Defensible conclusions from observing UK fiscal policy

by on October 26, 2012 at 7:25 am in Economics, Uncategorized | Permalink

Here are a few which are at least what I call “defensible”:

1. The UK economy was hit with serious problems, and fiscal (and monetary) policy did not respond strongly enough to keep the nation on track.  (NB: If you are citing measures of a cyclically adjusted gap in UK fiscal policy, you probably are citing evidence in support of this proposition.)

2. There has been a shift in the composition of government spending, which has led in turn to sectoral shift problems for former UK government employees.

3. UK government spending is underinvesting in that nation’s future, most of all in education but other public goods too.

You may or may not agree with these views, but again they are defensible.  You can point to both evidence and theory in their favor, noting that the skeptics may have other reasons for dissenting (but still they should accept the first-order evidence and theory).

Here is the view which is not so defensible:

4. A negative shock to UK government spending led to a negative AD shock and that drove the recent poor performance of the UK economy.

People, that one just ain’t true.  I’m receiving a lot of comments and emails, all citing evidence which supports versions of 1-3, but interpreted incorrectly as support for #4.

There is a big difference between #1 and #4 for their concrete implications.  For instance if you believe in #4, it seems that problem would be relatively easily fixed by more AD.  If you believe in #1, you have to think long and hard about what those initial shocks were, and then ascertain how much the resulting fallout from those shocks could be fixed by AD measures.  These become murky waters very quickly.  For instance a mix of collapsing London finance, disappearing North Sea oil, and mysterious British productivity puzzles (one possible set of options in these murky waters) probably can be fixed only a bit by a more expansionary fiscal policy.

I’m on board with the government spending/sectoral shocks to government employment point, though of course it is only one part of the problem.  I would note that everyone criticizes sectoral shocks theories until they wish to use them.  I also would suggest that this point is well explained by the conservative critique of entitlement spending, namely that it swallows up too many parts of the budget and the broader economy.

People are trying to use the UK fiscal policy evidence to argue for the “simple” view when instead they should be pushing the “murky” view.  And the murky view implies the whole mess just isn’t that easy to fix, or for that matter diagnose.

1 Saturos October 26, 2012 at 7:37 am

This post could have (should have?) been rewritten as: I don’t have a freaking clue what’s going on in the UK, and neither do you.

2 dearieme October 26, 2012 at 8:00 am

“the whole mess just isn’t that easy to … diagnose”: but it’s easy to apportion blame. Insofar as it isn’t Greenspan’s fault, it’s Blair’s and Brown’s. My being a forgiving sort of a chap, Blair is the only one I’d hang.

3 Bill October 26, 2012 at 8:28 am

Shocking how “a mix of collapsing London finance, disappearing North Sea oil, and mysterious British productivity puzzles” suddenly happened while the British at the same time decided to take a vacation from work.

What I thought was interesting were items 1, 2, and three were true, but didn’t lead to 4, which was better explained by disappearing North Sea oil (really, send out the Marines) and the sudden mysterious British productivity puzzle. That it was caused by a financial collapse of overleveraged banks, which got bailed out by government–oh, my god, government–purchases of stock and capital infusions is more likely, but of course, that may be a proximate cause, but does not exclude a remedy of replacing the lost AD.

4 Bill October 26, 2012 at 8:43 am

Prediction: Instead of increasing AD or at least not cutting government services and employment, the government will announce that, in order to get the economy moving again, it will reduce corporate taxes.

We wish to thank the English for their demonstration of the austerity to prosperity model.

5 Orange14 October 26, 2012 at 8:29 am

Too bad they cannot hold Olympic Games every six months!

6 Ritwik October 26, 2012 at 8:46 am

I don’t quite understand what is so mysterious about labour productivity in the UK. The Fay-Medoff results are not the starting point in explaining the cyclical variations in labour productivity, is it?

UK is choosing lower productivity. In the past, this used to mean a decrease in the share of corporate profits. In this recession, corporates have basically decided that they will not let profits or cash balances fall. So labour has to make do with a lower share.

This results in either low productivity, low real wages, decent employment (UK). Or high productivity, decent real wages and low employment (US).

What remains to be explained is the GDP behaviour itself. If you take GDP as a given, then rising corporate profits + differential labour market choices can explain most productivity and wage ‘puzzles’.

7 Luis Pedro Coelho October 26, 2012 at 9:42 am

But how the murky view allow me to argue that the UK experience really shows that my candidate has the right ideas and the other candidate is evil?

8 Ryan Cooper October 26, 2012 at 11:37 am

How about: “A bunch of pointless tax increases led to a negative AD shock and that drove the recent poor performance of the UK economy.”

9 David Ward October 26, 2012 at 1:26 pm

Clearly other factors are having an impact, but you can’t get away from the fact there was 2% growth before the emergency budget in June 2010, which fell to 0 and has stayed there pretty much ever since. Personally I also think the Coalition’s communication in 2010 had an impact as well. By claiming the UK was on the verge of bankruptcy they made households and businesses more cautious.

10 andy October 27, 2012 at 3:27 am

The UK economy was hit with serious problems, and fiscal (and monetary) policy did not respond strongly enough to keep the nation on track

I don’t understand it. It seems to me like “the patient was dying, and the doctor didn’t give the patient enough drugs to keep the patient alive”; while the patient has already been administered an incredible amount of drugs. What is the defence for “even more deficit would make things better”? (or should I read “strong fiscal policy” differently than “more deficit”? you don’t mean “less deficit, less spending”, do you?) BTW: don’t the theories about fiscal deficits mostly consider a composition of deficit to be an irrelevant information (there is some difference between transfers and spending, but both is supposed to help)?

11 Merijn Knibbe October 27, 2012 at 2:52 pm

To add to the UK conundrum:

looking at the quarterly government deficits (% of GDP) yields that these are steadily declining – until this year. 2012-I almost saw no decline compared with one year before, 2012-II saw a more than 6% of GDP decline – which is massive. Together, and analysed in combination with the rapidly increasing deficit on the current account and better than expected job numbers (though still not too impressive) this gives the idea that loads of money were used for the Olympics in 2012-I while 2012-II noticed loads of money already coming in, because of these Olympics (which of course were held in 2012-III). A very quick internet search learned that the Olympics provided 130.000 jobs (in a country with a popolation less than one fifth of the USA population).

12 UKGB October 29, 2012 at 3:32 am

Tyler, this seems very reasonable mostly. I would say under 1. that the biggest problem it was hit by originally was a hit to AD. This started recovering, but between October 2010 and July 2011 another big hit to AD took place, at the same time as a hit to AS through commodity prices, and the BOE’s remit then didn’t help (the yield curve tightened even as the economy was falling away.) Multipliers (in the presence of this BOE regime) have been predictably high meaning that the fiscal stance made worse the underlying situation.

There is a need for economic restructuring, though the overdependence is often exaggerated. THe two wings of politics argue about whether that restructuring happens more easily if you have a lot of austerity-related destruction, or government investment in science, technology, etc.

I think in 4 you are right if you are attacking those who put the recent underperformance purely at the door of the fiscal policy. But there is little from the UK experience to refute the idea that the lower end of the IMF’s analysis is broadly right. We know very little indeed, and properly speaking the Sumner critique ought to be having greater traction.

13 UKGB October 29, 2012 at 3:33 am

Sorry for a horribly edited comment – I meant overdependence on finance.

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