Fighting debt – examples from the USA, UK and Spain

In a report published in January and entitled “Debt and deleveraging: Uneven progress on the path of growth”, the McKinsey Global Institute examines the debt levels of several large advanced economies and the path that these economies have taken since the beginning of the crisis to reduce debt. The report pays more attention to the United States, the United Kingdom and Spain and compares them with Sweden and Finland, which had serious problems with debt levels and economic growth in the early 1990s. In this article I want to briefly review this research, which, through examples from the two Scandinavian countries, seeks to show what advanced Western economies should do in the current situation of high debt.

The experience of Sweden and Finland

The credit boom of the 1980s in Sweden and Finland led to a real estate bubble that quickly turned into a financial crisis. Both countries entered the last decade of the 20th century with a recession and high levels of debt, mostly government debt. Thanks to the determination to tackle the problem, the necessary reforms were implemented and economic growth was restored by 1994. The experience of the Swedes and Finns shows that the process of reducing debt levels consists of two main stages. The first is characterized by a reduction in non-government debt, an increase in government debt and weak or even negative economic growth. The second stage consists of a decline in government debt and a return to economic growth. Where do the United States, the United Kingdom and Spain stand on this scale?

Debt levels in developed economies ​

In the chart below, I have presented the total debt-to-GDP levels (private and public) of 10 advanced economies for the period from the first quarter of 1990 to the second quarter of 2011. If we assume that the end of 2008 is the peak of the crisis and, accordingly, the period when economies should have started reducing their debt levels, the picture is not at all rosy, especially for Japan and the United Kingdom. These countries have the highest relative debt levels, which continue to grow after the end of 2008.

USA

Since late 2008, non-government debt in the United States has declined across all categories. Financial sector debt has shrunk to 40% of GDP, and household debt-to-disposable income has fallen by 15%. This decline doesn’t seem so big when you consider that two-thirds of it is the result of mortgage and consumer loan defaults.

United Kingdom

Unlike the US, the UK cannot boast of a decline in debt levels. On the contrary, they have increased since the end of 2008, and according to McKinsey calculations, as of the second quarter of 2011 they amounted to 507% of GDP. The composition of these debts is also unique (see the chart below). While the largest component of Japanese debt is government debt, and in the US it is household debt, in the UK the leaders are financial institutions. Over the period under review, household debt levels in the UK have increased in absolute terms. The main reason for this is that in the UK banks do not declare bad loans as overdue and therefore they are not booked as losses. If debts were recorded as uncollectible, household debts in the UK would decrease by a rate close to that in the US. In addition, about two-thirds of mortgage loans in the UK have a floating interest rate, which would create great difficulties for households if the latter rises.

Spain

After adopting the euro in 1999, interest rates in Spain fell by 40%. This led to a boom in construction and lending in general. It is no coincidence that by the second quarter of 2011, corporate debt in the country was one of the highest in Europe. Although household debt in Spain has fallen by 6% since the end of 2008, total debt to GDP has increased from 337% to 363%. According to calculations by the Spanish central bank, about 50% of the debts of companies in the construction sector may turn out to be problematic. As part of the Eurozone, which means the inability to conduct independent monetary policy, Spain faces fewer options for dealing with the debt problem. The country can only rely on structural reforms and improving competitiveness.

Now where to ?

According to McKinsey research, there are six critical factors that must be in place for an economy to start growing after the process of reducing debt levels. These are:

• a stable banking system;
• a plan for long-term fiscal stability;
• the existence of structural reforms;
• export growth;
• growth in private investment;
• stable real estate market.

Although there is a positive trend in the three countries analyzed, there is a long way to go before we can talk about a real recovery. In addition, all three countries are still in the first stage of reducing debt levels. The United States is performing best so far, but overall, entering the second stage is far away for all three. The important thing is to address the six factors described above as non-government debt levels decrease and the next phase approaches. Only in this way will Spain, the United States and the United Kingdom be able to guarantee the restoration of their economic growth and, from there, their positions as some of the most developed economies in the world.

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