I heartedly commend this article in the New York Times. It’s about an American academic economist who’s thrust into British policymaking. It’s even more about what’s going on in the U.K. under the policies adopted by PM David Cameron and Chancellor of the Exchequer George Osborne.
Simply put, Cameron and Osborne won election in large part because they promised to return the economy to a sound footing. They would accomplish this by massively cutting federal spending and firing public-sector workers. They even promised as much.
But they were wrong.
Unfortunately, they are doubling down, arguing that their austerity measures must be extended along with the accompanying pain and suffering.
Cameron and his chief financial-policy minister, Osborne, say they have only deepened their commitment to austerity. Osborne recently announced that while he had hoped austerity could end by 2015, it now looks as if the policy will continue until at least 2018. That is, if the Tories are in power. Recent opinion polls show that after years in a dead heat, the Labour Party now has a solid lead in popularity, though elections are more than two years away.
The two competing theories, the article suggests, are between those who follow Keynes and those who follow Hayek, with some Milton Friedman and other freshwater economists thrown in. Adam Posen, the American advisor who accepted a position on the British counterpart to our Federal Reserve, is decidedly Keynesian. He argued in vain for expansionary policies. He was outvoted 8-1; the majority favoring austerity. While he may have lost the battles, he’s likely to win the war.
Posen arrived in London after the acute panic of the financial crisis had given way to the long slog we’re still in. At that point, policy makers around the world were given the task of assessing the damage and devising a plan that would best position the economy to function at normal levels. The United States had already responded with a roughly $800 billion stimulus package. In the spring of 2010, British voters went in another direction. They elected Prime Minister David Cameron, who had promised to reset the economy by severely cutting government spending, which would lead to significant public-sector layoffs. The economy’s only chance to return to long-term growth, Cameron argued, would be a painful, but brief, period of austerity. By shrinking the size of an inefficient government, Cameron explained, the budget would be balanced by 2015 and the private sector could lead the economy to full recovery.
Today these two approaches offer a crucial case study and perhaps a breakthrough in an age-old economic argument of austerity versus stimulus. In the past few years, the United States has experienced a steep downturn followed by a steady (though horrendously slow) upturn. The U.S. unemployment rate, which shot up to 10 percent at the end of 2009 from 4.4 percent in mid-2007, has now dropped steadily to 7.7 percent. It might be a frustrating pace, but it’s enough to persuade most economists that a recovery is under way.
The British economy, however, is profoundly stuck. Between fall 2007 and summer 2009, its unemployment rate jumped to 7.9 percent, from 5.2 percent. Yet in the three and a half years since — even despite the stimulus provided by this summer’s Olympic Games — the number has hovered around 7.9. The overall level of economic activity, real G.D.P., is still below where it was five years ago, too. Historically, it’s almost unimaginable for a major economy to be poorer than it was half a decade ago. (By comparison, the United States has a real G.D.P. that is around a half-trillion dollars more than it was in 2007.) Yet austerity’s advocates continue to argue, as Cameron has, that Britain’s economic stagnation shows that the government is still crowding out private-sector investment. This, they say, is proof that austerity is even more essential than was first realized. Once the debts have been paid off and the euro zone solves its political problems, the thinking goes, the British economy will bounce back quickly.
At any rate, if you find yourself in a bar arguing with an austerian, give your opponent a copy of this article.
UPDATE (Dec. 20, 2012):
Here’s a chart comparing the change in real GDP since 2007 between the U.S. and the U.K.: