Austerity vs. Stimulus- the US vs. the UK

My thoughts recently were kicked off by this NYT editorial:

Austerity was a deliberate ideological choice by Prime Minister David Cameron’s ruling coalition of Conservatives and Liberal Democrats, elected 17 months ago. It has failed and can be expected to keep failing. But neither party is yet prepared to acknowledge that reality and change course. Britain’s economy has barely grown since the budget cuts began taking effect late last year. The most recent quarterly figures showed the economy flat-lining, with growth at 0.1 percent.
New figures released this week reported Britain’s highest jobless numbers in more than 15 years. Independent analysts expect unemployment — now 8.1 percent — to keep rising in the months ahead. The government has kept its promise to slash public-sector jobs — more than 100,000 have been lost in recent months. But its deficit-reduction policies have failed to revive the business confidence that was supposed to spur private-sector hiring.
Drastic public spending cuts were the wrong deficit-reduction strategy for the weakened British economy a year ago. And they are the wrong strategy for the faltering American economy today. Britain’s unhappy experience is further evidence that radical reductions in federal spending will do little but stifle economic recovery.

I sent this to a conservative sparring partner of mine, and he responded with two comments (which I've paraphrased):

1. Applying the logic of the pro-stimulus forces in the US, one might say that things would be much worse in the UK if not for austerity.  Maybe cutting government saved two million jobs and they'd be in a Depression if they hadn't gone that route.
2. The UK and the US are both growing anemically.  Why would the Times look at one and say that policy has failed, while looking at the other and say their policy has succeeded?

As to the first comment, yes austerity is intended to create/save jobs just like stimulus is. I think that advocates of either policy need to present a model as to how this happens, and then find historical or current day examples that support the model. The view from 50,000 feet is important, yes, but you have to describe a plausible causal explanation. The causal explanation for austerity was that it would restore confidence and investment- this clearly hasn't happened. The formula for stimulus is that it would spur growth by stimulating demand.  I think there's more historical evidence for this over time, though it hasn't been tried at enough scale this time around.

My understanding is that the UK's situation got notably worse after they switched to austerity measures. In the US it seems that the economy was growing when there was (very moderate) stimulus (I say very moderate because states cut back at the same time that the feds stimulated, so the overall effect was small), and is now stuck in the mud with stimulus completed.

The thing about austerity specifically and Hayekian economics in general as I understand it is not that government action of the right kind in a down economy works wonders, but rather that the business cycle is fated to play out naturally and government is just counterproductive or at least unproductive. So in that case, austerity isn't a way to "kick start" the economy, but rather a way to stop interfering and let the business cycle bring it all back eventually through creative destruction. But in our current depressed economy it's pretty clear nothing is coming back on its own for a long time. 

 

Now I still respect the point- maybe it's true that government just can't help- but the theory doesn't say that these policies will goose the economy and speed up the recovery. As I understand it, conservative economic measures being proposed now are not intended to spur recovery, just make the eventual recovery that happens on its own more sustainable. If so, it's pretty clear that austerity specifically and conservative policies more generally are being oversold quite a bit right now.  I don't think it's too likely that ending some regulations is going to do much in the short term for a demand problem in the economy, and I don't think any serious conservative economist would say that either.

As to the second comment, it's a good point- the US isn't going great either. But things are worse in the UK than they are in the US.  This seems like an apples to apples comparison:

2011 Q2 growth in the UK was 0.2%, while in the US growth in the same quarter was 1.30%. Now on the one hand both countries are doing pretty badly. On the other hand, US growth was 6.5 times better than the UK's. Now I admit that is only one data point (though it's the first one I came across and compared googling, so I didn't cherry pick), and of course there are so many factors in all this (the UK might be much more affected by the European crises than we are, the UK has socialized medicine and a larger welfare state, etc. etc.) but it's something.

 

It is so difficult to get past one's biases in these matters.  The way I'm trying to get past mine is to set parameters at the outset regarding what constitues evidence of effectiveness, and then follow that evidence through, come what may.  We'll get a great chance for that if there is a Republican sweep in 2012 and they implement austerity as they say they will.  I think that will lead to a double dip recession in short order.  If the GOP does win and does implement the policies they're running on, and it works?  I'll have to rethink my positions.

 

In the current environment, however, I'm trying to do the same thought experiment by comparing different responses to the crises in different countries and seeing what happens.  Ever since the UK announced austerity, I've been watching them in contrast to the US to see whether that works better than the somewhat-more-stimulus approach of the Obama administration.  We'll keep watching.

 

Stimulus Fallacies

Paul Krugman has it right here.

Anyway, I don’t believe that it’s all political calculation. Watching Mr. Obama and listening to his recent statements, it’s hard not to get the impression that he is now turning for advice to people who really believe that the deficit, not unemployment, is the top issue facing America right now, and who also believe that the great bulk of deficit reduction should come from spending cuts. It’s worth noting that even Republicans weren’t suggesting cuts to Social Security; this is something Mr. Obama and those he listens to apparently want for its own sake.


Which raises the big question: If a debt deal does emerge, and it overwhelmingly reflects conservative priorities and ideology, should Democrats in Congress vote for it?

Mr. Obama’s people will no doubt argue that their fellow party members should trust him, that whatever deal emerges was the best he could get. But it’s hard to see why a president who has gone out of his way to echo Republican rhetoric and endorse false conservative views deserves that kind of trust.

Now it's clear that more stimulus spending is a hopeless cause.  But it didn't have to be that way- that's a product of choices, in both the policy and politics realms, that didn't have to be made. I blame Obama for not shooting high enough in the interest of being "moderate", and then coming out and telling everyone that the amount of stimulus he did was "just right". So now he's lost his chance, and the subsequent pathetic recovery is going to be blamed on him. Even if he got all the stimulus he could get, if he were saying "I want more of this, but conservatives won't let me have what I want- this will have to do", then it would be easier to argue a liberal point of view now.


Of course the unfortunate (for me) truth is that Obama just isn't a liberal. He's obsessed with being a centrist, as defined as the midpoint between liberals and conservatives. When conservatives went over the cliff, Obama decided to go halfway down the chasm to stay in the middle. And it hasn't helped him politically at all- conservatives still think he's a communist, it doesn't matter how close to their positions he goes.

So I'm madder at Republicans, who I think care more about their electoral victories than about the country's economic health, but I'm pissed at Obama and the Dems too, for not fighting at all for liberal values. If the economy tanks and Republicans sweep in 2012 it will be the Democrats' fault for having no guts.  Liberals can't seem to muster the courage of their convictions.

So as the economy continues to stagger, Republican chances in 2012 keep looking rosier.  And if they win, their Tea Party-dominated crackpot policies will make things even worse and Democrats will be back in 2016. But why should we have to put up with that?

Austerity Budgets & the Confidence Fairy

Paul Krugman's op-ed today is a good read.  Among other points:

Just ask the Irish, whose government — having taken on an unsustainable debt burden by trying to bail out runaway banks — tried to reassure markets by imposing savage austerity measures on ordinary citizens. The same people urging spending cuts on America cheered. “Ireland offers an admirable lesson in fiscal responsibility,” declared Alan Reynolds of the Cato Institute, who said that the spending cuts had removed fears over Irish solvency and predicted rapid economic recovery.

That was in June 2009. Since then, the interest rate on Irish debt has doubled; Ireland’s unemployment rate now stands at 13.5 percent.
And then there’s the British experience. Like America, Britain is still perceived as solvent by financial markets, giving it room to pursue a strategy of jobs first, deficits later. But the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback. As I like to put it, the Cameron plan was based on belief that the confidence fairy would make everything all right.
But she hasn’t: British growth has stalled, and the government has marked up its deficit projections as a result.

A quite conservative friend asked me a couple of years ago "what would it take for you to give up your belief in Keynesian economics?".  I responded that we were getting a little test case at that time: the US was doing signficant (though still not enough according to economists) stimulus spending, while much of Europe was pulling back and trying to balance their budgets.  Now of course everything is multi-factorial, and this doesn't constitute ironclad proof, but it's a data point anyway, and one I identified years ago. 

Current trends are pretty clear.  Ireland is a disaster, the UK isn't doing very well, and Germany hasn't recovered as much as we have.  It's not going great in the US, but it's going better than in places where there was less stimulus.

So until I see some pretty good evidence, I'm still a Keynesian.

Stimulus one year later (posted by DT)

Here's some correspondence with a conservative email buddy. I asked him what he thought of stimulus spending, now that the CBO has declared that it worked to keep us out of a much deeper hole. He is unconvinced:

This is classic economics, in that it is impossible to know definitively what the null hypothesis result is. What would the state be if everything else were held constant? What if a different policy were followed? I personally can't answer these questions. I have generally found that economists that supported the stimulus think that it worked, while those who did not support it think that it failed.

I remember asking you a long while back what you would take as proof that the stimulus did not work. You said that probably you would look at a country who followed a different policy to compare results. So, I think you should take a look at Germany, or at Canada. Both of these countries followed policies that involved controlling government spending - they are doing much better than we are. There are of course lots of variables that are different, so if you want to believe the stimulus worked, you'll discount these examples.

I think you should also look at what the President and his economists were saying prior to the stimulus. Without the stimulus, unemployment would rise to 9%, with the stimulus, unemployment would stay at 8% and then drop. Obama established he exact criteria by which he should be measured.

Me? I think that the overall policies following by the current administration - massive government spending, anti-business rhetoric, tax increases or the threat of tax increases, increased regulation, etc. have created a climate that is damaging the economy in a big way. This is the worst recovery from a recession ever. Unemployment is the highest in our lifetimes, with no sign that it will go down in a meaningful way for a long time. Obama owns these results, even if the recession started before he took office.

Oviously I disagree:

Of course counterfactuals are impossible in economics; but we have to go on the data we have. I've read some commentators who say that because we can't scientifically measure the effects, we should therefore not do stimulus, but of course that's absurd since any course of action can be criticized on that count, including inaction.

I think there are a few stances one could take on the stimulus:
It was a complete failure, the "multiplier" effect is 1, and we've gotten nothing from it except debt
Stimulus worked to boost production and increased GDP, but the effect wasn't enough to justify the debt incurred (i.e. it accepts Keynes theoretically but still isn't convinced). This argument could also encapsulate the Moral Hazard issue- moral hazard problem is too big to justify the temporary economic benefit.
Stimulus was a success, and without it things would have been much worse. It was worth the debt incurred.
Germany is an interesting comparison, but I don't think it can be looked at without seeing it as a part of the larger European Union, which makes economic decisions as a whole. I would see Germany as analogous to the Northeast Corridor, as the most educated and advanced part of the European economy. Like us here in the northeast, Germany has lower unemployment than southern Europe, which also didn't do much stimulus (as part of the same EU). Like the less developed parts of the US, southern Europe was hurt badly by this recession and isn't recovering well at all.

But I accept your point that we're all set in our preconceptions.

The President's economic team blundered badly in predicting an 8% top unemployment rate, but that speaks to their poor crystal-ball reading, and doesn't say anything about effects of stimulus. After all, unemployment went past 8% long before significant stimulus was in place.

As for your final point, it's true that the Democrats own the recovery (though not the Crash). I think they blundered in not doing enough stimulus (many on the economic team argued for stimulus well north of $1 trillion, and it ended up being $700 billion), but of course now we're into more counterfactuals.

The continued poor economy will hurt Dems at the polls, as it should. You think it's because they're pursuing the wrong policies, and I think it's because they didn't have the courage of their convictions. Either way it's their fault though.

The nice thing about an undivided government (like 2009-2010, and of course 2001-2007) is that we can hold the majority responsible for their record. If the GOP takes one or both houses of congress, things get much murkier.