Stephen King: Everyone likes a party, but what happens when the music stops?

Whichever way we look at it, consumers are more vulnerable than they like to think they are
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The Independent Online

As our fun-loving frolicsome youth descend on Faliraki, baring their bits, it becomes a little easier to explain why our economy is looking in such a parlous state. Last week, the Office for National Statistics confirmed what most of us knew already: that whereas the British like to have as much sun, sea, sand and sex abroad as they possibly can, the same doesn't apply to foreigners thinking about coming here. Strangely enough, the average continental European doesn't appear to have the appetite for donkey rides followed by 18 pints of beer and a good vomit, perhaps the main selling points of your typical British seaside resort.

Maybe I'm reading too much into the data. Nevertheless, the detailed GDP figures for the second quarter show that the UK is consuming a lot but, at the same time, is exporting very little. Indeed, the growth rate of UK consumer spending is now the fastest of the major industrialised countries whereas exports are shrinking more quickly in the UK than anywhere else. Given that British tourism overseas is counted as an import - thereby reducing GDP - whereas foreign tourism in Britain is counted as an export - thereby boosting GDP - it looks as though the Faliraki fun lovers may have something to do with the seemingly unbalanced nature of UK economic growth. The UK economy may still be expanding but its progress seems no more stable than that of a Faliraki holiday rep after one too many retsinas.

The disappointing performance of exports is made even worse by the lack of investment in the UK. And this is not just a case of an absence of capital spending in British seaside resorts. Across the board, investment just isn't happening. In the second quarter, business investment fell by over 1 per cent compared with the level recorded in the first quarter and by 3.5 per cent compared with a year before. Manufacturing investment was particularly bad, declining by over 10 per cent in just one quarter, the steepest such fall since this series was first recorded in 1994.

Of course, it's always possible to find a few redeeming features. Retail investment, for example, appears to be on the rise - perhaps to meet the demands for sun cream, ibuprofen, thongs and other necessary items for a life of fun in Faliraki - but this only serves to emphasise the imbalances that now exist across the UK economy. Anything to do with the short-term desires of the myopic consumer is easily delivered: anything to do with the long-term health of the UK economy is put to one side.

Should anyone be concerned about this state of affairs? After all, we all know that British consumers like to spend lots of money. What's wrong with a bit of enjoyment? Well, apart from the obvious concerns - hangovers, sunburn in the nether regions - too much fun today will lead to all sorts of problems later on.

This isn't just a story about wrecked livers. I'm more concerned with the financial rather than physical implications of a life of short-term debauchery. You might think I'm all too keen to get on my economic pulpit and warn of the dangers of excessive consumption but, ultimately, we will all have to recognise that we cannot go on like this forever. Everyone likes a party but, for policy makers, the key issue is the morning after. Policy makers have to think about the long term, about how they will manage the economy through both good and bad times.

Up until now, the Bank and the Treasury could reasonably argue that they've done a good job: the UK economy has outperformed the eurozone's over the past couple of years, avoiding the recessionary downswing that has blighted the progress of Germany and Italy, and unemployment has remained lower than in the US. All very welcome. But is this just the economic equivalent of a Mediterranean rave? We've all kept dancing, pumped up by the economic equivalent of speed and amphetamines, but we've yet to find out what happens when the music stops.

Oddly enough, the UK corporate sector can probably offer some lessons for UK consumers. UK companies had their rave in the sun in the late-1990s. They borrowed and they spent. They invested and their shareholders hoped to find happiness. What did they ultimately end up with? Too much debt, a bunch of under-productive assets and a lack of profitability. Of course, part of this story is tied up with the global technology boom. But the odd thing about the UK is that, despite all the investment, productivity never really improved. Put another way, there was little point in UK companies borrowing to invest unless the extra capital spending could help boost productivity and - hopefully - profits. And these things never really happened.

The ongoing weakness of exports is just one further sign of the worrying position of the British economy. Had the investment boom of the late-1990s paid dividends, we would presumably be experiencing an increase in our share of world trade. But with UK export growth now the weakest within the G7, we've ended up in exactly the opposite position. We may have had an investment boom, but there's little to show for it either in the form of improved competitiveness or a healthy balance of economic growth. In other words, the investment boom didn't deliver the goods. Why should a consumer boom do any better?

When the music does stop, we will face a number of economic problems.

Companies will have exported their capital abroad to take advantage of cheaper labour costs. Result: lower wage growth for consumers and, maybe, a higher unemployment rate.

Government will find itself with lower tax revenues. Result: either higher taxes, cutbacks in government spending or a prudence-busting increase in government borrowing.

The exchange rate may have to come down a long way as foreigners refuse to fund an ever-increasing UK trade deficit. Result: lower real incomes for consumers as import prices go up and a switch in demand from thongs to thermals as British holidaymakers stay at home.

Whichever way we look at it, consumers are more vulnerable than they like to think they are. They are vulnerable to capital flight, to higher taxes, to lower wages, to a falling exchange rate. And, for the icing on this particularly indigestible cake, they are also vulnerable to themselves, in the form of a weaker housing market.

It's all very well getting excited about the strength of retail sales or the buoyancy of consumer confidence but, at the end of the day, we have to ask ourselves whether we really can pay for all this extra consumption.

In my view, we can't. MC Brown and MC King have kept the music going through the night but, as dawn approaches, consumers may even begin to regret their nocturnal activities. They may not have been jailed for exposing their naughty bits, but they may nevertheless end up with a long-term sentence of hard labour and debt repayment.

Stephen King is managing director of economics at HSBC.

stephen.king@hsbcib.com

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