Friday, August 24, 2012

The United Kingdom’s Austerity Experiment

Paul Krugman is probably the foremost proponent of traditional Keynesian thinking. He is certainly the most outspoken proponent. He has taken many occasions to rail against the idiocy of economic austerity during a time of high unemployment and low economic growth. In his book, End This Depression Now!, he devotes a chapter to what he refers to as "Austerians"—those who would believe that fiscal contraction will lead to economic expansion.
"But a funny thing happened in 2010: much of the world’s policy elite—the bankers and financial officials who define conventional wisdom—decided to throw out the textbooks and the lessons of history, and declare that down is up. That is, it quite suddenly became the fashion to call for spending cuts, tax hikes, and even higher interest rates even in the face of mass unemployment."

Krugman describes the OECD as the repository for such "conventional wisdoms."

"And what was the advice this bellwether of conventional wisdom gave to America in the spring of 2010, with inflation low, unemployment very high, and the federal government’s borrowing costs near a record low? That the U.S. government should immediately move to slash the budget deficit and that the Federal Reserve should raise short-term interest rates dramatically by the end of the year."

The US decided to ignore this advice and pursue a more traditional approach. But the UK, with its new prime minister, was all in for giving austerity a go.

"For the most part, countries adopting harsh austerity policies despite high unemployment have done so under duress....But there was one dramatic case of a government engaging in unforced austerity because it believed in the confidence fairy: Prime Minister David Cameron’s government in Britain."

Did the confidence fairy drop by to bless the UK?

"On the contrary, business confidence fell to levels not seen since the worst of the financial crisis, and consumer confidence fell even below the levels of 2008-2009."

Krugman does point out that while Britain managed to maintain low interest, so did the US and Japan, two countries with even higher debt levels.

How have the US and UK fared given their two differing approaches? The US emerged from the recession with modest, but sustained growth. Here is a plot provided by The Economist of British quarterly growth.

The economy seems to have begun going downhill in 2010 and has now officially fallen back into a recession according to these numbers.

One can go to the very handy IMF Data Mapper and extract all sorts of interesting data. How have the two countries weathered the Great Recession thus far? Using the IMF’s estimated numbers for 2012, we find that between 2006 and 2012 the US GDP grew by 16.7%, while that of the UK grew by 0.16%. The IMF has an estimated GDP growth of 0.8% for the UK in 2012, a number they will have difficulty in meeting. The US economy has also performed much better than that of the UK over the last few years.

But what about debt one might ask. Surely the austerity measures have succeeded in bringing that burden down, and this brief period of pain will be rewarded in the near future. Again, using data on government gross debt (as a fraction of GDP) from the IMF database, we find that between 2009 and 2012 the US debt (as a fraction of GDP) has increased by 18%, while that of the UK has increased by 33%.

Krugman continues to be correct. When in desperate times, grow the economy and concentrate on the debt when better times return.

Thankfully, we had a leader who was better versed in economics than many other national leaders. Perhaps some appreciation is in order.

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