Learning budget lessons from Japan and Britain
While the world is transfixed by the U.S. budget paralysis, fiscal policies have been moving in several other countries, most notably in Japan and Britain, with lessons for Washington and for other governments all over the world.
Let’s start with the bad news: Shinzo Abe’s decision to increase consumption taxes from 5 to 8 percent next April. This massive tax hike, to be followed by another increase in 2015, threatens to strangle Japan’s consumer-led growth from next year onwards, since Abe looks unlikely to offset this massive fiscal tightening with stimulative measures that would maintain consumers’ spending power. Even if Abe delivers on his vague promise to compensate with business tax reductions, these will only aggravate the over-investment and corporate cash hoarding that have long distorted the Japanese economy. Meanwhile, the government’s willingness to risk economic recovery in the cause of fiscal discipline implies that those of us who believed Abe was making an unconditional commitment to do whatever it takes to achieve economic recovery were simply wrong. Now that the forces of budgetary austerity have reasserted themselves, Japan’s probability of ending its decades of stagnation is much reduced.
Now for the good news: a change of attitude to debt and borrowing is transforming Britain from the second-weakest G7 economy (after Italy) into a world champion of growth. As recently as last April, the British government was attacked by the International Monetary Fund’s chief economist for “playing with fire” by trying too hard to reduce its budget deficits. This week the IMF World Economic Outlook praised Britain’s rapidly improving economy and upgraded 2013 growth projections by 0.5 percentage points, to 1.4 percent. That may not sound like much, but this improvement comes when almost every economy is being downgraded — and compared with last year’s miserable 0.2 percent growth rate, it feels almost like a boom.
Does this experience prove that David Cameron was right to persist with his unprecedented program of spending cuts, tax hikes and fiscal austerity? The answer is no, for two reasons.
First, the British government, despite its tough fiscal rhetoric, has actually relaxed its efforts at deficit reduction and has effectively abandoned its commitment to balanced budgets. In 2010 and 2011 Britain’s structural deficit was slashed by 4.3 percent of GDP, by far the biggest fiscal tightening in any major economy. In the next two years, 2012 and 2013, the pace of deficit reduction has halved to just 2 percent, and according to the IMF’s latest analysis there will be no further tightening at all in 2014. So instead of a near-balanced budget, Britain will next year still have the biggest budget deficit among the advanced Western economies: 5.8 percent of GDP, against 4.6 percent in the U.S., 3.5 percent in France and 2.1 percent in Italy. Thus Britain’s better growth performance, far from demonstrating the wisdom of relentless budget cuts, has actually reflected an easing of fiscal austerity and a belated acceptance of much wider deficits than European and U.S. politicians seem willing to tolerate.
Secondly and more importantly, this year’s revival of growth in Britain has resulted directly from an audacious government policy to promote huge increases in highly-leveraged mortgage debt. This mortgage-support plan is equivalent, from a macroeconomic standpoint, to a huge expansion of government borrowing. When George Osborne, Britain’s finance minister, announced last March that the Treasury would provide unprecedented guarantees to support the reintroduction of 95 percent mortgages — which had been eliminated by prudential bank regulation — he immediately transformed Britain’s economic prospects, as explained here at the time.
This announcement meant that Osborne was finally accepting the fundamental principle of Keynesian economics: a country emerging from recession must increase, not reduce, its borrowings, until the point is reached where the economy’s excess savings are fully employed. Whether the additional borrowing is undertaken by the government or the private sector is of secondary importance. If additional government borrowing is unacceptable for political reasons, while large-scale business borrowing is unlikely because of weak demand, then a boom in household borrowing will do almost as well.
Bizarrely, the government’s plan to create a property and mortgage boom attracted little attention among economists, even though Osborne described it clearly last March, promising to create £130 billion of new debt over three years, a credit stimulus worth 4 percent of GDP annually. Although the proposed credit stimulus was roughly three times the size of this year’s fiscal tightening, many economists ignored it. They simply dismissed the possibility that the Cameron government would actively encourage a massive buildup of highly-leveraged consumer borrowing, while continually reiterating its slogan that “you cannot cure debt with more debt.”
As recently as last month, the IMF, the Financial Times and several business lobbies, responding to the rapid increase in house prices that started within days of Osborne’s March announcement, called on Cameron to reduce the maximum borrowing of £600,000 permitted under the guarantee scheme, to postpone the scheme’s expansion from newly built homes to existing properties or maybe even to cancel it altogether. Cameron responded to these critics by doing the opposite — bringing the scheme’s expansion forward to this week, instead of waiting until January.
Cameron probably made this decision for political reasons — he wants the property and mortgage boom to be in full swing by the time of the 2015 general election. But in doing so, he showed a better understanding of economics than many economists. Recessions are caused by excess savings and this means that higher borrowing, whether by the government through fiscal policy or by the private sector through the housing market, is a necessary condition for economic recovery. Nations that try simultaneously to reduce their public and private debts are doomed to stagnation, with monetary policy almost powerless to help when interest rates are near zero. Britain now understands this, while Japan apparently does not. Could someone please explain it to the budget warriors in Washington?
PHOTO: Japan’s Prime Minister Shinzo Abe arrives for the family photo at the Asia-Pacific Economic Cooperation (APEC) Summit in Nusa Dua, on the Indonesian resort island of Bali October 8, 2013. REUTERS/Murdani Usman