October 31, 2010
Contrasts Between the US's and UK's Post-Recession Policies
Contrasts Between the US's and UK's Post-Recession Policies-Becker
Many economists and others in the US are advocating a second fiscal stimulus program, believing that the close to $1 trillion in the Obama stimulus package was too modest. This call for another round of government spending is taking place despite the fact that about one third of the original package has not yet been spent, even though it is more than one and one half years since the package was signed by President Obama. Moreover, skeptics (including myself) about whether the US needs another spending package point out that leading economists in the President's Council of Economic Advisers were far too optimistic about the effects of a big stimulus on unemployment rates. Instead of a predicted decline in unemployment due to the stimulus of more than 1½ percentage points, the total fall in seasonally adjusted unemployment has been only ½ of a percentage point from its peak of 10.2 percent.
Of course, perhaps other factors, such as the uncertainty about the business environment that Congress and the President created through their rhetoric, and also through their actual and proposed legislation, offset powerful effects of the fiscal stimulus itself in reducing unemployment. The unpleasant fact we economists have to face is that there is not strong evidence on the actual effects of governmental spending on employment and GDP. The usual claimed effects are generally based on predictions from highly imperfect theoretical models of the economy rather than from strong direct and clear evidence on the employment consequences of different fiscal stimuli.
This is why the UK's experiment in reducing rather than raising government spending while Britain is still coming out of its serious recession is not only daring in the present economic climate, but it is also of great value in determining whether growing government spending is a valuable way to speed an economy out of a serious recession. In order to bring under control the large fiscal deficit of Great Britain that is well over 10% of the UK's GDP, the Tory (coalition) government of David Cameron has proposed a fiscal tightening that amount to about 1.5 percent of GDP during each of the next four years. This will be accomplished by some increase in taxes, but mainly by cuts in spending on public services, public investments, and various benefits to families.
It is informative to contrast this British approach with that of the US. Federal government spending during the past few years increased to about 25 percent of GDP from a level that had been rather stable for a couple of decades, under both Democratic and Republican administrations, at close to20 percent of GDP. The federal fiscal deficit in 2009 was about 12% of GDP, and is expected (or hoped!) to decline in 2010 to about 8%. These are two of the highest deficit ratios in many decades. Essentially nothing is being done in Washington about these enormous deficits, aside from some proposals to raise taxes on the rich that will bring in very little additional tax revenue. Moreover, these proposals have been opposed by many Democrats in Congress as well as by most Republicans.
So which approach will be more successful: the British one that will sharply reduce government spending and fiscal deficits, or the American one that believes these deficits are necessary, and perhaps even too small, to get this country out of the recession? No one knows for sure about the short run effects on their respective economies of these very different approaches. Perhaps, and this is only a "perhaps" that I am by no means persuaded of, the British approach will cause more short-run harm to employment and GDP than will the American approach.
However, I am convinced that the British way is a far better way to improve the long-term growth prospects of an economy. That is, reductions in the bloated levels of government spending and fiscal deficits will do much more to stimulate the longer-term growth of the British economy, mainly by encouraging private investment and innovation, than will the present American approach. Perhaps in good part due to the gridlock in Washington that Posner discusses, this approach shows little desire to cut back on federal government spending, or on actual and projected fiscal deficits.
The United Kingdom's Dramatic Response to the Economic Crisis—Posner
The new coalition government in England is embarking on an ambitious austerity program. One goal is to eliminate 490,000 jobs in the public sector; a related goal is to slash government expenditures by 19 percent over the next four years. Administrative budgets—overhead—of government agencies are to be slashed by 34 percent. (The U.S. population is five times as great as the U.K.'s—so imagine our eliminating 2,450,000 public sector jobs!) By a combination of tax increases and spending cuts, the U.K. government hopes to eliminate the annual national budget deficit, currently more than 11 percent of GDP (similar to ours), by 2015. Among popular programs to be trimmed or eliminated are housing subsidies for middle-class persons. Defense expenditures are to be reduced by 8 percent, education spending by 3.6 percent, and the teaching budgets of public universities by 40 percent. Since spending on technical subjects is to be protected, other disciplines, such as the humanities, will face especially steep cuts and tuition will rise.
England can make dramatic changes in policy overnight because its government is extremely centralized. The Cabinet dominates the House of Commons, thus fusing the executive and legislative branches (the legislative branch is effectively unicameral—the House of Lords counts for little), and except in Scotland and Wales, there is no regional autonomy, as there is in the United States by virtue of our federal system. Except in wartime, we cannot make major policy changes in a hurry, though the Obama Administration managed in two years to make more changes than any President, in a comparable period, since Lyndon Johnson (and much of the groundwork for his "Great Society" legislation had been laid in the Kennedy Administration and gained momentum from Kennedy's assassination).
England's economic crisis is a great deal like ours; its response has been dramatically different. England, Keynes's homeland, has rejected the Keynesian solution to depression or recession, which is to stimulate consumption by deficit spending aimed at increasing the incomes and confidence of the public; the Obama Administration has embraced the Keynesian approach (which Americans call "stimulus'), though its implementation has been erratic, in part because of deficiencies of timing, design, and execution, and in part because of political resistance.
But the two nations' diametrically opposed approaches have this in common: both proceed, in part, from a desire to use an economic crisis as an occasion for long-term economic reform. Both administrations are looking beyond the crisis. Both believe that the crisis has made the public receptive to reforms that they would resist in times of prosperity. The English government, being dominantly although not entirely conservative (for it is a coalition government and the Liberal Democratic Party is the junior member of the coalition), wants reform in the form of a leaner government. Our government, being dominated by liberals (at this writing, though perhaps not for long, both Houses of Congress, as well as the Presidency, are Democratic), wants a larger government, which will expand public subsidies of health care, increase regulation (and not only of financial institutions), and combat global warming with taxes and subsidies.
Both approaches risk making the economic crisis, which as I said is similar in both countries, worse in the short run, though long-term benefits of the attempted reforms may outweigh present costs. England is slashing public payrolls and subsidies at a time of high unemployment and economic anxiety, and this may reduce economic growth in the near term. The U.S. government is frightening business by its regulatory measures, the health reforms that may well increase the labor costs of business, the prospect of higher taxes, anti-business rhetoric, and a general ambition to make government larger and more aggressive, which is unsettling the politico-economic environment of business. There is a sense too that in their impatience to bring down the unemployment rate, the Federal Reserve and the Treasury may soon embrace policies that sow the seeds of future inflation. Uncertainty causes businesses and consumers alike to tend to freeze—to save (in "safe" forms that don't promote productive investment) rather than spend—and the Obama Administration has increased the level of economic uncertainty in the United States.
Unfortunately, as we have learned in the last two years, the economics of the business cycle, and in particular of the business cycle when it enters a deep trough, are not well understood. It is possible to tell a "story" about how the English program will stimulate investment and consumption by convincing businesses and consumers that a leaner government will conduce to faster economic growth. But there is an equally plausible "story" about how the English program will reduce growth by reducing employment and incomes, and that what both England and America need is further deficit spending to increase incomes and employment. There is too much uncertainty, compounded by the dramatic economic changes occurring in major trading partners of England the United States, to be confident that one "story" is true and the other false.
What may make the prospects for England brighter than those for the United States regardless of which story is true is that the English people are famously patient and stoic, and the English government as I said unusually centralized, and this combination may give the government flexibility in adjusting its policies to changing economic conditions. If anti-Keynesian policies don't work, the government can switch to Keynesian policies.
We don't have that flexibility. Not only is our government highly decentralized, but our politics appear to be approaching gridlock, in which neither political party will either raises taxes significantly nor cut public spending significantly nor even resist new spending programs. The Keynesian approach has been discredited, whether rightly or (as I think) wrongly in this country, but fiscal rectitude (as one might call the English approach) seems unattainable here as a political matter.