Undercover Economist

What will we buy to help us through hard times?

Anyone wondering how consumers behave in a recession need simply trawl the tabloids for inspiration. According to The Sun, sales of aphrodisiacs are up and so are sales of maternity dresses: not everything turns down in tough times, it seems. Elle Macpherson’s underwear is said to be doing well; so too is the budget store Poundland. Some stories seem contradictory: one newspaper claims that Ryanair is set to make a profit, while another reports that weekend breaks to European cities are no longer in demand. Other stories are frankly bizarre: the crunch is alleged to have given a fillip to sales of cake, wooden “gravestones”, West End musicals and tickets to see the film Mamma Mia!

The quality press has not resisted the temptation to join in the guessing game: The Economist imagined the return of the nutritious fish snoek, while this paper found evidence that physiotherapists were in demand to perk up stressed City workers.

All this speculation is an engaging diversion, but tells us little. Even the more solid reports are often based on anecdotes; many are simply spin or wishful thinking. I’ve heard a food retailer muse that Fairtrade-branded goods are recession-proof, because once people have seen the light about the importance of fair trade, they never turn back. A travel industry expert told me that the worse things get, the more people feel in need of a holiday. Perhaps he is right. I wouldn’t bet on it.

I doubt that these early reports will tell us much about what will happen in the trough of this recession. One of the reasons people curtail their spending is because they lose their jobs. But unemployment is not yet especially high: it was higher in late 2006 than in September this year. There is plenty of scope for things to worsen on that score.

Economic theory tells us that consumers should cut back their spending if they believe that their earning power will fall for an extended period of time, but if they believe the hard times are temporary – say, a short period out of work – they should “smooth” by borrowing in hard times and paying back when things pick up. Because of smoothing, consumption should not shrink as much as the economy does. That sounds reassuring, but Ray Barrell of the National Institute of Economic and Social Research has two pieces of bad news.

The first is that this is the wrong sort of recession: because it was precipitated by a banking crisis, consumption may well fall much more dramatically. That’s plausible. Consumers who want to smooth consumption can’t borrow to do so. This is what happened during the 14 banking crises in various high-income countries that Barrell and his colleagues have studied.

The second piece of bad news relates to the first. Because consumers were already borrowing heavily in the good times, both credit constraints and a long overdue realism are likely to bite all the more deeply. That, too, is a tendency Barrell finds in the data.

Of course, as the sellers of herbal Viagra are said to be discovering, when consumer spending falls, some products do well and others do very badly. Nervous retailers looking for clues might wish to pick up research from the 1990s by the economists Martin Browning and Thomas Crossley, called “Shocks, Stocks and Socks”. They found that when people are unemployed they save money in a logical way, by not buying “small durables” such as socks, and indeed clothes in general. In the short term, people get by and save about 15 per cent of their household budget. When they find a new job, they replace the tired old socks. Bad news for Marks & Spencer; good news for sellers of needles and thread.

Also published at ft.com.