Whither United Kingdom?

Don’t look now (Well, OK, look), but a massive natural experiment in economics is currently underway in the United Kingdom.  The Conservative-Liberal Democrat coalition government of Prime Minister David Cameron and Deputy Prime Minister Nick Clegg has concluded that the way to put economic growth on firm footing is to cut government spending–come what may.  The Washington Post reported on the specifics of the budget cuts last Thursday, October 21st.  This policy is based on a strong challenge to the principles of Keynesian economics.

Keynesian economics refers to the macroeconomic theories and policies advanced by John Maynard Keynes, the British economist best-known contribution focused on the means of ending a recession, rather than generalizing about the character of economic growth.  For Keynes, economic health is essentially a measure of the ability of money to transfer freely from one set of hands to another; hence the emphasis on its empirical score–gross domestic product–among our current economic statistics.  When the President–and George W. Bush was as inclined to do this as President Obama is currently–talks of the need for economic stimulus or the importance of people getting out and spending money, he is speaking Keynesian.  The Keynesian solution for a recession is a simple but massive government project: Create aggregate demand.  Cutting taxes on citizens and corporations during the recession can help by leaving money in the hands of targeted consumers and employers, but government stimulus spending–and this can include long-term investment in new public works projects (badly needed in this country), the one-off consumption of previously-overproduced goods, or (in theory) even a war–is potentially more-important than tax cuts, because it creates rather than encourages demand in key industries that need a lift.  Stimulus spending isn’t permanent, of course; it is supposed to taper off as the newly-employed feel secure-enough in their private finances to consume, and investors make new financial commitments.  Having been given medicine that only the government could prescribe, the markets are left to do their thing.

F. A. Hayek, alternately, had both an ideological and a practical objection to government stimulus of aggregate demand during a recession.  While both men are good Capitalists, Hayek is a strict free marketer who doesn’t believe instrumental management of the dynamics of consumption and investment is sustainable over the long-term.  He doesn’t seem to have an answer for an economic downturn, aside from thrift and forebearance.  (It isn’t surprising that contemporary democracies, regardless of ideology, have almost never been interested in this message while in the throes of a recession.)  Hayek’s analysis focuses not on what instrumental policies can get the economy out of recession, but on the overproduction or bubble investments that led to recession in the first place.  Hayek thinks stimulus spending is just government leveraging either to reward enterprises for which there was insufficient demand to begin with, or even to create inefficient levels of production which will catalyze yet another investment bubble.

To clarify the difference between stimulus spending to get an economy going and the minority conservative perspective which opposes this form of “pump priming” on the grounds that it facilitates investment bubbles, watch this helpful rap video.  No, I’m not kidding, watch it; it’s brilliant.

Where were we?  Oh, right–Britain.  Well, right Britain, as the ruling Conservative-Liberal Democrat coalition is banking the country’s future economic growth on the idea that foreign investors are more-concerned about the government’s ability to reduce its budget deficit–11.5% of GDP and the highest in the developed world–than its ability to boost aggregate demand.  That’s a radically pro-market assumption–one their government is essentially alone in making.  (The Greek government didn’t have much of a choice.)

The Liberal Ironist, like pretty-much everyone, is a Keynesian: He agrees with those who would say that the unsustainable investment and production choices of the past become more the subject matter of History than Economics once unemployment is high, consumption is flat and banks leery about lending.  We should want to create aggregate demand; recession can wreak havoc on near-all parts of life, as anyone who has been unemployed long-term or depends in some way on their State budget well-knows.  National governments are the only venue for deficit-spending not on a massive scale but in coordinated aggregation.  Sometimes in a large, complex system like the economy you can hurt a lot more people if you don’t “reward failure.”  We have no real reason to believe that letting over-leveraged industries collapse will discourage future investment bubbles or production gluts, so even if Hayek is essentially right about the causes of imprudent investments, that doesn’t matter during the recession to follow.  The Cameron-Clegg government is making a bold statement about its belief that international investors will reward its aggressive steps to get its fiscal house in order; the fortunes of over 60 million people are riding on a conjecture–one which, however-educated, defies a generally-effective procedure of post-Depression economics.  Paul Krugman, a Nobel-prize winning economist and very-much a Liberal, predicts doom.  In any case you’d think Republicans and Democrats alike should watch what happens in Britain in the context of massive budget cuts closely.

But you’d be wrong.  In practice Economics isn’t any more-parsimonious a science than Politics, and timing can be everything: The IMF has already opined in favor of austerity measures, and the year-to-date finding is that the Brits are spending more money in the face of massive budget cuts; GDP growth in the United Kingdom over the past year has grown at 2005-2006 rates!  The Financial Times‘ online “Short View” video segment hypothesizes that this may be a form of “reverse Ricardian equivalence,” meaning that the government’s austerity measures signal to the consuming public that their government isn’t going to have to raise taxes an indeterminate amount in the near-future to pay down its debt.  It warrants mention that this significant GDP growth in Britain launched well-before its recent, massive divergence in fiscal policy with the United States.

While a policy of austerity that works for a developed economy of 60 million might not be relevant to a developed economy of 310 million, we may just have a macroeconomic theory to challenge Keynesian economics on our hands.  That theory could be vindicated in Britain and still be folly in general–but if the sky so much as doesn’t fall in, Prime Minister Cameron’s austerity policies will likely capture the imagination of the Republicans going into the 112th Congress.  There is an outside chance that our new Federal economic and fiscal policies will be the work of the UK’s soft-spoken and pragmatic Conservative PM.


3 thoughts on “Whither United Kingdom?

  1. Kukri

    If it works, great! I hope it gives the GOP some ideas, because currently they are seriously lacking them. Hopefully these austerity measures (not necessarily the welfare part, but moreso the general cutting size of government part) should they work, can be extended to when the recession ends as well.

    1. liberalironist Post author

      So, you’re confident that spending cuts will undermine private spending in Britain, thereby discouraging investment and leading to years of stagnation…or do you just like the sound of that word?


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