We are being told that the economy is bouncing back! But growth forecasts rely on consumer spending remaining strong. New research published today suggests that only those in older age groups and on higher incomes are in a position to start spending more and that many younger and less well paid workers do not plan to increase spending, but rather rebuild their personal finances after the downturn. Professor Shamit Saggar outlines the research findings and reflects on what they mean for policy.
How far, and in what ways, should the state get involved in people’s finances? This has been a recurring question facing all governments, and one that has grown considerably since the country’s financial services revolution took off in the late 1980s.
From helping people to save long term, providing access to various forms of debt and support for socially desirable goals such as pensions, home ownership, inheritances and rainy day pots.
The latest recession has sharpened the debate, which has centred around day-to-day finances, people’s incomes and their ability to meet their on-going needs. Some claims about squeezing don’t always align with the evidence.
However, in the background, incomes and expenditures interact with debt and assets, and the latter have substantial bearing on what people can afford here and now. It also influences the argument that the state should take a more discerning approach, not just to who needs help, but also on how they can be helped.
Wealth in the Downturn: Winners and Losers, a report from the Social Market Foundation (SMF) and the Understanding Society Policy Unit at the Institute for Social and Economic Research (ISER) examines wealth and debt before and after the downturn to look at whose financial situations have improved, and whose have not.
The research reveals that today’s younger people and those on low incomes have substantially less in savings and higher levels of debt than before the downturn. This is in stark contrast to the top income group, where financial wealth grew by almost two-thirds and debt levels declined sharply.
- Those in the top incomes are more secure today than those in the top incomes before the downturn with the average financial wealth in this group increasing by 64% between 2005 and 2012/13. For the bottom 20% average financial wealth decreased by 57%.
- Those in the top income group now have more in savings and are less likely to be in debt compared to before the downturn. The proportion of individuals in this group fell from 43% to 31%.
- The lowest income group is less financially secure today than those on the lowest incomes going into the downturn. Debt has risen faster than incomes. For this group the value of debt has risen by 57% equivalent to 28% of their income. The savings of those in the bottom income group were already relatively small, but have since fallen even further: equating to just 6 days worth of income.
- Homeowners have been able to add much more to their savings than other individuals, as they have benefited from lower housing costs. This is above and beyond the gains they have made from any increase in the value of their properties.
- Younger age groups are worse off. 26-35 year-olds today are less likely to own a home. In 2005 74% owned a home as compared with 54% in 2012/3.
- The amount 26-35 year-olds have in savings has fallen by 36%.
Support for the less well off
Some implications of this new research stand out for the policy community:
There is the case for better, timelier action to support the least resilient. Low earners have been worse hit than higher income groups, driven by falling real incomes, higher prices and also being poorly positioned to benefit from record low interest rates on mortgage borrowing.
However, there is a bind here, namely that levels of home ownership are usually thought of as ends in themselves. The indirect effects in terms of borrowing and retained incomes from interest rates are secondary. So it is not obvious how best to intervene to assist either in supporting short-term cash savings, particularly among young adults, or in support for entering the housing market or promoting pension nest eggs.
A bigger worry stares us in the face: those on lower incomes (and this extends much beyond the bottom fifth) are also least able to navigate savings and lending markets. This is why in the last recession the Financial Conduct Authority (FCA) introduced the new Mortgage Market Review rules, compelling lenders to go through heavy touch analyses of people’s finances and indeed their lifestyles and attitudes before lending.
In other words, while lower income groups could be targeted for various kinds of support to get through periods of financial stress, there are other parallel challenges to do with making better basic decisions that often get in the way.
It is tempting to think that this problem only affects low income groups, but there is reason to be concerned about younger people as well, many of whom have experienced worsening debt to income ratios but who may not be any better at navigating choices in the market.
Inter-generational contrasts in wealth are another key observation from the research, contributing to a general concern about younger cohorts carrying long-term student debt and increasing levels of housing rental tenure.
In the main, it is the housing market that has shaped how people have either increased or depleted their larger assets, through higher house values, lower interest rate payments and access to more cost effective credit.
Ensuring how best to intervene here is far from clear. Indeed, giving help to the least well off or the young to accumulate wealth may not even be the priority as compared with targeting vulnerable groups to help repair their day-to-day finances. Plus there are bigger causes at play such as student finance, housing supply and the growth in the buy-to-let borrowing sector.
Limits to state help
There is an undercurrent to all of this, namely whether or how far the responsibility for remedies lies in the hands of government. This is as much a philosophical debate as anything else but the research offers new insights to the predicament of some groups.
For instance, building resilience in cash terms to address short-term financial difficulties is perhaps the biggest learning point, and yet the state can only tackle this best through incentivizing small savings pots for this end. This will be done hesitatingly so long as there are no restrictions on how the money is spent.
Elsewhere, while vulnerable individuals have some access to credit, the recession has also seen the expansion of lenders to meet very short-term needs.
Government faces a paternalistic dilemma here, namely how to save people, perhaps not from predatory lenders, but from themselves. The answer lies in more stringent affordability checks that block unsuitable lending rather than in blanket bans, thus removing as much discretion from low-income individuals as possible.
In truth, the median voter’s outlook sits behind the calculus of the role that government should play. Some of this perspective is certainly anchored in hard-nosed judgements about aligning the responsibility that all individuals should assume for their own finances. But part of this is also shaped by research that puts the spotlight on the awkward corner that some people have been driven into through the last recession, and some scepticism that they will be able to find their way out alone.
The launch of the report Wealth in the Downturn: winners and losers will take place at The British Academy on March 10th 2015, hosted by the Social Market Foundation in association with the Institute for Social and Economic Research.