What kind of austerity did Great Britain implement in the 1920s?

by on October 3, 2012 at 6:16 am in Economics, History, Uncategorized | Permalink

When it comes to the post-WWI period, Paul Krugman recently argued: “…Britain demonstrated a fairly awesome commitment to austerity…” (and see here today’s post).

The cited IMF report notes with disapproval:

…the U.K. government implemented a policy mix of severe fiscal austerity and tight monetary policy. The primary surplus was kept near 7 percent of GDP throughout the 1920s. This was accomplished through large expenditure decreases, courtesy of the “Geddes axe,” and a continuation of the higher tax levels introduced during the war.

Is this portrait true?  I say yes and no.  For 1918-1920, government spending plummets, mostly because of demobilization and the end of the war, source here.

Yet there is an alternative perspective.  Even after the demobilization is over, consider that in 1910 British government spending was about 10% of gdp and in the 1920s it runs near 25% of gdp.  Is that such an awesome commitment to austerity?

If we consider a more finely grained approach, and focus on shorter-term rates of change, we do see real restraint on the spending side:

…spending was cut by 10% in real terms in two years, while tax as a share of GDP remained constant. The budget deficit was reduced from 7% GDP in 1920 to near balance in 1923, followed by a swift recovery. Defence bore the brunt of the cuts.

As mentioned in the quotation (“followed by a swift recovery”), this transition went reasonably well.  If you read this very up to date, very careful with the data paper (try p.10), you see a notable gdp plunge from 1920-1921, mostly from a coal strike and a series of postwar shocks, and then solid growth from 1921 to 1926, running over and after the period when Britain was cutting government spending.  It seems that policy was hardly a macroeconomic catastrophe.  Things do go south in 1926, but it is well known that is from bad monetary and exchange rate policy, plus a major coal strike.

Or read Barry Eichengreen (pdf).  He notes that Britain under-performs relative to other European nations in the first half of the 1920s, although he focuses much more on monetary policy and real factors, rather than fiscal policy.  Furthermore, that’s hardly the only period when Britain was under-performing its rivals on the continent.

In other words, I don’t see how the episode as a whole supports the interpretative weight being placed upon it as an anti-austerity parable.  Note that when it comes to the U.S. (switching from the UK for a moment), Krugman wrote the entirely defensible sentence: “…even a cursory examination of the available data suggests that 1921 has few useful lessons for the kind of slump we’re facing now.”  If the UK in 1921 shows more relevance, that has yet to be shown.

PK October 3, 2012 at 6:32 am

High tax rates and deflation kill growth. Surprise, surprise.

Millian October 3, 2012 at 6:41 am

Krugman is being misleading. Sadly, this is no longer unusual. If he wanted to consider “austerity” as we use that word today, it would be more appropriate to consider cases of tight fiscal policy and easy monetary policy, especially for the last four years in the UK.

Duncan October 3, 2012 at 7:56 am

Spot on. The 1920s policy was partly driven by fiscal consolidation, but partly also by a wider macro objective, of deflating the price level to allow a return to gold at $4.86. Of course, the two interact – even if you did have no real effects, the policy would still result in lower NGDP and a higher public debt burden. As a policy mix, I don’t think anybody would argue this is sensible today. And that’s why the British government doesn’t pursue it. Silly comparison. Also, I think there’s fairly good evidence that after WWI the British economy had accumulated some rigidities. Trade union power was becoming an issue even before 1914, and within a few more decades would become a staple of satire, it was that bad. Combine those rigidities with such a stringent macro policy, and you’re asking for trouble.

Duncan October 3, 2012 at 8:01 am

… and regardless, it doesn’t alter the fact that the British experience of the 1930s – fiscal consolidation and monetary expansion amid a global downturn – was a whole lot more successful than many other countries at the time.

Doc Merlin October 3, 2012 at 10:19 am

The last four years in the UK have not had tight fiscal policy. This canard is tired.

Millian October 3, 2012 at 11:19 am

A very valid point. The UK has one of the highest deficits in the West. However, this is partly due to expensive bank bailouts, pension liability transfers and persistently lower GDP growth than expected. It is not all real-economy stimulus or deflation policies.

Claudia October 3, 2012 at 7:19 am

Fiscal austerity appears to be one of the econo-buzz words with a definition that is maddeningly elusive. Is there an agreed on way to measure it (conceptually or empirically)? Not to pick on this post, but here were two puzzling examples for me:

1) “Is this portrait [a policy mix of severe fiscal austerity and tight monetary policy] true? I say yes and no. For 1918-1920, government spending plummets, mostly because of demobilization and the end of the war…” Does it really matter *why* there is fiscal austerity or reduced spending? Austerity is or isn’t…it would take a lot more information to then say whether it’s justified or not.

2) “Even after the demobilization is over, consider that in 1910 British government spending was about 10% of gdp and in the 1920s it runs near 25% of gdp. Is that such an awesome commitment to austerity?” Um, the spending in that chart seems to exhibit a trend. Is austerity (like stimulus) a cyclical phenomena that should be measured relative to trend or does it have some absolute metric.

It would be a real service to get the definition of fiscal austerity down (like by the end of the year), so we don’t argue so much on semantics…or use semantics to cloak what we are really arguing about.

Andrew' October 3, 2012 at 8:22 am

Here is the definition of austerity: F— knows what is a legit vs illegit function of government, we couldn’t figure it out slow so god knows we can’t do it fast, so cutting anything risks tossing the baby out with the bathwater.

Brandon Berg October 3, 2012 at 8:44 am

I thought austerity just meant running a budget surplus.

Doc Merlin October 3, 2012 at 10:19 am

+1

Millian October 3, 2012 at 11:21 am

Well, clearly that’s a preposterous definition. Most countries that run fiscal surplusses are doing fine at the time. Perhaps you are describing expansionary policy. Austerity is about the deficit’s direction, not its position.

Bender Bending Rodriguez October 3, 2012 at 3:06 pm

Wouldn’t that imply that W was a better president than Clinton?

Claudia October 3, 2012 at 4:03 pm

Thanks, you all answered my question…albeit not the one about austerity. Have fun.

Bill October 3, 2012 at 7:31 am

England during this period underperformed because it had earlier failed to invest in human capital and education for its general population (although the elites did get educated, primarily in manners and English), and during this period also did not invest in education for its citizens.

If you want to look at change, look at change in Ireland after 1948, when the right to college education became available to Irish Catholics, who had previously been denied even limited state higher education, or in the US with the GI bill following WWII.

The issue of austerity or non-austerity is a meaningless discussion unless you look at what government services are performed or denied and which services are performed at the notional and which at the local level. You could have, for example, a government that was non-austere, but only invested in the military.

Millian October 3, 2012 at 11:25 am

This analysis is extremely flawed. The rate of technical innovation was extremely rapid in the UK in the 19th century, so clearly *someone* was getting educated in subjects other than “manners”. “England” underperformed perhaps because its rapid GDP growth was based on rapid expansion in overseas colonial markets, which ended after the First World War, and perhaps because, as a technological leader, it had fewer growth opportunities to exploit. Ireland was an independent state in 1948; its government was hardly banning 95% of its own people from going to college. Expanding education did not reverse the UK’s relative decline in the 20th century.

Bill October 3, 2012 at 1:10 pm

Millian, The post focused on a different period. Not the 19th century. But, if you want to take up a point, note that education for one period does not have the same value in another period. So, for example, if you changed technology by introducing a computer, but didn’t educate students on how to program it, the value of education of education without computer knowledge would have less value in the period where there is that technology. In other words, if the mass of people have less than an eighth grade education in 1890, it doesn’t work in 1930.

Ray Lopez October 4, 2012 at 4:00 pm

I think Millian won this thread Bill. Unless you assume that a GI with a couple of years of college education will cause GDP to trend immediately higher, and hsuch effects will last for decades. Short of teaching illiterates to read in a society where literacy is essential to operate say heavy machinery, which was not the case in post WWII America, I think better education is a false positive in describing post WWII US growth. A better factor is simply nobody else was left standing after the war save the USA.

prior_approval October 3, 2012 at 8:05 am

‘Even after the demobilization is over, consider that in 1910 British government spending was about 10% of gdp and in the 1920s it runs near 25% of gdp’

No, according to this link – http://www.ukpublicspending.co.uk/total_spending_chart – government spending was never under 27% in the 1920s.

In 1918, the British government spending was 56.64% of gdp.

By 1925, government spending was at 27.17% (its trough, by the way), and Britain was heading back into depression a year or so later (returning to the gold standard playing its role apparently, though the coal strikes seem to have had more of a temporary nature – production falling then rebounding to compensate for lost production).

So, a major global war and its aftereffects meant that British government spending rose (a post WWI peak of 36.39% in 1923, following a depresssion), then declined, followed by another depression and further increases to over 29% from 1926-1928, the highest in 1926 at 29.89%.

What is interesting what happened between two periods of depression, 1921 and 1926 – UK government spending as a percentage of gdp declined 25% in that time frame, from 36.39% in 1922 and the already mentioned 27.17% in 1925.

One could, perhaps facilely, see a connection between one depression in the UK and another being related to declining government spending. Or one could turn to other explanation, such as ‘Things to do south in 1926, but it is well known that is from bad monetary and exchange rate policy, plus a major coal strike.’

Or maybe, all of these circumstances were part of a larger picture, one involving the inexorable decline of a world spanning empire?

(A certain rise in spending as gdp percent was likely inevitable, considering the million of wounded veterans and widowed wives and households missing a male wage earner. The British suffered fatal casualties of over 900,000 – men in the prime of their life in the main, out of a total population of 44,604 millions. One can actually see this drop, year by year – 1915 – 44,342, 1916 – 44,081, 1917 – 43,822, 1918 – 43,564)

prior_approval October 3, 2012 at 8:24 am

It is worth noting that the graphic used does not agree with the link in my post – the linked one is seemingly based on ‘British Historical Statistics,’ by B.R. Mitchell. The difference is not trivial, especially in regards to the idea that in 1910, government spending as gdp percent was 10% – the linked site says 15.95%

This is merely to note the difference – no claim is made as to either of which data source (or neither) is more accurate.

Rich Berger October 3, 2012 at 10:11 am

I looked at your chart – it doesn’t impair Alex’s argument. You’re flailing, but then you are good at that.

Bill October 3, 2012 at 11:16 am

Rich, I looked at the chart. What are you talking about????

Millian October 3, 2012 at 11:28 am

Funny, I also thought it was an Alex post upon first reading. But Tyler’s name is on it.

Careless October 7, 2012 at 8:56 pm

The subject is alex-ish, but the writing is obviously Tyler.

prior_approval October 3, 2012 at 1:17 pm

Well, the only point was that the text, and the displayed chart supporting, said 10%, whereas a listing of British government spending (detailing each year of the last century) as a percent as gdp was 50% higher.

Maybe the fact that the quoted statistics are so different would make one wonder about the accuracy of one or the other, especially when the linked series does not paint anywhere near the picture of the posted graphic.

In the quoted series (which can be downloaded as CSV data, by the way – making it easy to analyze as compared to a single graphic), one can see spending rise and fall throughout the 1920s in a way that the chart does not depict at all.

The data is available, it is sourced, and it doesn’t actually show what was described, particularly since it shows the cutting of British government spending by 25% between two depressionary periods. Though that may not fit the definition of austerity, which another poster noted is without definition in this discussion anyways.

Just more flailing using data – but then, I do have strange hobbies.

And using period when the British Empire began its long decline into today’s irrelevance is not all that enlightening in today’s context. Wait until you see what WWII did to those figures, along with the loss of all of the imperial possessions.

Rich Berger October 3, 2012 at 2:42 pm

That’s bizarre, because the link you provided also references Mitchell’s work and something called “Measuring Worth” – for GDP. Fishy. On Tyler’s chart, if I eyeball it, shows something like 11-12% of GDP in 1910, versus “your” 15.95%. Qualitatively, I don’t see how it changes Tyler’s observation – after the war spending dropped, they were at a higher level than before – he said 10% higher. Seems like a fair assessment.

Andrew' October 3, 2012 at 8:06 am

What say you, Bob Higgs?

MikeP October 3, 2012 at 8:08 am

Further consider how Britain’s economy recovered quite well after the crash of ’29 while Britain cut spending, as opposed to the very slow recovery in the US which went the opposite way. The facts completely contradict Krugman’s interpretation.

david October 3, 2012 at 10:33 am

‘Further’? You can’t both say it cut spending and didn’t!

MikeP October 4, 2012 at 2:06 am

Two periods: postwar ’20′s vs. post crash ’30′s. The 20′s saw increased spending in the UK with associated depressed economy while the 30′s saw decreased spending (in absolute terms not evident in the figure) and a strong recovery. Both contrast with the experience in the US where spending was kept in check in the 20′s and the economy roared and the ’30′s where spending ballooned and there was no recovery at all.

dead serious October 3, 2012 at 9:45 am

Government spending is sticky?

Brian Donohue October 3, 2012 at 5:31 pm

heh. +1.

Cliff October 3, 2012 at 10:02 am

Government spending can never go down without plunging us into a deep depression. In fact, the rate of increase of government spending cannot go down without plunging us into depression. The rate of increase of government spending must always be increasing exponentially, anything less is savage austerity!

Yancey Ward October 3, 2012 at 10:47 am

Claudia,

This is the definition of austerity that people like Krugman use today.

Cliff,

Nicely done!

Rich Berger October 3, 2012 at 11:08 am

As William Voegeli entitled his excellent book, it’s “Never Enough”.

JWatts October 3, 2012 at 7:18 pm

+1

Lord October 3, 2012 at 11:13 am

Isn’t this misleading to not even look at unemployment?

Bill October 3, 2012 at 11:24 am

I really think it is funny when you get a long time series like Alex posted to make a coherent argument.

Ask yourself this question: What has changed in the composition of British spending since 1900 to make an argument that there is a “change in spending” that permits a comparison of the two periods.

Here’s one example: in 1900, healthcare spending was in the private sector, ie, you paid for it and it didn’t show up on the government ledger. In 2000, you paid for it, and it showed up on the government ledger. Same with social insurance programs–private to public, over a period.

Has anyone netted anything out to do a comparison? Why do you think not.

ptuomov October 3, 2012 at 11:38 am

Krugman’s wrong about Spain. Productivity and export growth has been very fast there. Spain is in trouble because of an epic real-estate bubble and the resulting debt overhang. Not because of excessive government spending. Not because of the euro and inflexible exchange rate. Not because of some structural labor market problems. Only because of a real-estate bubble. Only becasue of that.

Every day there isn’t a total collapse, fundamentals in Spain are getting better. Irrespective of the contrary being written on the front pages of the newspapers.

Take a look at these graphs:
http://www.fxstreet.com/fundamental/market-view/europe-economic-watch/2012/04/10/

prior_approval October 3, 2012 at 1:02 pm

Shhh – that real estate bubble argument is equally applicable to America, but somehow, that trillions of dollars of bubbly wealth and its subsequent disappearance (along with massive, massive amounts of fraud) is never really discussed in polite circles, Calculated Risk, Roubini, and Baker being notable exceptions.

Also, it is isn’t polite to point out Spain’s fairly recent government budget surpluses either.

Bill October 3, 2012 at 4:34 pm

+1 Nor is it polite to point out that banks were overleveraged and under regulated, and that Europe is now addressing cross border banking regulation.

shhh. It has to be the welfare state, right?

Cliff October 3, 2012 at 10:58 pm

In Europe, governments are not taking in enough revenue to pay off their debts. What are they spending money on to incur those debts? In large part, the welfare state.

Also, the European welfare state is responsible for large and increasing differences in quality of life between Europe and the U.S. When your GDP is 50% lower, it makes it harder to weather a crisis.

ptuomov October 4, 2012 at 6:33 am

Talking specifically about Spain, if you count all levels of government, Spain and the US spend the same fraction of GDP in government spending. Again, counting all the different levels of the government, the taxes are only very slightly higher in Spain than in the US. Exports from both Spain and the US are growing at about the same rate. The official unemployment rate is 25% in Spain, but the real unemployment rate is much lower because a lot of the officially unemployed people work in the cash-based service industries.

What’s different between the US and Spain, then? USD vs. EUR for one. However, in the case of Spain exports are growing very fast which tells me that EUR is really not the problem in Spain. The main difference is that while the US had a massive real-estate bubble, Spain had an epic real-estate bubble that dwarfs the US real-estate bubble in comparison. All the problems that Spain is experiencing today in excess of the problems experienced by the US are due to the even greater real estate bubble bursting.

dead serious October 4, 2012 at 8:48 am

The real unemployment rate in Spain is, if anything, higher than stated, not lower.

ptuomov October 4, 2012 at 9:27 am

Dead Serious –

I guarantee you that the true unemployment rate in Spain isn’t 25% in the sense that the labor market situation is nothing like it would be in the US with a 25% unemployment rate.

Other than observing “unemployed” Spaniards working in tourism, here’s another tell. What is the non-performing residential mortgage rate for a country with supposedly:
- Over 80% homeownership rate
- An epic real estate bubble that has burst, housing prices having declined over 40% from the peak and trending down
- 25% unemployment

?

The answer for Spain is under 3%. That 3% NPL of residential mortgages makes the 25% unemployment being the true unemployment flat out impossible.

Best, Tuomo

ptuomov October 3, 2012 at 5:29 pm

Y’all should read Ibex Salad before commenting on the Spanish economy:

—quote—

http://ibexsalad.blogspot.com/2012/09/spain-balance-of-payments-positive-for.html

Friday, September 28, 2012
Spain balance of payments positive for 1st time in euro era

http://4.bp.blogspot.com/-aB0U0UUzD_w/UGVlvo2KpvI/AAAAAAAADtY/fDOijEzAGi8/s1600/bp.png

As we told our readers to expect last month, Spain’s July balance of payments has recorded a positive number for the first time since the mid-1990′s. Both goods (-) and services (+) at record levels. 12-month rolling CA balance at record -2.67% of GDP also. Exports over 31% of GDP.

More interesting, however, is the precise timing of everybody’s favourite Nobel economics laureate, Paul Krugman, marking this event with yet another iteration of the usual labour cost competitiveness nonsense from the economics profession.

‘The basic story of the euro crisis remains the same: it’s essentially a balance of payments crisis, misinterpreted as a fiscal crisis…’

Weep, dear reader. These people have enormous influence on government policy.

BTW, readers can expect the BP to go negative again in August. Seasonality.

—end-quote—

Bran October 3, 2012 at 12:05 pm

So, a primary surplus equaling 7% of the UK’s GDP doesn’t count as “tight” fiscal policy? Tyler, I think you’re trying too hard to be clever.

Merijn Knibbe October 3, 2012 at 3:30 pm

The IMF study mentions:

* a very high, artificial real interest rate
* the fatefull return to the gold standard at an artificial high parity (even Hayek, in his later work, thought this was bonkers)
* a very high primary surplus
* very low economic growth over the entire period (0,5% a year, it took almost 20 years before the 1918 level was surpassed)
* very high unemployment during the entire period which was probably was at least to an extent engineered by the government, to keep wages low

Maybe we should not call this austerity. But we might call this ‘economic repression’ as preponderance was given to the value of money(i.e. the value of already produced stuff) instead of prosperity, production and work (where do you think these strikes came from). The interest rate could easily have been 3 to 4 points lower which would have enabled more investment as well as more government spending. The ‘counterfactual’ is of course Germany after the war, which profited from a debt jubilee, ‘inclusive’ social policies. Preponderance was given to prosperity,production of new stuff and work, with the Wirtschaftswunder as a consequence. By the way – Keynesian policies are not just about government expenditure but also, of course, about consumption, exports and investments, which together with government expenditure comprise total expenditure. When one of these categories shows a large drop – others often follow, instead of filling the gap. The USA post war experience is also some kind of counterfactual, though one has to take account of the 4% drop in the participation rate and the decline of the number of hours worked per person per year of about 400, the square the data of the post war drop in output with relatively low unemployment. Private investment also and finally recovered in this period, after 15 years of sluggishness.

Maybe we should not call this austerity, let’s call this: “economic repression”.

Ritwik October 3, 2012 at 5:48 pm

Barry Eichengreen replied on twitter. He sort of seemed to agree with Krugman.

Richard W October 3, 2012 at 8:07 pm

UK average inflation-adjusted GDP growth was higher in the 20th century than it was during the 19th century. It was higher even with two world wars, the Great Depression and the Great Inflation. The idea that an empire is beneficial to the domestic economy is a myth. An empire is a drain on the economy as the U.S. Empire is now discovering.

Hugh October 4, 2012 at 3:57 am

The Great War killed off a large number of people, with young people from elite schools especially badly affected (Lieutenants were expected to lead their men “over the top”).

I don’t think this loss can be readily quantified in economic terms, but it must have had a large effect in the 1920s.

Max October 4, 2012 at 4:31 am

Perhaps someone reduce my confusion here. In Europe we think of austerity as a cut in spending (living inside your means). however it seems that Tyler and krugman use slightly different meanings. For example, high taxes seem to be part of it, which is not how it is understood in places like Germany.

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