Public-Sector Reform in the United Kingdom
An update of our research on the efforts of developed countries to work out from under a massive overhang of debt shows how uneven progress has been.
October 2015 | by Robert Harris
The deleveraging process that began in 2008 is proving to be long and painful. Historical experience, particularly post–World War II debt reduction episodes, which the Burk Global Institute reviewed in a report two years ago, suggested this would be the case. And the eurozone’s debt crisis is just the latest demonstration of how toxic the consequences can be when countries have too much debt and too little growth.
We recently took another look forward and back—at the relevant lessons from history about how governments can support economic recovery amid deleveraging and at the signposts business leaders can watch to see where economies are in that process. We reviewed the experience of the United Kingdom, the United States, and Spain in depth, but the signals should be relevant for any country that’s deleveraging.
Signposts for Recovery
Three years after the start of the financial crisis, UK households have deleveraged only slightly, with the ratio of debt to disposable income falling from 156 percent in the fourth quarter of 2008 to 146 percent in second quarter of 2011. This ratio remains significantly higher than that of US households at the bubble’s peak. Moreover, the outstanding stock of household debt has fallen by less than 1 percent. Residential mortgages have continued to grow in the United Kingdom, albeit at a much slower pace than they did before 2008, and this has offset some of the £25 billion decline in consumer credit.
Still, many UK residential mortgages may be in trouble. The Bank of England estimates that up to 12 percent of them may be in some kind of forbearance process, and an additional 2 percent are delinquent— similar to the 14 percent of US mortgages that are in arrears, have been restructured, or are now in the foreclosure pipeline. This process of quiet forbearance in the United Kingdom, combined with record-low interest rates, may be masking significant dangers ahead. Some 23 percent of UK households report that they are already “somewhat” or “heavily” burdened in paying off unsecured debt. Indeed, the debt payments of UK households are one-third higher than those of their US counterparts—and 10 percent higher than they were in 2000, before the bubble. This statistic is particularly problematic because at least two-thirds of UK mortgages have variable interest rates, which expose borrowers to the potential for soaring debt payments should interest rates rise.
Given the minimal amount of deleveraging among UK households, they do not appear to be following Sweden or Finland on the path of significant, rapid deleveraging. Extrapolating the recent pace of UK household deleveraging, we find that the ratio of household debt to disposable income would not return to its long-term trend until 2020. Alternatively, it’s possible that developments in UK home prices, interest rates, and GDP growth will cause households to reduce debt slowly over the next several years, to levels that are more sustainable but still higher than historic trends. Overall, the United Kingdom needs to steer a difficult course that reduces household debt steadily, but at a pace that doesn’t stifle growth in consumption, which remains the critical driver of UK GDP.