Is the UK mending fast enough?
- 22 April 2014
- From the section Business
You may remember that for some years I have been highlighting research by the consultants McKinsey that shows - inter alia - how the UK has been neck and neck with Japan as the most indebted of the world's biggest economies.
Well because there has been controversy about whether the UK's current recovery is dangerously and unsustainably debt-fuelled, I asked McKinsey if it could update its analysis.
The results are striking.
They show that the indebtedness or leverage of the UK economy is falling, which most would regard as good news. Economic growth in the UK is happening at a time when the finances of households, businesses and banks are being strengthened (although, to state the obvious, the indebtedness of government continues to rise).
But this strengthening of what you might think of as the nation's balance sheet, this reduction in indebtedness, is perhaps not happening fast enough - in that the UK still has the dubious privilege of being a world leader for indebtedness, and any significant and unexpected increase in interest rates would be highly damaging.
According to the updated analysis, the UK's total debts - the aggregate of household debt, business debt, banking or financial debt and government debt - was equivalent to 484% of GDP, or national output, towards the end of last year.
Only Japan was more indebted, with debts equivalent to 514% of GDP, among a group of 10 rich large economies.
No real surprises there, given the huge size of the UK's banks and financial sector relative to our economy.
The UK would have had to shut down its big global banks to reduce its debts to the 282% level of the US, for example (Germany's indebtedness as a percentage of GDP is 268%; for France and Spain the ratios are 354% and 408% respectively).
Banking debt cut
However, what will be seen as more cheery is that the indebtedness of the UK is falling - and quite rapidly.
Here is the trend.
UK debts as a percentage of GDP reached an all-time UK record of 502% as recently as the end of September 2012.
By the end of 2013, that debt burden had dropped to 471% - which many would say is still far too high, but the decline looks significant (by the way, if you are confused by my use of 484% earlier, that's because for the purposes of comparison with Japan and other relevant economies, McKinsey had to use slightly older data).
So what is going on?
Well there has been little change in the absolute amount of debt on the books of businesses and households (that is the amount in pounds, rather than the amount as a percentage of national output).
By contrast banking debt has fallen sharply, by more than £100bn in just over a year, and by more than the increase in government debt.
Also the denominator for measuring the debt burden, the value of GDP in money or nominal terms, has risen, while the total of all those debts has fallen a bit. Which in theory means that the debts are more affordable.
There are therefore positives and negatives in all this.
Perhaps what is most important is that the current economic revival cannot be seen as debt-fuelled - which means it should be more sustainable than would otherwise be the case.
The point is that households are saving less than they were, rather than taking on bigger debts. Right now, their debts are not becoming bigger relative to their incomes.
In fact household debts reached a maximum of 103% of GDP in the middle of 2009, and were 90% at the end of 2013.
Less salutary, perhaps, is the reduction in corporate debts - which have fallen from a peak of 110% of GDP in the first quarter of 2009 to 95% at the end of last year.
Some of that fall is a necessary and arguably healthy writing-off of reckless lending by banks to property companies.
But a good deal of it is an unhealthy reluctance of banks to lend to viable companies and an unfortunate reluctance of many companies to borrow to expand.
It is striking that the fall in the indebtedness of British companies since the 2008 crash and onset of the global recession has been considerably greater than for companies in any of the other major economies.
In the US for example, the relative indebtedness of companies is more or less where it was at the time of the crash.
That may mean British businesses and banks are now taking too little risk, having hitherto perhaps taken too much.
But if the direction of travel is broadly benign, is the UK travelling fast enough?
Or to put it another way, is the debt burden falling sufficiently fast, such that there can be confidence that there won't be a bit of a shock to the economy, as and when interest rates rise?
The answer to that is probably no.
Just to focus on households for a second, the absolute level of consumer debt (as opposed to debt as a percentage of income) is as high as it ever was - at £1.48bn. Any significant rise in interest rates would squeeze millions of people's spending power to a meaningful extent.
The contrast with the US is again instructive, and not desperately flattering to the UK - because the reduction in the indebtedness of US households as a share of GDP is twice the UK fall.
That said, and for what it's worth, there are two rich countries, Australia and Canada, where consumers are even more indebted than in the UK.
Of course, when assessing long-term economic strength, it is also important to look at assets, as well as debts.
But there again, McKinsey's figures don't put the UK in a particularly attractive light.
In the US, the wealth of households is almost equally divided between property (homes), shares, life insurance and other investments. Or to put it another way, Americans don't have too many of their nest eggs in just one basket.
In the UK, shares are just a 20th of savings - and (guess what?) property is 50% of personal wealth.
So although the UK's finances are improving, if you believe there is something of a housing bubble here and that interest rates are set to rise sooner rather than later, then you would fear that Britain's balance sheet is perhaps not being strengthened fast enough.