Does the UK need a debt rewind?

StepChange Debt Charity
5 min readMar 28, 2017

A guest blogpost by Matthew Whittaker, Chief Economist at The Resolution Foundation following the release of today’s Statistics Yearbook 2016

Just like Craig David, debt made something of a comeback in 2016. Having peaked at 160% on the eve of the 2008 financial crisis, household debt as a share of income fell to 140% by the end of 2015.

Successive increases in the first three quarters of 2016 took the ratio to 144% — its highest level since mid-2012 — and the OBR thinks it has gone higher still since then.

Unsecured borrowing expanded especially rapidly, jumping by 14% in the year to the third quarter of 2016 — the fastest rate of growth since 2002.

So, with many households not yet recovering fully from the post-crisis fall-out, does the UK need a debt rewind?

At one level the answer is probably no. Strong employment growth and a sustained period of ultra-low inflation helped to drive something of a ‘mini-boom’ in incomes in 2014 and 2015. Buoyed by historically low costs of borrowing and rising house prices, households can be forgiven for entering into some modest re-leveraging in 2016.

Debt distribution

But debt remains elevated relative to past levels. And there’s evidence to suggest that a sizeable minority of borrowers are experiencing difficulty even in today’s relatively benign environment.

Data from the Bank of England shows that around one-in-three working-age households say they are concerned with their current level of debt, with this figure rising above two-in-five among the poorest fifth of working-age households, highlighting the extent to which the distribution of debt matters as much as the overall level.

It’s a finding reflected in the figures collected by debt advisers such as StepChange Debt Charity. The charity’s latest Yearbook shows that demand for its services has continued to grow year-on-year, with 600,000 people contacting them for advice in 2016, up from 370,000 in 2012.

As demand has grown, so the profile of its clients appears to have changed too: they have become both younger (60% were aged under 40 in 2016, compared with 52% in 2012) and more likely to live in rented accommodation (78% in the latest data, up from 61% in 2012).

They’ve also become marginally poorer, with the average after-tax income of those seeking help falling by nearly £600 in real-terms between 2012 and 2016, standing at £16,800 last year.

What comes next?

So debt remains a problem for many, but perhaps the biggest concern is in relation to what comes next.

The ‘mini-boom’ in income growth fizzled out mid-way through 2016 — thanks both to a plateau in employment growth and to the return of inflation. With both of these trends expected to persist in 2017, there’s a strong chance that workers will suffer a fresh wage squeeze in the coming months.

Higher inflation will also mean that the four-year freeze in working-age benefits that started in April 2016 will now bite significantly harder than previously thought.

The upshot is that inequality looks set to rise over the course of this parliament, with weak growth in the top half of the income distribution contrasting with falling incomes in the bottom half.

It’s a combination that would be unprecedented in modern times: during our last bout of sharp increases in inequality (back when Thriller — the only record to beat Craig David’s Born To Do It in MTV’s poll of the greatest albums of all time — was first released), incomes continued to grow across most of the distribution; while during the more recent squeeze on incomes inequality narrowed slightly.

Debt becoming less affordable

Against this backdrop of falling incomes and rising inequality, both existing and new debt commitments are likely to become less affordable. It’s likely therefore that our debt position needs — if not a rewind — at least to be placed on pause. Yet such is our economy’s reliance on borrowing, that such an outcome would have serious implications for our growth rate in the coming years.

Household spending accounted for more than 100% of GDP growth last year, supported by the refusal of consumers to cut their expenditure to match the slowdown in income growth they were facing.

The household saving ratio — the amount households have available to save as a share of their total income — thus once again moved into the negative territory it occupied in much of the pre-crisis era. If that position is to be reversed, then it’s likely to come at the cost of near-term economic growth.

Yet at some point this is precisely what must happen. Relative to the position immediately before the financial crisis hit, household debt appears to be less of an immediate macro-level problem, particularly with little sign of any imminent sharp increase in borrowing costs. But consumption growth can only outpace income growth for so long.

What can be done?

Plugging the gap lies in boosting incomes, though that’s easier said than done. Yet, while the government has little control over inflation, it’s far from powerless, in terms of influencing both the level of income growth and its distribution.

In part that means doing more to tackle the country’s chronic productivity problem — restarting growth in the output associated with each hour worked in the economy — and thereby supporting stronger wage growth.

Of course the productivity ‘puzzle’ got its name for a reason, so this isn’t easy, but boosting public investment and establishing the conditions for more private investment is likely to help.

The government can act more directly still by revisiting the more than £12 billion of working-age benefit cuts inherited from the previous administration, balancing the books if necessary by thinking again about some of the expensive and regressive tax cuts promised for the coming years.

Reflecting on the changed circumstances facing the country as it begins the process of leaving the EU, Chancellor Phillip Hammond has already established a fiscal ‘reset’ relative to his predecessor’s plans for deficit reduction, and he would do well to go further still at his Autumn Budget. After all, comebacks aren’t always welcome.

Guest blogpost written by Matthew Whittaker, Chief Economist at The Resolution Foundation

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StepChange Debt Charity

We provide free, impartial debt advice and solutions to anyone struggling with debt problems in the UK.