[Disclaimer: the title of this post is sarcastic. Don't actually do that.]
I’m afraid you’ll have to excuse another UK politics post, but for the second time this week, I’ve heard something from a national politician that doesn’t quite make sense economically.
The first was the Transport secretary’s claim that an 80 mph speed limit would boost the economy. The second is from David Cameron and his comments on debt. In the early drafts of the Prime Minister’s speech to his party conference, he appeared to call for Britons to pay off their debts. “The only way out of a debt crisis is to deal with your debts” David Cameron was due to say. “That means households – all of us – paying off the credit card and store card bills.”
The line didn’t appear in the final speech. All the papers had already reported it, so there has been considerable speculation about why it changed. Apparently it wasn’t meant to be a suggestion, but a statement of fact. “The only way out of a debt crisis is to deal with your debts” is how it came out in the actual speech. “That’s why households are paying down their credit card and store card bills. It means banks getting their books in order. And it means governments – all over the world – cutting spending and living within their means. “
The thing is, it doesn’t matter much whether Cameron was telling people to pay off their debts or just saying that they are paying off their debts, because I’m pretty sure he’s wrong either way.
First of all, if Cameron meant it as a suggestion, it’s a bad one from a macroeconomic point if view even if it’s responsible household management. If people actually followed through and paid off their debts right now, it would cripple the economy. Collectively, we owe £57 billion on credit cards and £152 billion in other loans. According to Nick Pearce of the Institute for Public Policy Research, if we paid that off in a year, it would lower GDP by 4% per quarter. Even spread out over the remainder of the parliament, it would depress GDP growth by 1% per quarter.
But let’s give Cameron the benefit of the doubt and assume that he was referring to something that was already happening, rather than something that should happen. That’s no better, firstly because it’s not entirely true, and secondly because the budget is based on the opposite.
Are people paying down their credit and store cards? Well, lending behaviour is certainly changing. More people are paying off their balance each month and avoiding debt, and fewer store cards are being issued that a couple of years ago. But the actual total of debt outstanding hasn’t fallen, and there has been a big increase in things like pay day loans. According to Credit Action, consumer credit lending grew by 2.3% in the last year, which rather undermines the idea of a responsible nation taking responsibility for its overspending.
What’s worse is that if Cameron is right and we are paying off our debts, then the treasury is wrong. The Office of Budget Responsibility has predicted a sharp rise in household debt, and the budget is based on this presumed extra debt. The OBR believes households will continue at the same standard of living as before, even though income will remain the same. Consequently, the forecast for March this year shows a rise from £1.6 trillion to £2.1 trillion by 2015 (that’s total household debt, which includes mortgages). If the budget is going to balance, the government needs the opposite of what Cameron is saying here.
I’m not surprised by the muddle though. We’ve been asking the impossible of our economy for some time. We want the banks to simultaneously re-capitalise and increase lending, and we want the economy to grow while we contract our spending. In short, we’re in desperate need of some fresh economic thinking.