This article is part of a new joint SPERI-Finance Watch series on “Untold stories of personal debt in Europe” to which different guest authors contributed.
In good economic times, the expansion of credit markets is generally seen as a stimulus to growth through investments, since it gives more borrowers access to loans at lower rates of interest. When “bad times” arrive, the increased borrowing suddenly becomes debt and transforms from an opportunity into a risk.
However, debt is neither good nor bad by nature, but just a part of our economic reality. At the level of the economy as a whole, the liabilities of all debtors and assets of all creditors add up to zero (macro level). However, debt is far from being a “zero-sum game” for individual firms or households (micro level).
In concentrating on a micro level of analysis and looking specifically at households’ debt, it is crucial to adopt a gender perspective – as also stressed by Sara Reis in this series – to consider differences in gender, but also in age, race, social status and income structure as determinants of individual over-indebtedness.
Why does household debt matter?
Household debt is an important analytical tool, because it allows policy makers, analysts and economic researchers to evaluate households’ financial situation and forecast final consumption expenditure. Households consumption expenditure typically represents the highest percentage of a country’s Gross Domestic Product (GDP). Consequently, fluctuations in household expenditure patterns affect economic output performance. Rising household consumption levels generally stimulate the economy, whereas slower growth or declines in consumption have the opposite effect.
In general, individual spending and saving behaviour is determined by the person’s material and social needs, traditions, standard of living, existing debt levels, net worth and disposable income. Household consumption expenditure is therefore determined by consumer income, as well as the household’s ability to spend future income now by making use of credit.
Factors behind debt
There are numerous factors that cause people to go into debt, in excess of their current and even future resources. Such factors include the deterioration of pay and pensions, which push consumers to turn to credit to meet basic needs, and the exploitative practices of financial institutions and retail sellers offering goods and services on (seemingly attractive) credit. But financial institutions are not the only source of debt; people also borrow from friends and family, and informal debt plays a key role in a person’s debt picture.
Over-indebtedness is a heterogeneous problem. Among the working poor and long-term unemployed, it usually arises from accumulated missed payments on bills (phone, energy, transport, etc.) and rent. The 2008 global financial crisis, with its negative impact on welfare systems, has enlarged this group of people with debt problems, which has long formed a major part of the over-indebted cohort. However, much of the recent increase in over-indebtedness has come from a different group: people who used to be in well-paid employment, but lost their jobs during the recession and were left with debts (e.g. mortgages) to be repaid, without the prospect of increasing their income in the near future.
In addressing policies for this latter group, the narrative of a two-stage European crisis should be remembered. In the first stage – the “he-cession” – men have been hit the most by the economic recession. Shortly thereafter, in the “she-austerity” stage, women have suffered the heaviest burdens of the fiscal retrenchment measures. If this scenario is true, the policy response to individual indebtedness cannot ignore the impact of the crisis on gender gaps in income and jobs.
Poverty and lack of financial literacy
Some individuals and households borrow because they are poor and lack enough money to survive. However, insufficient resources and generally low prospects for future income mean they are unable to fulfil their financial obligations, and consequently go deeper into debt. This scarcity-based indebtedness is linked to a lack of alternative options, combined with limited financial literacy which, under situations of uncertainty and distress, might drive vulnerable people to make financial decisions that might not benefit them in the long run.
Poor people are more likely to borrow at less favourable rates because they are considered to be ‘riskier’ clients and because their precariousness forces them to accept bad deals. As such, they constitute an important source of profits for lenders charging high rates and fees. Policymakers rarely recognise these aspects; they often fail to consider the gender gap in financial literacy and the overly complicated nature of loan contracts. Simple interventions such as straightforward credit terms and conditions, assistance with completing application forms, financial planning prompts, or even reminders about money management may be particularly helpful, especially for those who lack financial awareness.
The need to monitor indebtedness in its various forms stems from the fact that debt has become a permanent feature of our economic lives. Living debt-free is very difficult in a world where jobs are scarce, wages are declining and public services are scaled back. Even more importantly, debt is a complex issue that permeates all aspects of our lives and has profound consequences on people’s well-being and ability to function in society, as Richard Ahlström and Fredrik Tjulander untangle in their contribution to this series.
Therefore, we need to consider debt not only in terms of the financial debt burden on an individual, and the aggregated debt at a macro level, but also as a broader category of the contemporary human condition. Measures and analysis of the size, scope and incidence of excessive debt should lead to a deeper analysis of broader consequences that accompany over-indebtedness and impoverishment, especially for low-income people who are inherently more prone to falling into the “debt trap”.
A “Debt Watch” should systematically review national policies, actions and gaps in addressing over-indebtedness. Such a Debt Watch should be independent and impartial, ensuring that it provides an objective perspective on the situation, and is able to voice concerns that may not be otherwise politically acceptable or socially popular in a particular context.
Marcella Corsi, Sapienza University of Rome