This article appeared originally in Gulf News: link to original article
Household consumption makes up 51.9 per cent of the UAE GDP (CIA World Fact book). In other words, we are a consumption-based economy. And like the case is with consumption, the trade-off is to consume today or consume tomorrow.
Then, taking that into the context of saving today or saving tomorrow. Tomorrow here refers to later on. To better understand the dimensions of a consumption-based economy versus another, let’s consider the US and China.
The former has been chosen because it’s also a consumption-based economy, with consumption compromising more than 68 per cent of GDP. As for the latter, consumption in China is a bit north of 35 per cent of its GDP.
The remainder is distributed among government spending, investments, and net exports with different proportions in each. China is identified as an export-based economy, with quite a huge chunk of money going into investments.
So why is having a consumption-based economy or not a significant matter? And what are the effects of having a consumption-based economy, especially one fueled by borrowing?
The main effect, which the trade-off mentioned earlier illustrates is reduced saving now, and reduced consumption later. This partially explains why China has a very high share of investments as part of its GDP breakdown, which is the result of higher overall saving — more than 50 per cent of GDP (World Bank).
The significance of such a trend is embedded in the culture itself, and in how individuals, or households, perceive the distinction between what is necessary to consume now, what can wait, and what is nothing but a mere luxury. And when this is understood, the intricacies of UAE citizens defaulting on their loans become clearer, especially when it’s already known that what has been driving consumption are loans (as quoted by an Economist Intelligence Unit study (2014)).
Whether a personal loan, a car loan, or credit cards, where interest rates stood at 37.75 per cent in 2013, banks make it very easy and viable for individuals to borrow. And once they borrowed the money and spent it, they failed to realize that these loans were possible future savings consumed today, with interest being paid to banks and financial institutions for making it possible to bring one’s future income forward.
Consuming today is not necessarily a bad thing, but it all comes down to what the money has been spent on. The reason I have not mentioned home loans or mortgages is because that such long term loans are linked to assets with a certain price tag on them, which should secure one’s interests unless the price was somehow inflated to serve higher loan interest.
Also, there are interest free loans provided by Zayed Housing Programme and others which reduce the amount financed by banks. Now encouraging home ownership versus renting one is another issue altogether.
Consumption is a great way to spur growth in an economy, but when it gets out of control, you get to a situation similar to that of Japan where even increased government spending fails to make up to lost growth. Raising consumption tax from 5 per cent to 8 per cent wasn’t in the economy’s favor.
A similar dilemma is feared in Europe because of increased household debt that limits today’s consumption — exceeding 100 per cent in Estonia, Spain, France, Portugal, Finland, Sweden, and the UK, and exceeding 200 per cent in Denmark, Ireland, Cyprus, Lithuania, and Malta (Eurostat). Out of the total household liabilities, 90 per cent are loans.
According to research cited by Forbes, UAE household debt is around $95,000. With GDP per capita being less than half of that, that’s quite alarming. Again, referring that to a very high percentage of expats is another debate as financial products being marketed allow excessive borrowing.
Being bailed out when defaulting on loans is fortunate, but to what extent is this acceptable if the culture doesn’t shift towards better financial planning, better assessment of consumption today versus consumption tomorrow, and better saving patterns that will generate sustainable growth in the economy.
Consumption doesn’t necessarily have to drop in that regard, but should be in liaison with one’s disposable income. Moreover, awareness campaigns should direct some of its focus towards investing disposable income, and perhaps encouraging banks to create investment funds that cater to small household investors.
Once the culture moves towards a better sense of financial planning, saving, and investing, funds used to bail citizens out will be directed towards better uses. The last thought I want to leave you with is, what will eventually result from a high consumption fueled by excessive borrowing?