American dream versus UK nightmare: has austerity worked?

March 21, 2012 by Stuart Ryan

The respective economic recoveries of the United  States and the United  Kingdom could be likened to the Dickensian tale of two cities, but the reality is closer to a tale of two fiscal policies. Who is right? Or can they both be right?

The U.K. (and Europe for that matter) have adopted austerity. The logic being that we cannot return to prosperity before we have addressed our debts. The U.S. has taken a different approach and allowed public debt to rise. Recent economic data might suggest the U.S. is right. While  the U.K. is posting a contraction in GDP, possibly resulting in a recession (watch for next quarterly figures), the U.S. has seen positive GDP growth.

Similarly while unemployment  is falling in the U.S., it continues to rise in the U.K. This is particularly  painful for the younger generation, with some speculating the overall jobless figure could eventually hit the three million mark. So while the U.S. seems to be on course to trade out of the financial crisis, is the U.K. on course for a double dip recession with a ‘W’and  not ‘V’ shaped recovery? Mervyn King does not think so. He predicts that the U.K.’s recovery will be “zigzag”in shape with intermittent small contractions.

So would the U.K. and Europe have been better off adopting the short sharp shock approach that appears to have benefited the U.S. (an approach also favoured by Iceland who recently saw their credit rating increased by Fitch rather than downgraded)? The jury is still out. It is worth noting the U.S. economy does tend to perform well in an election year and this may well be a factor  as any fiscal belt tightening will be delayed until after the election has taken place.
 
The U.S. is also fortunate that the dollar is still the world’s reserve currency, meaning there is less impetus  to address both monetary and fiscal issues. In short,  people will keep buying the dollar almost no matter what - Sterling does not enjoy such a privilege.

The U.K. is very affected by its closeness to Europe and the debt crisis which is consuming southern Europe and most recently Greece. And clearly a greater proportion  of U.K. GDP and exports is tied to Europe (nearly 10% of GDP and 60% of exports compared to approximately  2% of GDP and 20% of exports for the U.S.)1. There is also a perceived cultural difference between the continents, with the ‘American Dream’ focused on driving entrepreneurial activity which reflects a bigger private sector relative to GDP compared with the U.K.. Only time will tell whether  the different  fiscal policies are right, or wrong, or if they both can be right. Many in the U.K. remain sceptical that austerity is the way to go.

“I am now convinced,” said former  MPC member David Blanchflower after the 2010 U.K. budget, “that as a result of  this reckless Budget the U.K. will suffer a double-dip recession or worse, not least because there is no room for interest-rate cuts, although lots of  additional quantitative  easing (QE) from the Bank of England could soften the blow….  I believe this Budget will stifle the British recovery in its infancy.” It may be that the U.K. and U.S. need to take different  fiscal approaches, but we must all hope that Mr Blanchflower will be proved wrong!