. But if they are, we can expect them to move closer together. This is cointegration.
And here's a reason for optimism. Recently, spending has been low relative to incomes. In Q2, real consumer spending was more than eight per cent below real after-tax incomes. That's a bigger gap than the long-term average. This points to spending rising.
Historically, this has been a powerful force. Cointegration, along with just two other things - changes in real incomes and unemployment - explained three-quarters of the variance in consumer spending growth between 1986 and 2010.
Herein, though, lies a problem. In the last few months, consumer spending has been weaker than its close historical correlations with income growth, unemployment and the income-spending gap would predict.
One obvious possible explanation for this is that households have been repairing their balance sheets. Whereas in normal times, low spending relative to income has presaged rising spending, it has recently been because households have been deliberately adding to their savings or paying off debt. The cointegration mechanism has thus stopped working. The upshot has been that, with real incomes falling, spending has been weak.
If this continues to be the case, then the outlook for consumer spending is bleak. With wages and most welfare benefits rising less than inflation, real incomes won’t rise much next year; the consensus is for them to grow just one per cent. And most economists, including the Office for Budget Responsibility, expect unemployment to rise a little, which would further squeeze spending.
Whether it will remain the case, however, is impossible to say, because we don't know what the "right" level of household debt is - because this depends upon unobservable factors such as expectations of future incomes. What we do know, though, is that the ratio of aggregate household debt to post-tax income has fallen from 1.59 at its peak in March 2008 to 1.34 now. In this sense, we are at least closer to a sustainable level of debt and hence to a brighter outlook for spending.
However, so poor is the outlook for real incomes and unemployment that even if cointegration does work "normally" - in the way it did between 1986 and 2010 - then spending would only rise by around two per cent next year. So it looks like being yet another tough year for retailers anyway.
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Chris blogs at http://stumblingandmumbling.typepad.com