Those searching for a panacea for our economic troubles shouldn’t be tempted by U.K.-style fiscal austerity. Economist Marshall Auerback—who along with over 100 other economists and historians signed The Daily Beast's manifesto calling for additional stimulus to get America back to work—explains why the cuts are already hurting England's economy.
The philosophy underlying the British government’s huge new spending cuts—namely, that fiscal austerity is good for growth—is spreading across the United States. Governments are increasingly being bullied into adopting austerity measures, apparently thinking they will help their economies grow, and if the recent polls for the midterm elections are anything to go by, this philosophy is likely to predominate in the new Congress. But an embrace of U.K.-style austerity will almost certainly ensure a major relapse for the U.S. economy.
The fiscal austerity measures announced by the British government this week, the largest since World War II, with welfare, councils, and police budgets all hit, follow on from earlier cuts made when the new leadership took power back in June. Then, pay for almost all government workers frozen for two years; now, as many as 500,000 public sector jobs are likely to be lost. Even the queen has taken a hit, as Chancellor of the Exchequer George Osborne has frozen government funding for her household and staff.
The first strong piece of evidence that the earlier fiscal measures are already having a deleterious impact on the British economy comes from the ICAEW/Grant Thornton U.K. Business Confidence Monitor for the third quarter of 2010, published by the Institute of Chartered Accountants in England and Wales. In its summary statement, the report notes: “Business confidence has weakened significantly as businesses acknowledge the path to recovery contains further challenges, with a fast return to strong growth by no means guaranteed.”
That weak business confidence is not a surprise. Companies will not increase production or build new capacity while the state of future aggregate demand remains uncertain. They do not want to hold unsold inventories.
What drives production and employment growth is aggregate demand growth. Implementing fiscal austerity undermines the very foundation of this growth. The report makes this result clear: “Currently the U.K. economy is running at more than 4 percent below pre-recession levels. The public-sector cuts outlined by the new government and consequent reduction in public-sector demand will have a significant downward effect on growth, constraining take up of spare capacity as the private sector recovers.”
It’s odd how history repeats itself. In September 1931, a forebear to today’s Tory-Liberal Democratic coalition introduced an emergency budget that John Maynard Keynes described as “replete with folly and injustice…every person in this country of super-asinine propensities, everyone who hates social progress and loves deflation, feels that his hour has come and triumphantly announces how, by refraining from every form of economic activity, we can all become prosperous again.”
Keynes’ approach to the Great Depression and his critical insights, which helped trigger recovery after 1934, have been completely disregarded, much as they were in 1931, when Britain promptly slumped and ultimately had to abandon the gold standard. The resulting depreciation of the currency stimulated exports enough to get some growth going, but it was the widespread government expenditures as the country prepared for war that finally drove the economy out of recession.
The claim that consumers and business investors are paralyzed by the state of public finances has never been empirically proved. Yet ample historical evidence supports the proposition that fiscal austerity can kill growth: Firms care about the state of the orders coming into their businesses, and households care about the likelihood that they will hang onto their jobs and enjoy some real wage growth. There is also widespread empirical support for the idea that cutting government expenditures in the midst of a serious recession/depression will actually exacerbate the very debt levels that now have our deficit hawks so exercised. In Britain, for example, after World War I government expenditure was aggressively cut from £1.85 billion ($2.9 billion) to £480 million ($752 million), but the public debt-to-gross domestic product rose to 180 percent from 114 percent. More recently, the Markit/CIPS U.K. Manufacturing Purchasing Managers’ Indices, which is calculated from data on new orders, output, employment, supplier performance, and stocks of purchases, fell to a 10-month low of 53.4 in September, down from a revised figure of 53.7 in August. This week’s budget will only make things much worse.
This week’s U.K. budget will only make things much worse. Consider that the next time some deficit hawk in the U.S. shrieks about the state of U.S. finances.
Consider that the next time some deficit hawk in the U.S. shrieks about the state of U.S. finances, or some German technocrat forces yet more fiscal austerity down the throats of the Irish or Greeks. Ireland today finds itself in a major banking crisis— Anglo-Irish Bank was recently nationalized, for example—despite the Irish government’s steadfast application of the fiscal austerian measures the European Central Bank has urged on it. In fact, this banking crisis stems from the austerity measures the government is taking. The Irish budget deficit, as a percentage of GDP, now stands at 32 percent. These are wartime-type levels of expenditures.
Don’t get me wrong: Government deficits ultimately put a floor on demand and help the economy recover. But isn’t it interesting that the policy prescriptions designed to eliminate the so-called scourge of public debt are increasing it? Shouldn’t that make our policymakers pause in their enthusiastic embrace of fiscal austerity? Policymakers here in the U.S. continue to hint at accounting tricks such as quantitative easing, on the premise that central banks swapping one financial asset for another will help incite more speculation. That seems to be doing the trick for the stock market, but it does nothing to boost underlying aggregate demand. How about a solution for Main Street?
• Get America Back to Work: The Daily Beast’s manifesto urging more stimulus. Even as the markets make new post-2008 recovery highs, governments construct more policies around bailing out fundamentally insolvent financial institutions. These policies ensure that the bankers and others can continue to get their exorbitant and totally unjustifiable bonuses, thereby sustaining the practices that created the crisis in the first place. Lloyd Blankfein of Goldman Sachs warned that the bank could shift its operations around the world if regulatory crackdown becomes too tough in certain jurisdictions. To this, any politician with an ounce of backbone ought to say, “Good! Take your socially polluting activities elsewhere and leave our populations alone.”
Needless to say, that hasn’t exactly been the response of this “change you can believe in” administration, despite a staggering 42 million people, more than one in eight Americans, on food stamps, and poverty and income inequality at an all-time high. Almost half the unemployed have been jobless for more than six months. This is, by any standards, still a major crisis. Enacting fiscal austerity, as the British did this week, will only mean a major economic relapse for our country.
Marshall Auerback is a senior fellow at the Roosevelt Institute and consulting strategist with PIMCO, the world's largest bond fund. He is also a fellow for the Economists for Peace and Security and regularly blogs at www.newdeal20.org.