Does Britain’s austerity hold lessons for the United States?

January 4, 2013

The dog’s breakfast of a deal that “resolved” the fiscal cliff fell far short of expectations. In the hours after it passed, deficit hawks at the Committee for a Responsible Federal Budget and the tag team of former Senator Alan Simpson and former Clinton White House chief of Staff Erskine Bowles all expressed disappointment in a bargain that was anything but grand. Senate Republicans gritted their teeth to accept a small increase in taxes on America’s highest-earning households while Senate Democrats made permanent the bulk of the Bush-era tax cuts. A number of tax provisions that hark back to the 2009 fiscal stimulus law were extended, as were unemployment benefits, thus delivering a modest income boost to a large number of low-income households. But the Social Security payroll tax cut, a Republican-backed replacement for the more narrowly targeted Making Work Pay tax credit that was part of the stimulus law, which benefited a wide range of affluent households as well as families of more modest means, was allowed to lapse. Long-term spending levels, meanwhile, were left largely untouched, which is why rebellious House Republicans came close to scuttling the delicately constructed compromise.

One group that offered at least two cheers for the deal were deficit doves, who believe that premature fiscal consolidation poses a grave threat to America’s sluggish economic recovery. Paul Krugman, the prominent economist and popular left-of-center New York Times columnist who never shrinks from apocalyptic pronouncements, was almost pleased to see that the deal avoided any serious spending cuts and that it entailed relatively modest near-term tax increases.

There is a coherent approach to reconciling the concerns of deficit hawks and doves, which has been championed by former Senator Pete Domenici and former Clinton budget director Alice Rivlin of the Bipartisan Policy Center’s Debt Reduction Task Force. Essentially, it entails addressing the federal government’s structural budget deficit — the gap between revenues and spending levels when the economy is humming along at its “normal” pace — while allowing for substantial deficits so long as the economy is in recovery mode.

There is one market democracy that has embraced something like the grand bargain American budget reformers have in mind, yet it has been widely panned as a poster child for the evils of fiscal austerity. Since 2010, Britain has been ruled by a coalition government that unites the center-right Conservative Party with the center-left Liberal Democrats. Faced with a tanking economy and a budget deficit of 11 percent of GDP on entering office, and constrained by public spending levels that reached 47.7 percent of GDP under the previous Labour government, the coalition committed itself to a course of slow and steady deficit reduction. The hope was that this fiscal consolidation would signal that Britain was serious about getting its public finances under control, and that this in turn would encourage growth. Yet Britain’s economic performance has been disappointing, and a growing chorus of critics insists that fiscal consolidation is to blame.

Before we turn to the fiscal consolidation debate, it is worth noting that Britain’s economic performance has also been downright confusing. The unemployment rate is 7.8 percent, roughly in line with the U.S. rate. It is also true, however, that Britain’s employment rate, i.e., the number of Britons who have a job, has recovered faster. But according to the GDP numbers, the U.S. economy is recovering, albeit slowly, while Britain’s economy is teetering on the edge of recession. Indeed, British GDP remains 3 percent smaller than it was in 2008. Normally we’d expect GDP and employment levels to go hand in hand, but that hasn’t been the case in Britain. Because employment levels have remained fairly robust while measured GDP has not, measured productivity has actually declined over the last year. One possibility is that Britain’s GDP is currently being underestimated, but the coalition is certainly not counting on that rosy scenario.

So is Britain’s dismal recovery a result of the coalition’s budget-cutting? During a recent visit to New York, George Osborne, Britain’s chancellor of the exchequer, offered a robust defense of efforts to curb his country’s structural deficit. According to Osborne, his government has been sensitive to the need to preserve Britain’s safety net in a time of economic distress while recognizing that the long, arduous process of deleveraging means Britain will need to increase the cost-effectiveness of public spending. He explicitly compared his approach to deficit reduction to that of America’s Bowles-Simpson commission, pointing to his insistence on using tax increases as well as spending restraint. Osborne was countering the oft-heard charge that he is a zealot blindly committed to deficit reduction at all cost, which seems fair given that Britain’s deficit last year was 8.3 percent, roughly similar to the U.S. federal government’s budget deficit of 8.7 percent that same year.

It is hard to know exactly why British GDP growth has been so weak. Fiscal consolidation aside, Britain has been buffeted by the ongoing economic crisis in the eurozone and a super-sized banking sector burdened by bad debts. We tend to think of Britain as a hybrid that lies somewhere between the social democracies and continental Europe and the more market-oriented economies of North America, and there is some truth to that.


There are, however, many other distinctive aspects of the British economy that make it a less-than-ideal petri dish for policymakers. The financial services boom of the 1990s and 2000s had a transformative impact on the country. Rising productivity in the financial sector made the British economy as a whole look quite strong. Surging tax revenues generated by the City of London helped finance a dramatic expansion of social transfers, a policy that effectively redistributed income from England’s flourishing, immigrant-rich southeast to the rest of the country. So it is hardly surprising that when the financial crisis struck, it had a profoundly damaging impact on Britain’s public finances. Moreover, the North Sea oil and gas fields, a major part of the Scottish economy, are in secular decline, with output per hour dropping by an alarming 40 percent over the past five years. Taken together, there was good reason to believe that Britain’s structural deficit had increased. That is, if the financial boom years weren’t about to come back and oil and gas weren’t going to ride to the rescue, Britain had to do the long, hard work of building a more balanced economy and a more fiscally sustainable public sector.

Rather than fixating on British fiscal policy, which has been caricatured by its critics, a number of observers, including Bentley University economist Scott Sumner, have argued that the real culprit behind Britain’s economic woes has been its monetary policy. That policy has in many respects been active and innovative. For example, the Bank of England and the Treasury launched Funding for Lending, a program designed to increase the availability of business loans and mortgages.

What the Bank of England has yet to do is adopt a nominal output target, a monetary policy rule designed to keep aggregate demand growing at a steady rate. By creating more certainty about future demand, such a target would tend to encourage long-term investments by companies and households. And one of the biggest weak spots in the British economy has been business investment, motivated in no small part by the ongoing chaos in the eurozone. Interestingly enough, the incoming governor of the Bank of England, the widely admired governor of the Bank of Canada, Mark Carney, has floated the idea of embracing a nominal output target. This would be a revolutionary step that might turn the transatlantic debate over economic policy on its head.

The economic policy debate in Britain is particularly relevant to the United States because, as Brad Plumer of the Washington Post has observed, the cliff deal includes $355 billion worth of deficit reduction in the form of tax increases and spending cuts, or 2.1 percent of GDP. Plumer notes that this is considerably more than Britain’s deficit reduction measures over the past two years of 1.5 percent and 1.6 percent. If a relatively modest deficit reduction effort causes economic bedlam, we’re all in big trouble. If, on the other hand, smarter monetary policy is what we need to make fiscal consolidation palatable, there is a way out of our economic doldrums.

Britain’s Chancellor of the Exchequer George Osborne leaves Downing Street in London, December 4, 2012. REUTERS/Stefan Wermut


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It doesn’t matter whether or not Britain’s austerity holds a lesson for the United States, the dimwits in Washington never seem to catch the message.

Posted by Shamizar | Report as abusive

Mr. Salam, you do realize that there is no “Bowles-Simpson commission report” since about the only bi-paritisan action of the prior year was the rejection, by both parties, of the slideshow from the commission chairs?

Again, the Bowles-Simpson commission never submitted a report. The Bowles-Simpson commission did not support any proposals.

And, while we’re at it, most people that quote the Bowles-Simpson commission report, don’t really support it.

Posted by JimLosAltos | Report as abusive

There was nothing slow about Britain’s deficit reduction. America will need to make huge spending cuts especially in defense and income transfer programmes but it needs to increase spending on infrastructure, education, R&D and energy development (particularly sustainable energy). All available American oil will only cater to a little over 10% of America’s energy needs.

Posted by asrinath3 | Report as abusive

Only increased tax revenues will bring this nation out of its economic problems.

Two articles from the UK Guardian might expand this article into the tax evasion and prosecution efforts that need to be stepped up, as well.  /04/swiss-bank-wegelin-close-tax-evasio n jan/04/hmrc-flickr-gallery-tax-criminals

When the US begins to get serious about US wealthy tax cheats, we will begin to make progress in saving this nation.

The American people need to understand that when the wealthy-driven US government talks about getting rid of “fraud, waste and abuse” in government spending, they are really talking about their own activities, but using the poor as a red herring to distract people.

Posted by PseudoTurtle | Report as abusive

America is one of few nations big enough to produce most of things it needs if wanted to and is separated by oceans form it’s competitors. Cheap transportation limited the effect of the oceans of late. China and Canada are the chief trading partners. The US has been ignoring trade failure for decades.

Britain in much smaller and very close to Europe. The rest of Europe is it’s trading partners. Trade is a much bigger portion GDP than in the US. Bad trade must be corrected faster.

From the size, isolation and nature of trade the two are not alike.

Posted by Samrch | Report as abusive

To be crude, the UK has the balls to face the problem and the US (not people, but the dimwits in DC) do not.

I think much of it might have to do with different campaign financing and lobbying laws

Posted by GA_Chris | Report as abusive

Sydenham’s Law: Increases in public expenditure decrease private sector growth.

This is a simple law of economics. See: ml

Even lowering the rate of increase of public sector spending can relatively stimulate the private sector (see link above).

Posted by Nojer | Report as abusive