Tighten or Stimulate? British v. American Economics
In the ongoing American and British debates on the financial crisis and the best ways to bring the economy out of the woods, two opposite views repeatedly collide – the one represented by those who prioritize deficit reduction, the other by those who argue for recapitalizing the economy. The case of the United Kingdom shows that drastic cuts – if not supported by stimulus packages – instead of tackling the debt may actually inflate it. The American policy record on the other hand, proves that even substantial stimulus packages do not always lead to economic [u][b]revival[/b][/u]. It’s not enough to throw some extra money into the pool – equally important is [u][b]what[/b][/u] these resources actually fund and [u][b]whether[/b][/u] they are accompanied by structural reforms.
Moody’s decision to [u][b]downgrade[/b][/u] UK’s rating from AAA to AA1 announced at the end of February was a serious [u][b]blow[/b][/u] to David Cameron’s government as it undermined the whole austerity program Conservatives embarked on [u][b]precisely[/b][/u] to regain the trust of both financial markets and rating agencies. [u][b]Nonetheless[/b][/u], in a speech delivered on March 7th Prime Minister announced he would keep on the chosen course [u][b]since[/b][/u] – as his famous predecessor once asserted – for this policy “there is no alternative.”
Many British economists [u][b]do[/b][/u], however, see an alternative, and their number grows as it becomes clear that the spending cuts introduced [u][b]so[/b][/u] far, instead of reducing the debt, have increased it (from 600 billion in 2008 to 1.1 trillion four years later [u][b]to be[/b][/u] precise). How is it possible to [u][b]cut[/b][/u] down on expenses and inflate the debt at the same time? Excessive savings lead to economic contraction, [u][b]which[/b][/u] in turn reduces state revenues and forces the government to continue on borrowing. “What [u][b]truly[/b][/u] is incredible is that Mr. Cameron cannot understand that, if an entity that spends [u][b]close[/b][/u] to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end [u][b]up[/b][/u] worse than when it started”.
Even The Economist magazine, known for its “favorable neutrality” towards the Conservative Party, criticized the government’s policies and [u][b]encouraged[/b][/u] chancellor George Osborne to dig out some additional funds for infrastructure investments, which could [u][b]boost[/b][/u] the economic growth (compared to 2009 such investments were reduced from £48.5 billion to £28 billion). But where to get the money from?
At least some of the needed [u][b]sum[/b][/u] can be obtained by reducing expenses on civil service. Those – [u][b]despite[/b][/u] all the austerity rhetoric – not only were not diminished but increased in the past decade [u][b]by[/b][/u] £300 billion. However, in case these savings are not sufficient, should the government borrow the [u][b]missing[/b][/u] funds? “Economist’s” editors reply in the positive, but [u][b]on[/b][/u] the condition that these resources are spent on infrastructure – roads, bridges, railways, broadband, etc. –[u][b]thus[/b][/u] contributing to long-term economic growth and improvement of the [u][b]competitiveness[/b][/u] of the British economy. Then, the increase in debt will be [u][b]offset[/b][/u] by rising state revenues, and – thanks to the [u][b]improving[/b][/u] condition of the economy – interest rates should stay at their [u][b]current[/b][/u] low level. As a result, debt service costs will also remain low.
If, however, the money is spent on immediate tax cuts and [u][b]exemptions[/b][/u], it will simply be wasted. The economy might benefit from such policies in the short [u][b]run[/b][/u], due to the increase in personal consumption, but [b][u]as soon[/u][/b] as the money is gone, we will go back to [u][b]square[/b][/u] one. According to Sachs, stimulus packages failed not because they were too small – [u][b]as[/b][/u] for example “The New York Times” columnist, Paul Krugman has [u][b]long[/b][/u] maintained – or too high – as the entire American right seems to believe – but because they have been poorly [u][b]targeted[/b][/u].
According to Krugman – whose views Sachs openly [u][b]challenged [/b][/u]– we should not be particularly worried by these numbers. On the contrary, in order to succeed [u][b]in reviving[/b][/u] the economy, stimulus packages [u][b]should[/b][/u] be enlarged. To introduce any major savings at this [u][b]stage[/b][/u] would throw American economy back into recession, cause economic contraction and decrease government revenues, thus leading to a predicament [u][b]roughly[/b][/u] similar to the one British economy has found itself in.
The trouble is, replies Sachs, that American decision-[u][b]makers[/b][/u] have long spent much more than they should, [u][b]both[/b][/u] in times of economic prosperity and at the time of the current crisis. Besides, [u][b]once[/b][/u] they have decided to stimulate the economy, they chose wrong targets. The [u][b]same[/b][/u] dollar invested well can bring substantial [u][b]return[/b][/u], but if invested badly, will either bring loses or have no effect [u][b]at all[/b][/u]. According to Sachs Krugman and other “crude Keynesians” – [u][b]unlike[/b][/u] Keynes himself – seem to have forgotten this simple truth.
Is it then [b][u]then[/u][/b] better to tighten or stimulate the economy in crisis? Challenges [u][b]faced[/b][/u] by the United States and the United Kingdom make [b][u]it[/u][/b] quite clear – the best solution is to do both these things at the same time.