Why Australians aren't spending - the effects of growing casual and contract work on the consumption function

In the latest political round, the Greens and Opposition have combined in the Senate to effectively block the immediate increase in the Australian Government's debt ceiling from $300 to $500 billion by passing a motion limiting the increase to $400 billion. The Government won't accept that, so the matter will have to go back to the Senate at a later date. 

While this gives the opposition some satisfaction in reprising the Government's words and approach, this is silly stuff. It is also a tad dangerous. Among other things, it gives the Government a lever, should they want to use it, for further expenditure cuts. And we don't actually need that just at present. However, this is not what I wanted to write about this evening.  

Today's post explores a simple question. Why aren't Australians spending?

Retail sales have been relatively stagnant over the last few years. Effectively, consumers have been on strike. There have been good practical reasons for this. In Australia as in may other countries, personal debt levels rose during the long period of economic growth, supported in part by rising asset values. Savings rates dropped to very low levels.

This process went into reverse following the global financial crisis and subsequent global recession. People sought to save more, to spend less, to de-leverage, adding to downward economic pressure. The effects were muted in Australia by the mining boom, but persisted nevertheless. However, this is not the whole story.

You can see this in the way that commentators discuss consumer spending. They are puzzled at the continued reluctance to spend when Australian economic performance has, in fact, been quite good. Some look at the increase in on-line sales, others suggest that de-leveraging has not yet finished, some point to continuing uncertainty.

My view is a little different. I think that there has been a structural shift in the consumption function linked to changes in workforce structures.  

Work force flexibility is very important to individual businesses. It allows businesses to more easily expand or contract numbers employed to meet changing business circumstances. This aids viability at firm level. However, the growing proportion of the Australian workforce working in contract or casual roles has affected consumer behaviour. Greater work uncertainty requires people to hold larger cash reserves, as do the periodic employment gaps often associated with such work. It also depresses Christmas sales, since a not insignificant proportion of the workforce is now only paid when they work. Christmas is actually a low income period for many people.

Let me illustrate with some simple hypothetical maths.

Say you are paid $200 per day, but only when you work. Say the Christmas shutdown period is two weeks. Say you are paid weekly. Then at Christmas you face three weeks without income, two because you are not working, one because of the week's lag before your first pay comes through. So to get through Christmas you have to save to cover both foregone income and the extra spend associated with Christmas. This means that you have to save a minimum of $3,000 (three weeks times $1,000) to give you you your normal cash availability plus whatever cash you need to buy presents etc.  

The story doesn't end there, for contract and casual workers on rolling contracts have to consider the potential lag between jobs, When might my current work finish, how long might it be before I get more work? Money must be saved to cover this. This has two effects.

The first is that a casual or contract worker will necessarily need to hold more cash reserves than a permanent worker on the same notional pay. This leads to a shift in the consumption function while the necessary reserves are built up. People spend less. Once the necessary reserves are there, spend as a proportion of income can increase, However, we now need to factor in a second factor, uncertainty.

The greater the uncertainty, the more people will want/need to save. This is both structural and cyclical. In structural terms, people just need to save more in general, leading to a shift in average savings. However, marginal spending will also shift up and down. As uncertainty increases, people will cut back on spending. Conversely, as they feel more secure in their jobs, they will spend more.

Just at present, uncertainty is quite high, although recent increases in consumer confidence have flown through into an increase in retail sales. How people will respond the Commonwealth Government's latest cut backs is still to be seen. My feeling is that it will act to depress growth in consumption beyond those immediately affected.