Austerity, Here and There

The British government has committed to meeting its deficit problems with austerity rather than stimulus, which has invited a lot of invidious comparisons from this side of the Atlantic. Of course, which country suffers in comparison depends on your political persuasion: the liberals highlight Britain's poor economic performance, while conservatives highlight its sincere and rapid committment to deficit reduction.  Kevin Drum points out that the parallels between their conservatives and ours aren't really that strong:

Right or wrong, the British variety are actually serious about the deficit: they've slashed spending but they've also raised taxes and kept high marginal rates for top earners. American conservatives, of course, have no such seriousness: they just want to use the deficit as an excuse to cut social programs that they've hated for decades.

Either way, though, it's not likely to work. Britain is probably going to be paying the price for this folly for many years to come.

I agree with the first paragraph, but the second illustrates exactly the peril of viewing Britain's cuts through an American lens.  Even if you think that stimulus is a good idea for America, that wouldn't mean that it was a good idea for the Brits.  Britain has a much smaller, much more open economy than we do.  That means that the country is more vulnerable to a run on its currency or its debt than we are.  The ruling coalition would say that it also means that stimulus is less effective--stimulus dollars spent in Britain will "leak" more readily into other countries.

Austerity alarmists like to tell horror stories where we slash spending to close the deficit, but this results in a sort of a death spiral where lower spending causes GDP to fall, and the deficit actually grows as we collect less tax revenue.  I find this story pretty unlikely.  In the United States, it implies that an increase of one dollar in total government spending creates an extra three dollars of GDP.  (If you just look at federal spending, this "multiplier" would have to be even higher--almost five dollars in GDP growth for every one dollar of spending).  This is lower than most empirical estimates of the multiplier here.  And of course, if you believe that British stimulus leaks, you have to assume that their multiplier is much lower than ours.

But this is not the sort of discussion that gets bandied about much on this side of the pond, because almost everyone in the debate is trying to use the British situation to prove something about America--either that austerity works, or that it's making Britons much worse off.  I am myself a skeptic of stimulus, but given the differences between their economy and ours, I am also skeptical that their experience tells us much about our own policies one way or the other.