Britain is losing the economic Olympics

By Anatole Kaletsky
July 25, 2012

As London prepares for another display of British pageantry and good humor to match the unlikely triumph of last month’s rain-sodden Royal Jubilee, a less impressive aspect of Britain’s stoical “stiff upper lip” may detract from the national pride associated with hosting the Olympics. In the global race out of recession, Britain has just been revealed as a prime contender for the wooden spoon.

Not only was the shocking drop of 0.7 percent in Britain’s second-quarter GDP reported on Wednesday much bigger than investors and independent economists had expected but it almost matched the 0.8 percent fall in Italy’s GDP the previous quarter. And that Italian drop holds the record for the biggest quarterly contraction suffered by any G7 country since the immediate aftermath of the Lehman crisis. Much more important than such statistical trivia is the fact that Britain’s economic output is still 4.5 percent below the peak level it reached in the first quarter of 2008, more than four years ago. The U.S. and German economies, by contrast, are now significantly bigger than they were before the crisis and, in this sense at least, have left the recession behind them. And even the euro zone as a whole, despite the severity of its financial crisis, has done much better than Britain, with GDP just 2 percent below its peak in 2008.

National economic performance is not, of course, a competitive Olympic sport, and there is more to economic success than GDP growth. Still, there is a good reason for connecting the Olympics with economics: International competitions and comparisons can teach useful lessons and create incentives to improve economic management.

The most instructive international comparison at present is between the British and American efforts to clamber out of recession and financial crisis. This race is about as close as economics can get to a controlled experiment of the kind favored by natural scientists, in which sharply different policies are applied to two countries with broadly similar structures and initial conditions, facing similar economic problems.

In 2008, the U.S. and Britain were two advanced economies with large financial sectors, dangerous housing bubbles, heavy consumer debt and similar government deficits and debt levels relative to GDP. Both suffered extremely severe banking crises that forced their governments to take on huge additional liabilities by guaranteeing their biggest banks. For two years after the Lehman crisis in September 2008, the two economies followed broadly similar policies: slashing interest rates to zero, allowing large expansions of their budget deficits and financing the resulting debt with newly printed money. The two economies moved closely in tandem, as economic theory would have predicted: both on the way down until mid-2009 and then on the way up until mid-2010.

But then, in the summer of 2010, the newly elected British government set a radically different course for one very specific and controversial aspect of economic policy – government borrowing. Instead of simply tolerating the big budget deficits that had resulted from weak economic growth, as both the U.S. and British Treasuries had done until 2010, David Cameron decided his top priority would be to reduce government borrowing. He planned to do this by slashing public spending and imposing substantially higher tax rates. The U.S. government, meanwhile, continued with a fiscal policy of benign neglect. Despite all the sound and fury in Washington about deficits and debt limits, U.S. tax rates and public spending plans remained broadly unchanged through 2011 and 2012, with a small cut in payroll taxes largely offsetting the fiscal impact of cuts in local government spending and employment. In all other respects conditions in the two economies remained unchanged. Both central banks continued to print money and to keep interest rates near zero. The dollar and the pound moved very little against one another, and exports grew moderately in both countries, despite the crisis in the euro zone. In short, this really was a controlled experiment on the impact of different fiscal policies.

Curiously enough, the two economies began to diverge from the moment this controlled experiment started, with the British economy contracting in the third quarter of 2010, while growth accelerated in the U.S. In the period since then, the U.S. economy has expanded by 2.7 percent, while Britain has contracted by 0.8 percent. The latest results of this experiment will be revealed on Friday, when the U.S. GDP figures are published and can be compared with the 0.8 percent fall in British GDP just announced.

It may be said, of course, that the British policy of fiscal consolidation was still justified, even if the U.S. enjoys much stronger growth, as it almost surely will. After all, controlling public debt and deficits is an important national objective that counts for more than simply juicing up short-term growth.

But this is where we get to the really significant and surprising feature of the race out of recession. Britain’s heroic spending cuts and tax increases imposed by the Cameron government may contrast starkly with lassitude and cowardice displayed by politicians in Washington. But this dramatic political contrast has made absolutely no difference on the debt and borrowing outcomes the two countries have actually achieved, because the British austerity has simply prolonged recession, while U.S. fiscal laxity has allowed the economy to grow. According to the latest IMF figures, published two weeks ago, the U.S. budget deficit has been reduced from 10.5 percent of GDP in 2010 to 8.2 percent in 2012. This reduction is a slightly bigger reduction in the deficit than Britain has managed to achieve in the same period – from 9.8 percent to 8.1 percent.

In short, any country determined to control public borrowing should forget about fiscal austerity and instead do everything to grow as fast as it can – a fitting economic message from Olympic Britain.

PHOTO: A rower from Hong Kong trains for the single sculls at Eton Dorney near London in preparation for the Olympic Games, July 25, 2012. REUTERS/Jim Young

21 comments

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the bullingdon club member lashed out at public spending, sucking up to his rupert murdoch cronies and protected the financially feudal interests of the city of london corporation

england’s recession does not interrupt that member’s privileged life of leisurely pursuits

heroic spending cuts” were that member’s cynical attack on the “other classes” of english life

but nannies for the well-bred earned a tax cut

the next ruse will be vaunting the “city” as some swiss folly

Posted by scythe | Report as abusive

In order for this to be reminiscent of a “controlled experiment”, the two economies under consideration would have had to consistently show comparable rates of growth for a long period prior to the recent divergence of policy.

To the best of my knowledge and belief, the UK has never delivered even a single quarter of growth comparable to that in the US for as long as I have been alive. Unless Mr Kaletsky can propose a credible mechanism by which a policy decision taken in 2010 can affect the UK’s output in the 1960′s, 1970′s, 1980′s, 1990′s and 2000′s, then his “experiment” is nothing of the sort. He is merely comparing a high growth economy with a low growth economy – something that requires no “cause” at all.

Posted by Ian_Kemmish | Report as abusive

If we get Romney come 2013, we in the US will be able to confirm whether the British experience is a fluke.

Posted by Sanity-Monger | Report as abusive

Obviously, austerity is just a right wing conspiracy designed to enhance the rich at the expense of everyone else. If eight percent deficits are good, then twenty percent deficits must be fabulous. No need for higher taxes, just keep spending. I don’t know why there is all this concern about health care. We should just make health care free for everyone. Who needs insurance companies when you have a government that understands the economic goodness of spending borrowed money. How could we have misread these important economic principles for so long. There’s no need to worry about budgets. If things slow down a little, no problem, just open the government check book and spend, spend, spend. What a great country.

Posted by gordo53 | Report as abusive

Well said, gordo53.

Let’s toss this log on the fire: A lot of those dollars the United States keeps printing wind up in the vaults of other countries, who use them a once gold was used…as a “solid currency”. In truth, it’s jell-O!

Does it take a rocket scientist to comprehend that the “worth” of a “dollar” is some percentage of the present and expected value of American land, resources, labor, management and actual productivity at a given moment in time. Increase the number of dollars and the value of each “in circulation” is decreased (to such extent as the value of American land, resources, labor, management and actual productivity has not increased).

Once some of those countries start pulling out those dollars and trying to spend them for improvements, etc. in their own countries, the whole, rotten house of cards may well come tumbling down. Duh?

Posted by OneOfTheSheep | Report as abusive

Budget cuts may not really stimulate growth, and they may not really help to reduce the deficit. But people think they do, and that is why there is no better time than an economic crisis to advocate them.

Cameron is not really interested in growth or in the deficit. He just wants a smaller government, and that is something that can be achieved through cuts. So Cameron is just seeing a window of opportunity whilst there is significant public support for austerity measures.

But ultimately the choice between a small and a large government is hardly a matter of economics. It is the choice between the ideals of the French revolution: the choice of freedom over brotherhood and equality or vice versa? And that is a matter of ideology.

So whilst Cameron may be loosing the Economic Olympics, he may not be doing too badly in the Ideology Olympics.

Posted by Huson | Report as abusive

@Ian_Kemmish

“To the best of my knowledge and belief, the UK has never delivered even a single quarter of growth comparable to that in the US for as long as I have been alive. ”

In the chart at the top of this page, slopes are proportional to rates of GDP growth. They are similar up to 2010.

Posted by dthal | Report as abusive

@gordo53 & OneOfTheSheep
Please re-read the last 2 sentences of the next-to-last paragraph. The British austerity policy has not resulted (as yet) resulted in lower deficits.

Posted by dthal | Report as abusive

@dthal
The problem with austerity or making an effort to not outspend your revenues is that it usually results in a contraction of the economy. This is painful and politically unpopular, but necessary if you have a problem with runaway debt and deficits. The Brits have been deficit spending for decades, just like the US. Unless you have a growth rate like the Chinese, you can’t spend and grow your way out of a debt level that exceeds annual GDP. It just doesn’t work. In the not too distant future, the world wide debt bubble will pop and we will get an object lesson on why prolonged deficit spending and massive debt levels are a bad idea. I hope we’re all around to see it.

Posted by gordo53 | Report as abusive

@gordo53
You would have a point if austerity was indeed more effective than stimulating growth in addressing the deficit. But the comparison between the UK and the US suggests it isn’t. The two routes vary in the amount of pain they impose, but they both lead to the same gain. So why choose the most painful route?

I believe that the answer is that Cameron has another aim than reducing the deficit, and that is to reduce the size of the government. He would advocate that under any economic climate, but he is currently using the momentum provided by the current economic crisis to achieve it. And there are some good reasons to aim for a small government, but they are in the realm of political ideology, not of economics

Posted by JHudson | Report as abusive

There is a time and a place for cutting the deficit, namely during times of runaway growth, like 2005-2008 was. Instead, the Bush administration raised deficits during those years with tax cuts and wars and took away much of our fiscal leeway that could have helped fight future recession.

The right wing seems to have a fantasy that we can achieve a perfect harmony of economic growth if we just deregulate the economy, but that’s just false. It’s the responsibility of the government to nudge and prod the economy into a stable growth pattern, much like what the Chinese government has done for the past 20 years. It’s ironic that the Communists are now the most Keynesian of us all.

Posted by areddy831 | Report as abusive

Austerity or stimulus, it really doesn’t matter. You have societies where the underclasses have no reason to help or care. The fact that I even say underclasses is an indictment on the politicians and their masters, the moneyed elite. Slaves should stop breeding slaves. They should also stop caring about your stupid economies which don’t include them as members, except as a commodity to be used for the purposes of the wealthy. A cow, a sheep, a worker, what’s the difference? Nothing really. All are consumed by the meat grinder.

Posted by brotherkenny4 | Report as abusive

@JHudson,

All other things being equal, the “smaller” government is, the less expensive it is, i.e. the more sustainable when revenue is not without limit. That’s not “political ideology. It’s economic reality!

Posted by OneOfTheSheep | Report as abusive

No way is Germany’s and the US ecomonies ‘significantly bigger’ than in 2008. We are bearly creeping along and now in a down turn. What rock has the author been living under or is it just too much liberal cool-aid.

Posted by EagleDriver | Report as abusive

Whatever route you take it’s not what you spend it’s what you waste.Here in the the UK we have the best of all wasters. The MoD, The NHS,and government in general. both organisations are needed, but for goodness sake lets find somebody who can run them .The bad old class system is alive and kicking.Cameron rewarding his cronies, and then screwing the pensioners and poorer members of Brit Ltd.Nothing changes, Brit Ltd is run by plonkers.

Posted by Granpaspy | Report as abusive

The biggest economic lesson from the Great Depression was that premature austerity prolongs the downturn. Not until WWII, when massive borrowing and military spending stimulated the American economy did the GDP lift to sustainable growth, after 13 years of austerity and depression.
It is entirely understandable in this present situation, where 30 years of borrowing has accumulated, that Americans are loathe to increase the public debt. But at a time when investors are paying the Treasury to hold their money, it is clearly the proper course to generate sustainable growth.
As for taxation, I often wonder when those who have benefited most from the past borrowing will be willing to pay for the past debt that their favorite administrations incurred.

Posted by Sarasota | Report as abusive

Is Mr Kaletsky out of a job, too?

Posted by REMant | Report as abusive

Let’s be fair -
There is an energy boom going on in the US, with new oil and natural gas being extracted in many states, and in Canada.
Roughly one out of ten new jobs in the US is linked to this energy boom.
Cheap energy is the bedrock of consumer economies.
The US got lucky again, and/or maybe Obama was smart enough not to listen too attentively to environmentalist lobbyists.

Posted by reality-again | Report as abusive

The US is unique and cannot be compared to other economies. Nearly 70% of all US dollars reside outside the US. So when the US prints money the rest of the world gets the inflation headache. If other nations were to just keep printing money like the US their economies would collapse from the inflation.

Posted by Sinbad1 | Report as abusive

Let’s get back to the Olympics. 1. This is not a sprint – restoring reality to government deficit policy takes time. 2. The US has not even started this event. 3. The US continues to run on performance boosting drugs (QE…) they will explode before the race is over.

Posted by b1quet | Report as abusive

All are entitled to their own opinions, but not to their own facts – hence this correction to the comment from Ian_Kemmish:”To the best of my knowledge and belief, the UK has never delivered even a single quarter of growth comparable to that in the US for as long as I have been alive.”

In the past 20 years (starting from Q3 1992)UK GDP has been HIGHER than US GDP growth in 33 out of 80 quarters. Moreover, these periods of faster UK growth have not just been temporary aberrations. If we compare total GDP growth from the third quarter of 1992 to the peak of the cycle in the first quarter of 2008, the British economy expanded by 65 per cent, while the US expanded by only 59 per cent. If we look at the period from 1992 up to the divergence of US and UK performance in the summer of 2010, we see that the UK grew by a total of 58 per cent, while the US grew by a total of 57 per cent.

That seems about as close to a controlled experiment as I can imagine.

PS All the above GDP figures are in real terms – ie they exclude inflation.

Posted by akaletsky | Report as abusive