Hamish McRae: Spending is the way to help the recovery take off

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The Independent Online

Just keep shopping – and not only to give a much-needed boost to the high street. One of the harsh truths that has become quite clear is that Britain will have to find ways of keeping demand up next year, as the eurozone slides back into recession.

However the European sovereign debt crisis develops next year, we have to assume that exports to the Continent will be very weak. We have also to assume that, as one or more eurozone countries are likely to default and as yet more austerity will be piled on consumers across the entire region, that confidence will receive further shocks. And we have to assume that such austerity will continue for several years. So what do we do?

There is no magic wand, and I think we should be suspicious of grand top-down macroeconomic notions, such as slowing down the process of fiscal consolidation. Anyone arguing that Britain should try to borrow yet more has to answer the question as to how much higher interest rates we would have to pay. I think we should also be suspicious of any top-down "growth strategy".

The economy does not grow faster because some politician makes an inevitably modest change in planning regulations. Even the huge monetary stimulus the Bank of England has organised in recent months may have had less impact on demand than the Bank hoped, and unfortunately more impact on inflation.

There is a powerful case to be made that governments should not get in the way of economic growth – for example by imposing pointless regulations. But when you look at what they might do positively, the list is short. We're pretty much on our own.

And that is where shopping comes in. Consumption makes up about 67 per cent of GDP, the rest being investment, exports and government. (The figure of government spending being 45 per cent or more of GDP is right, but much of that is transfer payments, with the tax coming in going straight out on pensions and benefits.) Consumption is so huge a proportion of the economy that what happens to it is the most important determinant of growth.

And here is the point of modest hope. Consumption has, of course, been depressed by the fall in real wages, with inflation much higher than wage increases, but it has not fallen off a cliff. From now on, there is the prospect of falling inflation, maybe a quite rapid fall if fuel prices decline. If inflation really does get down to the "low threes", as Spencer Dale, the Bank of England's chief economist, thinks will happen by March, then real incomes should be just about stable.

There is also the prospect of stable house prices, a key factor determining consumer confidence, and housing turnover seems to have revived a little. Most important, people seem to have made a solid start in rebuilding their savings. Whereas five years ago many people were bolstering their living standards by re-mortgaging their homes, now the reverse is happening, with many paying down mortgages ahead of schedule. The savings ratio, having gone negative, is just about at its long-term average.

We still carry a mountain of personal debt. But if the assets against that debt are stable and if we have made a start on paying it down then gradually our natural instincts to get spending will reassert themselves. This is not a recipe for a consumer boom – that is years away. But even a modest upward nudge in consumption would transform the growth figures, turning a stuttering recovery into a more solid one.

This would not of itself revive the high street. Other long-term structural changes in our behaviour, including out-of-town malls and online sales, mean that high streets have to find a new role, as the review by Mary Portas recognises. (The UK, by the way, vies with Denmark for the highest proportion of online shoppers in the world.) But there is a parallel between what needs to be done to revive the high street and what needs to be done to bolster the economy: first, remove unnecessary barriers to growth; and then make a string of small incremental changes that nudge activity upwards.

That, next year, will be the key to the recovery: a modest but sustained increase in consumption. Not easy, given the European turmoil, and not heroic. But it will be the only way we escape the double dip.

Bargain shares are the upside of Europe's woes

Sometimes small items of news slip by and you wish you had paid more attention because they gave an early warning of something big. One came yesterday, a note by Sushil Wadhwani and Michael Dicks on the outlook for share prices. (Dr Wadhwani, a former member of the MPC, runs an asset management firm.) The idea is simply that, in the medium-term, equities are likely to perform much better than bonds. Not only are they cheap in absolute terms, but they are exceptionally cheap relative to bonds – on one measure, the cheapest for 25 years. Even adjusting for a possible long period of poor growth for developed countries, shares are still reasonably cheap. Why are share prices not higher? Well, it seems "equity investors are attaching a highly significant probability to EMU breaking up, and with possible very large output losses".

We will see; the authors admit there are huge risks and that "an accident" might occur. Meanwhile, it is really interesting that, despite the bad news washing over them, this time the markets haven't panicked. Or not yet.

h.mcrae@independent.co.uk

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