What can the UK learn from Croatia’s debt cancellation?

The decision by the Croatian government to cancel the debts of its poorest citizens highlights the price of consumer debt on the whole of society, as Carl Packman explains

The experience of being heavily in debt can often feel like the old saying: running in order to stand still. You could be holding down more than one job or working as many hours as is possible, reducing your household costs and even, in extreme cases, going without meals or modest luxuries like holidays or mobile phones. But at the end of the month you find that the lion’s share of your pay has been spent servicing debts.

It doesn’t make very good financial sense for large numbers of people to be overburdened with personal debts. Economic growth needs confident consumers, and confident consumers need money in their back pockets; what they don’t need is to be piling debts on top of one another and to be lining the pockets of creditors.

But that is the only alternative for an ever-growing number of people, and it is having a sour effect on the state of the nation’s finances.

That is why the news that Croatia has decided to cancel a sizeable amount of low income people’s debts is very welcome indeed.

Starting from Monday February 2, 2015, some 60,000 Croatians who have had their bank accounts recently frozen because of their debts will have those debts written off by the government. Under the name Fresh Start a total of around 317,000 Croatians are expected to benefit from the new scheme.

The Croatian government has recognised that a

population in heavy debt is a drain on the whole economy

Given that there are only 4.4m inhabitants in the country, it was rightly deemed that to have such a large proportion of the population in such dangerous debt, would have a detrimental effect on the finances of the rest of the country.

There has been conflicting reports of how much the bailout will cost the government, ranging from between 210 million and 2.1 billion Croatian kuna ($31m and $300m) depending on which news agency you believe, but the prime minister Zoran Milanovic has convincingly pointed out that the long term benefits of making this investment now (note that he uses this word ‘investment’, which is precisely what it is) will outweigh the relative expense of the debt repayment programme.

Debt cancellation as investment
The most important implication, from which the UK and elsewhere can learn from, is that it is not merely a selfless act by a government who wants to make appealing sops to its electorate, but rather the realisation that the more people who spend their money just paying down their debts, the less money they spend elsewhere, on their local high streets for example, which contributes very healthily to economic growth and jobs.

In short, the Croatian government has recognised that a population in heavy debt is a drain on the whole economy and that when a household is caught in a debt cycle this doesn’t just impact upon them, but everyone in society.

We can spend a lot of wasted time moralising and bemoaning people who get in to debt, whether they are simply profligates or not (though this is not likely to be the case, particularly when a lot of non-secured debt is taken on to pay for essentials like food and bills), but in the meantime the debts of the poorest in society have a knock-on effect on us all, not to mention the devastating effects they have on debtors themselves.

Of course this doesn’t solve the whole problem. While it mitigates against the excesses of a debt-fuelled economy, it doesn’t get to the root of the problem.

Similarly when the regulator the Financial Conduct Authority late last year directed payday lender Wonga.com to write off £220,000 of loans from 330,000 borrowers, while this rightly recognised that the lender had breached responsible lending guidelines and the action was the right thing to do, we don’t even scratch the surface of why people seek more debts just to get by in the first place.

Others have been sceptical of the move in Croatia, too. Dean Baker, co-director of the Washington-based Center for Economic and Policy Research, told the Washington Post that he wasn’t ‘sure that this is the best way to help low-income people. If lenders think this can happen again they will charge very high interest rates to low-income borrowers’.

But that is why reform of the consumer credit market must not be done in a piecemeal way. A cap on the cost of payday loans was brought in early in January this year, but in order that we have consistency we must have a cap set on all forms of high cost credit.

To do this would mean that if a government deems the debts of a population to be too high, to the point where it is starting to have a negative impact on the economy as a whole, it won’t have to worry about the high cost credit industry punishing their customers with higher prices and interest rates.

Moving on we must settle the important question of why so many people are indebted today. We must address low pay, the cost of living, and employment standards. But in any case the programme of the Croatian government is a good start to demonstrate that household debt does not exist in a vacuum.