The fine art of squeezing: Britain vs America

 
Baroness Warsi Contrary to popular opinion, Baroness Warsi said, the US had cut its debt further and faster than the UK

Labour says America has grown faster in the past few years because it has not tried so hard to cut government borrowing. Is that true?

President Obama and Congress, so the argument runs, have not tried to cut America's humungous deficit "too far and too fast". As a result, their economy is now significantly larger than it was before the recession, whereas Britain's is still more than 4% smaller.

It's not only Labour politicians that say this. In the debate about the trade-off between austerity and growth, America is widely felt to be on the 'growth' side of the argument - and most European governments on the other.

So I was interested that the Conservative Party Chairman and minister, Baroness Warsi, fought back this week in an interview on the World at One, pointing out that the US "has cut its debt further and faster than the UK... it's a myth to say they haven't."

Quick-witted readers will note that she has made the traditional mistake, of confusing the government's annual deficit with its debt. The UK government's deficit will be around £120bn this year; its accumulated debt (all of the deficits it has run in the past, plus interest) will be well over £1,100bn.

The deficit is falling. The absolute debt figure almost never falls; in fact, it's going to be years before it even falls as a share of the economy, in either America or the UK.

So, there's a big difference between "cutting the debt" and "cutting the deficit". But let's face it, this is a mistake that senior politicians and journalists make all the time - including, on this occasion, the presenter interviewing Baroness Warsi (sorry, Martha).

'Surprising'

Let's assume they both meant deficit. Is Baroness Warsi right?

Tim Harford asked me to look into this for More Or Less on Radio 4. We discuss the answer on the latest programme.

On the surface, she is right. Using the latest figures from the International Monetary Fund (IMF), the US budget deficit is due to fall by nearly 5% of GDP between 2009 and 2012, from 13% of national income to 8.1%. That compares with a fall of just 2.4% of GDP over the same period in the UK, from 10.4% to 8% of GDP.

That is indeed interesting - and a little surprising. But, when you dig a little deeper, it's not clear that the story favours Baroness Warsi's side.

Why? Because the faster pace of deficit reduction in the US does not seem to come from greater government efforts to cut borrowing. Instead it seems to come from, er, faster growth.

This comes through when you look at what has happened to the "cyclically adjusted", or structural, deficit for each country since 2009. That is a much better (though still deeply imperfect) guide to whether a government is actively taking steps to cut borrowing, because it supposedly strips out the automatic effect that the rate of economic growth will have on spending and revenues.

When you do that, the UK and US positions are exactly reversed.

The IMF thinks that America's structural deficit has fallen by just 1.6% of GDP since 2009. By contrast, the coalition has been able to cut it from 9% of GDP in 2009 to 5.1% in 2012 - a fall of four percentage points.

So it turns out that the standard view - that America and Britain have been pursuing different paths - is true, after all.

The traditional view also seems to fit the facts in the eurozone, which the IMF reckons to have halved its structural deficit in this period since 2009, to 2% of GDP this year. However, the story for individual countries varies enormously, as you would expect.

Germany has cut its structural borrowing from a piddling 1.3% of GDP in 2009 to an even smaller 0.6% of GDP in 2012. Spain has had to cut its structural deficit from 9.7% of GDP in 2009 to 3.9% of GDP in 2012. So it has had a smaller relative tightening than Germany, but a much more punishing one for the economy.

'Day of reckoning'

Some will point out that, by maintaining or even increasing its borrowing, the US Federal government has been merely offsetting the tightening being done by individual states. So it's not really an example of fiscal tightening - or loosening.

The states have indeed been tightening more than the centre - especially in 2010 and 2011. But the IMF numbers are for the government as a whole, not just the part based in Washington, so the overall comparison still stands.

More fundamentally, you could argue that America has merely been delaying the day of reckoning - that it has literally "bought" a recovery that flatters the short-term borrowing numbers, while building up a big bill for the future.

If the IMF is right, America's structural deficit, at 5.9% of GDP, is now higher than Britain's.

Of course, Ed Balls would tell a different story with these numbers.

He would say the slower pace of austerity in the US had enabled the US to "grow out of" a good chunk of its borrowing, without any obvious cost to its economy or its market credibility (give or take a triple A). The US structural deficit, after all, is still falling, and the interest rate on 10 year US government debt is lower than Britain's.

In a speech earlier this year, Adam Posen, the US economist on the Monetary Policy Committee at the Bank of England, said America had grown faster than Britain because corporate investment and consumer spending had both been a lot stronger, and inflation had been lower.

The dearth of investment is largely due to British companies' greater reliance on banks for their funding, and their greater exposure to market tensions in the eurozone. The other two - weak consumer spending and higher inflation - owe something to the government, especially the increase in VAT.

That decision, by itself, almost certainly lowered Britain's growth last year. But as the Posen list makes clear, it wasn't the only factor holding the economy back and there were other factors supporting growth in America, including much faster growth in productivity.

What is clear is that America has been able to "cut its debt (sic) further and faster" than Britain - but this has not been the result of any closet commitment to austerity. Quite the opposite.

At this point, George Osborne would usually jump in to say that Britain and America are not strictly comparable, because America's dominant role in the global economy and world financial markets give it much greater room for manoeuvre.

That may well be true. But if the Chancellor does not want anyone to compare Britain and America's approach to government borrowing (or debt), someone forgot to tell Baroness Warsi.

 
Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this
    -1

    Comment number 15.

    Balls Mk II pushing the party line for sure.

  • rate this
    0

    Comment number 14.

    11 Notayesman,
    The reason why the banking interventions are not included in the debt figure is because the debt was issued, but almost all the money raised was never spent - it has been kept back to repay the principal. So the treasury is on the hook for the interest payments only, plus that portion that was actually spent bailing out the banks - much of which we will get back.

  • rate this
    +4

    Comment number 13.

    Of course fighting a war in Afghanistan is not only a factor in the deficit it also does not help our balance of payments but it is rarely mentioned as a candidate for the legendary "tough" spending decision?

  • rate this
    +4

    Comment number 12.

    Why do people continually try to compare the UK with the USA? The fact is there is no comparison and it is an excercise in futility to do so? The Bretton Woods accord, afforded the USD reserve currency status, giving the USA a huge advantage over the rest of the world. The USA can print money at will, export the inflation this creates and not care, making this comparison is particularly odious.

  • rate this
    +8

    Comment number 11.

    Actually the amount we have as a national debt is quite different to that reported here.

    "On that topic I have a thought for those who write about the UK national debt rising above £1 trillion.UK public sector net debt at the end of March 2012 was £2181.0 billion (140.8 per cent of GDP)."

    http://bit.ly/IOhiV5

    And with the repayments from RBS etc it is falling (10% of GDP in a year).

  • rate this
    0

    Comment number 10.

    Given that the UK has an ouput gap of at least 2.8%GDP, that means govt should spend another £42B at least to support the economy while the banks, businesses and households repair their balance sheets. Cuts should not be implemented until unemployment get well below £2million, and the only gradually.

  • rate this
    +4

    Comment number 9.

    I dont think Stephanie is saying that that austerity works because the figure that matters - the deficit is sensitive to activity in the economy which is highly influenced by spending and taxation. If all you are interested in is the deficit slash and burn of transfer payments (benefits) can produce a reduced deficit but at the expense of the economy. Reflate the economy & the deficit will reduce.

  • rate this
    +4

    Comment number 8.

    A good piece Steff, helps me understand more.

    That said, why have we let finance get so complicated that it's almost unmanageable? You can excuse Baroness Whats-her-face for mixing it up, cos that's how the market boys get away with so much smoke & mirrors - most of us can't work it out!

    Which is just how they like it

  • rate this
    +3

    Comment number 7.

    When I qualified as a doctor 50 years ago, treatment was couched in qualitative terms - based on "should work, will work". Evidence based medicine has led to more quantitative evidence - "does work". Lets have some evidence-based politics - not just "debt reduction" vs "growth" - to convince us what really will work.

  • rate this
    +6

    Comment number 6.

    Can one trust the official numbers coming out of the US?

    For starters, the BLS numbers on unemployment have unexplained seasonal adjustments. More glaringly, the number of people "not in the workforce" (and thus not counted as unemployed) has been steadilly increasing

    Official inflation numbers are below independent estimates so GDP growth looks higher since lower inflation = lower GDP deflator

  • rate this
    -6

    Comment number 5.

    All fascinating stuff and quite baffling.

    The fact remains that we need tax cuts for growth to liberate spending money.

  • rate this
    +9

    Comment number 4.

    Stephanie,
    Thanks for putting that little myth to bed - it is important politicians of all colours are not given room to be dishonest or make basic mistakes.

  • rate this
    +8

    Comment number 3.

    Of course, as Stephanie quite clearly mentions, the IMF figures include spending by US states.

  • rate this
    +3

    Comment number 2.

    Small mistake in the caption (US is compared to... themselves)

  • rate this
    -22

    Comment number 1.

    More socialist drivel.

    How about state spending. US States have cut their spending enormously. Did you factor this into your thought process?

    No, of course not.

    Lets have unbiased reporting from you for a change.

 

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