Britain’s Austere Future: Zombie Flick or Godzilla Movie?

Mark Blyth over at Mark Triple Crisis:

In my first triple crisis piece I wrote about John Quiggin’s new book thesis concerning Zombie Economic ideas. Lead zombie of the moment is the idea of fiscal austerity as the way out of the crisis, despite oodles of evidence to the contrary. In short, we need to cut budgets to restore fiscal sanity, and we know that this is the way forward since small open economies in the 1980s (Ireland, Belgium, Denmark) that cut their budgets still grew. The economic (ir)rationale for this has been pointed out by Krugman, Stiglitz, and others. But for me the most interesting, and most tragic part of this story, are the distributional consequences of these policies, and the politics that they engender.

The first problem with such a policy is that if it works at all, it only works when everyone else is growing. If everyone else shrinks at the same time then what is individually rational becomes collectively disastrous, and viciously zero-sum. The second problem, the distributional one, is who pays for this debt crisis? The answer is ‘not those who made the mess in the first place’ – namely, finance. Instead, the double ‘put’ (quite literally) is on those who can afford it least, lower income taxpayers and consumers: once in the form of the bailouts, lost revenue, and lost growth, and now twice in the form of the fiscal consolidation (zombie-slashed public services) needed to pay back the debt generated from the bailout.

It is in this context that the much-anticipated budget cuts of the British government announced last week come to the fore. Britain has embarked upon a giant natural experiment to settle the stimulus versus austerity debate once and for all by plumping for austerity, and on a truly epic scale.

As Reinhardt and Rogoff remind us, approximately eighty percent of the time you have a banking crisis it will be followed by a sovereign debt crisis. As the public sector levers up to compensate for the fall in private spending, deficits are generated and new debt issues become a necessity. The UK economy was hit harder than many of its European peers when finance imploded because a full quarter of all British tax receipts came from the financial sector. This, plus the effect of the British economy’s automatic stabilizers, resulted in a budget deficit of 10.1 percent of GDP by 2011, with British government debt issues rising to 58.5 percent of GDP to plug these gaps. This ‘death spiral,’ so the argument of the British government goes, has to be reversed since ever-increasing debts will lead to ever-increasing interest payments, eventually turning Britain into Greece. To avoid this the proposed sacrifice is a $128 billion reduction in public spending over four years, which it is hoped will reduce the budget deficit from 10.1 percent of GDP to 2.1 percent by 2014. Virtue, it seems, favors the bold.