Can spending dig us out our debt hole?

At the Conservative party conference last month, the media seized on the fact that David Cameron was forced to re-draft part of his speech. By instructing the public to pay off their credit card debt economists warned that if this advice was followed we would go straight back into recession. The line was changed to read “That is why households are paying down the credit card and store card bills”. Apart from the obvious worry that the guy in charge doesn’t seem to know what’s what, this mix up highlighted a paradox of this economic crisis: do we spend or save?

Households are, on average, paying back their credit card bills. In addition, they are saving a higher proportion of their income – a recent report from the Office for National Statistics showed that between April and June this year, the household savings ratio rose from 5.9% to 7.4%. With fears about the effects of reduced spending, interest rates are low, banks are being encouraged to lend, and the phrases “consumer confidence” and “retail slump” are bandied about to suggest that the British public needs to be more lavish. Meanwhile, average personal debt in the UK remains high at £10,000 excluding mortgages. Both Cameron and Obama have highlighted the problem of “living beyond our means” and its intimate relationship to the crisis. With the suggestion that “credit fuelled society” formed part of the cause of the global recession, can spending really be both the problem and the cure?

Of what importance is it to spend? In the UK, consumption has formed an increasing proportion of GDP in recent decades, currently around two thirds. Furthermore, with the retail sector forming a substantial part of our modern economy, our current economic structure depends on buying. The recession has negatively affected consumer confidence. People are reluctant to spend and even more reluctant to “buy it now and pay for it later”. Where jobs are unstable and cost of living keeps increasing consumers are frightened that later they just won’t be able to pay and increasingly see the need to “save for a rainy day”.

Whilst we reduce our spending and start to pay off our credit cards, business across the country begins to falter and their investment level decreases. In addition, rising unemployment creates more instability and herein the cycle continues. Since 2008, boarded up high streets across the country have become the visible casualties of this phenomenon. So, does this mean that we should all go out and spend everything we’ve got, squander our student loans, open that store card and go wild? After all, it’s for the good of the economy, the nation and once we’re back in the boom years it really won’t matter, will it?

Obviously for the individual this is a risky strategy. The truth is, even if you do go immediately to buy the iPhone 4S for you and all your mates it isn’t going to save the country. As an individual, you’re better off saving for a rainy day because the way things are going we’re in for a lot of rain. With their expansionary monetary policy, the Bank of England is not just trying to incentivise business investment but consumer spending too. Trouble is, it’s just not enough.

This is the basis of Keynes’s paradox of thrift, where individual and collective benefits are opposing. Aside from this however, there is perhaps a wider, societal problem. Should we really be relying on spending from those who can’t afford to pay? Should our society be structured in a way that means that we have to keep borrowing to buy more mobile phones, the latest fashion or even a house, when our incomes may never cover it? The financial crisis of 2008 was initiated by too much “bad debt” – mortgage debt that could never be paid off. It seems like fixing this problem with lending and spending is like trying to spring a right from two wrongs. It isn’t going to work.

Right now our economy needs the benefit that a boost in consumer spending could bring. Now is not the time for Cameron to tell us to pay off our debts. However, in the long run, unsustainable borrowing to finance equally unsustainable spending is bad for households and despite the potential for big profits, risky for banks. With so much of our economy tied up in financial institutions, the case for tighter regulation of lending is one which must be heard.