The UK Goverment's Flawed Consumer Gamble

So, in response to the economic woes our country is facing, the UK government has decided that it will reduce the rate of VAT on consumer purchases from 17.5% to 15%.

This, it thinks, will encourage consumer spending and help fend off a nasty recession. They're also slashing the bank base rate too.

It strikes me that their gamble is destined to fail because they have totally failed to understand the prevailing consumer mindset.

Reducing VAT might have helped stimulate the economy, were it not for the fact that, at the time they announced it, they also reeled off a list of the taxes they intend to increase in the near future to recoup all the tax they're going to lose (at a time that they're increasing spending).

The UK government has been forced to admit that it is going to borrow money like never before (on account of it having wasted the money it received during a lengthy period of economic growth).

So, let's look at this from a consumer perspective.

• At a time when lots of people are finding out the hard way that borrowing heavily is a risk that comes back and bites you on the backside, the government's answer is to borrow heavily.
  
• Over the past few months fuel and food prices have increased dramatically. Even though they are starting to drop again this had the effect of sensitising people to how much they were spending on products that they previously bought without consideration.
  
• They are afraid about what their (economic) future has in-store.
  
• The only thing they can be sure of about the future is that the government is going to come back demanding more money within a couple of years (not just their hand-outs back, but a lot more besides).

Personally, I don't believe this is a winning formula. Consumer confidence won't be increaed by a 2.1% saving that is flagged as a "save now pay us back more later". All this will do is compound fears about economic pain in the future and encourage greater caution.

People will (probably quite rightly) work on the assumption that the unknown future pain will be significant.

I'm not suggesting that this will be a conscious process. The adaptive unconscious mind is concerned with protecting us from avoidable pain. It logs the warning signs, pays particular attention to what's going on with our friends, and guides our feelings about how to act accordingly.

The situation isn't helped by the fact that many people's mathematics skills aren't able to appreciate that a reduction in VAT of 2.5% translates to a price decrease of 2.1%. These people have been primed to expect more than they get and are faced with an instant disappointment when they realise the reality.

What didn't seem like a huge number to begin with has now got smaller and, since we judge things in relative not absolute terms, it can feel like quite a lot has been lost. The difference between 2.5 and 2.1 is significant proportionately!

I fear things are going to get worse before they get better.

Philip Graves [Consumer Behaviour Expert]