Don't borrow. Be happy

Rule number six in Robert Louis Stevenson's "A Pattern for Living" is "Do things you enjoy doing, but stay out of debt." If, to judge by the continuing high level of consumption, the Great British Public seem to be heeding the first part of that, they are resolutely disregarding the second.

In a sense we should be grateful. Consumption kept the UK economy growing strongly during the third quarter, and if the new National Institute forecasts are right, will hold growth at 2.3 per cent this year and 2.1 per cent next. This would make the UK the fastest growing of the Group of Seven nations both years. But much of this consumption is sustained either by running down savings or by borrowing.

The figures confirm this. British household savings have been in long-term decline for a decade and are second from the bottom of the international league table – as the left-hand and centre graphs above show. And (see right-hand graph) personal sector debt has risen quite suddenly in the last four years. The ratio between debt and disposable income has risen so that people now have debts that are larger than their income.

Of course, the financing cost of such debt has fallen along with interest rates: the burden of servicing the debt is actually lower now than it was a decade ago. That explains why people have been happy to up their borrowings. In addition much of this debt is for home purchase; unlike, say, credit card debt, there is an asset, hopefully an appreciating one, against the loan.

But there are risks. One is that people will lose their jobs and be unable to service their debts. Another is that house prices may fall, cutting the value of the underlying assets. Still another is that interest rates will rise – at some stage a rise will be inevitable.

Those are macro-economic risks, dangers to the economy as a whole. I am actually more concerned about the micro-economic risks, including the dangers to the borrowers. Absolute high levels of debt conceal pockets of profound misery. Many people lost their homes in the last recession, when the expression "negative equity" entered our language. The danger is that this might happen again.

The numbers of people who need help with debts is enormous. Last year 1.5 million people sought advice from the Money Advice Trust, a charity that organises free, independent advice for people with serious debt problems. It is currently expanding its call centres and says new cases of serious debt are running at £1.2bn a year.

The bad debt problem is mirrored on the savings side. Many of us simply do not save enough to provide ourselves with an acceptable retirement income. The Association of British Insurers commissioned a report from Oliver, Wyman & Co to measure the savings gap. It concluded that total savings had to rise by more than 50 per cent and only households with an income of more than £35,000 a year were likely to be saving enough to give them an income of about two-thirds of their pre-retirement income. Even that was on favourable assumptions that people would retire at 65 and that investments would increase in value by an average of 7 per cent a year.

While the gap can be narrowed by people putting their savings into a better mix of assets and getting better tax advice, in the end people have to be persuaded to save more. Theoretically that should not be so difficult: living standards have been rising at around 4 per cent a year for most of the past decade; take just 1 per cent out of that and pop it into a savings pot and the whole retirement problem begins to look more manageable.

The practical problem is that there is an "exclusion zone" in the savings market, where people on low incomes cannot get good advice on savings because the cost of giving it makes them uneconomic as customers. Ironically the new regulatory regime, pushed by governments of both parties, has pushed up the cost of providing advice, so that the exclusion zone is much larger than it was in 1994.

The sad thing is that just as everyone is starting to focus on the need to boost savings, not only have savings declined but the cost structure of the financial services industry has made it likely that more and more people will be unable to afford savings advice. So what is to be done? Somehow we have to get better advice on both sides of the equation.

For debtors, it is easier to see how this could be achieved. It is powerfully in the interests of the financial services industry to cut bad debts. Many of us feel uncomfortable when yet another unsolicited application form for a credit card drops through the letter box. But people who don't pay back their debts are useless customers. Spending money on teaching people how to manage their debts is money well spent, which is why the big banks are helping fund the Money Advice Trust.

For savers, though, it is really hard to see how effective advice can be extended to lower-income households. (And let's remember that many higher-income ones did not get great advice from Equitable Life.) Simplifying regulation would help, and the ABI paper suggests a tiered system with a new form of savings agents to deal with people on modest incomes. Does that mean poorer people get less protection? Not really, when you consider the clumsy legalistic procedures that the present legislation imposes. Another suggestion is compulsion: make people in jobs save more for their pensions. It would not be popular – but sometimes governments need to be cruel to be kind.

Meanwhile consumers who decide they have to cut back a bit might take comfort from Robert Louis Stevenson's first rule: "Make up your mind to be happy. Learn to find pleasure in simple things."