With the Wednesday release of a mediocre gdp report, we are hearing that the United Kingdom austerity program is proving a macroeconomic failure.
Let’s look at the timing of the cuts:
So far, about GBP9 billion of the government’s fiscal tightening has occurred. However, around GBP41 billion of tax increases and spending cuts will begin to take affect from the start of the new fiscal year on April 5.
Some of the particular cuts were announced in October and at that time Ken Rogoff doubted whether half of them would end up taking place. So the cuts are in their infancy and arguably their credibility is still somewhat in doubt or at the very least has been.
A lot of the weak gdp report is blamed on construction, with some excuses drawn from snowstorms. There does exist an extreme rational expectations view, in which the last-quarter weakness of construction was based on the expectation that government spending cuts would start arriving later in April and thus new houses should not be built. Alternatively, it could be that after the greatest real estate bubble in history, the UK market is overbuilt. Weak UK growth dates to some time back.
Also recall that in many open economy Keynesian models, fiscal policy AD effects are to some extent — or completely — offset by exchange rate movements (pdf). And the fiscal multiplier is basically zero when the central bank targets inflation. Furthermore it is not obvious that the UK has been in a liquidity trap. When it comes to drawing Keynesian conclusions about practical fiscal policy, the theory here is a house of cards.
The UK economy suffers from a more serious technological stagnation than does the United States, in this case more forward looking than backward looking. Their pharmaceutical innovation seems to be drying up, they are overspecialized in finance, the “residential tax haven” status of the country may not yield continuing growth at high rates, tourism is OK but not enough, and their manufacturing base eroded some time ago, with nothing like a German-style comeback. The teacup sector aside, why should anyone be optimistic about that economy?
Two other considerations:
1. The case for the cuts is not that they will spur growth, but rather forestall a future disaster. That’s hard to test. A second part of the case is that not many political windows for the cuts will be available; that’s hard to test too. On that basis, it’s fine to call the case for the cuts underestablished, but that’s distinct from claiming that poor gdp performance shows the cuts to be a mistake.
2. Let’s say the cuts lower government consumption and raise private consumption, and that government consumption is wasteful but private consumption isn’t (and long-run growth is given by the Solow-like expansion of the international technological frontier.) That’s a good case for making the cuts, but they still won’t show up as higher gdp. The government consumption is valued into gdp figures at cost, so even cuts proponents with a good case don’t have to be predicting higher gdp.
I doubt if the UK fiscal austerity program will much boost their growth rate, which is likely low in any case and for non-Keynesian reasons. Simply citing a low UK growth rate is not a test of their fiscal policy, for a number of reasons detailed above.