Out of total spending estimated (in current prices) at £1.3 trillion (a thousand billion) in 2008, the private consumer, or household sector, accounted for over £800bn (62.5%).

A share of around 60% is common for most industrialised countries but in poorer countries it tends to be higher because investment is less.

Between 1995 and 2007, consumer spending grew in real terms (constant prices) at an annual average rate of 3.4%, a faster rate than the increase in GDP.

In only one year was the increase less than 2%. This growth implied that consumers contributed 2.3% to GDP growth, before investment and government consumption are taken into account.

In view of its significance, trends in consumer behaviour is a key indicator of the pace and direction of overall activity.

From 2005, the pace of consumer activity started to weaken and in 2008 growth dropped below 1% for the first time since 1992. As interest rates rose and the tax burden increased, the annual growth in consumer spending dipped to a rate slower than the economy as a whole. Given the high levels of consumer debt, it could be several years before any buoyancy returns to the personal sector.

Several indicators are tracked to give some clue as to how consumers are likely to behave, the most important of which are measures of consumer confidence.

Chart 7.9 shows the Gfk series back to 1986 and tracks these results against consumer spending. The ‘feelgood factor’ is influenced by a number of general economic issues such as employment prospects, interest rates and inflation.

The aggregate figures for consumer spending shown in the chart can be broken down into relatively detailed product categories, such as food, clothing, transport, etc.

There are also data showing spending on services (eg. catering, rent and transport) and a trend apparent over a number of years is that as consumers’ incomes rise, a smaller proportion of the extra income finds its way to the high street.

Services rather than goods are accounting for an increasing proportion of personal sector spending.

The performance of the consumer sector has been key in recent years, as Table 7.7 shows.

Table 7.7: Change in Expenditure Components, 2004-08

The fact that growth relied heavily on the personal sector is apparent from both its increasing share of the total spend and the deteriorating net trade position. This now seems to have levelled off, and is easing slight.

Domestic demand has been driving growth since 1995, underpinned by increases in employment / decreases in unemployment, rises in earnings above the rate of inflation and strong borrowing.

Table 7.8: Shares of Expenditure by Main Category, 2004-2008

(% shares)

Gross Fixed Capital Formation covers spending on factories, dwellings, machinery and equipment and its share of total spending rose after the lows of the mid-1990s, but then stabilised and is now falling.

Investment spending tends to be cyclical, varying with general economic prospects and is sensitive to interest rate changes.

The definition of investment, however, is rather confusing.

Government spending on roads, defence and education is generally classified as consumption rather than investment, although the payback period could be very long term.

Similarly, consumer spending on cars and other durable goods with a working life of a year or more is also considered to be consumption.

Finally, capital goods purchased by a financial institution and leased to an industrial company are usually classified as consumption, all of which suggests consumption is overstated and investment under-recorded.

Unfortunately, not all this investment can be regarded as ‘productive investment’.

Almost a quarter of the 2008 total investment spend was attributable to dwellings, which contribute little to productive potential). Back in 1970, when owner occupation was a lot lower, dwellings represented just 11% of investment.

A more useful measure is the ‘business investment’ figure published quarterly by the ONS. This reduces the £234 billion figure for 2008 by nearly 40%, to £146 billion, by stripping out those items, such as dwellings, that do not contribute directly to future output.

A substantially smaller total, it has been erratic over the last few years. Measured quarterly, business investment peaked in the last three months of 2007, since when it has been edging down.

In terms of the distribution of this business investment, there is no surprise that, since ‘general government investment’ is not classified as ‘business investment’, all but 3% was by the private sector.

Neither, given market conditions, is it surprising that investment by manufacturers has been very flat, to the point where a (supposedly capital intensive) sector currently accounting for 14.7% of GDP has just an 11.4% share of business investment.

Services have been the key to business investment, not only in terms of the absolute amounts (almost three quarters of the total) but also in terms of growth.

Retailing apart, investment by services increased in real terms by 61% in the three years between 1997 and 2000 (compared with an overall growth of 25%), and then seemed to stall.

Between 2005 and 2008, however, investment in services again rose by almost a quarter at a time the rest of business investment fell by 13%.

For business investment as a whole, one third was on machinery and equipment (other than transport), slightly less than was spent on buildings other than dwellings.

According to recent surveys of industry (eg. by the CBI), the principal motive to invest in manufacturing was to improve efficiency or replace older assets.

Expanding capacity was not an important motive and the outlook for general business investment is to slow as spending generally weakens.

In the second half of the 1990s government spending was the slowest growing component of GDP, but picked up sharply from 2002, and rose in real terms by almost 19% in seven years.

It was in 1994 that the government’s share of general spending dipped below 20% for the first time in the post-war era, having been above 30% in the early 1950s.

As the Chancellor’s increased spending on public services and the recession took effect, this trend was reversed. In 2008, government spending was the fastest growing component of GDP (2.8%) and the share was up to 21.6%.

Gordon Brown’s term as Chancellor was split into two unequal parts, corresponding to the Governments first and second terms in office.

• In the first term, from 1997 to 2001, he followed the guidelines set by his Conservative predecessor and kept a very tight rein on public spending. Surpluses were achieved which were used to reduce debt to levels amongst the lowest in the EU.
• After winning a second term in 2001, spending became a much higher priority, especially on health and education, and there was less evidence of ‘prudence’ than in the first term. In fact the surge in spending coincided with a weakening of tax receipts and, as a result, borrowing started to rise sharply. In his final budget in 2007, Mr Brown signalled that the growth of public spending in the medium term would return to rates below those of the economy as a whole.

The recession, however, has made life much more complicated for Gordon Brown's successor.

Both sides of Mr Darling’s financial accounts have been affected by the downturn and, as tax revenues fell and spending increased, he was hampered by the fact Mr Brown had overspent in previous years when the economy was growing.

(The trends in the trade data are discussed in the section on international trade – see UK External Position 17.1 Importance of Trade)

From Table 7.2 (in section 7.3 Output Trends - Manufacturing - the continued rise in absolute output it is apparent that the value of imports has regularly exceeded exports.

Only twice in the last 20 years, and most recently in 1997, has net trade made a positive contribution and the current shortfall of exports over imports (exports/imports %) has averaged 10% since 2001.

This demonstrates not only that imports have been rising more quickly than exports but underlines the strength of domestic demand.

Imports have had to come in to fill the gap created by the excess of home demand over home production, a familiar feature of the UK’s economic performance over the last half century.

Trade makes a substantial contribution to economic activity. Together, exports and imports together account for around 60% of GDP which makes the UK one of the most trade-sensitive of the industrialised countries. This helps explain why the exchange rate is such a pivotal issue.

A second consideration is that the negative contribution from net trade emphasises the fact that the UK economy as a whole has become increasingly unbalanced.

A continuation of the steady growth of imports, which is not matched by exports, poses risks for the economy in the medium term if it continues.

The chart below illustrates the contributions to GDP growth by the main spending categories, similarities between the current position and the late 1980s are obvious. The late 1980s trend was unsustainable and ended in the recession of the early 1990s.

And, 15 years or so on, history repeated itself. The domestic consumer was deliberately stimulated to take up the slack left by the fragility of the world economy but this spending (together with the expansion of the public sector) was pushed to excess.

Once the 2008-09 recession ends, the policymakers will need to ensure that growth is more sustainable. This means looking more towards investment and exports and less to private and public consumption to stimulate growth and jobs.