March 20, 2013 8:13 pm

Austerity Britain’s cautionary tale for US

When George Osborne became UK chancellor in 2010 and began an aggressive programme of fiscal austerity, he quickly became a darling of conservative economists, policy analysts and lawmakers in Washington.

In a June 2010 press release entitled “Earth to Democrats”, John Boehner – then Republican minority leader in the House of Representatives ahead of his party’s sweeping victory in elections that autumn – lauded British action to rein in deficits.

“On the very same day the Democrats were cancelling the budget for this year, George Osborne, the UK’s Chancellor of the Exchequer, unveiled a budget and promised to ‘balance Britain’s books within five years’,” his office said then.

But as Britain struggles – with Mr Osborne forced to reveal a halving of 2013 growth forecasts to just 0.6 per cent – it is becoming a political weapon for Democrats opposed to fiscal austerity.

With the US only now beginning a serious programme of fiscal consolidation, with tax rises on the wealthy and the expiry of a payroll tax cut at the start of the year, the UK has been a proxy for arguments about whether fiscal consolidation works.

But that debate has tended to skim over some big differences between the economies on either side of the Atlantic, making it more of a rhetorical weapon than a big input into US policy making.

“The focus on the details of the UK fiscal stance is limited, and I would say opportunistic,” says John Makin, a resident scholar at the American Enterprise Institute, a conservative think tank.

“Early in the game conservatives were saying ‘isn’t it wonderful, the British are moving ahead’, but now that the economy is quite weak there seems to be less of a tendency to focus on that,” Mr Makin says.

Democratic politicians and economists now point to the British model as a glaring example of what would happen if the US were to implement austerity and deficit reduction too aggressively and too early.

“It’s a cautionary tale of what might happen to us if we did cut aggressively up front,” says Ethan Pollack, senior analyst at the Economic Policy Institute, a liberal think tank. “You’d think, well they tanked their economy but at least they got their fiscal house in order, right? But that’s not true.”

Since 2010, Republicans have distanced themselves from the UK model by arguing that it increased taxes – which they oppose – and that the UK’s spending cuts and reforms happened too quickly and were not sufficiently phased in.

You’d think, well they tanked their economy but at least they got their fiscal house in order, right? But that’s not true

- Ethan Pollack, Economic Policy Institute

They argue that their main plans for cutting spending, notably big changes to Medicare, the health plan for the elderly, do not kick in for 10 years.

But Mr Pollack does not accept this defence. “This whole argument that, the principle was fine and the problems just came in the execution, that sounds a lot like the Iraq war, doesn’t it? It’s this kind of dodge,” he says.

However, all of this ignores some big differences between the US and UK, notably how badly the UK has suffered from the crisis in the eurozone; how its less diverse economy has been squeezed both by the decline in North Sea oil and by the recession’s impact on the City of London; and its relatively good employment performance compared with the US.

That makes direct extrapolation of how UK-style austerity would play out in the US more difficult.

In depth

UK Budget 2013

The Budget takes place against a troubling backdrop of persisting flat output and low confidence as the economy experiences its slowest recovery since the 19th century

Where Mr Osborne’s latest budget provides direct fuel for Washington arguments is its move to cut the corporate tax rate to 20 per cent. The US currently has a corporate tax rate of 35 per cent, and there is bipartisan agreement to lower the rate, but progress has been stalled by the relentless budget wars in Washington.

“This is once again a reminder of how out of step the US tax system is with the rest of the world. It makes the need for comprehensive tax reform that lowers rates and makes American companies more globally competitive even more urgent,” says Caroline Harris, executive director of tax policy at the US Chamber of Commerce.

But while the UK can occasionally be a useful stick with which to beat political opponents in the US, the more substantive policy traffic is in the other direction.

That was on display in Mr Osborne’s budget, in which he asked the Bank of England to consider copying the new US Federal Reserve system of thresholds, under which it plans to keep interest rates low until the unemployment rate falls below 6.5 per cent.

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