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Dean Baker

Dean Baker is co-director of the Center for Economic and Policy Research

February 3rd, 2011 11:15 AM

The Great British Austerity Experiment

With deficit hawks poised in the US, we watch with great interest UK economic policy. It's not looking an enviable example so far

Three months ago, I noted that the United States might benefit from the pain being suffered by the citizens of the United Kingdom. The reason was the new coalition government's commitment to prosperity through austerity. As predicted, this looks very much like a path to pain and stagnation, not healthy growth.

That's bad news for the citizens of the United Kingdom. They will be forced to suffer through years of unnecessarily high unemployment. They will also have to endure cutbacks in support for important public services like healthcare and education.

But the pain for the people in England could provide a useful example for the United States. After failing to see the $8tn housing bubble that wrecked the US economy, the austerity crew in the United States has been newly emboldened by the hugely partisan media that desperately want to eviscerate the country's bedrock social programmes: social security and Medicare.

The elite media and the politicians whom they promote would love to see the United States follow the austerity path of the UK's new government. However, if this path takes the UK into dangerous economic waters, it could provide a powerful warning to the public in the United States before we make the same mistake.

The British economy looks like it is doing its part. The fourth-quarter GDP report showing that the economy went into reverse and shrank at a 2.0% annual rate is exactly the sort of warning that many of us here were expecting. Weather-related factors may have slowed growth some, but you would have to do some serious violence to the data to paint a positive picture. Of course, the austerity in the UK is just beginning. There will likely be much worse pain to come, with a real possibility that the country will experience a double-dip recession, or at least a prolonged period of stagnation.

While the UK seems to be doing its part, the key question is whether anyone in the United States is prepared to take the lesson. Prior to this episode, there was already a solid economic case that large public deficits were necessary to support the economy in the period following the collapse of an asset bubble. The point is simply that the private sector is not prepared to make up the demand gap, at least in the short term. Both short-term and long-term interest rates are pretty much as low as they can be.

Furthermore, even if weaker demand did manage to push interest rates down from current levels, it is unlikely that they would have much effect on private spending. Businesses that didn't want to invest when the 10-year treasury bond rate was 3.4% are unlikely to start expanding if the rate fell to 2.4%, especially if the lower rate is coupled with higher unemployment and weaker demand.

The same story applies to consumers. This sort of drop in interest rates is not about to kick off a consumption binge. Consumers remain heavily indebted as a result of the collapse of the housing bubble. Lower interest rates will change this picture little. Furthermore, a consumption splurge is even less likely if government cutbacks mean that more workers are unemployed or worried about losing their jobs.

There might be more hope from an increase in net exports following a turn to austerity, but this would depend on a decline in the value of the dollar and healthy growth in US trading partners. Neither of these seems like good bets at the moment.

This means that the predictable result of austerity is slower growth and higher unemployment. The UK has volunteered to be our guinea pig and test this proposition. For now, it looks like things are going just as standard economic theory predicts: the economy is slowing and unemployment is likely to rise.

Hopefully, citizens of the UK will tire of the rhetoric of austerity as a way to make politicians feel good about tightening other peoples' belts. Maybe the Liberal Democrats will break away from the coalition and force new elections.

From this side of the pond, though, the goal is simply to encourage people to pay attention. The UK might be home to 60 million people, but from the standpoint of US economic policy, it is simply exhibit A: it is the country that did what our deficit hawks want to do in the US.

The takeaway lesson should be "austerity does not work; don't go there." Unfortunately, in the land of faith-based economics, evidence does not count for much. The UK may pursue a disastrous austerity path and those of us in the United States may still have to follow the same road anyhow. But we opponents of that course all appreciate the willingness of the UK to demonstrate the foolishness of this action.

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