From the TUC

UK & US Policy Compared

26 Apr 2012, by in Economics

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.

Adam Posen recently argued that:

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.

2 Responses to UK & US Policy Compared

  1. Will M
    Apr 26th 2012, 1:43 pm

    Isn’t the better argument that given the UK hasn’t actually cut spending yet and we’re already back in recession, the cuts that we have already committed to carry out are looking more and more dangerous?

  2. jonathan
    Apr 26th 2012, 4:59 pm

    Duncan, the real issue is this: when people can make arguments for or against in good faith that means the subject’s value is perspective dependent. An example of not good faith would be the idiot lies people tell to justify creationism: mis-stating the 2nd law of thermodynamics, claiming transitional fossils don’t exist, etc. But arguments about austerity can be made in good faith, so what does that mean? It means in this case that austerity has little value. It was promoted as a positive and now the defense is that maybe it isn’t that much of a negative. We tend to lose sight of this when we allow the argument to shift, as you do. Yes, you can argue that austerity is not the sole cause of this mess of an economy, but that is not the original point of austerity.

    The next question is whether austerity is building long-term benefits that don’t appear now. That is: is austerity a form of investment, like planting an orchard, that doesn’t pay off right away? We usually analyze that kind of thing by opportunity cost. I am under the impression that austerity was mandated by immediate requirements such as fear of imploding credit and catastrophic loss of confidence leading to significantly depressed demand. I am also under the impression that the other paths suggested were intended to lead to the same result in the future: more spending now, less spending in the future as the economy improves. Austerity was marketed as a better immediate choice. Seems to me that if you had a choice of two paths that would lead you to the same point, you’d take the less arduous route, the one that would inflict the least pain. I have come to believe Paul Krugman is right to call austerity the “pain caucus”.