Consumption growth or household spending has slowed meaningfully since the financial crisis. Over the past decade, consumption growth in advanced economies has averaged a compound annual growth rate of 2.9% between 2004 and 2014, compared to a CAGR of 4.3% between 1994 and 2004.
Consumption growth has slowed considerably due to a number of factors, including negligible wage growth, job stagnation, rising income inequality and less access to credit. But can household spending growth ever pick up again? That’s the question Goldman Sachs investigates in a new research report on the topic released last week.
The changing face of consumer spending
Consumption growth has been a key driver of world GDP growth since the 70s. Between 1970 and 2014 household spending had a 90% correlation with global GDP. At its peak in the 1990s, consumption in the US, Japan and Europe constituted 44% of global GDP. Today, consumption accounts for just 32% of GDP due to the explosive growth in Chinese fixed asset investment.
As with all economic arguments, there is both a bull and bear case for household spending. The bear case assumes a continuation of the current trend. An uneven recovery in employment and wage growth, coupled with increasing income inequality and unfavourable demographics (the ageing wealthier generation seems reluctant to spend) will prove to be a drag on consumption growth going forward. The bull case is that household spending growth will improve in the near-term as improving labour market conditions, rising labour demand and wage growth drive real disposable income growth. Cheaper energy prices, rising home prices (the wealth effect) and a pent-up consumer demand could also contribute to higher levels of spending. Pent-up demand could be one of the most significant contributing factors here. As Goldman Sachs explains:
“When millennials grow up: Pent-up demand perhaps applies the most to today’s 25-34 year olds. Against a backdrop of weak economic conditions in the last decade, younger consumers have postponed major spending and life decisions. In the US, the mean age of first marriage has risen to 28.2 years versus 26.4 a decade ago. In the UK, on average, women are having their first children after they turn 30 (compared with 28 two decades ago). However, millennials are coming of age. In both the US and the UK, the number of births picked up between 1985 and 1990, implying that more consumers will be turning 30 and starting families over the next few years.
There are signals that this delayed spending will materialise imminently. Household formation has picked up in the US (second chart), while in the UK, the number of first time home buyers began to recover in 2013-14 after more than halving between 2006 and 2011 (only 43% of 25-34 year olds are home owners in the UK currently, vs. 67% in 1991). As and when young adults buy their first houses, cars and durables, total consumer spending may receive a leg up from a generation whose contribution has lagged those of prior generations.”
Consumer spending: Near-term growth
The above trends lead analysts at Goldman Sachs to conclude it is likely that bull case for household spending growth will play out in the short-term.
As conditions in the labour market tighten and consumers start to feel the effect of higher wages in their pockets, it’s likely they’ll go out and spend after years of consumer austerity. However, in the medium to long-term the outlook for consumer and household spending becomes much more uncertain. Structural bear arguments will gain momentum, the problem of an ageing population won’t go away overnight and most developed market economies will have to deal with this issue for decades.
With this being the case, Goldman Sachs believes that over the long-term, older households will prove to be a drag on consumption growth. Increasing longevity is already pushing health care costs higher, with healthcare spending per capita in the US up by 75% over the past 15 years. Also, there has been a significant shift towards employee funded pension schemes in both the UK and US, which is important because it increases uncertainty around retirement income leading to more cautious consumers. Thirdly, the risk of automation and weaker job security could push up savings rates once again reducing spending.
Figures from the past decade show how these trends are already playing out. Goldman Sachs has put together the colourful chart below to highlight how shifting demographics are driving higher spending on healthcare, insurance and education at the expense of discretionary spending for those younger than 45.
(Click to enlarge)