Even if the economy improves, living standards may notby Gavin Kelly / November 16, 2011 / Leave a comment
In the three months from July to September, Britain’s economy actually grew—by 0.5 per cent. That performance was less bad than many had feared, and some have seized on it as a source of hope. For Chancellor George Osborne it was a “positive step… laying the foundations for the future success of the country.” Even Bank of England Governor Mervyn King, hitherto the nation’s self-appointed prophet of economic doom, recently said that the squeeze “is now beginning to come to an end.” Whether or not such sparks of hope prove justified, they obscure a much bigger question: even if the economy recovers, will living standards improve?
For the 11m adults living on low-to-middle incomes, the answer is likely to be no. This broad section of the British population, defined as living on household incomes from around £12,000 to £48,000 per year (depending on the number of children they have), is overwhelmingly in work and not heavily reliant on benefits. To understand why people in this group may face continued stagnation even when growth returns, we need to appreciate the reasons why they continued to feel better off up until the middle of the last decade—and why these forces for prosperity are unlikely to play the same role in the decade ahead.
Take personal debt, for a start. Thanks to easier access to mortgages, loans, credit cards, as well as a housing boom, Britain’s ratio of household debt-to-income (what a household owes compared to what it earns) rose from around 100 per cent in 1988 to a peak of around 170 per cent in 2008.
Although interest rates have been close to zero for over two and a half years, those on low-to-middle incomes now have to spend a greater share of their income paying the interest on their debt than they did during the 1990s. That is because the total amount of debt rose so rapidly, and because banks and other lenders did not pass on these rock-bottom interest rates fully to borrowers.
Even if interest rates were to stay low, paying down this debt would still require households to spend a large part of their income on mortgages and loans for years to come. And interest rates must eventually rise. That will hit working families hard. The Bank of England estimates that if interest rates rise again to 5 per cent, it will mean a near doubling of the…