Letting people know that you have something interesting to ‘sell’ is just the first step. Once they learn about your product there is still the small matter of completing the sale and delivering the service/item purchased to the customer.
I wanted to share a recent experience I had as a potential customer. I learnt about a product through an ad on a social media platform. They were also advertising an offer on the product for £7.50. This was a small vendor selling a speciality product.
When I clicked through to the checkout I got a rude shock. The total price was now showing as £11.50! They had added £4 for delivery. I could get free delivery if my order was more than £20 but I didn’t want to order that many items! I decided that the value I was getting was not matching the total cost I would have to pay (so called ‘net value’ = – £4). So I decided to abandon my ‘full’ basket.
This is called the ‘Abandoned Basket’ problem – and it is seen in bricks-and-mortar stores as well where people simply leave a shopping basket with items and leave the store.
So one might have thought that is the end of the story? But no! Things have become a lot more ‘technical’.
A few hours later I got an email. Before showing me the real price or anything that might scare me away they had taken my contact details! That means they could try and change my mind at a later date. Unlike in a bricks-and-mortar store an e-retailer can chase after prospective customers (GDPR notwithstanding).
The email was not a normal ‘you have items in your basket – click here to complete your purchase’. No way. They were a lot cleverer than that. They had done their research. The email identified high-delivery costs as a common reason why people don’t complete their purchase. It also attempted to justify £4 worth of shipping costs when the item was coming from within UK (I don’t know why?).
But I was still not convinced and I ignored the email. Then a few hours later I received another email. This one was offering me £3 off if I spent at least £10. This meant my net value went from – £4 to -£1 and I did not need to spend a lot more than what I was willing to.
In the end they successfully converted an abandoned basket into a sale and I received the items on time and in good condition!
We can see three main elements in this ‘success’ story:
Getting a foot in the door by capturing customers details before they can ‘run away’ – this gives them a second chance at converting the customer
Understanding what made the customer run away in the first place and attempting to arrive at an acceptable ‘middle-point’
Ensuring that the product/service delivery is pain free to encourage the customer to order again
Simply put, it is the ratio of all the government debt carried by a country divided by the productive capacity of the country. This is similar to the debt-to-earnings ratio used to evaluate the financial worth of companies as well as individuals.
Typically if an individual or a company has a bad debt-to-earnings ratio they will find it tough to get a loan or attract investment. But debt-to-GDP doesn’t work the same way because not all countries are the same!
How does the Debt-to-GDP Ratio work?
Debt by itself is not bad. Similarly, a rising debt-to-GDP ratio may not be a bad thing. Why? Because borrowing is not bad if it leads to a growth in productivity. Productivity here is linked with one or more objective measures like income growth, we are not talking about subjective measures like ‘personal’ growth.
For example, if you as an individual borrow money to buy a car that you will drive as a taxi during the weekends as a second job, then while your debt has increased so has your income (assuming everything goes well). As long as your income (which can be used to measure productivity) increases faster than your debt, things will be fine. Obviously, individuals are limited by how much they can increase their income within the time frame of the borrowing. But when it comes to a country the limits are lot more relaxed. A country can always find productive uses for the money it borrows. Some examples include: strengthening infrastructure, improving education and improving connectivity (both national and international).
If productivity of an individual or a country increases faster than debt then they become an attractive target for future loans.
The flip side is more interesting! If a person spends the borrowed money in meeting day-to-day expenses then it is unlikely their income will rise faster than the debt, if it rises at all. Such an individual will find themselves in trouble very quickly with their creditors. When it comes to a country this logic starts to fail. Some countries end up attracting money even if things are bad all over. In fact, they keep attracting money even if they are not doing so well and are at the heart of a global financial crisis!
We can see this clearly in Figure 1 where USA and GBR (UK) have been borrowing heavily. Their debt-to-GDP ratio has a ‘step up’ right after both countries started borrowing to spend their way out of the 2008 Financial Crisis. The interesting thing is that this data is mostly till 2018 and we expect a similar (perhaps larger) ‘step up’ due to Covid-19 relief spending when we review the data for 2020!
A Question of Trust
‘In God we Trust’ is the official motto of the USA. For the financial world it is ‘In the Dollar we Trust’. That explains why, where other countries have had massive backlash to high debt-to-GDP ratios in terms of no access to cheap borrowing, rating downgrades and currency devaluations we can see time after time, during a crisis, funds from all over the world flowing into the US financial system allowing it (the US govt.) to borrow cheaply! This is similar to how when facing a storm all fishing boats rush back into the harbour. This is one reason why it was relatively easy for the US to propose borrowing massive amounts of money (some $3 trillion) to support its economy through the Covid-related lockdown and beyond.
There is a similar narrative of stability and productivity around the UK. Always seen as a strong player in the world of financial services and second only to the USA in the financial sector. UK has similarly been borrowing a lot more without the corresponding growth in GDP. The first Conservative Government of David Cameron (2010 onwards) sought to stem the tide of borrowing by introducing ‘austerity’ and ending the massive spending spree of the previous government that was dealing with the 2008 financial crisis. There were all kinds of positive signs that despite the impact of Brexit on growth, the debt growth was coming under control and ‘austerity’ would end for good. All this was before Covid-related lockdown.
Only the data from 2020 will tell the scale of ‘step-up’ in the debt-to-GDP graph.
If you look at Figure 1 the debt-to-GDP ratio of all countries presented is heading only in one direction – ‘up’! It is either a gentle slop of a hill or a steep step of a plateau. As a point India (orange dots) may seem like the odd-one-out but that is not the case as in the recent budgets the Govt. has been forced to let the deficit widen (data is only till 2018) and also there are doubts as to the true figure of the Govt. debt.
The big tip of the iceberg question is ‘what happens next’? If the US/UK are the safe-harbours what happens when they become less and less safe, especially after Covid? Would that reduce their appeal? What ‘safe harbour’ will all that money seek? When does it become unsustainable? Who are the debt-holders who will take the decision to declare the situation unsustainable? Does a smaller population help in faster recovery?
To give an example, the cash rich economies like China, who have a massive surplus, behave like a fast-food chain. They want you to keep eating more of their food but also not fall ill. Their food is money and the delivery mechanism is through the world of finance. It is in their interest that their target markets are healthy so that they can continue buying from China. Where China cannot find a big market they plant the seeds of one by financing infrastructure projects to improve its access to trade routes. So it will be interesting to see how the net-exporting countries behave over the next 1 year. This also makes the current UK 5G ban on Huawei equipment very interesting.
Blast from the Past
As a final remark I need to mention what one of my favourite economists John Maynard Keynes said about this topic. Politicians remember the first half of his advice: it is fine to run a deficit (i.e. spend more than what you can earn) in times of great need (e.g. the Great Depression). But they forget the rest of his advice that the Govt. must balance the budgets during the times of plenty.
This is common sense. When you have good income levels it is logical to use that to reduce your debts so that in the time of scarcity you have a lower debt burden and more money left for your personal needs.
But this is also political suicide – no elected Govt. would survive if it told people that it was going into austerity mode when things were going well . This is one of the big reasons we see a constant increase in debt-to-GDP across the world as shocks and crisis are never in short supply and it is unpopular to claw-back when things are going well. The thinking here is that if you grow your productivity (e.g. measured by income) fast enough you can always keep getting a bigger loan and stay one step ahead of the debt-collector.
Or if you are ‘big enough and transparent enough’ as a country, people will always be willing to lend to you (what else will they do with their money?).
 Two examples where this did not happen from the World’s largest democracy India: demonetisation and maintaining high domestic fuel price when internationally crude oil prices have fallen. In both the cases strong steps were taken by the elected Govt. and they still came back to power with a larger majority. Unfortunately, in both the cases Govt. managed to loose the advantage gained from these tough steps due to mismanagement.