Are the British natural Austerians?

Reader Bill Spight writes from the US, pointing to today's Brad Delong article and asking if I think the British psyche has a special tendency towards austerity.

I hadn't read Delong's piece (I find his blog a little too predictable usually, and while I agree with much of what he says, I don't need to re-read the same opinions every day). He is quite right, though, about the Tories' lack of a real economic theory behind their actions.

Osborne obviously has some acquaintance with economic theory - though it may be selective. He understands the idea of crowding-out, the impact of long-term interest rates on private investment, and the idea that monetary policy can sometimes compensate for fiscal policy. But the current cuts are more driven by political ideology than economics. Notably, they fail to understand the difference between public borrowing in an economy with high unemployment and output gaps, and in an economy running at full capacity. This of course is the basic Keynesian insight, and as Bill says, the Treasury View seems to have come back into fashion with this government.

A caveat here: the Bank of England and our newly constituted Office of Budget Responsibility (our version of the CBO) seem to think that the output gap in the UK is much smaller than common sense would suggest. Despite a 5-6% decline in output, the OBR has said that the output gap is only 2%. I can't understand why they would think this, although the relatively small rise in unemployment (it has only reached 8% here) and relatively high inflation (well over 3%) does perhaps explain why they may have come to that view. If the output gap really is only 2%, then perhaps there really is a crowding out effect. But I can't believe that the real figure would be so low. I think that low unemployment is more due to a recognition that skills in the UK are slow to adjust and therefore employers are hanging onto labour; and high inflation is due to the fall in the pound and to uncompetitive markets and high pricing power in certain sectors. Simple observation in UK businesses suggests that they could easily raise production by 5-10% without running into serious capacity constraints.

I do support some of the Tories' ideas: our public sector should be more flexible and entrepreneurial, and the idea of the private sector supplying some public services is a good one. I hope that one of the positive side-effects of these cuts will be to stimulate more private provision of those services - both because it should lead to more efficient supply, and because services will be more accurately targeted to what consumers really want. However, the impact of the cuts on short-term aggregate demand will be serious, and will probably outweigh whatever short-term benefits arise from a transfer of activity to the private sector.

So why has this happened? I think Bill's psychological explanation points in the right direction. British culture, as well as that in Germany and some segments of the US population, does tend towards masochism and the idea that "debt is sin, savings are virtue". Maybe it's no accident that "savings" and "salvation" are from the same root in English.

Looking at another recent post from Delong, we can get a clue: "...the London School of Economics, where the dominant view was that the depression was an inevitable result of the prior boom..." This is a common view in Britain. Indeed, there is a sense of natural justice to it which speaks to the cognitive desire to make dramatic sense out of a sequence of events: punishment must be a consequence of earlier sin, and immorality must lead to downfall. Thus, a recession must be due to overindulgence. Certainly there is a sense in Britain that excessive consumption (and economic growth) is rather untoward, perhaps even American. A boom must lead to a bust.

Maybe it shouldn't be surprising that this attitude in the US is most closely associated with the party that's also the most culturally Christian. Sin leads to punishment, and too much partying leads to a hangover. The Democrats on the other hand, having sympathy with people who ended up poor through no fault of their own, are more willing to believe that bad things (depressions, recessions) sometimes just happen, and are not a righteous punishment on people who clearly deserve it. If you believe that, it's much easier to think that the technocratic solution of increased public borrowing might be the right one.

Public discourse in the UK in the 1960s and 70s was strongly Keynesian (and to some extent even Marxist). I don't know if that was true in the US too, but I suspect not. This could have been why Keynes was so discredited in the UK by the financial problems of the 70s - not just among neoclassical academic economists, but in the public mind too. Not that everyone in the UK knows Keynesian theory, but "the chattering classes" certainly have an idea of it, and so there's an influential intellectual class who are uncomfortable with the idea of high public debts, maybe more so than in the US. It was quite easy for the Tories to turn those people towards Austerian ideas.

Probably the political timetable helped: Labour was unpopular for lots of reasons (the general disillusion started with Iraq, was amplified by the row over MPs' expenses and in the end was mostly a function of the inevitable ineffectiveness of a government that had been in power for 13 years). The Keynesian policies followed by the Labour government in 2008-09 were not even particularly deliberate, but simply a result of the automatic stabilisers built into the UK tax system. A fall in profits and high incomes led to a 15-20% fall in UK tax revenues, resulting in an automatic stimulus and a big rise in the deficit. That deficit was implicitly blamed on a tired, unpopular Labour government, and the Tories stepped in, making themselves look responsible and giving them the political cover to make cuts that they wanted to make for other reasons. Almost the opposite happened in 1997, when in the mid-90s the Tories had been the ones to run up record deficits (as a result of a recession) and Labour managed to look responsible, giving them the ability from 1999 onwards to increase taxes (a bit) and public spending (a lot) which was a political, not an economic, choice.

So, there probably is a basic British cultural tendency to dislike both private and public debt, partly due to an innate conservatism and partly resulting from the perceived failure of Keynesian ideas in the 1970s. But the current political environment is as much due to an accident of the electoral cycle than to this basic psychology.

Finally I note that Osborne has done at least two useful things:
  1. deferred some of the planned cuts in public spending, so that over half of the cuts will not kick in for 2-4 years
  2. shifted some of the burden of the cuts onto transfers (welfare benefits) rather than cuts in actual government consumption
These two moderations should reduce the impact of the cuts on aggregate demand. After all, Osborne has no political need to be austere as long as he appears to be.

Update: Paul Krugman (and here) and Steve Randy Waldmann also write on the topic of morality in economics. It's an interesting subject, and may provide an evolutionary hint as to why markets work at all.

Also: More from Karl Smith, Niklas Blanchard and David McRaney.


Anonymous said…
"Debt is sin" isn't Christian, but Jewish.

In debt deflation. The "private sector" is dead. Literally. They can't produce a thing. The next financial crisis will end it nastily. They think the central bank can overcome the loss of demand. I doubt it.

You need to go back to the origin of market liberalism and its ties to freemasonry and its illumanti derived thinking. "Keynesianism" is just a branch off of market liberalism, continuing the Jewish theme. They are the reform to the conservative(and the Austrians the Orthodox).

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