Americans fight through the crowds to do their Black Friday shopping, while in the United Kingdom students take to the streets to protest steep cuts to education spending | Matthew Staver/Bloomberg/Getty Images, David Moir/Reuters
In late November crowds took to the streets in cities across the United States and Britain. As mobs rampaged and destroyed property, fights broke out and a number of victims were sent to hospital. By the time the ordeal was over, police had been called in to bring the unruly hordes under control, and two stunned nations were left to wonder how it had come to this. Mind you, those who rioted in the United Kingdom were students protesting deep government cuts to education spending. In America they were just Black Friday shoppers trampling each other to get to the discount bin at Toys “R” Us.
Since the Great Recession morphed into the Grudging Recovery last year, the U.S. and U.K. have taken radically different paths with their economic policies. In October, the coalition government of Tory Prime Minister David Cameron waged war on the country’s fiscal deficits with a vow to slash spending by $131 billion and raise taxes over the next four years. Meanwhile, across the pond, the Obama administration shook hands with Republicans last month to launch yet another round of stimulus in the form of temporary tax cuts and help for those out of work that will add US$892 billion to that country’s deficits over the next five years. While the British struggle to tighten their belts, American policy makers are doing everything they can to loosen theirs.
But this is about more than just two countries going their separate ways in the global economy. Ever since the 1930s, when economist John Maynard Keynes argued governments should boost spending to stimulate business and consumer demand, a battle has raged over the wisdom of that strategy. Each year, academics churn out papers arguing the matter, while many a politician has claimed to have saved his or her economy from recession by letting government spending flow. The issue has sparked a very public battle between Nobel prize-winning economist Paul Krugman, an avowed Keynesian, and Harvard University historian Niall Ferguson, a prominent deficit hawk. Krugman says Ferguson “hasn’t bothered to understand the basics” of economics with his warnings about America’s rampant spending, while Ferguson says “nothing would spook the markets more than for Paul Krugman’s advice [for more stimulus] to be accepted by the administration.” Yet for all the back and forth, no one has conclusively shown how fiscal policy affects the business cycle, and whether deficit-spending is a force for good or the route to economic collapse.
Which is why economists and financial experts are watching what’s happening in America and Britain so closely. With the U.S. pursuing a policy of expansion and stimulus at the same time Britain has opted for hard-nosed austerity, the two countries offer a real-world, real-time economic experiment that could reshape the way economists view the world and how it works. “It is a huge lab test on all of us in the U.S. and U.K. to see who will survive these alternative policy approaches,” says Ed Yardeni, the chief investment strategist at Yardeni Research in New York. “It could be very costly for those who turn out to be in the wrong trial sample, and could be surprisingly uplifting for those who happen to be the beneficiaries of the right policy.”
The question now is, which side will win as the greatest economic policy debate of the last 100 years plays out right in front of us?
All experiments require a benchmark from which to measure results, and for the showdown between American stimulus and British austerity, that may well turn out to have been the G8 and G20 summits held in Toronto last June. By the time world leaders met within the vast security perimeter, the economies of each country were on a relatively even footing. Both were growing again, albeit slowly. Both still suffered hangovers from their respective housing bubbles. And in both, unemployment was still far above historical norms.
Yet in the first face-to-face meetings between President Barack Obama and Cameron since the British election, it was clear the similarities would end there. While Obama warned that if stimulus was withdrawn too soon, the world risked plunging back into another recession, Cameron said developed countries needed to deal with their deficits in order to restore confidence and “live within our means.” The summit concluded with a declaration that set the stage for their divergent policies: “There is a risk that synchronized fiscal adjustment across several major economies could adversely impact the recovery. There is also a risk that the failure to implement consolidation where necessary would undermine confidence and hamper growth.”
Britain and the U.S. share something else in common—horrendous deficits and staggering debt loads. Last year, America’s federal deficit hit 9.9 per cent of GDP. The Congressional Budget Office predicts the U.S. debt load will hit US$20 trillion within a decade. Meanwhile, Britain’s fiscal deficit topped 10 per cent of GDP last year. According to Michael Wickens, a professor of economics at the University of York, over the last decade spending on heath care and welfare more than doubled, while revenues rose at half that pace. “This has been brewing for years,” he says. “The U.K.’s deficit problem has nothing to do with the recession.” But the financial crisis did bring the problem into sharp focus.
It’s against that backdrop that Chancellor of the Exchequer George Osborne laid out the government’s austerity plan in October, the most sweeping cuts to spending since the end of the Second World War. The goal is to cut the deficit back to nearly zero by 2014, and begin paying down the debt at that point. “Today is the day when Britain steps back from the brink, when we confront the bills from a decade of debt,” he said. “It’s a hard road, but it leads to a better future.”
Any way you look at it, the government’s ruthless assault on spending was designed to send a high-voltage shock through the British psyche. The average government department will see its funding slashed by 19 per cent, while roughly half a million government jobs—or nearly one in 10 civil service positions—will be axed. Millions more government workers will face pay cuts and reduced benefits. (The public sector accounts for roughly 20 per cent of all jobs in the U.K.) Britain will cut its military spending by eight per cent by 2014 and will slash the budget for its diplomatic corps by a full quarter.
The list goes on. University tuition fees will double—which has prompted weeks of riots—while rail fares are expected to jump 30 per cent over the next four years. The government will increase the retirement age for both women and men to 66 by 2020 (it’s currently 60 for women, and 65 for men), saving it $8 billion a year. Child-benefit payments to middle-class households will be slashed, and nearly $200 million may be cut from school sports programs. Even the royals will feel the pinch—funding to maintain Queen Elizabeth II’s household will be chopped by 14 per cent. All these cuts and many more will be accompanied by a hike in the value-added tax to 20 per cent from 17.5 per cent.
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