British austerity not keeping up with American growth

by Russell's Rants

Originally published February 1, 2011

A British one pound coin is pictured in

The American and British governments are engaging in a gigantic macroeconomic experiment in their differing fiscal approaches to the recession. The U.S. is following the Keynesian model of fiscal stimulus based upon short-term deficit spending to prime-the-pump of stalled consumer demand. On the other side of the pond, the U.K., under its new conservative Prime Minister, David Cameron, has adopted the opposite approach: austerity budgets aimed at immediately redressing the country’s debt in the hopes of restoring a sound economy. The early economic growth figures put America in the lead.

At the onset of the recession, Anglo-American fiscal policy was mostly in sync. Labor Prime Minister Gordon Brown proposed re-capitalizing the frozen banking sector, which inspired U.S. Treasury Secretary Hank Paulson to do the same with funds initially appropriated for the Troubled Assets Relief Program (“TARP”). Britain passed a medium-sized fiscal stimulus of $40 billion followed by newly elected President Obama’s rather more massive $787 billion American Recovery & Reinvestment Act of 2009.

Both countries lowered interest rates and engaged in quantitative easing, and both started coming out of recession and returned to positive growth toward the end of 2009.

But then in June 2010, the British took a sharp right turn. Cameron’s new conservative government announced a 5-year austerity budget aimed at trimming $180 billion from its deficits with large cuts in spending (including a 25% cut in non-prohibited government departments) and tax increases (raising the sales taxes from 17.5% to 20%). Obama doubled-down on his economic theory, reaching a lame-duck session compromise with Republicans for another whopping dose of fiscal stimulus – this time $858 billion in various form of tax cuts (some more stimulative than others).

At the time that Prime Minister Cameron enacted his austerity budget, American conservatives saw it as a potential model for Republicans to follow here. According to George W. Bush’s former chief speechwriter, Michael Gerson,

“If Cameron succeeds, he will. . . . provide a model for Republican victory in the 2012 U.S. presidential election. . . . In his passion for fiscal austerity, Cameron resembles the new breed of Republican governors for whom the art of governing begins with the discipline of accounting. He is a taller Mitch Daniels, a svelter Chris Christie. . . Cameron’s June 22 emergency budget proposed the deepest, most sustained reductions in British spending since World War II. . . . If Cameron’s approach works — dramatically cutting deficits without stalling economic growth — it will be an obvious, powerful example for America and other nations.”

The problem is that Cameron’s classical economic approach that emphasizes balanced budgets over stimulating growth is not working. Fourth quarter gross domestic product figures are out that show the U.S. economy continuing to grow at strong annualized rate of 3.2% — while the U.K. has slipped back into negative territory of minus 0.5%. In other words, America is continuing with moderate growth that, frankly, needs to be even higher to expand the economy at a rate to begin soaking up those left jobless in the recession. But Britain is turning backward toward recession with what amounts to an anti-growth fiscal policy.

Now, of course, there are always exigencies that might explain the disparity in growth, including cold weather in Britain at the end of last year, and the potential for anomalies in one quarter’s results, which do not yet make a trend.

But one British commentator in the Financial Times called the U.K. fourth quarter contraction a “warning shot for the British experiment,” explaining,

“The preliminary figures on UK gross domestic product for the fourth quarter of last year were a shock. Where now is the robust recovery that justified the government’s rapid fiscal retrenchment? In a word, nowhere.

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“The inflexibility of George Osborne, the chancellor of the exchequer, is a political gift to the Labour opposition and Ed Balls, Labour’s new shadow chancellor. Just hoping for the best is simply irrational. The chancellor should plan for the worst, right now.”

Some in Britain are even wondering whether the new economic numbers portend a double-dip recession in the U.K.

So rather than the British setting an example of financial rectitude for the American to follow, the British need to get back on the program of short-term fiscal stimulus. Neither country can do long-term debt reduction without first restoring growth and jobs. Keynes, who was British after all, did not believe in deficits forever. His approach was to shore up one’s budgets in the good years so that one can spend in the leans years: think Bill Clinton, not George W. Keeping the need for immediate growth in mind, Obama knew that going into 2011 with Republicans scheduled to take control of the House that he had to pass whatever added stimulus he needed to get through the 2012 election, and he got that stimulus in the form of those lame-duck tax cuts. The President’s State of the Union called for additional investments, but that proposal is not likely to go anywhere. Revenue bills must originate in and spending bills must be passed by the House, which is more than hostile to sound economic theory. The next two years are about holding and defending the legislative victories of the first two years. We’ll know soon which macroeconomic experiment will carry the day. Obama’s out to an early lead.