The Hazards of Comparing U.S. and U.K. Economic Policy

Imagine a basketball game during which the contrast between two players catches your eye. John Bull, a 5’11” guard, makes lots of three pointers but never gets a rebound. Meanwhile, his 6’10” Cousin Sam plays power forward, grabs many rebounds but never makes a three pointer. Would you expect John Bull to become a prolific rebounder if he moved to power forward, or criticize him for making three pointers in his currently chosen position? Of course not. The two players have different characteristics and therefore shouldn’t play the same position nor be evaluated by the same metrics.

That sort of contrived comparison is one of two problems with this chart on U.S. and U.K. economic policy, which appeared on Martin Sullivan’s website and was also highlighted by Andrew Sullivan (no relation, I presume). On its face, it seems to prove that Prime Minister Cameron was foolish not to follow in President Obama’s footsteps by proposing a big stimulus package. But that simply was not a position that Britain could play. Britain’s debt situation was among the worst in the developed world, and the humiliation of an IMF bailout is still a fresh and painful memory in the country. If Cameron had engaged in even more borrowing and spending increases, the U.K. could easily, like the PIGS, have had a debt crisis leading to a loss of sovereignty. President Obama, with a reserve currency and greater popular comfort with debt in his country behind him, did what he could do and got what he wanted: A spike in growth in exchange for taking on more debt. PM Cameron did what he could do and got what he wanted: Confidence in the bond market (The U.K. is borrowing at one of the lowest rates in Europe) in exchange for austerity.

The other problem with the chart is that it leaves out a critical bit of information: Obama and Cameron were elected two years apart. Shorn of that information, the chart’s narrative resembles two roads in a yellow wood: Two people made different decisions at a critical moment and that has made all the difference. But Gordon Brown’s free-spending Labour government was in power for at least a year after the growth lines diverge, and Cameron’s austerity drive is really only hitting the state budget significantly now. The implied simple contrast is thus not so simple.

Author: Keith Humphreys

Keith Humphreys is a Professor of Psychiatry at Stanford University. His research, teaching and writing have focused on addictive disorders, self-help organizations (e.g., breast cancer support groups, Alcoholics Anonymous), evaluation research methods, and public policy related to health care, mental illness, veterans and drugs. He is the author or co-author of numerous books and scholarly articles, and has written for the New York Times, Wall Street Journal, Washington Post, The Guardian (UK), the San Francisco Chronicle and other media outlets. When he is not in the San Francisco Bay Area, he is usually in London, where he is an ad hoc policy adviser to the national and city government, an honorary professor of psychiatry at Kings College, a senior editorial adviser to the journal Addiction, and a member of The Athenaeum. When he is not in the San Francisco Bay Area or London, he is usually in Washington D.C., where he serves as a frequent science and policy advisor to federal agencies, and where he has served previously as an appointee to a White House commission and several Secretarial task forces. From July 2009-2010, he served as Senior Policy Advisor at the White House Office of National Drug Control Policy. When he is not in the San Francisco Bay Area or London or Washington D.C., he is usually in the Middle East, where since 2004 he has volunteered in the international humanitarian effort to rebuild Iraq’s mental health care system. This work has taken him to Turkey, Egypt, Iraq, Jordan and Lebanon to teach and consult with Iraqi health professionals and policy makers.

19 thoughts on “The Hazards of Comparing U.S. and U.K. Economic Policy”

  1. You neglect the fact that Cameron’s misplaced austerity drive has produced an economy that all the current indicators say is going to tip back into recession, plus the highest unemployment of the last 17 years, not to mention having already choked off a recovery that was starting to show up in the last months of the Brown government. Being able to borrow cheaply isn’t much use if your whole aim is to not borrow in the first place. Britain has followed a failed US economic model for the last 30 years – and, like the US, is increasingly paying the price. All the evidence is that austerity has failed both in the US and in Britain – and for similar reasons.

    1. The ability to borrow cheaply isn’t just important to countries that want to borrow new money. It’s also critical to countries like, well, everybody, that need to roll over their debt. I’m not sure that austerity was the right choice for Britain, but this is a weak argument against it.

  2. Wow this post is bad. The U.K. would never have gone the way of the PIGs because there wasn’t a run on the UK after a bubble and it has its own currency. But you are right Cameron got what he wanted, austerity, shrinking the size of government and slow growth.

    1. Rob: You are being too literal-minded — of course the UK is not part of the Euro, but it faced the same risk as the PIGS: Massive debt leading to a loss of sovereignty. At the risk of patronizing readers, I have edited the post to make this more obvious.

      1. No, it isn’t being too literal its why the PIGS are the way they are. No the UK doesn’t face the same risk because they could reduce the debt through inflation. Debt load isn’t the issue except in Greece, Spain didn’t have debt problems. The PIGS had a huge capital exodus leading to the crash and inability to deal with the downturn due to EU rues and not controlling their own currency. The UK didn’t have those issues. Cameron made a choice to have people suffer so he could be considered serious and liked by The City.

        1. Rob said “Cameron made a choice to have people suffer so he could be considered serious and liked by The City.”

          Here are 10-year government bonds rates for different countries from the latest issue of the Economist:
          Austria: 3.06 Belgium: 4.42 France 3.20 Germany: 2.06 Greece 22.91 Italy: 5.90 Netherlands: 2.49 Spain: 5.39

          The U.K. figure is 2.47, that’s what Cameron got for his policy, despite very high debt. To say he did it to make people suffer (as if there is no suffering for people in countries where the borrowing rate is much higher), to be considered serious (as opposed to being serious) and be “liked by the City” (Do you think he would care who liked him if borrowing costs were twice as high?) is not reasonable.

  3. You assert Keith that the UK had this super-high debt level. I am doubtful of that assertion. If I recall correctly, the debt-to-GDP ratio in Britain is like 60-70%, which is not optimal, but is not dire either. Japan has a much higher debt-to-GDP ratio; it pays about the same as Britain does.

    The UK’s debt level should not have compelled it to engage in austerity. Instead, it should have engaged in deficit spending to revive the economy and re-oriente Britain’s economy for the long-term away from being dominated by finance.

  4. During the Labor government, the UK achieved historically low rates by having an economy that had fallen into a disastrous recession. Cameron has succeeded in bringing rates even lower by convincing the market that he aims to damage the economy further.

    As others have noted, the problem with the PIGS (excepting Greece) is that their economies deteriorated, not that their debt has exploded. Had the UK joined the Euro, they might be in a similar spot, but the solution for Britain is to not be in the Euro (mission accomplished!) and to pursue expansionary policies.

  5. Keith, this is a very strange post. The real disputes surrounding these issues are just sort of assumed away. You assume that the lower interest rates paid by the UK result from Cameron’s policies. You assume that the debt crisis in the PIIGS led to a loss of sovereignty. The critics of Cameron’s policies see causality going in precisely the opposite direction. Loss of sovereignty (over monetary policy) led to a debt crisis. A country without an independent currency has no alternative but default if it cannot generate sufficient tax revenue. Knowing this, lenders demand extraordinary rates. Extraordinary rates accelerate the crisis. The UK still has its own currency and so has a low risk of default. Despite real budgetary issues, this independence makes the UK a better investment during a crisis than the alternatives. The rate differential is not about austerity, it is about risk of default.

    I would tend to assume you are aware of these arguments but then how could you post on this question and ignore the main points of contention?

  6. I followed links from this wikipedia article on debt-to-GPD ratio and found this map, which dates to April 5, 2010 (shortly before Cameron’s election).

    As you can see, at the time of this chart, UK public debt as a percentage of GDP was not as high as that in the U.S. UK debt is higher nowadays, no doubt because of lack of GDP growth and the automatic expenditures built into the system for tough times.

    1. politicalfootball: See 2010 article on debt sustainability by country in my reply to Frank above.

      1. The Economist defines default this way:

        There is a long and not very honourable history of sovereign default, either explicitly or implicitly via inflation and currency depreciation.

        If this is how we’re defining “default,” then sure, the UK is an “implicit” default risk. Portugal, Spain and Italy – all less risky on this chart than the UK – would be well-served by “implicit” default, but Euro membership makes that impossible.

        So I think the Economist is measuring the wrong thing, but I don’t have any gripe with their method of measurement. Here are the three criteria for the Economist’s ranking.

        The ability of a government to honour its debt depends on a number of factors, in particular the size of the debt burden relative to GDP, the interest rate paid on that debt relative to the economy’s growth rate and the size of the government’s primary budget balance—the surplus, or deficit, before interest costs.

        The first two categories rely on debt-related factors. Cameron’s logic, and yours, is that you can improve those figures and thus improve default risk.

        The problem is, all three factors rely on economic growth. Improve economic growth and you improve all three. Cameron’s moves were pro-cyclical and therefore damaging to economic growth.

        You, Cameron and the Economist start out with the assumption that bond-holders’ needs must be put above all other factors – hence your measure of success relies on interest rates, and not the more obvious measure: economic growth. This assumption leads the Economist to mis-define default, but allowing a bit of “implicit” default is just what the doctor ordered, and would be good for the UK, the EU and the US.

        1. I don’t assume at all that the bond holders needs should be put above all else; rather I recognize their power to do great harm to the country as they have before. It is easy to overdrawn the conflict between the “evil” bondholders and the people. Not to say at all you are advocating this, but if keeping bondholders happy was irrelevant to what happened to the people, the right policy would be the null all bonds immediately. That of course would crush the British economy and the British people for a generation because no one would lend to the UK anymore.

          As for growth, of course, we all want more growth, the question is how to get it. If interest rates spiked in the UK to even Italian levels, would that not harm growth? .

          1. I did not say that bondholders should be utterly disregarded, and – unlike The Economist – I am implying no moral judgment whatsoever about the appropriateness of prioritizing their demands. If I agreed with you that the bond vigilantes were credibly threatening to blow up the UK economy, I’d support doing what is necessary to appease them. Such situations can happen, but that’s not what’s happening in the UK now.

            For 18 months or so before Cameron, interest rates in the UK were at historically low levels (per my previous chart). The economy had stalled, and there was little prospect for recovery. Hence little prospect for inflation. Hence low nominal interest rates. Cameron changed “little prospect of recovery” to “no prospect,” and you see the results, both in economic growth and in the bond market.

            Italian fiscal policy wasn’t, and isn’t, unusually irresponsible (as your Economist chart notes). However, Italy’s monetary policy is largely being made by Germany and France, and those two countries want to enforce a potentially unsustainable fiscal austerity on Italy and the other PIIGS. Unlike the UK, Italy hasn’t got the option to inflate its debt – and therefore, if push comes to shove, it will be forced into actual default. That risk is embodied in higher interest rates, which in turn further increase the possibility of default. Unless somebody with clout in the EU wises up, there’s a real danger of an unstoppable downward spiral. The weak Euro countries are, in effect, at risk of a massive bank run.

            There has been plenty of money available in the UK at reasonable rates for three years now. That money isn’t being borrowed because the government isn’t willing to do so, and private actors haven’t got any productive use for it. As soon as demand recovers, then inflation and interest rates will go up, and that will be a good thing, though when it happens, you will hear grave warnings about the depredations of bond vigilantes.

  7. If it was expected that Cameron would be elected and enact austerity, rational expectations could cause that to show up in the stats before he reaches office. Not that it’s my actual theory of what happened, just a possibility.

    1. Wonks Anonymous: You are right of course that signaled policies can trigger economic movement in advance. This would not though resolve the analytic problem posed by the time gap between the UK and US elections, as President Obama signaled his intentions prior to election just as did Cameron.

  8. The UK economy comprises (in descending order of size) the economies of England, Scotland, Wales and Northern Ireland. In 2013 the UK was the 4th-largest exporter in the world and the 4th-largest importer, and had the 2nd-largest stock of inward foreign direct investment and the 2nd-largest stock of outward foreign direct investment.[19][20] The UK is one of the world's most globalised economies.

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