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Conservative Austerity Idea Is Failing: David G. Blanchflower

Jan. 28 (Bloomberg) -- Sorry, fiscal austerity doesn’t work. For evidence, look no further than the U.K.

This can’t be good news for the U.S. political right, whose mantra has been: cut spending, put a lid on deficits, and growth will improve.

All sorts of good things, it is claimed, will spring from a turn to austerity that stops all this stimulus nonsense and prevents the Federal Reserve from doing more quantitative easing. Reductions in spending, according to a theory known as Ricardian equivalence, will do no harm because lower borrowing will automatically lead to higher private spending. Plus, of course, there is the notion of crowding out, meaning that reining in the public sector leaves room for the private industry to step in and all will be well.

This is dangerous hogwash.

There is little historical precedent in the real world, though lots of fantasizing in the made-up world of economic theorists, to suggest that fiscal austerity works. The best example of austerity’s failure is the double-dip that occurred in the late 1930s in the U.S., when spending was reduced too soon in a nascent recovery. In contrast, the U.K. didn’t have a double-dip because it was engaging in classic Keynesian spending as it began re-arming.

Claims are often made that there are examples where fiscal austerity has worked. But it turns out that this is generally due to the monetary stimulus that accompanied it, as in the U.K. under Margaret Thatcher in the 1980s. The most frequently cited example is Canada, but it was able to cut interest rates while at the same time benefiting from the Clinton boom of the 1990s.

Back in Recession

Fiscal austerity has already been started in Greece, Ireland, Spain and Portugal, and this seems to be pushing all of them back into recession. Over the last four quarters, growth in Greece was negative and falling, and bond investors are once more demanding sky-high returns to compensate their risk. The excuse in these countries was that they have little choice because they are stuck in the European monetary union and don’t have the ability to depreciate their exchange rate.

The U.K. may be a purer case of the harm austerity at the wrong time can inflict. Britain now looks as if it is headed back into recession on fear about the damage that will be done by massive spending cuts and tax increases, which haven’t even gone into effect yet. Government ministers with their talk of austerity have already smashed confidence.

The Chancellor of the Exchequer George Osborne has said the economy was “bankrupt” and had “run out of money,” which of course is simply untrue. Prime Minister David Cameron and other ministers made similar unsupported claims, which seem to have had a deleterious effect on animal spirits.

Confidence Game

Despite the government’s claims that its intent was to raise confidence, consumer and business confidence tumbled right after the new government took office.

Businesses and consumers know what is coming and have cut back accordingly. Retail spending has flat-lined. The balance of trade is deteriorating. Unemployment is rising, and house prices have started to fall again.

Earlier this week, the Office of National Statistics reported that fourth-quarter gross domestic product slumped 0.5 percent while forecasters had expected a gain of 0.5 percent. The ONS suggested that bad weather -- as if the U.K. had any other kind in the winter -- had contributed to the decline and without it growth would have been zero.

Even so, this was consistent with a sharp slowing of the economy following growth of 1.1 percent in the second quarter and 0.7 percent in the third, which at the time led Osborne to pronounce that the government’s policies were working.

First-Quarter Forecast

There may be worse to come with the recently imposed rise in the national sales tax to 20 percent from 17.5 percent and more tax increases to come. My own forecast is that growth in this year’s first quarter will be negative, meaning the U.K. probably will be back in recession.

Too bad the government is in such deep denial. “There is no question of changing a fiscal plan that has established international credibility on the back of one very cold month,” Osborne said earlier this week. “That would plunge Britain into a financial crisis. We will not be blown off course by bad weather.”

That didn’t convince anyone.

The government’s Plan B to this point has been to count on the central bank to keep rates down and, if the recovery goes into reverse, do more quantitative easing. But with inflation rising, and minutes of the last meeting of the Bank of England’s Monetary Policy Committee showing signs of hawkishness, it’s hard to imagine that monetary policy will ride to the government’s rescue.

Fiscal austerity in the U.K. is failing. The only good thing to be said about it is that it might offer some lessons for the U.S.

(David G. Blanchflower, a former member of the Bank of England’s Monetary Policy Committee, is a professor of economics at Dartmouth College and the University of Stirling. The opinions expressed are his own.)

To contact the writer of this column: David Blanchflower at

To contact the editor responsible for this column: James Greiff at

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