The Corner

A Look at Private-sector Austerity in the U.K.

Tyler Cowen sends me this good piece from the Washington Post’s Steve Pearlstein on austerity in the United Kingdom. Here’s a tidbit:

In economic terms, the austerity debate here, as in the United States, has become as silly as it is stale.

With a relatively high debt level and credit markets increasingly wary, Britain probably had no choice in 2010 but to embark on a credible program to reduce a cyclically adjusted structural deficit that had grown to 6 percent of GDP.

But to argue that this has now driven the British economy back into recession is an unconvincing stretch. Most of the cuts have yet to take place, fiscal stimulus this year is still in excess of 8 percent of GDP and the Bank of England has embarked on yet another round of monetary stimulus. If the recovery here has stalled, it is primarily the result of rising energy prices and the financial and economic crisis in Europe, which accounts for 60 percent of British exports.

As you know by now, much of the criticisms about austerity measures implemented in the U.K. make it sound like the country has dramatically cut spending. But the data show that to be far from the truth. Spending in the U.K. is growing at a slower rate than it was scheduled to, but it is growing. Unfortunately, British taxes are also growing.

#more#Originally, Chancellor George Osborne had announced that he would cut  £3 in government spending for every £1 in new tax revenue. However, of the roughly £40 billion that was shaved from the deficit (not the budget) during the 2010–2011 deficit-reduction cycle, for every £3 of new tax revenue, U.K. taxpayers got £1 in cuts — exactly the reverse of what was promised.

That, of course, is at the core of the problem with the balance approach. Even if this approach appeals to a certain sense of fairness, it never ends up playing out this way in reality. Instead, the tax hikes materialize but spending is rarely cut to the promised levels.

Among the tax increases implemented in the UK in the last few years we have:

(For more, go here.)

Sadly, the 2012 budget seems to be doubling down on this strategy. And yet I don’t see any headlines coming from liberal blogs and newspapers arguing that the U.K. must stop increasing taxes because this is a terrible idea when the economy is weak. That is true even in standard Keynesian theory. As Washington Post’s Brad Plumer reminded us a few weeks ago:

The standard Keynesian prescription for countries that are stuck in a deep economic slump — and this seems to describe much of Europe — is to actively increase deficits through more spending or tax cuts. Instead, most countries in the euro zone have done the opposite. They’ve been cutting spending and hiking taxes while the economy’s still weak. This is austerity. The typical criticism is that pursuing austerity during a downturn hurts economic growth — and, as such, makes it even harder to get debt burdens under control.

From this paragraph, one would think that Keynesian economists would be very upset about these large tax increases. But they have remained mostly silent about this part of the austerity packages. Instead, they have preferred to blame the “austerity debacle” in Europe on spending cuts. On that point, I remain confused because the reality is that while the UK has at best slowed down the growth of spending, the country has not actually engaged in spending cuts (i.e., one spends less tomorrow than today).

A look at the data in Her Majesty’s Fiscal Year 2012 Budget shows (see table 2.3) that total managed expenditures will increase from £696.4 billion in 2011–2012 to £733.5 billion in 2014–2015, and further to £756.3 billion in 2016–2017. Adjusted for population growth, this is slow growth, but not a savage cut. That table also shows a “projected” drop in Public Sector Gross Investment between 2012–2013, but if it ever materializes, it will be contained to that year alone.

The bottom line is that the U.K. is another case of private-sector austerity without public-sector austerity. Now, some have argued that the overall spending isn’t growing enough or that some of the cuts were in areas that are essential to economic growth (I don’t buy it), but that is still quite different from complaining that the spending cuts were savage while saying nothing about the tax increases.

Finally, it would be wise to remember the work of University of California–San Diego’s Valerie Ramey on the impact of increasing government on the economy. In a recent study, she finds that in most cases, private spending falls significantly in response to an increase in government spending. That’s more private-sector austerity. She finds that in general the multiplier is less than 1. She warns that these results may not be necessarily applicable to a case where government spending is financed through debt, but it applies when it is financed by an increase in tax rates. She has more great work on the issue.

On Sunday, I appeared on C-SPAN’s Washington Journal to talk with host Steve Scully about austerity in Europe.

Juan Carlos Hidalgo has written about austerity in the U.K. here.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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