Why The Economist’s response to me on debt is wrong
I wrote a piece on household debt before Christmas which The Economist magazine has responded to. First of all, The Economist began their piece by being very complimentary about me: I shall respond in kind by saying that The Economist is an excellent magazine that should be compulsory reading for any politically minded people who want to understand the world around them.
I also want to include this disclaimer: I am not an economist, and have never pretended to be. The piece they object to was a blog, not a column: every Tuesday morning I have to write a quickfire (and I mean quickfire) response to a headline story: on 22nd December, that happened to be rising concerns over household debt. The reason I’m responding isn’t to defend my own ego, but rather because The Economist have written what you could call a ‘template piece’: lots of people (of varied political persuasions) have raised concerns about debt, their article can be used to rebut whoever next comes up with them.
Because I’m not an economist, I’m simply going to paste the nuanced response (via email) of Dr. Jo Michell, an economics lecturer at UWE, who deals with the weaknesses in my argument and explains what’s wrong with The Economist’s response, and another comment too. A copout? Perhaps, but as I say, I’ve never claimed to have economics training, so the response is best left to someone who does. And indeed — without being too cocky— I would argue that the misunderstandings made by The Economist are rather more problematic than those made by non-economist me.
Before I post Dr. Michell’s reply, though, my own quick comments. My original piece itself pointed out that household debt as a percentage was lower than the crash. What The Economist didn’t engage with was that I pointed out the Office of Budget Responsibility last year projected it could reach 182% of disposable income by 2019; late last year, that was revised down to just over 160% (though Dr. Michell says these “forecasts in general seen as much too optimistic on growth, deficit, trade, etc). In 2013, I wrote, out of 53 countries, Britain came 11th out of 53 countries for per capita total household debt. “Britain is not low down but neither is it a basket case,” says The Economist (I never claimed it was…) Britain is currently — self-evidently — high up. But look what the projections say about trajectory:
The point the TUC make in this blog is that even after deleveraging, British household debt is up there with the highest in the world, and compares badly with our own history.
As for the relationship between George Osborne, debt, economic instability and political machinations — as well as the point that who is accruing debt matters, rather than simply saying ‘ah but wages overall are growing’— don’t listen to me. Listen instead to notorious lefties like Jeremy Warner, assistant editor at The Telegraph back in 2014 and one of the country’s most renowned economics commentators:
“George Osborne tends to come over all offended when accused of attempting to recreate, for electoral purposes, the Brown boom with “Help to Buy” and other measures designed to juice the credit markets. Why would he deliberately set out to foster economic and financial instability, he is prone to ask, when all his financial and fiscal reforms are designed to embed the reverse? The answer, a cynic would say, is an old one. Let’s win the election first, and worry about long-term stability later.
Two main and quite alarming conclusions can be drawn from all this. One is that the UK — and perhaps other post-industrial economies — is finding it difficult to grow without relatively high levels of house price inflation, and corresponding increases in household indebtedness. It can be argued that these debts don’t really matter, because they are dwarfed by the size of household assets — houses, pensions, Isas and other forms of saving. Unfortunately, those with the debts and those with the assets tend to be two different groups of people.
High household indebtedness also tends to amplify shocks, especially in economies such as Britain’s with a disproportionately large share of consumption in the mix. If you are highly indebted, you are much more likely to cut back on spending in response to economic setbacks than otherwise. What’s more, high debt makes it difficult to raise interest rates without knocking the stuffing out of demand.”
As the TUC have pointed out, the Bank of England’s Chief Economist Andy Haldane presented a warning to the Treasury Select Committee last November, that consumer credit is “picking up at a rate of knots”. Unsecured debts (that is, excluding mortgages) per household, the TUC point out, reached £11,800 per household last year; last November’s jump of 8.3% in “annual growth in consumer credit is the highest for ten years (give or take a couple of months)”; the OBR expects household unsecured debt as a percentage of disposable income to hit the 2008 peak by the beginning of 2021:
OBR forecast of household unsecured debt, % disposable income
So, here is Dr. Jo Michell (via email):
“ You’ve certainly waded into a bit of a minefield. Fortunately, I think The Economist attack is mostly pretty weak and can be fairly easily dealt with.
I do have some reservations about your argument. I’d be careful about predicting a definite credit meltdown (and using terms like timebomb). My feeling is that we really don’t know how long these kind of debt build-ups can last. They can also come to an end in more mundane ways — think Japanese-style stagnation rather than 2008 US-style meltdown.
So I try to phrase things along the lines of ‘one way or another, this will come to an end’, rather than ‘this will end in another 2008’. I think one of the most likely outcomes is that Osborne will just fail to eliminate the deficit.
I’m also uneasy about your claim that ‘Osborne made a strategic decision to commit to a failed model of debt.’ It’s not entirely clear to me what Osborne thinks he’s doing — but I probably wouldn’t accuse him so directly.
So — the Economist piece. There’s an annoyingly technical distinction that’s quite important in all this: the distinction between the financial balance of the household sector and gross household borrowing (or total debt).
This comes from the fact that households can lend to each other but can also borrow and lend to other sectors, such as the government, firms and overseas. These two types of financial transactions get mixed up in discussions of private debt and austerity.
The usual ‘sectoral balances’ story says that for the government to run a surplus, the private sector must run a deficit (in the absence of a surplus with overseas). That’s unquestionably true (it follows from the accounting) but it’s not the case (as often implied) that a government surplus will lead households to lend more to /each other/, which is how the majority of (gross) household debt arises (mostly intermediated through banks in the form of credit card or mortgage lending).
Andrew Lilico wrote a bit about this, arguing that the sectoral balances story is completely wrong:
He gets it wrong himself, however — there /is/ a connection between the two mechanisms but it’s more complex than in simple stories that say government surplus = private credit card binge.
This matters because your piece and the Economist response mix up these two types of financial positions.
The first figures — the 67bn surplus turning into a 40bn deficit — refer to the household position with respect to other sectors. However the second figure of £1.5tn refers to gross household debt, much of which is household-to-household mortgage and credit card lending.
The first line of the Economist attack is that you imply that Osborne is responsible for the 40bn household deficit because of ‘mismanagement’. The mismanagement thing is a red herring — what matters is that, if Osborne were to run a surplus, it’s inevitable simply from accounting (unless we completely close the deficit with overseas) that the domestic private sector will run a deficit. This is exactly what’s shown in the OBR projections out to 2020 -and they explicitly attribute the household deficit to Osborne’s austerity. I wrote a blog on this:
The Economist’s claim that the household sector going into deficit is normal at the start of a recovery is also wrong. It would be easy to show this by looking at the historical data of past recoveries.
So the first Economist point is straightforward to rebut even if the argument is a bit technical.
What doesn’t immediately follow from the widening overall household deficit is that household mortgage and credit card lending will rise — e.g. it is possible for households to collectively run down their savings without also choosing to lend more to each other on credit cards. So the link between the household deficit and the 1.5tn isn’t direct.
The link is that, with government spending falling, there isn’t enough demand to maintain growth and, given stagnant wages and therefore household incomes, if consumption spending is going to make up for lack of government spending then debt will have to rise. This is connected to income inequality — not /all/ households that are going into debt, it’s going to be those who are struggling to get by, while wealthy households accumulate assets at the same time.
Here the data is a bit more equivocal. Mortgage lending was almost completely stagnant until 2013, then picked up but is still pretty subdued. However credit has almost all gone to buy-to-let landlords who are almost certainly over-leveraged and thus badly exposed to interest rises and Osborne’s tax changes (these are interesting because they go against the grain of Osborne relying on housing debt).
Credit card debt is picking up much more rapidly — currently growing about 9% a year which is high but still well below where it was in the 90s.
What matters, however, is that even if debt growth is still moderate, the outstanding stocks are very high at about 140% of disposable income. So the Economist chart titled ‘not too bad’ is just weak spin. The exact same chart is in a recent Bank of England Financial Stability Report with a caption saying something like ‘debt is still very high both by historical and international standards’.
What also matters is that the debt is going to be increasingly concentrated among those who are likely to have trouble coping if interest rates rise or there is another downturn — poor people with credit card debt and speculative buy-to-letters.
Their point about quoting nominal figures is fair — what they are getting at is that it’s not surprising that UK per-capita debt is high in absolute terms given that the UK is a rich country. They are saying that you should quote figures as % of GDP or disposable income (which you do in some cases). But this doesn’t undermine your overall argument — even when the numbers are turned into % ratios, they are still high.
The subsequent points are kind of dealt with once you’ve taken apart the initial ones — as I said, I think you over-state the case for Osborne relying on debt to get through the 2015 election. I’d frame it more in terms of him failing to fix and rebalance the economy so that households could deleverage effectively — the Economist’s claim about falling household debt from 2010 to 2015 is pushing it — so that another five years of austerity, wage stagnation etc will result in rising debt on top of an already big pile alongside weak banks etc. This fits with your point about the OBR household debt projections which are pretty eye-catching. So it’s a question of emphasis rather than the overall argument and distinguishing between the situation now and what it would look like in five years time /if/ the government deficit were eliminated.”
Thanks to the excellent contribution by Dr. Michell, by the way. I also wanted to repost a comment below The Economist’s article because it was interesting, and emphasises a key point by Dr. Michell — that it is important to look at who is accruing debt (i.e. is it poorer people who are less able to pay it back and more susceptible to sudden shocks, like a hike in interest rates or a financial crash?)
“Can the Economist really say that the increase in personal debt is OK, because it is matched by an increase in wages? What is the demographic profile of wage inflation. Is the 3% figure the Economist cites a figure for the population as a whole, and if it is, to what extent does it mask big differences in wage inflation across high, middle, and low earners?
The Economist does not need reminding that the financial crash of 2008 was not caused by people like the Glazers over leveraging themselves in their running of Man Utd, but by low earners defaulting on their relatively modest mortgages in the US. What we need to know is who is doing the borrowing? This would give us a better understanding as to how much personal debt is an increase in consumer spending caused by greater confidence in the economy, and how much is borrowing by necessity in order to get by?
By citing the 3% wage figure, the Economist is making the same mistake as Owen Jones in taking a headline figure and building a case around it. It is a mistake for a political commentator like Owen Jones to do this, but it is an error of a far bigger magnitude for a journal such as the Economist to make the same mistake. In order to make the case that the increase in personal debt is affordable, the Economist requires much more nuance in their wage level figures.
The Economist also makes a massive omission by failing to contextualise the increase in personal debt by not framing it within George Osborne’s plan to produce a government surplus within the next four years. The point of Owen Jones’ article is exactly this ; to try and say that the level of personal debt is a consequence of government policy. Now it is fine for the Economist to argue that on its own personal debt is not a problem. However in a context where George Osborne is seeking to run a government surplus we run into problems. As George Magnus, the former chief economist at UBS told me;
“Surpluses and deficits have add to 0. If the public deficit falls, someone’s deficit has to get bigger, or (their) surplus fall. Someone (in this case) is Households, and or companies, and or rest of world. Debt, per se, isn’t evil. So long as its affordable.”
This zero sum gain analysis of surpluses and deficits leads to some simple and worrying conclusions. We can remove the “rest of the world” from the balance sheet for now, as only ridiculous optimism can see the UK running a trade surplus anytime soon. I do not know the mechanism whereby UK companies will produce a government surplus. This therefore leaves personal (household) debt. If we accept George Magnus’s description of the economy, the only way therefore that Osborne is going to reach a government surplus by 2020 is by a parallel increase in personal debt over the same period. This must be why the OBR is forecasting personal debt to hit 182% of disposable income by 2019 (higher than 2008).
The Economist is therefore left with two options. Either it can argue that this increase in personal debt is sustainable, even over a period where most commentators are predicting a rise in interest levels. Or it can suggest a mechanism of producing a government surplus without increasing personal debt (e.g printing money/QE).”
And indeed the point about debt and income inequality above is crucial. Here are some pieces about it:
This is a really important debate to be had. But it shouldn’t be conducted by left-wing polemicists and quickfire blogs, so what I’m going to try to do in the coming months is give a platform to the work of economists such as Dr. Michell. A public debate over household debt — and so many other issues — between economists (including those who are all too often ignored) would be very welcome indeed.