After the longest convalescence since (recorded) recessions began, the UK economy is showing clear recovery signs. Year-on-year national output (GDP) growth doubled to 0.6% in the second quarter, according to estimates by the widely respected National Institute of Economic and Social Research. The International Monetary Fund has upgraded its full-year growth forecast to almost 1% while downgrading the rest of the EU. On top of this, the Office of National Statistics recently revised its national output data to show that the widely lamented ‘double dip’ recession never actually occurred.
Even more remarkably, the recovery is being led by consumer spending. Households that shunned the shops after 2008, to cope with falling real incomes and reduced credit options, are starting to splash out again. Although strong second-quarter retail sales growth helped online channels more than embattled High Streets, upbeat buyer-intention surveys suggest it will be more than a warm-day wonder.
This isn’t quite the promised ‘rebalancing’ recovery, which was meant to be driven by exports and investment. Businesses are still refusing to invest despite large cash piles and record low interest rates, and the current-account deficit is at its widest for almost 25 years as consumer spending draws in imports with which UK producers still can’t compete. But whatever is driving it, this change of fortune should be celebrated. When debts are too high in relation to national income, growing the income is a better route out than unlashing inflation to shrink the debt.
More than a baby boom?
New royal arrivals and sporting heroes have done something to revive the ‘feelgood factor’. But there are more objective reasons for thinking that a corner has now been turned. After house- and share-prices crashed in 2008, households responded by paying down debt and building up savings. More loans were paid off, and many fewer were taken out. As a result, the UK’s household debt has dropped back down to pre-recession levels as a proportion of household income. The government can claim to have helped this improvement with pro-poor measures, including a rise in tax-allowances that raised post-tax income for some of those most heavily in debt.
Although households’ debt-to-income ratio is still above 120%, compared to less than 80% when the long boom began in the late 1990s, other changes may mean they can sustain this and still spend again. In particular, the recovery in share prices and (over the past year) house prices means households have more assets to offset those liabilities. Their ‘net worth’ (the difference between the two) is back to healthier pre-2002 levels on some counts. And while debt is still higher, the cost of serving it has been brought down by low base lending rates, which new Bank of England governor Mark Carney won’t want to abandon any time soon.
Inevitably, some economists don’t see this as a solid foundation for recovery. Although falling, the household debt ratio is much higher (over 140%) on measures that use a tighter definition of post-tax income. Because real incomes have fallen since 2008 (as prices rose faster than average wages), leaving them no higher than a decade ago, all the improvement has been due to debt reduction, which gets harder as refinancing and consolidation options are exhausted. Present low mortgage costs can’t last for ever – and when interest rates rise, many households will find their debts are still too large to handle, as a new Resolution Foundation study reveals. Some are already struggling, and sinking further into high-cost debt through the use of payday lenders, whose rapid expansion is, like that of food banks, one of the gloomier contributors to that rising GDP.
Any reversal of the house-price recovery could, likewise, push many households back into negative equity (meaning negative net worth for some) despite their lower debts. And further price rises for fuel and other essential goods and services – which could result from a weakening of the pound made necessary to revive exports – would undermine the still fragile revival of disposable income. On this basis, some economists believe belt-tightening must continue until household debt drops below 120% of income, which could mean the recession has several more years to run.
A deeper problem is that, while UK households may have reduced their debts (or de-leveraged, as the jargon goes), the UK as a whole has not. Continued borrowing by government and banks means that total UK debt has gone on rising since 2008, despite many large businesses also boosting national saving by sitting on large cash piles. This contrasts with overall debt reduction in the US and most other parts of Europe, and means the UK now vies with Japan as the world’s most-indebted large economy. Many economists doubt that this is a solid foundation for recovery, especially as some banks may still be too weak to absorb a widespread write-off of household and business debts that have become unrepayable. But with the government desperate to reduce its own debt, and main Eurozone markets still sinking, the better alternative – an investment-led recovery – is unlikely to happen unless households can somehow keep spending.
Alan Shipman 19 July 2013
Alan Shipman is a lecturer in Economics at the Open University. He is responsible for the modules You and your money:personal finance in context and Personal investment in an uncertain world, part of the foundation degree in Financial Services.
The views expressed in this post, as in all posts on Society Matters, are the views of the author, not The Open University.
Cartoon by Catherine Pain