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).


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

    Comment number 35.

    US is in serious trouble. It will not deal (openly) with serious trouble til post-election because it would make Obama totally un-electable. As of 2012, US debt ceiling is currently set at $16.394 TRILLION, estimated to be hit around Sep 14, 2012. Then Congress must act to raise ceiling or US will face default. What will US do two months pre-election?

  • rate this

    Comment number 34.

    Kettle to pot: would you please fix the caption under the picture?

  • rate this

    Comment number 33.

    "GDP is the principal means of determining the health of the UK economy and is used by the Bank of England and its Monetary Policy Committee (MPC) as one of the key indicators in setting interest rates.
    .. if prices are rising too fast, the Bank would be expected to increase interest rates to try to control them. But it may hold off if GDP growth is sluggish..." This is why inflation is high.

  • rate this

    Comment number 32.

    Rule of Thumb Definition of a Recession:
    "two down consecutive quarters of GDP"

    Can someone please explain how we can get out of a recession by cutting Government Spending when Government Spending boosts GDP?

    Banks favour lending to Property Markets, diverting newly created money away from Production. Only 8% of Bank Lending goes into Productive Enterprises. 92% goes into speculation.

  • rate this

    Comment number 31.

    Any comparisons to the US are folly so many parameters are different. The US have a far larger market with better economies of scale, a more diverse group of investers outside of banks, vastly superior natural resources, cheaper property & taxes overall, less foriegn ownership of its industries as well as virtual ownership of certain industries like IT (Microsoft, Apple, Intel, Google, Oracle etc)

  • rate this

    Comment number 30.

    In 2010 tax receipts were £513 billion & expenditure was £670 billion (deficit £156 billion). In 2012 tax receipts were £570 billion & expenditure was £696 billion (deficit £126 billion).Consumers have suffered huge tax increases on top of food & fuel inflation hence feeling battered.The tax increases do not seem to be discussed and the focus is on "spending cuts". What am I missing?

  • rate this

    Comment number 29.

    The Government creates only 2.8% of the money supply where as the Banking Sector creates and controls 97% of the money supply through lending. The Government cannot afford to reduce deficit spending too harshly as it will reduce the money supply. Austerity measures are having an effect on the economy - they are reducing the money supply as money is debt.

  • rate this

    Comment number 28.

    It is difficult for me to grasp your surplus theory with a character limit. I recommend going to Prof Bill Mitchell's blog, where many of the commentators have other disciplines apart from economics, and layout the theory there asking for feed back from Bill or other commentators. They are usually very accepting of new input.

  • rate this

    Comment number 27.

    GDP = private consumption + gross investment + Government Spending + (exports − imports)

    "Government Spending" includes money collected from taxes and money borrowed by the Government for additional Deficit Spending. Deficit Spending increases the money supply as the Government borrows this using Treasury Bonds. The Financial system creates new money and lends it to the Government.

  • rate this

    Comment number 26.

    GDP = private consumption + gross investment + Government Spending + (exports − imports)

    From the above formula, if the Government cuts spending it also reduces GDP.

    Is it not possible to have a reduction in deficit spending that appears to increase as a percentage of GDP ?

  • rate this

    Comment number 25.

    This is the problem in dealing with numbers where the margin of error is greater than the numbers. We don’t know which country decreased its deficit faster: the UK or the US. More important is where the cuts were (or were not) employed. The US has always been far more willing to throw the weakest to the dogs: Britain hasn’t. It's a tradeoff between humanity and wealth.

  • rate this

    Comment number 24.

    Good one Stephanie nice to hear from you! How are the different parts of the 'defecit' affected by the nominal growth in the economy rather than real growth. Doesn't inflation help with eg. VAT revenues?
    Hope I've stayed clear of the BBC moderating police today! Yesterday's BOE debate seemed harshly treated

  • rate this

    Comment number 23.

    All assume bau means permenant GDP growth. A new paradigm is needed that accepts less return for worthless jobs like casino style so called 'investment' and more for real world goods and services. Then we might actually make the 'progress' that more automation should bring in terms of working hours and spreading the real jobs around. Now consumption growth is over we need common sense.

  • rate this

    Comment number 22.

    Charles Jurcich @17

    Ian G-B seems anachronistic but doesn't a similar argument apply to USD as a settlement currency? Demand for transactions is one type of demand for USD.

    However, I don't think this affects your point on the ability of UK government to spend. Surplus theory needs to be redefined using labour accounting. This would show government consuming surplus rather than saving.

  • rate this

    Comment number 21.

    Like many economists, your report has nice facts and figures, but misses the most important point. Last I heard there were 43 million receiving food stamps in the USA. How does that compare to the UK? If the USA grows it's GDP because some enormous corporations manage to grow sales, but all the profit from this sits in the bank accounts of the rich, while the people starve, is this good?

  • rate this

    Comment number 20.

    I wouldn't trust Baroness Warsi with any facts she always speaks the language of workshop roll plays, finger pointing and the need to hear her own voice.
    Remember there are 2 sides to debts;
    We owed the US 578bn Euros they owed us 834bn earlier in the year. Debt is always talked about bit now "owed.

  • rate this

    Comment number 19.

    How can you compare the USA with the UK? Over there they all have a nice day, they are not miserable like us.

  • rate this

    Comment number 18.

    Lady Greenshoots doesnt know the difference between deficit and debt

    So there is a surprise. I'm afraid I switched off as to what she has to say then

    Market appears to be dumping money into UK sov debt at artifically low IR due to the aversion to the Southern EZ.The UK should be using that borrowing opportunity to stimulate growth to mitigate damage

  • rate this

    Comment number 17.

    12 Ian G-B
    This is an easy mistake to make because the concept of 'reserve currency' still appears in many older text books. The Bretton Woods accord collapsed in 1971 and most currencies floated, making the term 'reserve currency' irrelevant.UK govt has exactly the same capacity to spend as the US, Japan, Australia etc.

  • rate this

    Comment number 16.

    Welcome back, we missed you. (Poor old Robert has had to work twice as hard!)

    Its always easy to compare ourselves with the cousins but in many ways they are 2 very different economies. Eg. US benefits from military activity, UK tends to lose, UK has high tax social model, US less so. Change occurs faster in US, slower in UK.

    That said, things from there do come here: eg. bonuses


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