Wednesday, 24 April 2013

Graph of the week: British austerity, three years on

How effective has British austerity been so far? This graph from Ryan Avent during the budget debates (taken away from the Spectator) might shed some more light on the story (I was meaning to comment on this before, but anytime is a good time). It is entitled "Not what they had in mind" (click to enlarge)

Source: The Spectator 
I've written about European countries' austerity measures quite often and have almost every time emphasized the faulty of their tax-based consolidation approach. More and more research papers from both camps (the pro- and against- austerity) are stressing the failure of an approach focused on increasing the tax burden and keeping spending high at the same time. 

Alongside the UK (which was the focus of the graph), we can see Ireland, Spain, Greece, the US (among others); all countries which had large government stimuli and more importantly large bank bailouts in the years in before the crisis. From an earlier post (and in an article for the ASI), I have emphasized that it was precisely these classical Keynesian solutions (bailouts and stimuli) which have led to large deficits and ballooning government debt, and not the immediate shock of the crisis as some tend to claim, since the crisis shock by itself wouldn't have led to a two-fold or a four-fold increase in debt over just a few years. No, the culprit were bank bailouts done in Ireland, Spain, UK and the US.

To go back to the above graph, the causes of the UK's budget instabilities are well known (in 2010 they had the second highest budget deficit in the World, behind only revolutionary Egypt). However, the reason why they still haven't recovered from it is their stagnant GDP growth and declining productivity. So all the proponents of growth as opposed to austerity in the UK are right - the UK should switch to pro-growth, but surely not in the way the pro-growth proponents desire. Higher government spending (combined with a gradual austerity approach that extends over a few more years), combined with picking-winner strategies won't be very helpful. On the contrary, it could yield unwanted side-effects of creating a new bubble. I've stressed on several occasions the temporary vs permanent income hypothesis and a range of other reasons why such approaches are not welcomed in times of fragile recoveries, and why they will mostly end to be ineffective to start a robust recovery. This is something the current Chancellor also fails to understand when he attempts to spur activity in the UK housing market, setting stage for another potential disaster looming to happen. I can't seem to stress enough the need for a change in approach focused on tax cuts not hikes, and change in composition of spending.

To go back to the initial issue, how effective was British austerity so far in cutting the deficit? Not too much, is it? Some would argue that a decrease from around 10% down to 6% of GDP is quite an achievement, but others would argue that this would have been even faster if proper spending-side reforms have been done.

One can't help at noticing what would have happened if the British government was cutting spending faster, while simultaneously cutting taxes as well (as Sweden did in the 1990s). Perhaps today we would have had the same size of deficit (around 6% of GDP), but with stronger growth led by the currently highly constrained private sector. That would have undoubtedly been the better solution. However, take this with caution as this is purely my guess. Further research and forecasts would be needed to prove something like this (who is to say that Britain would perfectly emulate Sweden after all?).

4 comments:

  1. Vuk, I see a mistake in this graph. US GDP is 15.7 trillion US$ and budget deficit now is 1.047 trillion. This gives a 6.69 % budget deficit. Although this error is not important for your discussion, it might be important for some future analysis.
    Generally I strongly support your opinion – “Higher government spending (combined with a gradual austerity approach that extends over a few more years), combined with picking-winner strategies won't be very helpful.”
    Just like Croatia, more or less, unfortunately.
    But one point is interesting on the graph: it is position of Sweden once known as a heavy pro-welfare state with high budget deficits. How they managed to turn the trend?
    The answer can be found in the speech by Anders Borg, Swedish Minister of Finance, given on April 23, 2012.
    Here is the link: http://www.piie.com/events/event_detail.cfm?EventID=222&Media

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    1. Oh, I know all about Sweden's U-turn, and in particular I know it from Borg's lectures and speeches. I wrote about it back in June last year. I've been using the Swedish example ever since as a positive one. The Nordic economic model is no longer a pancea for collectivists. It is a model based on high levels of both personal and economic freedom - the best combination, in my humble opinion, for prosperity.

      As for the US deficit numbers, you're correct, however, the graph gives us an estimate for the budget deficit levels in 2014/2015. Perhaps I should have mentioned that in the text. The part where I comment on it might have been misleading.

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  2. thanks for share..

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  3. Austerity does not seem to be working in the united kingdom.

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