Yesterday’s GDP figures have reopened the debate on the UK versus the US recoveries and the effectiveness of different policy responses.
Some commentators are loath to blame the government’s austerity programme for the stagnation of the economy over the past 15 months. Instead they point to factors such as the Eurozone crisis and an external inflation shock that depressed household incomes. Now of course the Eurozone crisis will have impact on UK exports – but there was little evidence of this in 2011 where net trade actually added to growth whilst the domestic economy contracted. Equally the inflation shock has certainly had an impact, but it seems clear to me that the government’s fiscal policies have also been a drag on growth.
Fiscal policy, however, played an important role as well. Cumulatively, the UK government tightened fiscal policy by 3% more than the US government did – taking local governments and automatic stabilizers into account – and this had a material impact on consumption. This was particularly the case because a large chunk of the fiscal consolidation in 2010 and in 2011 took the form of a VAT increase, which has a high multiplier for households.
Some people seem to doubt this. They argue that UK government spending continued to rise in absolute terms in 2010 and 2011 and point that that there have been large cuts in state level spending across the United States. In effect they argue that UK and US policy was similar.
This is to miss the point. As Posen argued the UK tightened by 3% of GDP more than the US did. Fiscal policy is about more than just government spending and what has been key in 2010 and 2011 is tax policy. Austerity in the UK in this period mainly took the form of a rise in VAT, whilst in the US the ‘second stimulus’ pursed by Obama took the form of a cut in pay-roll taxes that boosted demand and put money back in workers pockets.
The results are seen not so much in the contribution of government spending to GDP growth but in consumption.
The chart below presents an interesting picture – a rebound in the US and a collapse in the UK.
It is certainly true that next year US fiscal policy is due to tighten sharply (although obviously this might be changed). But in 2010 and 2011 there is no doubt that the UK and US were pursuing very different policies – one tightening fiscal policy and one stimulating the economy. The results are pretty clear.