‘Excess saving’ in lockdown: a big new economic challenge
By Dan Corry, a formerTreasury and Downing Street economic adviser; Peter Kenway, Director of the New Policy Institute; and Steve Barwick, Director of DevoConnect
Update: In response to Labour's British Recovery Bond announcement in Febuary 2021, a follow up piece has been written by Dan Corry and Peter Kenway, Economic recovery should be driven by investment rather than consumption by better off households.
This blog was featured in the Guardian on the 1st June 2020 by Observer economics editor Phillip Inman.
The Coronavirus emergency has, quite rightly, brought close attention to excess deaths. But another extraordinary feature of the lockdown is that it has forced the better off segment of the population still in work to save a lot more than they usually would. They have they been unable to spend their income on holidays, restaurants, sport, travel – even going to the hairdressers. Commuting costs have shrivelled. While it is a matter of judgement exactly what to count, our estimate, compiled using official statistics (see chart below), suggests that the top fifth of households (numbering 5.5 million) will have reduced their spending by some £23 billion if the lockdown were to last for three months (one quarter of the year). Those in the second highest fifth of households will have reduced their spending by around £14bn over one quarter.
Not all of this unspent money will have been saved: spending on some items, like food to eat at home, will have gone up, some debts may have been paid off and a number of these households will have suffered a drop in earnings. But overall, the evidence is clear: the amount which households near the top of the income distribution have saved since the lockdown began is huge. By way of comparison: £23bn is equal to 4.5% of GDP over a quarter or 48% of what the government gets in over a quarter from basic, higher and additional rate income tax payers combined.
Figure 1: estimate of money not spent, per quarter (£bn), as a result of lockdown, by each fifth of households in the income distribution
Source: authors’ analysis of the Living Costs and Food Survey, 2018-19. The percentages refer to the proportion of each line of spending which we have assumed is no longer being spent during the lockdown.
Excess saving on this scale isn’t a surprise because it is just as much a reflection of an economy out of balance as is the deficit that the Government is running up to keep the economy going. The two are opposite sides of the same coin. The question is what should happen to this excess as the lockdown starts to unwind.
The Government could just leave the excess saving to work its way off over time in the hope that high income households will spend as soon as they are able, helping revive the hospitality and night time economy, leisure and tourism, and so on. But doing nothing like that is a bad option. First, it is clear that social distancing is going to delay the revival for quite some while. Second, this saving surge for the better-off is happening at the same time as many are looking at severe drops in their earnings and the UK is facing a severe recession with mass unemployment in the months ahead. That inequality cannot be ignored. Third, if these savings are not spent on productive activity, there is a real danger that they will simply add to asset price inflation, a productively useless but nevertheless profitable activity at least for some.
If doing nothing has adverse macroeconomic and adverse distributional consequences, what are the alternatives? Should the Government try to keep the saving as saving, to finance its debt? Should it tax it away to reduce that debt? Or should it seek to redirect the spending towards productive investment and, if so, how?
The simple truth is that it is the Government – national, city regional and local - who will lead the recovery, just as it did in 2008. The Prime Minister has stated what people want to hear – as he is wont to do – that there will be no return to Osborne style austerity but we have already seen the Treasury suggest some firmer grip on the public finances. Given the size of the Government deficit that is in prospect, that is not surprising.
As most agree that at some stage taxes will need to rise, the burden should fall on those with high incomes -on the higher, not standard, tax rates. It is striking though, that the amount brought in even by relatively large rises in the upper rates of income tax is still small when compared with the amount of excess saving. For example, putting the higher rate of income tax (payable by those earning more than £50,000) up by five pence to 45% and the additional rate (only payable on income above £150,000) up by 10 pence (taking it to 55%) would bring the Government about £1.5bn per quarter. So tax rises would still leave the majority of excess savings untouched and therefore other interventions may also be considered.
If the Government really wants to do something else about where these savings go, it will need to think creatively. There are several other options available. The first would be some kind of savings tax. Although appropriate to the problem, it is hard to design and unlikely to find political support. Second, Government could try to persuade these households to lend to the Government; a specific new product could be launched – say a Coronavirus Bond – issued by National Savings and supported by an effective marketing campaign appealing to people’s sense of social solidarity. A third option would be to issue a product to mop up household savings but with a specific purpose in mind, for example, to help capitalise a Decarbonisation Fund.
The mood for supporting for the state and indeed for giving is now. Economics provides the evidence for the Government to act.