Sunday, January 27, 2013

Austerity: Britain Doesn't Even Know the Meaning of the Word

I've read it more than once, whether it's from economic writers Paul Krugman, Matthew Yglesias, Lawrence Summers, or most recently, my former economics professor: austerity, particularly in Britain, has failed. It must be bad enough if the British government is being pressured to stop

What is the commonality between the four aforementioned writers? The Keynesian school of economic thought. The reason why this is worth noting is because the idea from a Keynesian standpoint is that these recessionary times are bad, and we need to boost aggregate demand, i.e., spend our way out of the recession by increasing government expenditures.

"Austerity" comes off as a nice buzzword when discussing fiscal policy, but what exactly is austerity? Austerity comes from the word austere, which has its roots in the Greek word αὐστηρὸς (austēros)meaning "harsh" or "severe." Trying to come up with an economic definition for austerity is more difficult. Some might define that as "cutting back on the rate of government expenditure growth." I find this definition to be faulty because, as Cato Senior Fellow Daniel Mitchell puts it, it's analogous to saying "your diet is successful because you only put on two pounds a week instead of five." For others, this means reduced government expenditures and overall frugality on the government's part in order to minimize the debt-to-GDP ratio. I like this definition, but I would like to maintain the etymology and add the "severity" component, meaning that any spending cuts that do place have to be drastic, in short, be austere.

Can Britain's spending patterns be considered austerity? Are they at all austere? Let's see what Britain's national statistics have to say about it. I took a look at the British government's data on government expenditures in real terms (£) [as opposed to nominal] in order to adjust for inflation, and this little graph below illustrates what I found:

Where are the drastic spending cuts? They don't exist. As a matter of fact, since the onset of the recession, Britain decided to raise government expenditures in all but one fiscal year, i.e., last fiscal year. Rather than have a [drastic] decrease in government spending, what did Britain do? They decided to increase their net annual spending in real dollars since the beginning of the recession by 8.96% (∆Spending = [£665.1-£610.4]/£610.4 = +8.96%). Even with the modest decrease in spending from the 2010-11 to 2011-12 fiscal year, Britain's government expenditures have not gone below pre-recession levels. Government expenditures as a percent of GDP has dropped slightly (from 51.1% to 49.8% in 2011), but has been lower in years past (e.g., in 2000, it was 36.8%). Nevertheless, nearly having your expenditures add up to nearly half of your economy is not by any means flattering. And all of this is without even looking at the government expenditures in nominal dollars!

Britain historically has had some egregious debt-to-GDP ratios, but the fact that it has increased drastically to an estimated eighty-plus-percent since the recession is not favorable. Furthermore, the debt-to-GDP ratio is predicted to skyrocket if spending continues at its overall present rate (BIS, Graph 4). We've already observed with Greece what happens when a government walks the path of fiscal irresponsibility. To label its modest spending cuts as "austerity" and label it is a failure ignores the issue that got them in their mess in the first place, mainly that of a capricious, expansionary fiscal policy. France's economic situation isn't particularly rosy, either because they are heading in a similar path of trying to spending itself out of oblivion. Neither France, Greece, nor Britain have partook in austerity since the recession. The British government has even admitted (Office for Budget Responsibility, p. 43) that economic growth is lethargic due to the eurozone crisis and the subsequent tightening of lending credit, not austerity.

It would be nice to get into a discussion about Britain's tax increases or what sort of structural reform it needs to implement to assure that bad doesn't turn into worse because the inability to address these issues overshadows whatever modest spending cuts that were experienced in the past fiscal year. However, I think those topics exceed the scope of this blog entry.  To get back on track, saying that Britain has made drastic spending cuts, and bemoaning about the failure of contractionary fiscal policy in Britain, is intellectually dishonest. Austerity has not failed in Britain because it has yet to be implemented. Intuitively speaking, looking at cleaning up one's fiscal mess sends a much better signal in terms of credit risk than increasing spending or taxes. Instead of playing politics or acquiescing to faulty Keynesian diatribes, maybe, just maybe Britain should follow examples like post-WWII United StatesLatvia, or Estonia and implement actual austerity.


  1. I suppose it would be demanding too much to ask how much of the debt-GDP increase is due to the recession rather than a change in policy. The effect of the recession would be a fall in tax revenues as incomes fall and an increase in automatic spending as more people fall below thresholds for various safety nets. We'd need to look at how policy has changed to see if there is austerity. That is, unless we're going to suggest that during a recession we cut the stabilizers and raise taxes. Is the resulting suffering and potential death worth it?

    I'm glad to see you've picked up the "it wasn't big enough and therefore doesn't count" argument that we Keyensians like so much. :)

    1. I thank you for your comments, Andrew!

      Considering that the Brits were able to maintain their debt-to-GDP ratio at a respectively low level pre-recession, it'd be safe to assume that the recession was the genesis of the increase. As to whether certain policies exacerbated the increase or whether the increase could have been avoided are immaterial at this point. The main questions in this post, at least, are "Has Britain tried austerity?" and "If so, has it failed?" We could expand it to "Should Britain try it if they potentially are approaching a third dip in its recession," but that can be an exceptionally elongated discussion.

      It was a bit of a bugger finding tax data, so I hope that the data in this Guardian article is accurate, but from the looks of it, the initial year of the recession experienced a dip in tax revenues, and rose back up in subsequent years. If you're worried about the safety nets decreasing, I can tell you that they have been increasing since the recession (p. 7).

      Since spending cuts are the primary factor in what determines "austerity policy," we shouldn't have to do something as nuanced as look at Britain's policies across the span of multiple bureaucratic institutions. It should be as simple as determining whether the country's net effect of fiscal policy has been contractionary or expansionary since the onset of the recession, and the data is stating that it is the latter.