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While the world is transfixed by the U.S. budget paralysis, fiscal policies have been moving in several other countries, most notably in Japan and Britain, with lessons for Washington and for other governments all over the world.
Let's start with the bad news: Shinzo Abe's decision to increase consumption taxes from 5 to 8% next April. This massive tax hike, to be followed by another increase in 2015, threatens to strangle Japan's consumer-led growth from next year onwards, since Abe looks unlikely to offset this massive fiscal tightening with stimulative measures that would maintain consumers' spending power. Even if Abe delivers on his vague promise to compensate with business tax reductions, these will only aggravate the over-investment and corporate cash hoarding that have long distorted the Japanese economy.
Meanwhile, the government's willingness to risk economic recovery in the cause of fiscal discipline implies that those of us who believed Abe was making an unconditional commitment to do whatever it takes to achieve economic recovery were simply wrong. Now that the forces of budgetary austerity have reasserted themselves, Japan's probability of ending its decades of stagnation is much reduced.
Now for the good news: a change of attitude to debt and borrowing is transforming Britain from the second-weakest G7 economy (after Italy) into a world champion of growth. As recently as last April, the British government was attacked by the International Monetary Fund's chief economist for "playing with fire" by trying too hard to reduce its budget deficits. Last week the IMF World Economic Outlook praised Britain's rapidly improving economy and upgraded 2013 growth projections by 0.5 percentage points, to 1.4%. That may not sound like much, but this improvement comes when almost every economy is being downgraded - and compared with last year's miserable 0.2% growth rate, it feels almost like a boom.
Does this experience prove that David Cameron was right to persist with his unprecedented program of spending cuts, tax hikes and fiscal austerity? The answer is no, for two reasons.
First, the British government, despite its tough fiscal rhetoric, has actually relaxed its efforts at deficit reduction and has effectively abandoned its commitment to balanced budgets. In 2010 and 2011 Britain's structural deficit was slashed by 4.3% of GDP, by far the biggest fiscal tightening in any major economy. In the next two years, 2012 and 2013, the pace of deficit reduction has halved to just 2%, and according to the IMF's latest analysis there will be no further tightening at all in 2014. So instead of a near-balanced budget, Britain will next year still have the biggest budget deficit among the advanced Western economies: 5.8% of GDP, against 4.6% in the U.S., 3.5% in France and 2.1% in Italy. Thus Britain's better growth performance, far from demonstrating the wisdom of relentless budget cuts, has actually reflected an easing of fiscal austerity and a belated acceptance of much wider deficits than European and U.S. politicians seem willing to tolerate.
Secondly and more importantly, this year's revival of growth in Britain has resulted directly from an audacious government policy to promote huge increases in highly-leveraged mortgage debt. This mortgage-support plan is equivalent, from a macroeconomic standpoint, to a huge expansion of government borrowing. When George Osborne, Britain's finance minister, announced last March that the Treasury would provide unprecedented guarantees to support the reintroduction of 95% mortgages - which had been eliminated by prudential bank regulation - he immediately transformed Britain's economic prospects, as explained here at the time.
This announcement meant that Osborne was finally accepting the fundamental principle of Keynesian economics: a country emerging from recession must increase, not reduce, its borrowings, until the point is reached where the economy's excess savings are fully employed. Whether the additional borrowing is undertaken by the government or the private sector is of secondary importance. If additional government borrowing is unacceptable for political reasons, while large-scale business borrowing is unlikely because of weak demand, then a boom in household borrowing will do almost as well.
Bizarrely, the government's plan to create a property and mortgage boom attracted little attention among economists, even though Osborne described it clearly last March, promising to create £130 billion of new debt over three years, a credit stimulus worth 4% of GDP annually. Although the proposed credit stimulus was roughly three times the size of this year's fiscal tightening, many economists ignored it. They simply dismissed the possibility that the Cameron government would actively encourage a massive buildup of highly-leveraged consumer borrowing, while continually reiterating its slogan that "you cannot cure debt with more debt."
As recently as last month, the IMF, the Financial Times and several business lobbies, responding to the rapid increase in house prices that started within days of Osborne's March announcement, called on Cameron to reduce the maximum borrowing of £600,000 permitted under the guarantee scheme, to postpone the scheme's expansion from newly built homes to existing properties or maybe even to cancel it altogether. Cameron responded to these critics by doing the opposite - bringing the scheme's expansion forward to this week, instead of waiting until January.
Cameron probably made this decision for political reasons - he wants the property and mortgage boom to be in full swing by the time of the 2015 general election. But in doing so, he showed a better understanding of economics than many economists. Recessions are caused by excess savings and this means that higher borrowing, whether by the government through fiscal policy or by the private sector through the housing market, is a necessary condition for economic recovery. Nations that try simultaneously to reduce their public and private debts are doomed to stagnation, with monetary policy almost powerless to help when interest rates are near zero. Britain now understands this, while Japan apparently does not. Could someone please explain it to the budget warriors in Washington?
© (c) Copyright Thomson Reuters 2013.
11 Comments
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JeffLee
In other words, the conservative Republicans are morons who don't know how fiscal and monetary policy work, and are imposing their ignorance, while holding the world's biggest economy hostage. I agree.
sangetsu03
Are you arguing that Obama has a better understanding of monetary policy? How many more trillions of your descendant's dollars will he have to spend before you begin to understand that he is as ignorant about money as the rest of Washington? Except as far as it goes to lining the pockets of his biggest supporters, of course.
Apparently the president forgets these works which he spoke so eloquently only a few years ago. Is he a failed leader for doing the exact thing now that he argued against back then? Is he a failed leader for not only following in Bush's footsteps, but for spending several times as much?
Everyone in the world is being held hostage by profilgate governments and special interests, the republicans ranting now in Washington are small-fry in comparison. But everyone seems to think that what the president is now doing is right. It is not. He knows it's not. He and the rest of Washington have no right to burden millions of citizens which massive debts incurred by his wanton mismanagement of the people's money. But the president, like the rest of Washington, is simply a tool.
davestrousers
It makes little sense to me to go around talking up absolute GDP growth figures of 1.4% for the UK and thinking that's good. Even conservative estimates put population growth, mainly due to migration, at around half a million people a year. That knocks almost 1% off in real terms. So over the last couple of years GDP growth probably less than population growth... what's to celebrate?
JeffLee
The idea that fiscal debt burdens are inherited from generation to generation is pure myth. The US had a staggering debt load after WW2, which was quickly paid down by GDP growth.
pochan
The difference is that we are not seeing those levels of GDP growth for advanced economies anymore and likely never will again.
sangetsu03
After the second war America was the world's largest manufacturer of cars, planes, ships, buildings, clothes, and lumber. America was also the largest producer of agricultural goods.. With population and GDP growing at near double-digit rates, a scant minority of people drawing on entitlements, and the non-military government sector consuming a very small part of GDP, it was quite possible to pay down even large debts.
Right now, state, local, and federal spending consume nearly 40% of GDP, "growth" (somehow government spending is figured into growth, so the term is ambiguous) is hovering at 2%. The debt is growing far more quickly than GDP. Fully one-third of Americans are receiving enitilement benefits, while only one-fourth are working full-time.
Next, America no longer dominates manufacturing, and the number goods produced in America is dwindling. As a result, there are few sectors which can produce meaningful growth, and none which will be able to keep up with the current accumulation of debt, let alone repay it.
It is illegal for me to buy things with other people's money, or to live a Donald Trump lifestyle on a McDonald's worker's budget. Were anyone else doing what our governments were doing now, they would be charged with fraud. It seems the our governments are running the largest ponzi schemes in human history. It has to stop,
JeffLee
America is the world's leader in today's most profitable and cutting-edge industries, like IT and aerospace. American workers are among the world's most productive. Home to the world's finest universities and institutions like Silicon Valley, American remains the world leader in ideas.
You are not a sovereign nation engaged in public finance. Or maybe you think you are, because that's about as delusional as your opinions appear. (Hint: fiscal debt and private debt are two very different things, and why would you borrow money (US dollars) that you have the sole authority to issue?)
sangetsu03
And nearly all of these goods, though developed in America, are produced elsewhere. Apple, Dell, etc. manufacture their goods in China, Boeing now outsources the production of components around the world. Were they to fully develop and manufacture their goods in America, they would earn significantly less.
The universities in America are the best (some of them), I attended one myself. But a "good" university education is becoming beyond the reach of most Americans. The numbers of foreign students are beginning to outnumber the local students in some classes, so many Americans don't or can't receive the benefit of a good university education. Many of the state universities are simply awful, with high drop-out rates, and poor instruction.
As for fiscal debt and private debt, the debt incurred by Washington becomes the people's debt. With nearly half of our income now consumed by the government in the form of taxes and fees, we have little left to pay our own debts, to contribute to the economy, or to raise and educate our children. When the amount of fiscal debt becomes so high that default, or the risk of default on these debts can cause a collapse of the world's economy, then there is a big problem. Wasnington's only answer seems to spend even more, and to further increase the debt.
JeffLee
Indeed, Americans hold the majority of their own debt. So they can declare default on themselves, right? The social security funds are the biggest owners, and they use the debt servicing money paid by Washington to fund your pension. A lot of other debt is found within other gov't instituions. Then there's individual bond holders, who are saving to buy a house, retirement, etc. So the debt repayments circulate throughout the economy as income or revenue. Foreigners buy about 10-15 percent, because they have lots of faith in the US economy. If the US was Greece, that figure would be zero.
Anyway, the debt is in dollars, which the govt issues, so how exactly does the govt run out of its own money...which is produces? The money is there, the problem is a bunch of conservative Republicans trying to take hostage a system the don't understand.
gaijinfo
What UK is better because they can blow a bubble that will inevitably collapse?
Duh. Japan did that twenty years ago. Once bubbles pop, you can't re-inflate them.