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OPINION

Rebalancing, RIP

Rebalancing, RIP
March 22, 2013
Rebalancing, RIP

This much is evident in the OBR’s forecast. It expects consumer spending to contribute 5.9 percentage points to real GDP growth between 2013 and 2017, whilst net exports chip in a measly one point.

This consumer growth is not founded solely upon higher real incomes. Instead, the expectation is that the mortgage guarantee plan, and the Funding for Lending Scheme, will increase household borrowing. The OBR expects the personal sector’s financial balance (roughly, the difference between saving and spending on buying houses) to fall from a surplus of 1.4 per cent of GDP now into deficit by 2016. And it expects households’ debt to rise from 147 per cent of annual disposable income now to 155 per cent by the start of 2017.

This poses two questions. Is this likely? And if it happens, is it desirable?

There’s a big problem with forecasting household borrowing. It’s that this depends upon expectations of future incomes and these expectations – which might or might not be rational but that’s another tale – are largely unforecastable. The OBR hopes that rising private sector employment will create a sense of job security, thus increasing borrowing. But there are at least four reasons to be sceptical of this:

■ Labour productivity might recover – either because its fall is due partly to labour hoarding, or because “zombie firms” finally shut down. If this happens, employment might not pick up so much, thus dampening households’ animal spirits.

■ Memories of the 2008-09 recession might have a long-term scarring effect, causing people to revise up their estimation of desired savings even years into the future.

■ How should we interpret the fact that there has been relatively little deleveraging? (Household debt is actually slightly higher than it was in 2009, and the debt-income ratio has fallen only because inflation has raised nominal incomes). On one view, this is because households in aggregate were not especially over-geared. But it might be because the squeeze on real incomes has prevented the desired deleveraging. If so, any pick-up in income growth in coming years might be used to reduce debt.

■ What effect will sustained low interest rates have on saving? The government (and Bank of England) hope they’ll cause consumers to prefer consumption to saving. But it’s possible that this substitution effect will be offset by an income effect; we’ll save more to make up for the fact that our wealth is growing so slowly.

I say all this in a spirit of scepticism, not dogmatism. The economy has not been in this position in our lifetimes, so any forecast must be even more uncertain than usual.

But let’s assume the OBR is right. Is economic growth along these lines desirable?

On the one hand, yes – owt is better than nowt. But there is a problem here – such borrowing could increase the fragility of the financial system.

The OBR doesn’t just expect households’ financial surplus to fall. It also expects the corporate sector’s to do so; these declines are, in an accounting sense, a necessary counterpart to the government’s deficit falling. These falling surpluses, however, imply increased borrowing. The OBR expects bank lending to households and non-financial firms to rise by almost 25 per cent - £476bn – between now at the start of 2018. This implies either that banks’ issue more equity, or that they cut back on other activities, or that their capital ratios decline as they become more reliant upon debt. Bank shareholders, please note.

There’s a further problem. The OBR expects the UK to run an external deficit in the next few years – albeit declining thanks in part to an eventual recovery in the euro area. Such a deficit, by definition, means that UK residents (government, households and firms taken together) are saving less than they are investing. But this might well mean that they are depositing less with banks than they are borrowing, which in turn means banks must be increasingly reliant either upon overseas deposits or upon wholesale funding. And – as you might have noticed – such sources are unreliable. It is no accident that the countries to have suffered the worst banking crises had current account deficits in the preceding years.

Now, I am not predicting disaster here – merely pointing out that debt-fuelled consumer-led growth has its drawbacks.

And herein lies a paradox. The government’s strategy amounts to privatizing borrowing – shifting it from government to households. But we know from the fact that index-linked gilt yields are negative that the government can borrow freely and more cheaply than households can. Unless you think the dangers of a government debt crisis are greater than those of a private sector debt crisis – an opinion which requires some defending – such privatization replaces a small risk with a bigger one.