Lawrence Summers is a professor at and past president of Harvard University. He was Treasury secretary from 1999 to 2001 and economic adviser to President Obama from 2009 through 2010.
The British economy has experienced the most rapid growth in the Group of 7 over the past several months. In the first quarter of 2014, it enjoyed growth at an annual rate of more than 3 percent even as the U.S. economy barely grew, continental Europe remained in the doldrums and Japan struggled to maintain momentum in the face of a major increase in the value-added tax. Naturally enough, many have seized on Britain’s strong performance as evidence vindicating the austerity strategy that the country has followed since 2010 and rejecting the secular-stagnation idea that lack of demand constrains industrial growth over the medium term.
Interpreting the British experience correctly is important because of the political stakes in Britain, the impact on future British policy and, most important, the effect on economic policy debates around the world. Unfortunately, properly interpreted, the British experience refutes austerity advocates and confirms Keynes’s warning about the dangers of indiscriminate budget-cutting in the midst of a downturn.
Start with the current situation of the British economy. While growth has been rapid very recently, this is only because of the depth of the hole that Britain dug for itself. Whereas in the United States gross domestic product is well above its pre-crisis peak, in Britain GDP remains below previous peak levels and even further short of levels predicted when austerity policies were implemented. Not surprisingly, given this dismal record, the debt-to-GDP ratio is now nearly 10 percentage points higher than was forecast, and the date when budget balance will be achieved has been pushed years back to the end of the decade.
The most commonly offered excuse for Britain’s poor performance is its dependence on financial services. Yet the New York metropolitan area, which is even more dependent than London on financial services, has seen GDP comfortably outstrip its previous peak. While the euro area has performed poorly, even a casual look at trade statistics confirms that this cannot account for most of Britain’s poor growth.
The U.S. economy grew at a rate of 9 percent for a number of years after the trough of the Depression in 1933. Such rapid growth in peacetime is unique in American history. Why did it happen? Only because of the depth of the Depression. No one has ever taken the pace of that recovery as validation of the austerity policies that helped to induce the Depression. Likewise, part of the story of British growth is simply one of catching up after a major crisis caused a huge output gap to develop.
Two additional points about Britain’s growth experience require emphasis. First, the acceleration in growth has less to do with austerity spurring growth than with a slowdown in the pace at which policy became more austere. The pace of fiscal contraction has slowed over the past two years. Slowing fiscal contraction means the decrement to growth caused by fiscal policy becomes more attenuated. Other things equal, this would be expected to produce more favorable growth performance. Ironically, the greater the fiscal multiplier, the greater would be the predicted turnaround when the pace of contraction slowed. So the turnaround in growth over the past 18 months is as much evidence against austerity as for austerity.
Second, in the face of deficit reduction’s potential damage to demand and economic growth, the British government has been forced to introduce extraordinary measures to support lending. Most significant is the so-called Help to Buy program that gives low, teaser-rate mortgages to some borrowers and guarantees the mortgages of others so that they can put only 5 percent down. There are also special programs to reward banks for lending to small business and to get the central bank involved in export finance.
Help to Buy manages to recapitulate most of the sins of the U.S. government-sponsored enterprises. The stated goal of the austerity program was to improve confidence in Britain as a sovereign credit. Yet guaranteeing mortgages en masse creates a huge potential government liability, as do other loan-guarantee programs. Moreover, subsidized credit for housing risks reinflating bubbles as house prices in London have risen much faster than GDP over the past year. And, of course, all programs for the benefit of homeowners rather than renters have perverse distributional consequences.
Britain’s growth reflects a combination of the depth of the hole it found itself in, the moderation in the trend toward deeper and deeper austerity and the effects of possibly bubble-creating government loans. It may be better for the citizens of Britain than any alternative. But it certainly should not be seen as any kind of inspiration for other companies or countries.